Understanding the Basics of Currency Trading

Investors and traders around the world are looking to the Forex market as a new speculation opportunity. But, how are transactions conducted in the Forex market? Or, what are the basics of Forex Trading? Before adventuring in the Forex market we need to make sure we understand the basics, otherwise we will find ourselves lost where we less expected. This is what this article is aimed to, to understand the basics of currency trading.
What is traded in the Forex market?

The instrument traded by Forex traders and investors are currency pairs. A currency pair is the exchange rate of one currency over another. The most traded currency pairs are:

EUR/USD: Euro
GBP/USD: Pound
USD/CAD: Canadian dollar
USD/JPY: Yen
USD/CHF: Swiss franc
AUD/USD: Aussie

These currency pairs generate up to 85% of the overall volume generated in the Forex market.
So, for instance, if a trader goes long or buys the Euro, she or he is simultaneously buying the EUR and selling the USD. If the same trader goes short or sells the Aussie, she or he is simultaneously selling the AUD and buying the USD.

The first currency of each currency pair is referred as the base currency, while second currency is referred as the counter or quote currency.
Each currency pair is expressed in units of the counter currency needed to get one unit of the base currency.
If the price or quote of the EUR/USD is 1.2545, it means that 1.2545 US dollars are needed to get one EUR.

Bid/Ask Spread
All currency pairs are commonly quoted with a bid and ask price. The bid (always lower than the ask) is the price your broker is willing to buy at, thus the trader should sell at this price. The ask is the price your broker is willing to sell at, thus the trader should buy at this price.

EUR/USD 1.2545/48 or 1.2545/8

The bid price is 1.2545

The ask price is 1.2548

A Pip
A pip is the minimum incremental move a currency pair can make. Pip stands for price interest point. A move in the EUR/USD from 1.2545 to 1.2560 equals 15 pips. And a move in the USD/JPY from 112.05 to 113.10 equals 105 pips.

Margin Trading (leverage)
In contrast with other financial markets where you require the full deposit of the amount traded, in the Forex market you require only a margin deposit. The rest will be granted by your broker.

The leverage provided by some brokers goes up to 400:1. This means that you require only 1/400 or .25% in balance to open a position (plus the floating gains/losses.) Most brokers offer 100:1, where every trader requires 1% in balance to open a position.

The standard lot size in the Forex market is $100,000 USD.

For instance, a trader wants to get long one lot in EUR/USD and he or she is using 100:1 leverage.
To open such position, he or she requires 1% in balance or $1,000 USD.

Of course it is not advisable to open a position with such limited funds in our trading balance. If the trade goes against our trader, the position is to be closed by the broker. This takes us to our next important term.

Margin Call
A margin call occurs when the balance of the trading account falls below the maintenance margin (capital required to open one position, 1% when the leverage used is 100:1, 2% when leverage used is 50:1, and so on.) At this moment, the broker sells off (or buys back in the case of short positions) all your trades, leaving the trader “theoretically” with the maintenance margin.

Most of the time margin calls occur when money management is not properly applied.

How are the mechanics of a Forex trade?

The trader, after an extensive analysis, decides there is a higher probability of the British pound to go up. He or she decides to go long risking 30 pips and having a target (reward) of 60 pips. If the market goes against our trader he/she will lose 30 pips, on the other hand, if the market goes in the intended way, he or she will gain 60 pips. The actual quote for the pound is 1.8524/27, 4 pips spread. Our trader gets long at 1.8530 (ask). By the time the market gets to either our target (called take profit order) or our risk point (called stop loss level) we will have to sell it at the bid price (the price our broker is willing to buy our position back.) In order to make 60 pips, our take profit level should be placed at 1.8590 (bid price.) If our target gets hit, the market ran 64 pips (60 pips plus the 4 pip spread.) If our stop loss level is hit, the market ran 26 (26 pips plus the 4 pip spread equals 30 pips) pips against us.

It’s very important to understand every aspect of trading. Start first from the very basic concepts, then move on to more complex issues such as Forex trading systems, trading psychology, trade and risk management, and so on. And make sure you master every single aspect before adventuring in a live trading account.

