In equities or futures, the smallest unit of measurement is called "tick" or "point". In Forex this unit is called a "pip" (for Percentage In Point). As shown in the most trading platforms a pip is the 4th decimal place after the comma or, which is the same, the ten-thousandths place in the quoted exchange rate (0.0001).
A well known exception is any currency pair that contains the Japanese Yen where a pip is the 2nd decimal after the comma (0.01). The same happens with the Thai baht.
The reason to establish a common incremental unit in Forex is due to the fact that differently to equities which are all quoted in the same currency, in Forex each currency can be quoted in any other currency. That makes sense, doesn't it?
If the exchange rate of a currency pair moves from 1.3000 to 1.3010, we say that the price moved up 10 pips. The pip incremental is what shows if a position is winning or losing. So you make money when the pips move in your favor in a trade.
An increment of a single pip has a certain value and in the case of direct-quote pairs (pairs quoted in US Dollars) that value is 10 US Dollar per standard lot, and 1 US Dollar per mini lot. Other currency pairs, like reverse quote pairs (with the USD being the base currency), and cross rates (pairs without the USD) will have different pip values.
1. Currency Pairs With Direct Quote (EURUSD, GBPUSD)
For currency pairs with direct quote the pip value is constant and doesn't depend on the current exchange rate of the pair being traded.
pip value = (lot size) X (pip size, with the corresponding decimal location / exchange rate)
where the exchange rate is always the ask price.
Here is an example with the EUR/USD with the quote being 1.2599/1.2600.
However, to get the value of the trade in Dollars, then multiply € 12.6 by the current EURUSD quote:
This phenomenon is observed when the Dollar is the counterpart or quote member within the pair: the pip value is always the same.
In the above example, a EUR/USD standard lot represents 100,000 Euro which can buy 126,000 US Dollars at the exchange rate of 1.2600. Therefore, the EUR/USD currency pair could be expressed as 100,000 EUR / 126,000 USD.
If you buy the EUR/USD and it moved up by one pip to 1.2601 you have earned $10. You can see the difference by substracting the pair as 100,000 EUR/126,010 USD. The amount of USD has grown on the right side of that equation by $10- the value of the pip.
2. Reverse Quote Pairs (USDJPY, USDCHF)
For those pairs having the USD as the base currency the pip value measured in Dollars is calculated with the same formula as with direct quote pairs:
However, in reverse quote pairs the pip value in US Dollars changes depending on the current quote.
For example, exchanging a standard lot with the pair USD/JPY at the rate 107.00, the pip would be worth:
In these cases you don't need to exchange the pip value to US Dollars in order to get the face value of the trade, because the lot size is always in the base currency and so is the pip value.
3. Cross-Rates (GBPCHF, EURJPY etc.)
The pip value measured in Dollars in cross currency pairs is a little trickier.
For example: with the EUR/NZD rate representing 1 / 2.5040, or expressed in a standard lot, 100,000 EUR / 250,400 NZD at the current exchange rate, if the pair moves up one pip to 2.5041 then the position would have incremented 5,03 US Dollars per pip.
Too abstract? Alright, this is the formula:
where the base exchange rate is the current quote of the base currency against US Dollar, and the exchange rate is, like in the previous formulas, the current quote of the traded pair. Therefore:
For cross-rates the pip value is changing depending on the current exchange of the traded pair AND the base currency exchange rate to the US Dollar. Got it? Great!
The formula seems complicated because we are converting it to US Dollars. But if your account is in EUR and the traded pair is the EUR/NZD, then you don't need to input the base exchange rate in the calculation. Supposing you buy a standard lot of EUR/NZD, the value of the pip is:
The PIP
The Spread
As with other financial instruments, there is a price an investor can sell at which is called "bid" price, and a price the investor can buy at which is called "ask" price.
From the broker-dealers' perspective, the bid is the price at which the broker-dealer is prepared to buy, therefore to "bid" a specific currency pair from you as a trader. At this price, you can sell the base currency to the broker-dealer.
For example, in the quote EUR/USD 1.2872/73, the bid price is 1.2872. This means you sell one Euro for 1.2872 US Dollars.
In turn, the ask is the price at which the broker-dealer is prepared to sell (is "asking" for) you a specific currency pair. At this price, you can buy the base currency. It is shown at the right side of the quotation. Sometimes it's also called the "offer" price.
