What Is Forex

From: www.mefx.org

Great question!
The Foreign Currency Market is the largest financial market in the world. With the right tools and skills, there is a vast amount of money available for the taking.

Learning to trade can become a lifetime skill that will allow you to live any lifestyle you choose. It is also the greatest home based business on the planet. No customers to deal with, no employees and no time clock to punch.

Most people are familiar with the stock market, where the stocks of individual businesses are traded. In a sense, currency is like a country’s stock. The foreign exchange market (shortened to Forex, or Fx) is where participants from all around the world trade international currencies. International traders from hedge funds, large and small banks, large and small companies and most importantly, MeFx Forex members just like you trade currency, which causes the exchange rates to fluctuate. Because of this, every day the volume in the Forex market is over 25 times higher than the largest stock exchange in the world. That’s not just Billions, it’s Trillions traded every day.

Forex as an Asset Class
Savvy traders and investors include currencies in their portfolio to diversify risk and gain exposure to opportunities in different markets. Not only does Forex have significantly higher liquidity (as it trades in Trillions per day), but brokers around the world offer higher leverage than any other financial market is able to provide. 50-1 in the States.

Here Come the Currencies, Two-by-Two
Currencies are traded in pairs (just like an exchange rate). For example, the EUR/USD has a “base” currency (EUR) and a “quote” or “counter” currency (USD). The base currency remains constant while the counter currency fluctuations in value. So when you see the EURUSD quoted as 1.3500, then it simply means that 1 Euro = 1.3500 US Dollars. In other words, one Euro can buy one dollar and thirty five cents.

If the rate goes up to, say, 1.3520, this means that the Euro is getting stronger and the US Dollar weaker, as the Euro can buy more of the US Dollar (it increased by 20 “pips” or basis points). If the exchange rate goes down to say 1.3480 (less 20 pips), the Euro is weakening against the US Dollar as can buy less. On average, the EURUSD can move 100 to 120 pips on an average-volume day.

What is a “pip”? 
Pip is an abbreviation for Percentage in Point and it is the smallest amount of value that a currency can move. It is also called a “basis point” but the term “pip” is more commonly used. More on this below.

ISO Codes Identify Each Currency
Each currency has its own ISO (International Organization for Standardization) code. The following chart includes the most commonly traded currencies. There are many more! Take notice that the Euro (EUR) doesn’t conform to the “first two letters for the country, last letter for the currency” format, and that’s okay. Also, one of those interesting things about the Swiss Franc (CHF) is that they use the Latin name for Switzerland: Confœderatio Helvetica (Latin for Swiss Confederation). That is such a long name for such a small country!

The Majors
Some countries are more active than others when it comes to international trade. The greater its participation in international trade, the greater and more frequent its global currency transactions. Also, a given country may be more active in trade with one country versus another major country. The major players are as follows:

·         EUR (Europe)

·         JPY (Japan)

·         GBP (Great Britain)

·         CAD (Canada)

·         CHF (Switzerland)

·         AUD (Australia)

·         CNY (China)

Although each of the countries listed above are major economic players in global trade, the Europe and Japan’s currency are the most widely traded of them all. China, as large a player as it is, does not have the same trading volume as the other majors (yet!). When it comes to cross currencies, say EUR/JPY, EUR/CAD, etc., the trading volume will vary depending on the economic demand for each cross. Also, note that for each pair, the average volume and volatility will vary. GBP/USD may have a trading range of 120 pips on average, but the GBP/JPY may have a trading range on average that nears or exceeds 200 pips daily!

Buy Low, Sell High!
Many factors cause a currency rates to fluctuate on a daily basis. It all comes down to money flow and trade. For example, if more money flows into the Euro zone than the United States at a given time, or if more money is leaves the US faster than it does the Euro zone, then the Euro will rise against the US Dollar.

Your goal as a speculator is to buy the currency that appreciates in value (or sell the currency that depreciates in value) and take a profit. In short, buy low and sell high.

