Forex trading for beginners Part 3: Markets, Activities, Quotes

Factors Driving Currency Market Movements: Data Releases and Expectations

In the currency markets, data releases are a key driver of exchange rate fluctuations. The term “data” encompasses a wide range of economic reports and events, such as:

• Economic indicators of the countries issuing the traded currencies.
• Interest rate decisions by central banks.
• Economic reviews or reports on the state of national economies.
• Other significant events that affect the global financial landscape.

The Power of Expectations and Events

Both the anticipation of an event and the actual release of economic data have a profound effect on the movement of exchange rates. It can be difficult to determine which has a stronger influence—the event itself or the expectations surrounding it—but it is clear that major data releases can result in substantial and prolonged currency movements.

Examples of such critical data include:

• Nonfarm Payrolls (NFP)
• Gross Domestic Product (GDP)
• Industrial Production
• Consumer Price Index (CPI)
• Producer Price Index (PPI)

Economic Calendars and Market Preparation

The date and time of these releases are typically known in advance, as most countries publish economic calendars that list important indicators and events. Traders and investors use these calendars to prepare for the data releases, and markets often exhibit increased activity leading up to them.

Before the release of major economic indicators, there are usually forecasts or expectations about the potential values of these indicators. Market participants closely watch these predictions to gauge the possible impact on exchange rates.

Impact of Data Releases on Currency Movements

When the data is released, it can cause sharp fluctuations in exchange rates. The direction of the movement depends largely on how market participants interpret the data:

• The release can either reinforce an existing trend, lead to a correction, or trigger the start of a new trend.
• The effect depends on several factors, including:
  • The current market situation.
  • The economic conditions of the countries involved.
  • Preliminary expectations and market sentiment.
  • The actual value of the released indicator compared to forecasts.

In summary, the anticipation and release of economic data are critical drivers of the currency market. Understanding these releases and their impact is essential for market participants to navigate potential exchange rate fluctuations effectively.

Market Reactions to Data Releases: A Deeper Look

When key economic indicators such as GDP, Nonfarm Payrolls, CPI, and PPI show a consistent upward trend, speculation about an interest rate hike often begins. For example, a series of strong U.S. economic reports can lead traders to anticipate a possible increase in U.S. interest rates. Even if this rate change is expected to occur months later, market participants may start buying U.S. dollars in advance, leading to a strengthening of the dollar against other currencies. This initiates an uptrend in the dollar, creating a steady appreciation of the currency.

However, once the actual interest rate change is announced, a correction often occurs, as traders adjust their positions following the news.

Market Sayings and Their Significance

Several well-known sayings are associated with market reactions to data releases and other impactful information:

1. “Sell when good data is released” (Sell the good news) – This refers to the tendency for traders to sell after positive data is announced, as the market has often already moved based on expectations.
2. “Buy on rumors, sell on facts” (Buy the rumor, sell the fact) – This highlights the phenomenon where the market prices in the expected event long before it actually happens. When the event finally occurs, traders often take profits, leading to a reversal in the price movement.

Pre-Event Positioning and Post-Event Reactions

Before the release of major data or announcements, the market often moves in a specific direction based on expectations of the event. This phenomenon is known as the market “setting up” in anticipation. Once the data is released, if the information matches expectations, the exchange rate frequently moves in the opposite direction. This is because positions were opened based on expectations, and once the event materializes, traders often close their positions to lock in profits, leading to a movement known as “profit taking.”

“Priced In” Market Movements

The term “priced in” refers to a situation where the market has already adjusted for an expected event, meaning that the anticipated outcome is already reflected in the current exchange rate. For example, if traders are expecting a rate hike, they may begin buying a currency well in advance, so by the time the actual announcement is made, the exchange rate may already reflect this expectation. After the announcement, there may be little movement or even a reversal, as traders take profits and adjust their positions.

In essence, these dynamics illustrate how both expectations and reality shape market movements, often leading to sharp reversals when the anticipated event becomes fact. Understanding these patterns is crucial for navigating the currency market effectively.

Foundation Activities in Currency Markets

In the realm of long-term exchange rate movements, funds—such as hedge funds, investment funds, insurance funds, and pension funds—play a pivotal role. These institutions have a significant impact on currency trends through their investment activities. By managing substantial sums of capital, they can influence the direction of currency movements over extended periods.

Role of Fund Managers

The funds are managed by professional fund managers, who are experts in their field. They have access to a wide array of analytical tools and techniques, which they use to make informed investment decisions. Their positions can be categorized into:

• Long-term positions: Investments held for an extended period.
• Medium-term positions: Positions held for a moderate time frame.
• Short-term positions: Trades that last for shorter durations, sometimes even within a single trading day.

