Basic Forex Trading
– See How Easy It Can Be ?

Forex trading is a form of investment, in which currencies are bought and sold against eachother according to how you the trader, based on your analysis or signals believe currencies will rise and fall in value against eachother.

Unlike the foreign exchange transactions we looked at
on the currencies page, when your broker quotes you a price for a currency to trade they will quote two prices for each currency pair.

These terms make logical sense if you think of it like an auction;

Someone wanting to buy something at an auction will offer a bid, i.e. the price they are willing to pay.

In forex trading it's the international banks who are willing to buy if you will sell to them at their bid price.

Likewise, in an auction someone wanting to sell something will have an asking price, i.e. the price at which they are willing to sell their item to you.

In forex trading the international banks are willing to sell to you if you buy at their ask price.

The market Spot rate is simply the rate at any point in time at which international banks trade the currencies with eachother.To enable you to buy and sell the currency pairs Buy and Sell rates are wrapped around the spot rate. So for example, let’s say you’ve just seen on your price chart that GBP/USD is trading at a spot rate of GBP/USD 1.6535

Your broker might quote this to you as

GBP/USD Sell (Bid) 1.6532 : Buy (Ask) 1.6538

So, can you see what’s happened to our spot rate in the above quote ?

The broker has simply applied what’s called their spread to the spot rate. Think of the spread as the dealer/broker’s profit margin.

Let’s have a look at how it works;

The broker has added 3 pips to create the buy price and deducted 3 pips to create the sell price. If you were to instantaneously buy and sell at the broker’s prices you can easily see that you would have just given 6 pips of profit to the broker.

To calculate your profit (or loss) you now need to look at the sell price as you need to sell in order to realise a profit or loss.

So on the above quote you bought at 1.6538, at which time the sell price was 1.6532. So as soon as you open your position it’s showing a loss of 6 pips (the broker’s spread). Now if the GBP strengthens against the USD, and the sell price becomes 1.6540 you would now have a profit of 2 pips.

The spread varies considerably from fx pair to fx pair depending on its market liquidity and volatility and also of course depending on whether your broker charges fixed or variable spreads.

For example GBP/SGD would typically have a 20 pip spread, but for EUR/USD 1 – 2 pips would be more normal. This is perhaps not terribly surprising as you would expect far more world trade to be done in forex trading between Euros and US dollars than would be the case between the British pound and the Singapore dollar.

Hence, as the EUR/USD is more liquid it is less susceptible to jerky price movements.

Those fx pairs with the highest volume, and hence the safest to trade are called major fx pairs.

The fx pairs classified as majors are as follows

• EUR/USD
• GBP/USD (Known as “cable”)
• EUR/GBP
• USD/JPY
• AUD/USD
• USD CHF

With this wide variety of instruments to trade, all tradable 24 hours a day from around 21:00 GMT Sundays through to 22:00 GMT Fridays, now you can see why so many people choose forex trading.

By comparison, if you trade stock markets or indices such as the Dow, the Nasdaq or the FTSE, it is only possible to trade any particular stock instrument during market open hours which is only 6 – 8 hours a day depending on which exchange you’re trading through.

There also tends to be a big correlation between movements on the major indices, so that if the Dow is going sideways (consolidating) and giving you little trading opportunities, it’s fairly likely that the Nasdaq and the FTSE or DAX if they’re open at the same time are doing something similar.

Forex trading however gives you much more variety to trade, and nearly 4 times as many trading hours per week, not to mention also higher leverage at your broker.

Now that you understand the basics, let’s look at a trading example.

Let’s say that you believe the Euro is going to strengthen against the US dollar. In order to take advantage of this movement when it happens you want to buy the EUR and sell the USD. In trading terminology this is known as going long the EUR and going short the USD.

Because every transaction must have a buy and a sell, you cannot be long one currency without being short another. So in this case you believed in imminent Euro strength, and decided that you could get most profit by buying it against the USD.

For example you could have chosen the EUR/JPY pair, but perhaps you thought that the JPY was also looking strong and likely to remain fairly stable against the Euro, so you chose the USD which you thought was more likely to weaken.

So, in this case you would go to your broker’s dealing platform and Buy the EUR/USD.

Similarly if you had believed the opposite, and expected the Euro to weaken and the US dollar to strengthen you would have sold the EUR/USD.

Let’s say your broker quotes you EUR/USD Sell 1.4192 / Buy 1.4195

and you want to short the Euro in the belief that the buy price will drop down to 1.3800, but probably not much lower than that. However, you also want to protect yourself from a big loss and believe that your assessment would have proven to have been wrong if the buy price ascended above 1.4300.

To place this trade you would

Sell the EUR/USD at the current sell price of 1.4192Set a Limit order at 1.3800 to take your profit of 392 pipsSet a Stop order at 1.4300 to curtail your loss at 108 pips

In forex trading you are buying or selling a financial instrument. Typically your broker will offer you forex trading through an instrument called a CFD, which is a contract for difference.

Using a CFD to trade for example the EUR/GBP, you can arrange with your broker for your profits / losses to be recorded in whatever currency you choose, so that your profits / losses for the pips you gain or lose on trading in any currencies all translate into profits or losses in US dollars for example.

To see a great free video from experts OTA explaining what forex trading is all about click on the What is forex ? link.
(Note: opens in new window and requires your contact details)

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