Forex Practice > Basics Currency Trading

 

Investors and traders around the world are looking to the Currency market as a new speculation opportunity. But how are transactions conducted in the Currency market? Or, what are the basic principles of Currency Trading? Before adventure in the Currency market we must ensure that we understand the basics, otherwise we will lose ourselves where we less expected. That is what this article is addressed to, to understand the basis of currency trading.

Currency Trading Basic

The instrument traded by Currency traders and investors are currency pairs. A currency pair is the exchange 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 total volume generated in the Currency market.

So, for example, if a trader goes long or buys the Euro, he or she is simultaneously buying the EUR and selling the USD. If the same trader goes short or sells the Aussie, he or she is simultaneously selling the AUD and buying the USD.

The first currency of each currency pair is referred to as the base currency, while second currency is called the counter or quote currency. Each currency pair is expressed in units of the counter currency needed to produce one unit of the base currency.

If the price or quote of EUR / USD 1.2545, this means that 1.2545 U.S. dollars are needed to get one euro.

Bid / Ask Spread

All currency pairs are often quoted with a bid and offer price. The bid (always lower than the ask) is the price your broker is willing to buy, said the trader should sell at this price. The question is the price your broker is willing to sell, so 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. A PIP is to price interest point. A step in the EUR / USD from 1.2545 to 1.2560 equals 15 pips. And one step in the USD / JPY from 112.05 to 113.10 equals 105 pips.

Margin Trading (Leverage)

Unlike other financial markets where you require the full deposit of the amount traded in the Currency market, you need only a margin deposit. The rest will be provided by your broker.

The leverage provided by some brokers goes up to 400:1. This means you need only 1 / 400 or 0.25% in balance to open a position (plus the floating gains / losses.) Most brokers offer 100:1, where every trader requires 1% in balance to one open position.

The standard lot size in the Currency market is $ 100,000 USD. For example, a trader would get long party in EUR / USD and he or she is using 100:1 leverage. To open such position, he or she must 1% in balance or $ 1,000 USD.

Of course it is not advisable for a position with such limited resources in our trade balance to open. If the trade goes against our trader, the position is closed by the broker. This brings 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 for a position, 1% when the leverage used is 100:1 open, 2% when leverage used is 50:1, and so on.) We, the broker sells off (or buys in the case of short positions) all your transactions, where the trader theoretically with the maintenance margin. Most of the time margin calls occur when money management is not implemented.

What Are The Mechanics Of A Currency 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 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 right way, he or she will get 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) or our risk point (called stop loss level) we will have to sell at the offer price (the price our broker is willing to our position to repurchase.) order 40 pips, our take profit at 1.8590 should be placed . If our goal is hit, the market ran 64 pips (60 pips plus the 4 pip spread.) If our stop loss level is hit, the market ran 30 pips against us.

It is very important to every aspect of the trade to understand. Start from the very basic concepts first, and then go to more complex issues such as Currency Trading Systems, trading psychology, trading and risk management, and so on. And make sure you master every aspect before adventuring in a live trading account.

All currency transactions related to the purchase of one currency and selling another, simultaneously. Currency rates are given as exchange rates, i.e. the value of one currency against another. The relative supply and demand of both currencies will determine the value of the exchange rate.

If a trader wants to trade a currency he bought the currency to appreciate in value sites against the currency sold. His ability to determine which direction the price will move, will dictate his gain or loss on the market. Let’s take an example with a currency quote obtained from the currency trading system.

Example of Currency Trading

The current bid-ask price for EUR / USD is 1.0120/1.0126, meaning you can buy 1 euro (EUR) for 1.0126 U.S. dollars (USD). [If you need help to understand how currency quotes, interpreting click on this link.]

Suppose you feel that the euro is undervalued against the dollar. To implement this strategy, you buy Euros (simultaneously selling dollars) and then wait until the price rise.

So you make the trade: the purchase of 100,000 EUR (1 lot) and the sale of $ 101,260. (Remember to 1% margin, your initial margin deposit would be 1000 Euros.)

As you expected, EUR / USD rises to 1.0236/42. Since you bought Euros and sold Dollars in your previous trade, you must now sell Euros for Dollars to realize profits. You can now sell 1 euro for 1.0236 U.S. dollars. If you sell 100,000 Euros at the current EUR / USD rate of 1.0236, you get 102,360 USD.

Since you originally sold (paid) $ 101,260, your profit is U.S. $ 1100 (note: the price of the euro against the U.S. dollar would have gone down instead of by the same amount in the above example, there would have been lost of $ 1100 instead of a profit. One possibility for profit is always accompanied by a risk of loss). Total profit = U.S. $ 1100.00