Analytical Approaches

Fund managers rely on a comprehensive analysis of financial markets, combining several methodologies:

• Fundamental analysis: Examines economic indicators, interest rates, inflation, and other macroeconomic data to predict currency movements.
• Technical analysis: Utilizes price charts and historical data to identify patterns and trends.
• Computer analysis: Involves algorithmic trading and automated systems that assist in decision-making.
• Psychological analysis: Gauges market sentiment to anticipate potential market behavior.
• Interconnected market analysis: Looks at how different markets (such as commodities or equities) may influence the currency market.

By processing this diverse range of data, fund managers aim to predict the outcomes of various events and position their trades accordingly, often seeking to stay ahead of market developments.

Influence on Currency Trends

Due to their large capital reserves and sophisticated strategies, these funds can:

• Initiate new trends: By investing heavily in a particular currency, they can create significant demand that moves the market.
• Strengthen existing trends: When a currency is already trending in a certain direction, additional capital inflows from these funds can further amplify the movement.
• Correct trends: If a currency is moving in a direction that fund managers view as unsustainable, they can place large trades to correct or reverse that trend.

Strategic Vision

Fund managers often take a bird’s-eye view of the currency market, analyzing the broader picture before making trading decisions. Their strategic vision allows them to select the appropriate tools and trading direction based on a clear understanding of market dynamics.

Although no analysis can guarantee perfect results, the combination of a well-developed trading system and access to vast resources enables these funds to significantly influence the currency market, impacting trends for weeks, months, or even years.

In summary, fund activities are a major force in driving, sustaining, and correcting currency trends in global markets, primarily due to their deep analysis, substantial capital, and professional management.

Activities of Exporters and Importers in the Foreign Exchange Market

Exporters and importers are essential participants in the foreign exchange market, but they are primarily market users, meaning they engage in buying and selling currencies to support their business activities. Exporters typically focus on selling foreign currency received from international sales, while importers are constantly looking to buy foreign currency to pay for goods and services sourced from abroad.

Market Influence of Exporters and Importers

Exporters and importers have a more pragmatic approach to the currency market, driven by the need to secure favorable exchange rates for their operations. Many reputable firms engaged in export-import activities have analytical departments dedicated to forecasting exchange rates. These departments aim to optimize the timing of currency transactions, ensuring that they can buy or sell foreign currency as profitably as possible.

Their influence is particularly noticeable in certain markets, such as the Japanese market, where exporters and importers significantly impact the USD/JPY exchange rate:

• Exporters tend to keep the rate from rising too high as they sell foreign currency.
• Importers exert downward pressure on the rate, preventing it from falling too low.

As a result, exporters and importers can help create periods of range trading, where the exchange rate stays within a specific range for a time, driven by their consistent buying and selling activity. In such cases, resistance levels (where exporters are likely to sell) and support levels (where importers tend to buy) are often indicated in market analyses.

Hedging and Currency Risk Management

For both exporters and importers, managing currency risk is essential. They often use hedging strategies to minimize the impact of exchange rate fluctuations. By opening a position opposite to their future currency needs, they can protect themselves from unfavorable movements in exchange rates. For example:

• An importer who expects to buy foreign currency later might buy it in advance if they expect the currency to rise in value.
• An exporter might sell foreign currency in advance if they expect it to lose value over time.

This form of hedging helps ensure more predictable financial outcomes for companies involved in foreign trade.

Short-Term Market Impact

The influence of exporters and importers on the foreign exchange market is generally short-term. Their activities are not strong enough to cause global trends because the volume of foreign trade transactions is relatively small compared to the overall FOREX market. However, their actions often lead to market corrections or pullbacks. When certain price levels are reached, it may become profitable for exporters or importers to act, triggering temporary adjustments in the exchange rate.

In summary, while exporters and importers play a crucial role in the currency market by managing short-term movements and mitigating currency risks, their activities typically do not drive long-term global trends. Instead, they influence range-bound trading and market corrections, especially when specific support and resistance levels are reached.

Impact of Politicians’ Statements on Currency Markets

Statements from politicians and central bankers often have a significant impact on exchange rate movements. These remarks typically occur during reports, summits, meetings, press conferences, or after important discussions on matters like interest rates. For example, statements following meetings of global leaders such as the G8 or during a press conference after a central bank meeting can strongly influence market sentiment.