Using the same EUR/USD quote, the ask price is 1.2873. This means you can buy one EUR for 1.2873 US Dollars. The ask price is also called the offer price.
The difference between both prices is known as the "bid-offer spread" or "the spread", and it's expressed with a similar quote convention than the pair:
In our example, the spread value would be of 1 point, the difference between 1,2873 (the price the broker-dealer is ready to sell) and 1,2872 (the price the broker-dealer is ready to buy at).
So to summarize:
Another example illustrates that the bid price of the AUDUSD pair is 0,6520 USD and the offer price is 0.6528 USD:
The critical characteristic of the bid/ask spread is that it is also the transaction cost for a round-turn trade.
The formula for calculating the transaction cost is:
The spread in this case is made of 8 points, also called "pips".
The spread is usually lower in the majors, since a high turnover assures ample liquidity to meet the trading needs. That is why interbank and retail dealers charge less for the majors through the spread. For less traded pairs or cross currency pairs the spread will be bigger, since at an interbank level these trades may involve the use of synthetic pairing and dealers have to assume more risk in completing those transactions.
Currency Pairs
The following is a list of the most frequently traded currencies, their trading symbols, their nicknames and major characteristics:
USD (US Dollar)
The US Dollar is by far the most transacted currency in the world. This is due to several factors as you have already learned in the last chapter. First, it's the world's primary reserve currency, which makes this currency highly susceptible to changes in interest rates. Second, the USD is a universal measure to evaluate any other currency as well as many commodities such as oil (hence the term "petrodollar") and gold.
70% of the U.S economy depends on domestic consumption, making its currency very susceptible to data on employment and consumption. Any contraction in the labor market has a negative effect on this currency.
All US Dollar denominated bank deposits held at foreign banks or foreign branches of American banks are known as "Eurodollars". Some economists maintain that the overseas demand for Dollars allows the United States to maintain persistent trade deficits without causing the value of the currency to depreciate and the flow of trade to readjust. Other economists believe that at some stage in the future these pressures will precipitate a run against the US Dollar with serious global financial consequences.
Nickname: Buck or Greenback
EUR (Euro)
The European Monetary Union is the world's second largest economical power. The Euro is the currency shared by all the constituting countries which also share a single monetary policy dictated by the European Central Bank (ECB).
This currency is both a trade driven and a capital flow driven economy. Before the establishment of the Euro, central banks didn't accumulate large amounts of every single European national currency, but with the introduction of the Euro it is now reasonable to diversify the foreign reserves with the single currency. This increasing acceptance as a reserve currency makes the Euro very susceptible to changes in interest rates.
Nickname: Fiber or Single Currency
JPY (Japanese Yen)
The Japanese Yen, despite belonging to the third most important single economy, has a much smaller international presence than the Dollar or the Euro. The Yen is characterized by being a relatively liquid currency 24 hours.
Since much of the Eastern economy moves according to Japan, the Yen is quite sensitive to factors related to Asian stock exchanges. Because of the interest rate differential between this currency and other major currencies that preponderated for several years, it is also sensitive to any change affecting the so-called "Carry Trade".
Japan is one of the world's largest exporters, which has resulted in a consistent trade surplus. A surplus occurs when a country's exports exceed its imports, therefore an inherent demand for Japanese Yen derives from that surplus situation. Japan is also a large importer and consumer of raw materials such as oil. Despite the Bank of Japan avoided raising interest rates to prevent capital flows from increasing for a prolonged period, the Yen had a tendency to appreciate. This happened because of trade flows. Remember, a positive balance of trade indicates that capital is entering the economy at a more rapid rate than it is leaving, hence the value of the nation's currency should rise.
GBP (Pound Sterling)
This was the reference currency until the beginning of World War II, as most transactions took place in London. This is still the largest and most developed financial market in the world and as a result banking and finance have become strong contributors to the national economical growth. The United Kingdom is known to have one of the most effective central banks in the world, the Bank of England (BOE).
Sterling
While 60% of the volume of foreign exchange are made via London, the Sterling is not the most traded currency. But the good reputation of the monetary policy of Great Britain and a high interest rate for a long time contributed to the popularity of this currency in the financial world.
