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Basic Concepts

Foreign exchange market


The foreign exchange market (forex, FX, or currency market) is a global, worldwide-decentralized financial market of trading currencies. Financial centres around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.

The foreign exchange market assists international trade and investment by enabling currency conversion. For example, it permits a business in the United States to import goods from the United Kingdom and pay pound sterling, even though its income is in United States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation on the change in interest rate in two currencies.

In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.

The foreign exchange market is unique because of

 

  • its huge trading volume representing the largest asset class in the world leading to high liquidity.
  • its geographical dispersion.
  • its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday.
  • the variety of factors that affect exchange rates.
  • the low margins of relative profit compared with other markets of fixed income and
  • the use of leverage to enhance profit and loss margins and with respect to account size.

 

 As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding currency intervention by central banks. According to the Bank for International Settlements, as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion.

 

Who are market participants?

 

1.    Bank.
2.    Commercial companies.
3.    Central banks.
4.    Foreign exchange fixing.
5.    Hedge funds as speculators.
6.    Investment management firms.
7.    Retail foreign exchange traders.
8.    Non-bank foreign exchange companies and
9.    Money transfer/remittance companies and bureaux de change.

 

Determinants of exchange rates


1.    Economic factors.
2.    Political conditions and
3.    Market psychology.

 

What are Financial instruments?


1.    Spot.
2.    Forward.
3.    Swap.
4.    Future and
5.    Option.

 

 How to trade?


Today, currency trading is primarily done online through software or web-based trading platforms. If you have access to a personal computer or a cell phone, you most likely have everything that is required to trade forex with.

One of the best ways to learn how to trade forex is by learning and by experience. You can start with a demo and practise with virtual money with real scenario and decide your situation as a trader. All you need just to register under any forex broker. Before that you must have basic training from an institute or an expert person.

 

Dealing with the Currency pairs

 

Each forex transaction involves the buying of one currency and the selling of another. For example, you might buy euro (EUR) while selling US dollar (USD). This transaction is often referred to as buying the EUR/USD currency pair. Currency pairs are needed to create exchange rates, which tell you the value of one currency relative to another. For example, when buying, you have to pay 1.3500 us dollars and when selling, you will receive 1.3500 us dollars when you will sell euro. Left side currency is called base currency which remains same (unit 1) when you sell or buy.

 

What is PIP?

 

A pip is a common term that is used in the currency market. It refers to the smallest movement (not considering fractional pips) that a currency exchange rate can make. For example, if the GBP/USD exchange rate changed from 2.0010 to 2.0012, you could say that it increased by 2 pips.

Most currency pair exchange rates are priced to the fourth decimal place, frequently making the fourth decimal place represent the pip value. However, for currency pairs like the USD/JPY, which are only priced to the second decimal place, the pip value is not the fourth decimal place but instead the second. So a two pip increase could be represented by a change of 85.35 to 85.37.

Calculating price changes in pips helps you to determine transaction costs, profit and loss on trades, among other things.

 

What is LOT?

 

A lot is the smallest trade size available and is determined by the account type. For example, with a Standard account, the lot size can be 10,000 units of currency. Therefore, the smallest trade size is 10,000 units of currency. Additionally, Standard account holders can place trades of any size, so long as they are in increments of 10,000 units like, 20,000, 30,000, 100,000, 310,000, etc.

 

Placing a trade

 

After registering under any forex broker, we will be facilitated with trading platforms. In the forex market, you buy or sell currencies. Placing a trade in the foreign exchange market is simple: the mechanics of a trade are very similar to those found in other markets, so if you have any experience in trading, you should be able to pick it up pretty quickly.

The object of forex trading is to exchange one currency for another in the expectation that the price will change, so that the currency you bought will increase in value compared to the one you sold.

 

What is LEVERAGE?


One of the reasons currency trading is attractive to some individuals is because it can be traded with leverage. Leverage allows an individual to control market positions that exceed the equity available in the trader's account. For example, a trader may have $5,000 of equity in their account, but still open a trade size with a value equivalent to $10,000. This would represent a position that is leveraged 2:1 because the market position is twice as large as the equity in the account. This way, leverage can be 1:1, 2:1, 10:1, 100:1, 200:1, 500:1 etc.

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