News agencies like Reuters and Bloomberg track these statements closely and broadcast them in real-time. Such statements can have an effect on the market similar to that of economic indicators, sometimes causing immediate volatility.

Market Preparation for Key Speeches

In many cases, the date and time of these speeches are announced in advance, allowing the market to prepare. Ahead of these events, forecasts or rumors often circulate about what might be said and how the markets will interpret it. As a result, market participants may position themselves based on expectations before the speech occurs.

However, there are also instances when such statements are made unexpectedly. In these situations, the market can react with sudden, unpredictable movements in exchange rates, as traders quickly adjust their positions based on new information.

Long-Term Consequences of Political Statements

When certain statements have long-term implications—such as potential changes to interest rates or shifts in fiscal policy—they can create lasting trends in currency movements. These trends can emerge if market participants interpret the statements as signaling a major policy shift that will impact the economic outlook.

For example, a significant event in the financial calendar is the Humphrey Hawkins testimony, where twice a year (in winter and summer), the head of the Federal Reserve delivers a speech before two banking committees of the U.S. Congress. During these speeches, market participants analyze the language carefully for hints about the future direction of U.S. interest rates. Depending on how traders interpret these statements, they may establish a new trend in the U.S. dollar.

Unpredictable Market Reactions

While the market often anticipates and prepares for these political events, the actual impact of a statement can vary greatly depending on how unexpected or controversial the remarks are. If the statement deviates significantly from expectations or reveals new information, it can lead to sharp and sometimes prolonged exchange rate movements. This unpredictability makes such statements closely watched by market participants worldwide.

In conclusion, political statements can be powerful drivers of short-term volatility and long-term trends in the currency markets, depending on their content and timing. Market participants carefully monitor these speeches for insights into future policy directions, and even a subtle hint can cause significant market shifts.

“Talking a Course” and Its Impact on Currency Markets

In the context of currency markets, the term “talking a course” refers to the practice of politicians or central bankers making public statements to influence the exchange rate of the national currency. When a currency reaches levels that are unfavorable for a country’s economic interests, officials may talk down the currency by suggesting that:

• The currency will not be allowed to weaken further.
• Further movement in the current direction will be prevented.
• They are prepared to intervene in the market if necessary.

Since these statements are made by trusted figures with established authority and decision-making power, they have an immediate impact on the market, often altering the behavior of traders.

Correcting Long-Term Trends

Politicians or central bankers usually engage in “talking a course” after a currency has experienced a strong and prolonged trend in one direction. These statements serve as a signal to the market that the currency has reached a level that is unsustainable or undesirable for the country. As a result, traders often react by closing their positions to avoid the risks of continued movement, especially if intervention becomes a possibility. This process is known as “swearing” (taking profits or exiting positions) and often leads to a correction in the currency’s trend.

Intervention and Its Market Impact

If a currency reaches critical levels despite verbal efforts, central banks may follow up with actual market interventions. Intervention involves the central bank directly buying or selling large amounts of its own currency to alter its value. This is considered an extreme measure and can have a profound effect on the market. Some key impacts include:

• Immediate and significant movements: The exchange rate may move by hundreds of points in a short period (sometimes within minutes) as a direct result of intervention.
• Trader caution: Following an intervention, traders often become more cautious about opening positions in the old direction, fearing further interventions. This can result in a sharp and sustained reversal of the previous trend, as the market becomes reluctant to challenge central bank actions.

Summary

• “Talking a course” is a strategy used by officials to verbally influence the direction of a currency without immediate intervention.
• Such statements are often made after a long-term trend and can cause traders to exit positions, leading to trend corrections.
• If the verbal efforts are not enough and the exchange rate reaches critical levels, central bank intervention can follow, resulting in sharp and dramatic movements in the exchange rate.
• Following an intervention, the market may become wary of continuing in the previous direction, further reinforcing the corrective movement in the currency’s value.

This combination of verbal influence and potential intervention serves as a powerful tool for governments and central banks to manage their currency’s value, particularly when it reaches levels that could negatively impact the economy.

Activities of Central Banks in the Foreign Exchange Market

Central banks play a crucial role in the regulation and management of a country’s currency value in the foreign exchange (FOREX) market. They exercise their influence through various methods, including direct interventions and indirect monetary policies.

In the rare case where a central bank does not interfere at all, the domestic currency is considered to be in a state of “free-floating.” However, most currencies are in a state of “dirty floating,” meaning that while they generally float in the market, the central bank may step in from time to time to influence the exchange rate.