Let’s suppose you bought the EUR/USD (buying the Euro in exchange for [or selling] the US Dollar) at a rate of 1.3500. You are now “long” the Euro against the US Dollar. At the end of the day, the EUR/USD exchange rate is 1.3600. You have just gained 100 pips or basis points (1.3600-1.3500 = .0100). If you traded one micro lot (equivalent to 1,000 notional), you gained $10. If you traded a mini lot (10,000 notional), you made $100. If you traded a standard lot (100,000 notional), you made $1,000. Note that lots are customizable which means you can trade lot sizes in between (such as two, three, four micros or minis or standards).

Conversely, you can go “short” or sell the EUR/USD. In this case, you would be buying US Dollars and borrowing Euros to sell. So if you “sold” EUR/USD at 1.3500 and it depreciated to 1.3400, then you would have a gain of 100 pips as well. The dollar amount you make or lose depends on the size of lots you trade.

If this confuses you, do not worry. We can train you to understand the mechanics of forex in a manner that it will become as simple as buying or selling a stock.

Your Favorite Fruit, and Longer Prices
If you go to the grocery store tomorrow, and (because of supply and demand) the price of your favorite fruit has risen to $1.20/lb, you might choose to wait until it drops back to its normal price of $1.13/lb. This is similar to what many MeFx Forex members do with the currencies they watch. Now imagine that the fruit price had more numbers. So instead of $1.13/lb for your favorite fruit, the price is $1.1256. When you have access to more information like that, you are able to make a clearer decision about whether you want the fruit at that price, or whether you’ll wait to get the fruit because you’ve been watching the price fall recently.

The exchange rate for any currency pair will look something like this:

·         1.1234 (most EUR pairs, USD pairs, and others)

·         120.34 (JPY pairs)

If the smallest number on the end, the 4 in both examples, increased to a 6 then you would refer to that as an increase of two pips. Remember that a pip is the smallest movement a currency can make.

How Much Can a Currency Move in a Day? Volatility = Opportunity

This question brings to the fore the opportunities available in the forex markets. Each currency has a different average daily range. For example, the EUR/USD can move anywhere from 100 to 120 pips on an average day (sometimes less and sometimes more). The GBP/JPY can move an average of 200 pips a day. Regardless of the currency pair, when economic events move the markets, currencies can really take off and move in large ranges and for sustained periods. And this is the opportunity that every currency trader is looking for. This is where money can be made.

Leverage is Neutral, Neither Good or Bad
Forex brokers in the U.S. offer leverage ratios up to 50:1. One way of looking at that is, for every $1 you put towards a trade, you can trade notionally up to 50 times that amount.  So if you have $20 in the account, you can trade $1,000 of a foreign currency. If you have $20,000 in your account, you can trade notionally $1,000,000 or one million of a foreign currency. When you close your position, you will have in your account the amount you started with plus or minus your profits or losses. That’s the quick answer.

Margin is like escrow. When you place a trade, the broker holds onto a small portion of your account (margin) while that trade is open, like putting the money in escrow. When that trade closes, the broker returns that margin back to your account (it never really leaves the account, but you can’t use it while that trade is open).

Some people worry about using too much leverage when they are in a drawdown. But of course they don’t complain when their trades are more profitable because of leverage! That’s okay, we’re all human. MeFx Forex educates its members to trade conservatively, and in doing so, MeFx members are rarely worried about small drawdowns and are excited about their larger profits because of leverage!

So, How Much is a Pip Worth?
By the way, some people are surprisingly curious about what the dollar value of a pip is. There’s more math to figure that out, but for now here’s the simple answer.

When the US Dollar is the second currency (quote or counter currency) as in EUR/USD or GBP/USD or AUD/USD, then one pip will have a value of:

·         $0.10 if trading a micro lot (1,000 currency units)

·         $1.00 if trading a mini lot (10,000 currency units)

·         $10.00 if trading a standard lot (100,000 currency units)

The math for the above is simple. Taking the micro lot example, 1,000 (lots size) x .0001 (one pip) = 0.10. The same calculation goes for the other lot sizes as well. For currency pairs in which the US Dollar is the “base” or first currency, or for cross currencies where the dollar is not present at all, contact us and we will show you how to do the math. However, one great thing is that most forex platforms will calculate the pip value for each trade and show it to you so that you don’t have to make those calculations.