Lesson 1 – What Exactly Is Forex?
With a daily trade volume of up to 4 trillion USD, forex is the largest financial market in the world. In comparison, the daily trade volume of the New York Stock Exchange is only USD 25 billion. There is an evident disparity in the trade volumes between forex and stock markets. Its actual trade volume is more than 3 times the total trade volume of the stock and futures market!
What is Traded in the Forex Market?
The answer is simple, money. Forex trading is the buying of one currency and the selling of another simultaneously. Forex trades can be carried out through foreign exchange brokers or dealers. Trading of foreign currency is done in pairs, e.g. Euro against US Dollars (EUR/USD) or British Pounds against Japanese Yen (GBP/JPY). Buying and selling foreign currencies is like investing in a country’s stock. When you buy Japanese Yen, for example, you are actually acquiring a stake in Japanese economy. The pricing of the currency is a direct reflection of the immediate and future outcome of the Japanese economy.
• Margin addition.
• When you open a forex trading account, you will need to inject capital into this account. This will be your trading capital.
• The dealer will use a leverage ratio to determine the margin required.
• Your trades will be carried out based on this margin requirement.
• In summary, forex refers to various means of payments in the settlement of international claims and liabilities with foreign currencies.
• Another major difference between stocks and forex.
• Unlike in general stock trading, the balance in your trading account need not be greater than the nominal amount you invest in the foreign currency.
• Using stocks as an example, if the share price for Bank of China is HKD 4, you must have at least HKD 8,000 in your trading account in order to buy 1 lot (2,000 shares) of shares.
• This is the main reason why forex is attractive.
• Similar to futures trading, the trader can trade with a pre-determined proportion of the margin.
• This is the leverage ratio.
• In forex trading, many brokers provide traders with a leverage ratio of 200:1.
• If the price of 1 standard contract is USD 100,000, and the leverage ratio is 200:1, then one can trade with only USD 500 in his account (100,000/200).
• Some brokers also refer to the initial margin as the required margin.
Broker’s Policy on Insufficient Fund (Take Note!)
• Different brokers have different policies on insufficient margin balance in the trader’s account.
• Some brokers will square your open position when the unrealized profit and loss falls below the required margin, resulting in a zero balance in your account.
• Other brokers may open a corresponding opposite position on your behalf to ‘lock in’ your losses. In this way, your account balance will not be reduced to zero.
• Most brokers will require clients to top up the margin in their trading accounts within a specific deadline. If the margin is not topped up by the deadline, the broker will square the client’s open position, even if the client’s realized profit and loss may be lower than the current balance.
• In forex trading, pip is the smallest unit in the fluctuation of currencies.
• 1 pip is 1% or 1/100.
• Most currencies are quoted with 4 decimal places, e.g. EUR/USD. If the EUR/USD rises from 1.3514 to 1.3515, the difference of 0.0001 is called 1 pip.
• If trading is done in the standard unit of USD 100,000 per contract, then 1 pip would be worth USD 10.
Pip in Currency Pairs
Refers to the last digit in the quote.
EUR/USD @ 1.3512
GBP/USD @ 1.5085
USD/JPY @ 89.14
USD/CHF @ 1.0810