How Individual Investors Can Benefit from Forex Trading

Indeed large multinational and individual banks and other major financial institutions have dominated FX trading (also known as Forex trading), but there is a paradigm change in the nature and type of investing. According to one estimate, in the new millennium, there are over 6 million online investment accounts, up from 1.5 million in 1997. As a result, start-up firms now compete directly with financial institutions to serve investors in the new technologically driven economy, and the clear winner is the customer. The competition between the brick and mortar institutions and the Internet-based companies has dramatically lowered the costs of investing, and empowered the individual investor to take control of their own investment strategy in Forex trading.

We know Forex trading is direct access trading of currencies. In the past, foreign exchange trading was limited to large banks and institutional traders but recent advancements in technology have allowed small traders to take advantage of the many benefits of Forex trading using online trading platforms to trade. Virtually Forex trading is done 24 hours day and almost 5 ½ days of a week. In the recent times, online trading has revolutionized the currency markets by making it accessible to the small and medium sized investor.

The Forex trading is perhaps the largest financial market in the world, with a daily average turnover of approximately $1.5 trillion. Foreign Exchange is the simultaneous buying of one currency and selling of another. The world's currencies are on a floating exchange rate and are always traded in pairs, for example EUR/USD or USD/JPY or USD/INR etc.

In the new millennium, the Forex trading has become accessible for an individual investor or small group of investors. In the current scenario, investors reap many benefits from Forex trading than stock market, e-mini futures and such other trading. Today mostly traders are choosing Forex trading than stock trading because there are approximately 4,500 stocks listed on the New York Stock exchange. Another 3,500 are listed on the NASDAQ. In spot Forex trading, you have 4 major markets, 24 hours a day 5.5 days a week. If you are so inclined, you have approximately 34 second-tier currencies to look at in your spare time. You can concentrate on the major forex and can find your trade. When you are investing in forex you can spend your afternoon on the golf course or with your spouse watching movie or celebrating holidays—in short it is easy and hassle free than stock/future market.

Not only is it an accessible, easy and less capital-intensive business opportunity, but it is much more cost efficient too to invest in the Forex market, in terms of both commissions and transaction fees. Generally, commissions for stock trades range from a low of $7.95-$29.95 per trade with on-line brokers to over $100 per trade with traditional brokers. Opposite to that, typically stock commissions are directly related to the level of service offered by the broker. At the high end, traditional brokers offer full access to research, analyst stock recommendations, etc. In contrast, on-line Forex brokers charge significantly lower commission and transaction fees.

An Introduction to Currency Trading

The simplest definition of currency trading is the practice of exchanging one country's currency for another country's currency. Basically, currency trading involves four main variables: currencies, exchange rate, time, and interest rate. The interplay of these variables creates opportunities for small investors to obtain investment returns that are generally unheard of in the traditional investment world. It is also referred to as foreign exchange, FX or Forex, but the essence remains the same that currency trading is the exchange of one currency against another.

Perhaps, in terms of trading volume, the currency exchange market is the world's largest market, with daily trading volumes in excess of $1.5 trillion US dollars (although the figures may differ, but this is just an approximation to show its importance). One thing is for sure that in orders of magnitude it is much larger than the bond or stock markets. For example, the New York Stock Exchange has a daily trading volume of approximately $50 billion. So you can easily imagine its importance in the trading world of today. Moreover, contrary to earlier thoughts, currency trading is not limited to just larger organizations and other large banks and financial institutions, but open to everyone who has enough expertise and determination to hard work.

You can start playing the currency trading market with real market conditions immediately. Trading opportunities in the forex currency trading market are now available to individuals through technology interfaces such as those used by major currency trading brokerage firms (usually large corporations with big tummies). If you decide to hire a professional who takes advantage of this technology, you will be able to view your accounts' closed trades 24 hours per day through a secured, online access portal.

Historically, SMBs and individual investors have had limited access to the forex market. For decades, major banks, multinational corporations and other participants, trading in large transaction sizes and volumes, have dominated this market. However, just like many other business segments technology has lowered the barriers of entry and opened up this attractive marketplace to a new breed of investors and speculators.

Technological advancement, along with liberal market sentiments, has allowed almost everyone to deal in currency trading, unlikely to the past when there were only few organizations that could trade the currency. You also can open a mini account with as little as $300 US although $2000 US is recommended. You can open a regular account with as little as $2000 US although $10,000 US is recommended. Mainly major banks, international organizations and some other are doing well in currency trading.