Nickname: Cable or Sterling
CHF (Swiss franc)
The Swiss franc moves primarily on external events rather then domestic economic conditions, and is therefore sensitive to capital flows as risk-averse investors pile into Franc-denominated assets, during global risk aversion times. Also much of the debt from Eastern European economies is denominated in Swiss Francs.
Nickname: Swissy
CAD (Canadian Dollar)
Canada is commonly known as a resource based economy being a large producer and supplier of oil. The leading export market for Canada is by far the United States making its currency particularly sensitive to US consumption data and economical health.
Being a highly commodity dependent economy, the CAD is very correlated to oil - meaning that when oil trends higher, USD/CAD tends to trend lower and vice versa.
Nickname: Loonie
AUD (Australian Dollar)
Australia is a big exporter to China and its economy and currency reflect any change in the situation in that country. The prevailing view is that the Australian Dollar offers diversification benefits in a portfolio containing the major world currencies because of its greater exposure to Asian economies. This correlation with the Shanghai stock exchange is to be added to the correlation it has with gold. The pair AUD/USD often rises and falls along with the price of gold. In the financial world, gold is viewed as a safe haven against inflation and it is one of the most traded commodities. Together with the New Zealand Dollar, the AUD is called a commodity currency. Australia's dependency on commodity (mineral and farm) exports has seen the Australian Dollar rally during global expansion periods and fall when mineral prices slumped, as commodities now account for most of its total exports.
Nickname: Aussie
NZD (New Zealand Dollar)
This currency behaves similar to the AUD because New Zealand's economy is also trade oriented with much of its exports made up of commodities. The NZD also moves in tandem with commodity prices.
Along with the Australian Dollar, the NZD has been for many years a traditional vehicle for carry traders, which has made this currency also very sensitive to changes in interest rates. In 2007 the NZD was mainly used to conduct carry trades against the Japanese Yen accounting for a higher volume than the Australian Dollar against the Yen.
Nickname: Kiwi
Although there are many currencies worldwide, the vast majority of all daily transactions involve the exchange of the so called "major" currency pairs:
* US Dollar / Japanese Yen (USD / JPY)
* Euro / US Dollar (EUR / USD)
* Pound Sterling / US Dollar (GBP / USD)
* US Dollar / Swiss Franc (USD / CHF)
* US Dollar / Canadian Dollar (USD / CAD)
* Australian Dollar / US Dollar (AUD / USD)
The pair is always expressed with the convention: Base currency / Quote currency set by the Society for Worldwide Interbank Financial Telecommunication cooperative (SWIFT).
Other currency pairs are referred to as "minors" or "exotic" pairs. These are some of the lesser-traded pairs that contain the USD and a currency from a smaller and/or emerging economy:
* USD/SEK (US Dollar / Swedish Krone)
* USD/NOK (US Dollar / Norwegian Krone)
* USD/DKK (US Dollar / Danish Krone)
* USD/HKD (US Dollar / Hong Kong Dollar)
* USD/ZAR (US Dollar / South African Rand)
* USD/THB (US Dollar / Thai Baht)
* USD/SGD (US Dollar / Singapore Dollar)
* USD/MXN (US Dollar / Mexican Peso)
Other pairs where the US Dollar is not a member currency are called "crosses". Basically, a cross is any currency pair in which the US Dollar is neither the base nor the counter currency. For example, GBPJPY, EURJPY, EURCAD, and AUDNZD are all considered currency crosses.
When you think about buying or selling a cross currency pair, don't forget that the US Dollar, despite not being a member within the pair, is still influencing the price behavior of the cross. Buying EUR/JPY is equivalent to buying the EUR/USD currency pair and simultaneously buying the USD/JPY. Knowing from the previous chapter how interbank platforms work, you also understand why cross currency pairs frequently carry a higher transaction cost. To build a cross, interbank dealers have to combine two orders on different platforms.
By knowing how currencies are related and transacted you will be given a basic understanding on how to analyze trading opportunities on majors as well as on crosses. The principles guiding you to profit from a trade with a cross should be technically the same as with the majors: basically you want to analyze which is the strong and which is the weak currency within the pair.
The Exchange Rate
The concept of buying and selling capital can be confusing because you're not buying anything in exchange for money, like you do in the stock market, for example. Instead you are simultaneously buying one currency and selling another.