Why Central Banks Intervene

For the sake of economic stability, production growth, and consumer spending, states often need to regulate their exchange rates. Central banks use a combination of direct and indirect methods to achieve this:

• Indirect regulation involves influencing the broader economic conditions that affect currency value, such as controlling inflation, managing the money supply, and setting interest rates.
• Direct regulation includes foreign exchange interventions and discount rate policies, which have an immediate impact on the currency’s value in the market.

Foreign Exchange Interventions

A foreign exchange intervention occurs when a central bank buys or sells its own currency in the international market, usually in large amounts, to influence the currency’s value. These interventions are conducted through commercial banks on behalf of the central bank and involve billions of dollars. As a result, such interventions can cause significant shifts in the exchange rate.

Key points about foreign exchange interventions:

• They typically involve the sharp release or withdrawal of large volumes of currency.
• The central bank aims to strengthen or weaken its currency depending on the economic goals of the state.

For example, in 1998, the Bank of Japan carried out multiple foreign exchange interventions to prevent further depreciation of the Japanese Yen against the U.S. dollar. By releasing several billion dollars into the market, the U.S. dollar fell sharply against the Yen, achieving the central bank’s objective of supporting the Yen.

Central Banks’ Influence on Exchange Rates

Central banks have a unique ability to influence currency markets because of their ability to:

• Inject or withdraw significant currency volumes: This can create upward or downward pressure on the exchange rate.
• Shape market sentiment: Traders often watch central banks closely, and the mere anticipation of intervention can lead to preemptive movements in the market.
• Implement monetary policy changes: Through interest rate adjustments and inflation control, central banks can indirectly affect exchange rates over the long term.

Conclusion

Central banks are key players in the foreign exchange market, using both direct interventions and monetary policies to manage the value of their currencies. While they generally allow currencies to float, they intervene when necessary to stabilize the economy and prevent extreme fluctuations in exchange rates. These actions can lead to dramatic movements in currency values, making central bank activities highly influential in the global financial landscape.

Joint Interventions by Central Banks

Central banks from different countries can collaborate to execute joint interventions in the foreign exchange market to achieve common economic goals. These coordinated efforts are often necessary when the currency fluctuations of one nation affect the global financial system. For example, during a 1998 intervention in the USD/JPY market, the US Federal Reserve (FRS) partnered with the Bank of Japan to stabilize the exchange rate of the U.S. dollar against the Japanese yen. Such joint actions send a powerful signal to the market and can lead to significant movements in exchange rates.

Devaluation and Revaluation of Currencies

A country’s central bank may intervene to either devalue or revalue its currency, depending on its economic strategy. These actions are designed to influence the currency’s value to support broader economic objectives such as boosting exports or controlling inflation.

• Devaluation: If a country needs to depreciate its currency (lower its value), the central bank can increase the supply of its currency in the international market. This is often achieved by printing more money or through monetary easing policies. By flooding the market with more of its currency, the exchange rate drops, making the currency cheaper relative to others.
• Revaluation: Conversely, if a country wants to increase the value of its currency, the central bank can buy its own currency on the foreign exchange market. This is done using the bank’s foreign currency reserves, and by reducing the supply of its own currency, the exchange rate increases, making the currency more valuable.

Example: Swiss National Bank (SNB) and the Swiss Franc

A real-world example of currency devaluation occurred with the Swiss National Bank (SNB) when it adopted a policy to keep the Swiss franc low to support the country’s export-driven economy. When the franc appreciated significantly against other currencies, it became a concern for Swiss exporters, as their goods were becoming more expensive abroad. To counter this, the SNB “entered” the market and injected liquidity—increasing the supply of francs at a lower interest rate, thus weakening the currency.

This strategy helped reduce the franc’s value, making Swiss exports more competitive on the global stage. The SNB’s actions demonstrate how central banks can actively manipulate their currency to achieve favorable economic outcomes.

Impact of Joint and National Interventions

• Joint interventions are typically more effective because they signal broad international consensus and can lead to larger movements in the exchange rate.
• National interventions, like the SNB’s actions with the franc, help address country-specific issues but can still influence global markets, especially if the currency plays a significant role in international trade or finance.

In both cases, central banks use their monetary tools to guide exchange rates in a direction that supports national economic goals, whether that’s through currency devaluation or revaluation. These interventions can have profound short- and long-term impacts on the foreign exchange market.

Margin Trading: Features and Mechanism

Margin trading emerged in the mid-1990s, opening the doors of the FOREX market to a broader range of participants, including private investors with limited capital. Before that, only banks and large financial institutions could participate, as the minimum contract size was at least $5 million. However, with the introduction of margin trading, even small investors could take part in the market through the use of leverage.

