The concept of trading FX is simple, once it is
realized that a currency is a commodity whose value fluctuates against
another currency. By buying (or selling) a currency, FX Traders look to
earn a profit from the movement in the FX rate. The beauty of FX is
that the cost of trading is so low. This means that trades can be
transacted for the extreme short-term, literally seconds, as well as
for a longer duration.
Example:
A trader believes the EUR is about to increase in
value against the USD and buys €1 million at 1.5000. Shortly after, the
rate is 1.5050 and the trader closes the position for a US $5,000.
€1,000,000 at 1.50 = US $1,500,000
€1,000,000 at 1.5050 = US $1,505,000
Difference = Profit of US $5,000
There
are around 170 currencies in the world. However, activity is
concentrated into six ‘major’ currency pairs, which account for around
two-thirds of the total turnover.
The Majors are:
EUR/USD (27%)
USD/JPY (13%)
GBP/USD (12%)
AUD/USD (6%)
USD/CHF (5%)
USD/CAD (4%)
In
FX, one currency is always quoted against another. The ‘base’ currency
is the one that can be thought of as the reference. For instance, in a
EUR/USD quote, EUR is the base currency and the quote defines how many
USD it costs to buy. Similarly, in USD/JPY, USD is the base currency
and the rate defines how many JPY it costs to buy.
The
Bid is the price the market is willing to pay for a certain FX currency
pair. The offer, or ask, is the price it is prepared to sell at.
For example, in a USD/CHF quote of 1.1650/1.653,
the bid is 1.1650, while the offer is 1.1653. Frequently, quotes are
abbreviated to just the ‘small numbers’. In this case, a phone quote
would be 50/53.
The difference between the bid and the offer is known as the spread.
A
“Pip” (price interest point) represents the smallest fluctuation in
price of a currency pair. For most currencies, the rate is quoted to
the fourth decimal place, with USD/JPY the notable exception. A pip
represents 1/10,000th or 0.0001 of the counter currency. A
change of 1 pip for GPB/USD at 1.6319 is 1.6320. The Pip for USD/JPY
is only quoted to the second decimal point (1/100th or 0.01).
Most
modern platforms, automatically
calculate a trader’s profit and loss (P&L) on open positions. This
allows traders to keep track as the market moves. Understanding how
these calculations work is crucial for all traders.
Examples:
For most brokers, 1 lot equals $100,000. For pips, 1 lot = $10, .1 Lot = $1, .01 Lot = $.1