In the stock market, traders buy and sell shares; in the futures market, traders buy and sell contracts; in the Forex market, traders buy and sell "lots". When you buy a currency lot, you are speculating on the value of one currency compared to another, on the exchange rate itself.
Currencies are traded in pairs. The pair is written in a particular format, best demonstrated by way of two examples. The Euro and the US Dollar:
or the British Pound and the Japanese Yen:
Every purchase of one currency implies a reciprocal sale of the other currency, and vice versa. This means that buying equals selling - curious isn't it? But the fact is that you are buying and selling the exchange rate, not a single currency.
The first member of every pair is known as the "base" currency, and the second member is called the "quote" or "counter" currency. The International Organization for Standardization (ISO) decides which currency is the base and which one is the quote within each pair.
The exchange rate shows how much the base currency is worth as measured against the counter currency. For example, if the USD/CHF rate equals 1.1440, then one US Dollar is worth 1.1440 Swiss francs. Remember, the value of the base currency is always quoted in the counter currency member within the pair (hence the name "quote currency"). A simple rule to understand the exchange rates would be to think of the base currency as one unit of that currency being worth the value of the exchange rate expressed in the quote currency.
Following the example above, one US Dollar is worth 1.1440 Swiss Francs.
Therefore, any unrealized profit or loss is always expressed in the quote currency. For example, when selling 1 US Dollar, we are simultaneously buying 1.1440 Swiss francs. Likewise, when buying 1 US Dollar, we are simultaneously selling 1.1440 Swiss francs.
We can also express this equivalence by inverting the USD/CHF exchange rate to derive the CHF/USD rate, that is:
This means that the quote of one Swiss franc is 0.874 US Dollars. Note that CHF has now become the base currency and its value is accrued in USD.
In spot Forex, not all pairs have the US Dollar as the base currency. Primary exceptions to this rule are the British Pound, the Euro and the Australian and New Zealand Dollar.
When looking at a chart you can see if a currency pair, or in other words, the exchange rate between two currencies, is rising or falling.
In a free floating system, there are two main factors that can affect exchange rates every day: international trade (import/export of commodities, manufactured goods and services) and capital flows (following certain interest rates, equity performance, government debt instruments like bonds).
It is by buying and selling a currency, therefore exchanging it with other currencies, that it becomes stronger or weaker, independently from the fact that this transaction was speculative or not.
Currencies reflect the performance and policies of entire economies, sovereign governments and industry. It is the comparison of different currencies and their economies that drives exchange rates up and down.
Basically there are two main methods to estimate where a currency is heading: the fundamentals and price action.
The first refer to the economic and political factors that influence the value of currencies, such as the release of economical data and news. The second are graphical representations of the exchange rates like you see above. Graphs show offer and demand levels and price patterns which can be recognized visually. And as a numerical sequence, prices can be also technically analyzed using mathematical formulas.
The Advantage of Forex Trading
Unlike the stock market, the currency trading market does not require a trader to pay a commission to place a trade. This will come as a welcome sign of relief to those who have grown accustomed to the vast amount of money they must fork over to their brokers which go towards clearing, exchange and government fees. In the 4x market you also do not have to worry about having a large sum of money in your account to sell your currency pairs. This concept of selling as you may already know is commonly called shorting in the equities world. You can buy or sell at will in the currency trading arena.
It is so amazing to be able to participate in this market right now. You can do so from the comfort of your very own home. As long as you have a computer that is connected to the Internet you are in business. You can begin trading with as little as 300 dollars. I will show you how to turn this 300 dollars into some serious money in no time at all. This should be a lot easier to do given the advantages that you know the 4x market has over its competitors.
The Forex market is traded by some of the world's richest individuals including Bill Gates and Warren Buffett. You now have access to the same opportunities as they do. What is stopping you from getting on the road to financial freedom. You can start now. You do not have to wait. You have already begun the journey by choosing to educate yourself on the pros of the Forex market.
I personally love the fact that you can trade whenever you want to with the Forex. You see, in the stock trading world you are flagged if you are deemed to be a daytrader. In other words if a trader of stocks chooses to trade every day, he or she must have an account balance of 50,000 dollars to do so. There are no such restrictions when it comes to trading the 4x. If you work at night, you may trade in the daytime. If you work during the day, you may trade at night. You simply trade according to the schedule that works best for you.