How Margin Trading Works

In margin trading, an investor places a security deposit (called “margin”) with a bank or a broker. In return, the investor receives access to trade much larger amounts than their initial deposit by using the leverage provided by the broker. For example:

• With an initial deposit of $2,000, an investor could control $200,000 worth of currency by using 1:100 leverage.
• Leverage magnifies both potential profits and potential losses. In this case, the investor could make a profit (or incur a loss) 100 times larger than if they were only using their own $2,000.

Leverage allows small investors to enter the market and participate in currency trading that would otherwise require substantial capital. For example, with a $10,000 margin, a trader might operate with $1 million in currency, risking only their $10,000. However, the use of leverage comes with its own risks and costs.

Standard Levels of Leverage

Leverage levels can vary:

• Banks typically offer leverage of 20 to 50 times.
• Dealing desks and brokers that cater to small investors often provide 1:100 leverage.

This leverage system was specifically designed to attract small investors, making it feasible for them to participate in the FOREX market with relatively low capital. Without leverage, small investors would see minimal gains from exchange rate fluctuations, as even small movements in the floating exchange rate could only yield negligible profits with a small initial investment.

Risks and Rewards of Margin Trading

While leverage magnifies potential profits, it also amplifies losses. Despite using borrowed funds, the investor alone bears the profits or losses of their trades—brokers or banks do not share in the profits. This makes margin trading a high-risk, high-reward endeavor, where the trader must be mindful of both opportunities and risks.

• When a trade is profitable, the profit (calculated on the larger amount controlled through leverage) is credited to the trader’s account.
• In case of a loss, the loss is deducted from the trader’s account, but the risk is limited to the margin deposit.

For instance, if a trader uses $10,000 of their own funds with 1:100 leverage and their $1,000,000 position moves unfavorably, they could lose the entire margin ($10,000). This is why risk management strategies are crucial in margin trading.

Closing Positions and Rollover

In margin trading, the actual delivery of currencies is replaced by an obligation to close the position through a reverse transaction. This means that when the trader closes a position, only the profit or loss is credited to their account, rather than the actual exchange of currencies.

If the position is not closed by the end of the trading day, it is rolled over to the next day using the Swap Tom/Next mechanism. This swap process involves carrying the open positions to the next day, and typically, it results in either a small interest credit or charge based on the interest rate differential between the two currencies involved in the trade.

Conclusion

Margin trading revolutionized access to the FOREX market, enabling small investors to trade large amounts using leverage. While it offers the opportunity for greater profits, it also carries a higher risk of losses. The key to success in margin trading is understanding the dynamics of leverage, practicing effective risk management, and being aware of the costs involved in maintaining positions.

Understanding Exchange Rates and Currency Quotations

1. What is an Exchange Rate?

An exchange rate, or currency quotation, represents the price of one currency in terms of another. It indicates how much of one country’s currency is required to buy or sell a unit of another country’s currency. Exchange rates can either be:

• Market-determined: The rate is influenced by supply and demand in the foreign exchange market.
• Government-regulated: Central banks or government authorities can fix exchange rates, adjusting them based on economic policy.

2. Currency Pairs

In the FOREX market, exchange rates are always quoted as a currency pair, representing the value of one currency relative to another. The exchange rate essentially tells you how much of the second currency (quote currency) is needed to purchase one unit of the first currency (base currency).

For example, in the pair USD/CHF:

• USD (US Dollar) is the base currency.
• CHF (Swiss Franc) is the quote currency.

In this pair, the rate tells you how many Swiss Francs are required to buy one US Dollar. If the exchange rate is 0.90 USD/CHF, this means that 1 US Dollar equals 0.90 Swiss Francs.

3. Key Global Currencies in FOREX

In the FOREX market, trading typically focuses on the most liquid and widely traded currencies, known as the “majors”. These are the currencies of the world’s leading economies, which exhibit high liquidity and are involved in the majority of global trade and financial transactions.

The eight most traded global currencies are:

• USD: American Dollar (United States)
• EUR: Euro (Eurozone)
• CHF: Swiss Franc (Switzerland)
• JPY: Japanese Yen (Japan)
• GBP: British Pound (United Kingdom)
• SEK: Swedish Krona (Sweden)
• CAD: Canadian Dollar (Canada)
• AUD: Australian Dollar (Australia)

4. Understanding Currency Pairs and Their Structure

Currency pairs in the FOREX market are always quoted in a specific order, with the base currency first and the quote currency second. The base currency is always considered 1 unit, and the exchange rate shows how much of the quote currency is required to buy that 1 unit of the base currency.

