Finer Details About The Forex Market

[tmbaru 10]

As a trader, to make money in the Forex market you have to clearly understand the basic principles that rule this financial market. Forex trading has grown drastically over the past few years and is now one of the most crucial elements in the global economy. The aspect that Forex market trades in currencies helps to regulate the value of the major currencies in the world. This financial market is the largest liquid market in the globe with a value of around $ 2 trillions being transacted at any given time. Forex market operates around the clock during business week to take care of various traders across the globe. Different countries have varying timelines and thus the need for this financial market to operate 24 hours per day. Forex market is not based in any permanent location but managed by different financial hubs which are New York, Singapore, Tokyo and London.

 

Forex trading involves exchange of ‘base’ currency and ‘quote’ currency which is commonly known as a ‘trading pair’. Here, a trader uses base currency to buy quote currency with hope that base currency value will depreciate as the value of quote currency appreciates. As base and quote currencies rise and fall in the Forex market, correct predictions by a trader will translate to substantial profits. For instance, if a trader uses CAD (Canadian Dollar) as a base currency and USD (United States Dollar) as the quote currency then 1.10/1.00 implies that $ 1 buys 1.1 CAD. When he buys 11,000 CAD he will use $ 10,000. Assume that after his purchase the rate changes to 1.00/1.00 this means that $ 1 buys 1 CAD and by him converting his 11,000 CAD to USD, he will make a profit margin of $ 1,000. On the flip side, if the CAD appreciated or USD depreciated then it means he could have made a loss.

 

Forex market is a free market and the value of the currencies is basically determined by buyers and sellers. It is worth mentioning that in every trade pair, USD has to be there either as a quote currency or a base currency. But how much a currency is worth is essentially the decision of Forex traders across the globe. Some of the parameters that affect currency’s overall value are national debt, monetary policies, country’s fiscal health and inflation. Thus, an overall economic health of a country determines the quality and value of its currency in the financial market. For instance, when European Union (EU) went through the Euro crisis, it translated to Euro dollar losing ground in comparison to USD.

 

When a country experiences a high level of unemployment, high inflation rates and large trade deficit; its currency drops in value. This makes it more expensive to import goods and cheaper to export goods hurting the economy more. Forex traders take advantage of rise and fall of currencies to make profits. It is a business that involves high risks but also has high return on investments if you master the art of trading in the currencies. It is easier for an expert to make profits in Forex trading than a newbie because he has mastered the art of predicting the performance of various currencies against USD.

In conclusion, it is worth mentioning that for any trader to perfect the art of Forex trading, they must take time to practice it using real money in real time. As the mantra goes, practice makes perfect. You must also learn to accept when losses when you lose a trade and gradually built up a trustworthy system that will enable you to trade successfully in the Forex market.

[jimmec 10]

Hey,

I love the intentions of this post, because for the longest time, I never understood what exactly my trades were doing, relying on the trading platform to tell if I'm profiting or not. And that works fine until you start trading real money; can't just blindly trust the system anymore.

 

Unfortunately, the explanations here are really confusing, and not directly applicable Forex trading. Additionally I believe there are a few inaccuracies.

 

So in the interest of proper enlightenment (and to help me remember), let's address these one by one:

 

... a trader uses base currency to buy quote currency with hope that base currency value will depreciate as the value of quote currency appreciates.

Using the relevant terminologies, a trader going long on a given currency pair will be buying units of the BASE currency, paying in units of the QUOTE currency.

One long contract says that we are buying one lot of the base currency, such that an increase in value (appreciation) of the base currency is the desired profitable outcome and is thus reflected in the rise of the quote. (eg. going from 1.2 to 1.21)

 

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... if a trader uses CAD (Canadian Dollar) as a base currency and USD (United States Dollar) as the quote currency then 1.10/1.00 implies that $ 1 buys 1.1 CAD. When he buys 11,000 CAD he will use $ 10,000.

The convention for listing currency pairs is this: BASE/QUOTE.

So to rephrase the original example in trader terminology, we would be trading the CAD/USD (although I believe this pair will always be quoted as USD/CAD in real life as USD has precedence over CAD for historical reasons) which currently is quoted at 0.9091(=1/1.1, because the quote always tells you how many units of QUOTE currency is needed to buy 1 unit of the base).

 

The act of buying CAD here is then going long.

 

... after his purchase the rate changes to 1.00/1.00 this means that $ 1 buys 1 CAD and by him converting his 11,000 CAD to USD, he will make a profit margin of $ 1,000.

Intuitively, the quoted rate going up on a long trade results in profit. And that follows here since after purchase, the quote changes to 1, from 0.9091.

 

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It is worth mentioning that in every trade pair, USD has to be there either as a quote currency or a base currency.

This is not true, since there are brokers offering cross pairs for trade. Eg. EUR/GBP.

 

I basically regurgitated the Wikipedia page here. Hopefully in a more digestible manner. :doh: