Tuesday, July 21, 2009

Introduction To Forex

AVAFX

The FX Market

The Foreign Exchange market, which is often referred to as the "forex" or "FX" markets is the largest, most liquid and most transparent financial market in the world. Daily average turnover has now exceeded 2 trillion USD. All the US equity markets combined do not reach 3% of the volume traded on the FX market.

Unlike other financial markets, where for the most part you can only profit in rising markets, in the FX market profits are made by accurately predicting shifts in the relative values of any two currencies. So the cyclical changes that affect other markets are meaningless to the FX market. The constant fluctuations of exchange rates offer a continuous opportunity for profit.

Basic Concepts

The term Foreign Exchange means selling one currency and buying another simultaneously. Since currencies are traded in pairs, to profit from an exchange rate move you need to buy the currency that you expect will strengthen and sell the other. For example if you believed that the Euro (EUR) was going to appreciate against the dollar (USD) you would buy the EUR/USD; or in other words buy the EUR and sell the USD. Alternatively, if you believed that the EUR was going to depreciate against the USD then you would sell the EUR/USD; or sell the EUR and buy the USD.

There is no need to wait for a bullish market to profit, for at any given moment, one currency will be strengthening against another. The FX market is therefore constantly producing opportunities to invest.

Who Trades in the FX Market?

Foreign exchange traders can be separated into two groups, hedgers and speculators.

Hedgers: Governments, companies (exporters and importers) and some investors have foreign exchange exposure. Adverse movements between their local or domestic currency and the foreign currency of the group they are either doing business with (for the exchange of goods and services) or investing in will affect their bottom line. This is the core of all foreign exchange trading; however it only makes up approximately 5% of the actual market.

Speculators: This groups, which includes banks, funds, corporations and individuals creates artificial rate exposure in order to profit from the variations or movements in the price.
Forex reviews and currency trading information.

Currency Pairs

Currency Pairs: Each currency is recognized by a three-letter code. For example, EUR is the EURO and refers to the European currency, USD is the United States Dollar. The worlds leading currencies (often referred to as the majors) are the EUR, USD, JPY (Japanese Yen), GBP (the British Pound or Sterling), CHF (the Swiss Franc), AUD (the Australian Dollar) and the CAD (the Canadian Dollar).

Currencies are traded in pairs and are displayed as such. There is always the three-letter currency code a slash and another three-letter currency code. The first currency displayed refers to the "base", "leading" or "primary currency"; the second currency refers to the "secondary currency".

For instance when looking at the EUR/USD the EUR is the leading currency and the USD is the secondary currency. The "currency pair" or "currency cross" is then followed by a number; this is typically a five digit number with a decimal point after the first, for instance 1.2660.

The number represents the ratio of one currency against the other, and can be read as "the amount of the secondary currency needed in order to have one unit of the major currency". In the example just given, EUR/USD 1.2660, one would require 1 Dollar and 26.6 cents to exchange for 1 Euro.

Bid and Ask or Buy and Sell

There are always two numbers given after the currency pair, the first always has a smaller numerical value then the second. This can once again be shown using the same example (EUR/USD 1.2660 1.2663). The first number is known as the "Bid" or "Sell" and the second number is known as the "Ask", the "Offer" or "Buy".

The Bid (Sell) number represents that price where one can sell the major currency and buy the secondary currency, in this case the price at which one can sell the EUR and buy the USD. The Ask (Buy) number represents the price where one can buy the major currency and sell the secondary , in this example the price at which one can buy the EUR and sell the USD.

In the trading window below the trader is able to buy the EUR against the USD at 1.2847 or sell the EUR and buy the USD at 1.2844. The trader is also able to buy the USD against the JPY at 117.60 and sell the USD and buy the JPY at 117.57.


Calculating your P&L

As discussed above the foreign exchange rate represents the value of one unit in the major currency in the terms of a secondary currency. Since when opening a trade you exercise the trade in a set amount of the major currency and when closing the trade you do so in the same amount, the profit or loss generated by the round trip (open and close) trade will be in the secondary currency.

For example if a trader sells 100,000 EUR/USD at 1.2820 and then buys 100,000 EUR/USD at 1.2760, his net position in EUR is zero (100,000-100,000) however his USD is not. The USD position is calculated as follows 100,000*1.2820= $128,200 long and -100,000*1.2760= -$127,600 short. The profit or loss is always in the second currency. For simplicity's sake the P&L statements often show the P&L in USD terms. In this case the profit on the trade is $600.

As can be seen from the Open Position window below in Ticket number 411 the trader has bought 20,000 EUR against the USD at 1.2806. The current rate to close is 1.2844, so the trader has a current profit of 38 pips and 20000*0.0038= $76.


A Pip

We can see that in this case the trader made 60 points, or pips. This is calculated as follows 1.2820-1.2760=0.0060; therefore 1 pip=0.0001 and on a 100,000 EUR/USD position 1 pip is worth $10. In a USD/JPY position where the market rate is 118.30 one pip is 0.01. We can therefore see that a pip is equal to the last decimal point shown on a rate. The value of 1 pip in USD/JPY for a 100,000 position can be calculated as follows: 100,000*0.01= 1,000 JPY. In USD terms this is equal to 1,000/118.30= $8.45 (rounded to the nearest cent).

Orders - Stops and Limits

As in other financial markets, one can enter the foreign exchange markets at the market or deal rate (this is often known as a Market Order) or at a future rate this is known as a Stop (often known as a Stop Loss) or Limit Order. However as opposed to other financial markets, placing orders in the FX market is much easier, gives far better results and has many more opportunities and variations on the order placed.

When you wish to enter into a trade at current market conditions, you simply execute a buy or a sell market order. Often a trader will wish to either limit the loss of the position that he has open (in which case he is able to set a stop order) or wish to enter a trade - but at a rate that is more attractive than the current market (in which case he can place a limit order).

As discussed above, a stop order can be placed on an existing open position to limit the possible loss on the open trade. For instance, if a trader is long 100,000 EUR/USD at 1.2820, he is obviously expecting that the EUR/USD rate will rise to where he will be able to get out at a profit. However the trader may wish to limit the loss that he is willing to take on the trade. If the maximum loss the trader is willing to take is $1,000 and he knows that every pip is worth $10 in this case (calculated by 100,000 EUR*0.0001= $10) then he will want to set his stop order 100 pips from his execution price in this case 1.2720. At 1.2720 the client will lose $1,000 if it is not closed earlier and the AVA platform will execute the order if and when the Bid (since in this case the stop order is a sell order) reaches the stop rate of 1.2720.

During times of extreme volatility it can be difficult or impossible to execute orders.

Orders – O.C.Os, I/Ds and Trailing Stops

As mentioned above there are many combinations of orders that are possible to carry out in the FX market, using AvaTrader platform. Stop and Limit orders as described above are the basic orders available. All the rest are simply combinations of them or contingent orders.

During times of extreme volatility it can be difficult or impossible to execute orders.

O.C.Os

O.C.O is short for "One Cancels the Other". This is used against an open position, and is done in the following way: the trader places a stop order and a limit order against an existing open position. The first one that hits closes the position (a loss if the stop order hits and a profit if the limit order hits), and when the trade is closed the remaining order is cancelled.

This can best be described by an example. Say the trader is short 250,000 AUD/USD at 0.7730 and he wishes to profit $1,250 USD but is only willing to risk losing $750 USD, then he would place the following orders: The trader would set a limit order 50 pips away from the execution price since 50 pips at $25 per pip is $1,250USD; therefore the limit order would be placed at 0.7680 at the same time the trader sets a stop order 30 pips from the executed open price since 30 pips at $25 per pip is $750US; therefore the stop order would be 0.7760. The orders would be placed O.C.O which means that one order can be hit or triggered to close the open position and when that occurs the remaining order is cancelled automatically.During times of extreme volatility it can be difficult or impossible to execute orders.

I/Ds

I/D is short for "If Done". This is a spin on the O.C.O. Where the O.C.O is placed on an existing trade, the I/D is placed on a trade that has not yet been exercised. This can best be shown by an example: say the trader wishes to go short on the AUD/USD at 0.7770 in 250,000 AUD but the bid price is currently only 0.7730. Now as above the client wishes to profit $1,250 USD but is only willing to risk losing $750 USD; then the trader would set an original limit to sell the 250,000 AUD/USD at 0.7770 and place another limit that becomes active if the first limit hits (hence the term If Done).

The I/D order can also have a stop order attached as above. If the trader would like to set the same conditions as the O.C.O order above i.e. 50 pip profit and 30 pip loss then the full order would read as follows:

Sell 250,000 AUD/USD at 0.7770 I/D 0.7720 Limit and 0.7800 Stop.

Below we can see an actual I/D order with a combination O.C.O on the Orders worksheet where in Order number 205 the trader wishes to buy 20,000 EUR against the USD at 1.2680. If this occurs then there is a stop order against it at 1.2670 (a maximum loss of 10 pips) and an O.C.O limit of 1.2790 for a profit of 110 pips. During times of extreme volatility it can be difficult or impossible to execute orders.


Trailing Stops

A Trailing Stop is an active stop loss that keeps a set distance away from the current market price and updates according to the market. This is best used in a moving market that is going in the direction the trader wants and the trader wishes to guarantee the profits made. This can be best illustrated by an example:

Say a trader enters into a long 200,000 USD/CHF position at 1.2430 and sets a stop order at 1.2380 with a trailing stop of 50 pips. The maximum the trader can lose is 50 pips as above, but the stop loss will automatically update itself as the market moves. For instance, if the market moves to 1.2450 then the stop loss would update itself to 1.2400, always keeping 50 pips from the maximum rate. The stop loss will keep updating itself until it triggers or the original trade is closed. During times of extreme volatility it can be difficult or impossible to execute orders.

Hedging Trades

On the AvaTrader platform, traders have the opportunity to hedge their positions. A hedge is a trade that is in the opposite direction of an existing trade or open position. This can be a partial or a full hedge and does not close the position although it has the same effect. Some traders enjoy this feature and use the capability to hedge an open trade rather then close it out as part of their trading strategy. It should be noted that a hedge has the same effect as closing or partially closing an existing trade except for the fact that both the long and the short positions remain in the open positions table, are treated as open trades and must be closed at a later date.

Rollovers

On the AvaTrader platform all open positions are automatically rolled or swapped to the next business day. Traditionally all spot trades in the FX market are performed for a period of two working days when the delivery of the transaction is to take place. Since Ava through its AvaTrader platform does not permit delivery trades all trades must eventually be closed. Hence in order to avoid the delivery of the trade, the positions are automatically closed for the original trade date and reopened for the next trade date. In order to keep things simple and give maximum advantage to its clients the open and close rates of the roll are kept the same as the open position rate. A premium is then either added or subtracted based on the interest rate differential between the two currencies being traded.

This is a very beneficial and time saving method to continue the trade on the traders behalf until such time as the trader decides to close the trade.

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