I want you to think about money for a moment. Who uses it? The whole world does in some form or another. Another advantage that the Forex market has is that there will always be a need for money. You are simply trading one currency for another in the currency market as the 4x is commonly reffered to. The Forex market is not going anywhere. It is here to stay. The only question is then who will be a part of it. We need money to buy the things we use everyday and so do those who live in the other parts of this world.
Another advantage that 4x has over stocks is the advantage of trading focus. Instead of having to choose between over 4,000 stocks you can deal with 4 main currency pairs. Any good business person knows that focusing on too many things is a recipe for financial disaster and this can hold equally true in the stock market. A stock trader also must grapple with the time issue doing research on all those potential stocks presents. It is also much easier to become familiar with 4 things as opposed to 4,000 things. Focus is the name of the game and 4x trading makes it much easier to do so.
The ball is now in your court. Will you take it and make the decision to win with currency trading? 4x is indeed the winner's game and those who win consistently know how to play it well.
Should You Involved In Forex Trading?
Constant trading is done in the forex markets as time zones will vary and the markets will open in one country while another is near closing. What happens in one market will have an effect on the other countries forex markets, but it is not always bad or good, sometimes the margins of trading are near each other.
A forex market will be present when two countries are involved in trading, and when money is traded for goods, services or a combination of these things. Currency is the money that trades hands, from one to another. Often times, a bank is going to be the source of forex trading, as millions of dollars are traded daily. There is nearly two trillion dollars traded daily on the forex market. Should you get involved in forex trading? If you are already involved in the stock market, you have some idea of what forex trading really is all about.
The stock market involves buying shares of a company, and you watch how that company does, waiting for a bigger return. In the forex markets, you are purchasing items or products, or goods, and you are paying money for them. As you do this, you are gaining or losing as the currency exchange differs daily from country to country. To better prepare you for the forex markets you can learn about trading and purchasing online using free 'game' like software.
You will log on and create an account. Entering information about what you are interested in and what you want to do. The 'game' will allow you to make purchases and trades, involving different currencies, so you can then see first hand what a gain or loss will be like. As you continue on with this fake account you will see first hand how to make decisions based on what you know, which means you will have to read about the market changes or you will have to take a brokers information at value and play from there.
If you, as an individual want to be involved in forex trading, you must get involved through broker, or a financial institution. Individuals are also known as spectators, even if you are investing money because the amount of money you are investing is minimal compared to the millions of dollars that are invested by governments and by banks at any given time. This does not mean you can't get involved. Your broker or investment advisor will be able to tell you more about how you can be involved in forex trading. In the US, there are many regulations and laws in regards to who can handle forex trading for US citizens so if you are searching the internet for a broker, be sure you read the print, and the information about where the company is located and if it is legal for you to do business with that company.
Practicing in the Forex Market
To get started in learning about forex trading, you will need to locate the forex trading software, education-learning system you want to use. As you find the games, as they are called, you will enter information about yourself, about what you are interested in learning and then you will download software to your computer. In following the 'game', you will learn how to make and lose money in the forex market. This type of game is going to make you more aware of what happens daily, how the markets open and close, and how different the various countries currencies really are.
You will open an online 'account' using the gaming system. You will then be able to read the news, find and compare markets, and you will be able to make 'fake' trades so you can watch your money build or be eaten away in losses. As you learn the system, using it a few times a week, you are going to be more prepared, more educated and you will be ready to use the forex trades to make money. Of course, you may still need the aid of broker or a company to make your transactions happen but you will better understand the process, what will happen, and what calls you may want to make when you read about the news, the markets, and the currencies in other countries.
The forex market is also referred to as the FX market. If you are interested in joining the millions who are making money in the forex markets, you want to ensure you are dealing with a reputable banker or company involved in forex trading. With the spur of interest in the forex markets, there are many types of companies that are popping out on the Internet appearing to be genuine forex trading companies but in reality, they are not. Forex trading can be completed through a broker, a company that deals in the funds, and from within your own country. For example, the US has many regulations and laws regarding forex trading and what companies are permitted to work with the public dealing with international trading and markets.
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