FOREX EDUCATION

What is forex? Forex, an acronym for foreign exchange, is the largest financial market in the world. With an estimated $1.5 trillion in currencies traded daily, forex provides incomes to millions of traders and large banks worldwide. Currencies are traded directly through networks of banks and brokers via an electronic network or the telephone. The foreign exchange market is therefore, also refereed to as an interbank or over the counter market. Foreign exchange market is therefore the mechanism by which currencies are valued relative to one another, and exchanged. Currency trading always occurs in pairs where one currency is sold for another and is represented in the following notation: EUR/USE or CHF/YEN. In forex, traders generate profit or losses by speculating whether a currency will rise or fall in value in comparison to another currency. The value of a currency is a reflection of the condition of that country’s economy with respect to other major economies. More than ninety five (95%) percent of all trading performed today is for speculative purposes (i.e. to profit from currency movement) and the rest belong to hedging (managing business exposures to various currencies). BRIEF BACKGROUND HISTORY Historically, forex has being dominated by commercial banks, large corporation, money brokers, money portfolio managers and very few private traders. But lately, the trend has changed because of the advance in internet technology which has provided ample opportunity for more private traders to invade the forex market. FOREX ADVANTAGES o Forex trading is flexible o It requires small capital to start o There is transparency in pricing o Nobody has monopoly or can dictate the market o There is high liquidity. OPERATION: EIGHT MAJOR CURRENCIES On the forex market, major trading takes place in only few currencies. They are o US Dollars USD o European currency unit EUR o Japanese Yen JPY o British Pound Sterling GBP o Swiss Franc CHF o Canadian Dollars CAD o Australian Dollars AUD o New Zealand Dollars NZD These major currencies are mostly traded because they represent countries with o Stable Government o Relatively low inflation rates o Esteemed central banks GLOBAL FOREX TIME: A 24-HOURS MARKET The forex market operates 24-hours a day. When traders are inactive in one part of the world due to nightfall, there are traders elsewhere who are actively engaging in trades as it is daytime in that location. Foreign exchange moves in response to: o Geopolitical events o Press releases from key central bank officials o Reports from government statistical bureau. Forex market closes on Friday at 4 pm for the weekend, and re-opens at 5pm EST on Sunday. FOREX TERMINOLOGY Ø Exchange Rate: because currencies are traded in pairs and exchanged one against the other when traded, the rate at which they are exchanged is called the exchange rate. Ø Base/Counter Currency: As stated earlier, currency trading always occurs in pairs. In this pair, the first currency is called base currency while the second currency is called counter currency. The base currency is usually represented by 1 and the counter could be anything other than 1. Ø Long Position: is a situation in which one purchase a currency pair at a certain price and hopes to sell it later at a higher price. It is also referred to as buy low, sell high. In forex, when one currency in a pair is rising in value, the other currency is declining and vice versa. Ø Short Position: occurs when a trader thinks a currency pair will fall, he will sell it and hope to buy it back later at a lower price. It is the opposite of a long position. Ø Bid price is the rate at which the market is prepared to buy a specific currency pair in the forex trading market. Ø Ask price: is the rate at which the market is ready to sell a particular currency pair. The bid/ask combination comprises a quotation which is based on a floating exchange rate. The quotation lists the bid price first, then the ask price. For example, the USD/JPY pair, the quote will be 120.93/96. Ø Spread is the difference between buy and sell or ask and bid. In general, smaller spreads are better for forex investors since they require a smaller movement in exchange rates in order to profit from a trade. Ø Pip is defined as the change in price of one point in forex trading. It is equivalent to the final number in a currency pair’s price. For pairs that involve the YEN, a pip is counted from the second decimal place. For all pairs that don’t involve the Japanese Yen, a pip is the fourth decimal place. ROLE OF SUPPLY AND DEMAND IN FOREX The value of a nation’s currency, under a floating exchange rate, is determined by the interaction of supply and demand. The laws of supply and demand show that Ø High supply causes low prices, and high demand causes high prices. Ø When there is an abundant supply of a given commodity, then the price should fall. Ø When there is a scarce supply of a given commodity, then the price should increase. Ø Therefore, an increase in the demand for a commodity would cause it to appreciate in value, whereas an increase in the supply would cause it to depreciate. When the forces between supply and demand changes, the market moves in ways to clear itself through a change in price. In international finance market, if many investors are selling a particular currency, they are making it more readily available and increase its supply. If there is not an equal amount of buyers or demand for that currency, its price will go down in order to strike a new balance between supply and demand.