• Base Currency: The first currency in a currency pair (e.g., USD in USD/CHF). It is always equal to 1 unit.
• Quote Currency: The second currency in the pair (e.g., CHF in USD/CHF). The exchange rate shows how much of this currency is needed to buy 1 unit of the base currency.

For example:

• EUR/USD at 1.15 means 1 Euro equals 1.15 US Dollars.
• GBP/JPY at 150 means 1 British Pound equals 150 Japanese Yen.

5. Bid and Ask Prices

Each currency pair has two prices:

• Bid Price: The price at which the market (broker) is willing to buy the base currency.
• Ask Price: The price at which the market (broker) is willing to sell the base currency.

The difference between the bid and ask price is called the spread, which represents the broker’s profit margin.

Summary

Major currencies include the USD, EUR, JPY, GBP, CHF, CAD, AUD, and SEK, with the USD being the most traded.

Exchange rates reflect the value of one currency relative to another.

Currency pairs in the FOREX market involve a base currency and a quote currency.

The base currency is always equal to 1 unit, and the exchange rate shows how much of the quote currency is required to purchase it.

Types of Exchange Rates

In the world of currency exchange, two main types of exchange rate quotations are used: Direct Quotes and Indirect (Reverse) Quotes. Understanding how these work is fundamental to trading and interpreting the FOREX market.

---

1. Direct Quotes

A direct quote expresses the price of a unit of foreign currency in terms of the national currency. This is the most commonly used system in most countries, where the foreign currency (often the US dollar) is expressed in terms of how much of the national currency it is worth. In the FOREX context, a direct quote shows how many units of a country’s domestic currency are required to purchase one unit of a foreign currency (typically USD).

For example:

• Japan: USD/JPY shows how many Japanese Yen (JPY) are needed to buy 1 US Dollar (USD).
• Ukraine: USD/UAH shows how many Ukrainian Hryvnia (UAH) are required for 1 USD.

Examples of Direct Quotes in FOREX:

• USD/JPY
• USD/CHF
• USD/CAD
• USD/SEK

In these cases, USD is the base currency (the first currency in the pair), and the national currency is the quote currency (the second in the pair).

---

2. Indirect (Reverse) Quotes

An indirect quote expresses how much of a foreign currency is needed to buy one unit of the domestic currency. It is essentially the inverse of a direct quote and is also known as a reverse quotation. In the FOREX market, this often applies when USD is the quote currency and the foreign currency is the base.

For example:

• GBP/USD shows how many US Dollars (USD) are required to buy 1 British Pound (GBP).
• EUR/USD indicates how many USD are needed for 1 Euro (EUR).

Examples of Indirect Quotes in FOREX:

• GBP/USD
• EUR/USD
• AUD/USD

Here, USD is the quote currency, and the foreign currency is the base currency.

---

Understanding Bid and Ask Prices

In the FOREX market, a quote consists of two numbers:

• Bid: The price at which the client can sell the base currency. This is always the first number in the quotation.
• Ask: The price at which the client can buy the base currency. This is always the second number.

The difference between the Bid and Ask prices is called the spread. For instance:

• In the quote USD/JPY 118.65/118.70:
  • The Bid price (where the client can sell USD) is 118.65 JPY per USD.
  • The Ask price (where the client can buy USD) is 118.70 JPY per USD.
  This means the client can sell 1 USD for 118.65 JPY or buy 1 USD for 118.70 JPY.
• In the quote EUR/USD 1.1354/1.1359:
  • The Bid price (where the client can sell EUR) is 1.1354 USD per EUR.
  • The Ask price (where the client can buy EUR) is 1.1359 USD per EUR.

This shows that the client can sell 1 EUR for 1.1354 USD or buy 1 EUR for 1.1359 USD.

---

What are Pips (Points)?

A pip (short for percentage in point) is the smallest possible price change in a given currency pair. It is used to measure the change in value between two currencies. For most currency pairs, a pip is the fourth decimal place in the exchange rate.

For example:

• In the pair EUR/USD, a change from 1.1354 to 1.1355 represents a 1 pip movement.

There are a few exceptions:

• For USD/JPY, a pip refers to the second decimal place. So, if the pair moves from 118.65 to 118.66, that’s a 1 pip move.
• For USD/SEK, a pip is measured in the third decimal place.

---

Summary

A pip is the smallest unit of movement in a currency pair, typically the fourth decimal place in most pairs, but the second for JPY and the third for SEK.

Direct quotes show how much of the national currency is needed to buy 1 unit of a foreign currency (e.g., USD/JPY shows how many Yen are needed for 1 USD).

Indirect (reverse) quotes show how much of the foreign currency is needed to buy 1 unit of the domestic currency (e.g., GBP/USD shows how many USD are needed for 1 GBP).

The Bid price is where the client can sell, and the Ask price is where the client can buy, with the spread being the difference between them.

Direction of Appreciation/Depreciation of Currencies

When trading in the FOREX market, it’s crucial to understand how the movement of exchange rates reflects the appreciation (strengthening) or depreciation (weakening) of currencies. The lack of uniformity in how different currencies are quoted can sometimes cause confusion, especially for beginners. Let’s break it down:

---

1. Understanding Direct and Reverse Quotes

• Direct Quotes: In direct quotation, such as for EUR/USD or GBP/USD, the foreign currency is quoted first (base currency) against the US dollar (quote currency). If the exchange rate increases, this means the foreign currency is appreciating against the dollar, and the US dollar is depreciating. For example, if the EUR/USD rate goes up, the euro is strengthening, and the dollar is weakening.
• Reverse Quotes: In reverse quotations, such as USD/JPY or USD/CHF, the US dollar is the base currency and is quoted against the foreign currency. Here, an increase in the exchange rate means the US dollar is appreciating, and the foreign currency is depreciating. For example, if USD/JPY goes up, the US dollar is strengthening against the yen.

In summary:

• Direct quotes (e.g., EUR/USD, GBP/USD): A rising chart shows the foreign currency is appreciating, and the US dollar is depreciating.
• Reverse quotes (e.g., USD/JPY, USD/CHF): A rising chart shows the US dollar is appreciating, and the foreign currency is depreciating.

---

2. Speculative Trading Operations in FOREX

The primary goal of speculative trading in the FOREX market is to profit from changes in exchange rates. This is achieved by executing trades where you buy or sell currency pairs, anticipating whether the base currency will appreciate or depreciate relative to the quote currency.

There are two primary types of transactions in FOREX:

• Buy (Long): You buy the base currency, expecting its value to appreciate against the quote currency.
• Sell (Short): You sell the base currency, expecting its value to depreciate against the quote currency.

---

3. Opening and Closing Positions

Every trade consists of two operations:

1. Opening a position: When you either buy or sell a currency pair to establish your trade.
   • Buy (Long): You expect the base currency to rise in value, so you buy at a lower price and aim to sell at a higher price.
   • Sell (Short): You expect the base currency to fall in value, so you sell at a higher price and aim to buy it back at a lower price.
2. Closing a position: Once the price moves in your favor, you close the position by executing the opposite trade.
   • If you initially bought (long), you close the trade by selling.
   • If you initially sold (short), you close the trade by buying back the currency pair.

---

4. Profit from Price Movements

To profit in the FOREX market, the goal is to capitalize on price movements in the following ways:

• Buying Low, Selling High (Long Position):
  • You open a position by buying when the currency price is low and close the position by selling when the price is higher, profiting from the appreciation of the base currency.
• Selling High, Buying Low (Short Position):
  • You open a position by selling when the currency price is high and close the position by buying when the price is lower, profiting from the depreciation of the base currency.

It’s essential to remember that every currency pair represents two currencies. When you sell one, you are simultaneously buying the other. For example, if you open a short position on EUR/USD, you are selling euros and buying dollars, expecting the euro to weaken and the dollar to strengthen.

---

5. Key Takeaways

• In direct quotes (e.g., EUR/USD), a rising chart indicates the foreign currency (EUR) is appreciating, and the US dollar is depreciating.
• In reverse quotes (e.g., USD/JPY), a rising chart shows that the US dollar is appreciating, and the foreign currency (JPY) is depreciating.
• To profit, you can either:
  • Buy low, sell high (if you expect the currency to appreciate).
  • Sell high, buy low (if you expect the currency to depreciate).
• Every trade must be closed with an opposite transaction to realize the profit or loss.

In speculative trading, understanding the direction of currency appreciation and depreciation is crucial for making informed trading decisions.

In practice, the designation of a currency pair is often reduced to one symbol; the common component of the USD is omitted. For this reason, for example, a buy-JPY operation can be taken literally by beginners as actually buying JPY. In fact, the USD/JPY pair will have the US dollar for the Japanese Yen as the base and traded pair.

Transactions (Deals) in FOREX

In the FOREX market, transactions are carried out using standard trading volumes known as lots. A lot represents the minimum amount of a currency that can be traded. The standard lot size in FOREX is 100,000 units of the base currency, i.e., 100,000 units of the first currency in a currency pair.

