Forex

Introduction

It is usual in the financial world for the different markets (stocks, bonds, commodities, etc…) to be described as upward markets (BULLISH MARKET) or downward markets (BEARISH MARKET).

In upward markets (BULLISH MARKET), stocks, commodities, etc… have their values rising. In downward markets (BEARISH MARKET), stocks, commodities, etc… have their values going down.

Forex has a dynamic and non-bureaucratic structure, which allows initial buy or sell orders, making it possible to profit in both markets, upward and downward.

Currency Pairs

Also known as the Foreign Exchange Market, Forex is the biggest market in the world. The Forex investor hopes to get profit by speculating on the value of one currency against another. That’s why currencies are always traded in pairs. One currency only has its value changed in comparison to another.

Example of a currency pair:

GBP/USD

Base Currency / Counter or Quote Currency

Example of quotation for the pair above:

1.56205

The base currency is used as a reference. The quote price is how much of the second currency is needed to purchase one unit of the base currency. In the example, 1 GBP (1 British pound) is worth approximately 1,56 USD (US Dollars).

Two Business Opportunities

Scenario 1 – Buy Order (ASK)

If an investor, after his analysis, believes the British pound will rise in value against the US dollar, he can enter the market buying GBP/USD, hoping that indeed the British pound will be worth more than the US dollar. In this case, the investor believes the British pound is upward (BULLISH) and the US dollar is downward (BEARISH).

Scenario 2 – Sell Order (BID)

If an investor, after his analysis, believes the British pound will lose value against the US dollar, he can enter the market selling GBP/USD, hoping that indeed the British pound will be worth less than the US dollar. In this case, the investor believes the British pound is downward (BEARISH) and the US dollar is upward (BULLISH).

That makes it easy to understand how FOREX presents profit opportunities both in the BULLISH market as well as in the BEARISH market.

The largest market in the world

VOLUME AND LIQUIDITY

While stock markets trade billions of US dollars daily, Forex trade more than 4 trillion US dollars a day. There are plenty of opportunities for lucrative trades.

This great volume of business makes it possible for a trader to enter and leave the market very quickly. This ability to enter and leave the market so swiftly is called liquidity. A high volatility and liquidity market mean more potential profit for a trader.

24H/DAY 6 DAYS/WEEK

In the stocks, options and futures markets and others alike you can only trade in standard business hours (8h/day), during working days (5 days/week).

Forex has many more business opportunities and can be traded 24h a day, 6 days a week. This is possible because:

At 5 pm Sunday (New York time), the Pacific financial markets open (Australia, New Zealand, Japan, and several eastern countries). As these markets begin to close, the ones in the Middle East and Europe open shop. While Europe is in the middle of its business hours, the US markets open.

This pattern goes on until 5pm Friday (New York time), when the US markets close for the weekend. This alternating opening and closing of markets around the globe grant access to trades 24h/day, 6 days a week. This is why Forex is the global market.

Who trades Forex?

From big banks such as Deutsche Bank, City Bank, UBS, BNP Paribas, Barclays, Hedge funds and SMC, to small and medium investors.

Margin, Leverage, Lots and Pip

WHAT IS MARGIN?

Margin is the money in your account you need to keep an open position during a trade.

WHAT IS LEVERAGE?

It is a tool that allows the investor to hold a hefty position in the market with relatively little money in his account.

Let’s suppose you have U$ 100,000.00 (one hundred thousand dollars) in your account. And then you decide to enter the market using 30% of your margin. In this example, you would actually put U$ 30,000.00 (thirty thousand dollars) in the market. By using 1:100 leverage, this U$ 30,000.00 (thirty thousand dollars) will be able to trade orders up to U$ 3M (three million dollars).

Most traders find the leverage offered by Forex brokers very attractive. But know this, leverage can maximize your profit as well as your loss.

WHAT IS A “LOT”?

A lot in Forex is a trade unit. In most Forex brokers, a lot equals 100.000 currency units. One lot is the minimum order you can trade.

In the example above, where we used U$ 30,000.00 (thirty thousand dollars) as margin for a U$ 3M (three million dollars) order, we can say we traded 30 lots. (1 lot = 100.000,  x 30 lots = 3.000.000).

WHAT IS A PIP?

Pip (Percentage in Point) is a price movement (change) unit of a currency pair. In the example above, one pip equals 1/100 of a cent for the pair British pound/US dollar (the fourth decimal place).

If the quote for the pair GBP/USD went from 1.56205, to 1.56255, we would say the pair went up 5 pips.

The smallest change possible for a currency pair is called Fractional Pip (fifth decimal place in the example above).

It is common practice in Forex to measure the performance of trades using pip.

What is an ECN?

In a traditional broker company, when you decide to open a position, as a client you will have only one quote price for a specific currency pair at a time, which is provided by the broker company.

An ECN (Electronic Communication Network) broker is an environment where the client has access to multiple quote prices for a specific currency pair at a time. It is the same environment in which the major banks of the world perform their transactions.

Why trade with an ECN?

The client can visualize the best quotes, the spreads charged, the volume of money each bank or financial institution is offering in a particular moment.

This structure shows more evidently the mechanisms of a free market and competition. Furthermore, the trades between the different participants in the market increase noticeably the liquidity of the system, allowing deeper orders.

Another important factor for successful clients, that trade deeper orders (over U$ 100,000,000.00 – one hundred million dollars), is that ECNs provide certain anonymity, preventing other players to deliberately maneuver (“corner” (read more) or “squeeze” (read more)) against their orders.

Another advantage in trading with ECNs is that it prevents unscrupulous brokers to tamper with the quotations offered to the clients, putting in their pockets that difference between a fake quotation and a real one.

Benefits of trading with an ECN:

  • Best quotations
  • Smaller spreads
  • More liquidity
  • Anonymity and protection of trades
  • Protection against fraud