The number of lots reflects the volume of the trade. Depending on the leverage provided by the broker, traders can control large positions with relatively small amounts of capital.

---

Example: Understanding Profit/Loss in a Single Transaction

Let’s walk through an example to explain how income or losses are generated when a trader conducts a transaction with a standard lot of 100,000 units using a 1:100 leverage.

1. Account Setup

• Account Balance: 1,300 USD
• Currency Pair: EUR/USD
• Leverage: 1:100
• Lot Size: 1 standard lot = 100,000 EUR

2. Opening a Buy Position

A trader expects the EUR/USD pair to rise. The Ask price (buy price) offered by the broker is 1.1345. The trader opens a Buy position for 1 standard lot, meaning they are buying 100,000 EUR:

• Trade Setup:
  • “+ EUR 100,000” (buying 100,000 EUR)
  • “- 113,450 USD” (selling 113,450 USD to buy EUR)

The margin required for this trade with 1:100 leverage would be:

• Margin = (100,000 EUR × 1.1345 USD) ÷ 100 = 1,134.50 USD.

3. Closing the Position

After some time, the EUR/USD rate increases, and the trader decides to close the position at the new Bid price (sell price) of 1.1410. The trader now sells the 100,000 EUR they previously bought:

• “- EUR 100,000” (selling 100,000 EUR)
• “+ 114,100 USD” (receiving 114,100 USD from selling EUR)

4. Calculating the Profit

The financial result of this trade can be calculated as follows:

• Received on Sale = 114,100 USD
• Initial Investment = 113,450 USD

Profit = 114,100 USD – 113,450 USD = 650 USD.

---

5. Final Account Balance

The trader’s initial account balance was 1,300 USD. After making a 650 USD profit on this trade, the new balance becomes:

• 1,300 USD + 650 USD = 1,950 USD.

---

Key Points to Consider:

• Lot Size: One standard lot represents 100,000 units of the base currency.
• Leverage: Using 1:100 leverage, the trader only needed 1% of the total trade value (in this case, 1,134.50 USD) to open a position worth 113,450 USD.
• Profit/Loss: The profit is determined by the difference between the buying and selling prices, multiplied by the lot size. In this case, a price change from 1.1345 to 1.1410 resulted in a 650 USD profit.
• Risk: Leverage allows for significant profits with a small amount of capital, but it also increases the potential for losses if the trade moves in the opposite direction.

This example illustrates how transactions in the FOREX market work and highlights the importance of leverage, margin, and price movement in determining profits and losses.

In a simplified form, the formula for calculating the financial result (in English, Profit and loss or simply profit/loss) is as follows:

Profit/Loss = N_lot*100000*(Sell – Buy)

where N _lots – the number of lots of 100,000 used by the trader,

Sell ​​- the price of selling the base currency

Buy – the purchase price of the base currency

Positive or Negative Results in FOREX Transactions

The result of a transaction, whether positive or negative, reflects the profitability or unprofitability of the trade. This result is always expressed in the quoted currency (the second currency in the pair). For example, when trading a currency pair like EUR/USD, the result will be expressed in USD (the quoted currency).

The calculation of profits or losses in the FOREX market can be standardized using a universal formula, regardless of the order in which the transaction was conducted (buy first, then sell, or vice versa). The calculation also applies whether you are dealing with a direct or reverse currency quotation.

Key Points on Profit/Loss Calculation:

1. Reverse Currency Pairs:
   • If a reverse currency pair is involved (like USD/JPY), the result of the transaction is always expressed in USD.
   • For a reverse quote pair, the cost of 1 pip is $10, because the US dollar is the quoted currency.
2. Direct Currency Pairs:
   • If the transaction involves a direct currency pair (like EUR/USD), the result will be in the national currency, and the profit or loss needs to be converted into USD.
   • This conversion is done at the closing price of the transaction. You take the final calculated result in the national currency and divide it by the exchange rate at the close of the position.
   • For direct currency pairs, the cost of 1 pip varies with the exchange rate. A quick calculation to determine the pip value is summarized in tables for convenience, based on the closing price of the trade (denoted as P_Close).

Universal Formula for Profit/Loss Calculation:

Regardless of the type of transaction (buy first, then sell or sell first, then buy), the formula remains universal:

• Profit/Loss = (Closing Price – Opening Price) × Lot Size × Pip Value.

For reverse pairs, you can simplify the pip value to $10 for a standard lot, and for direct pairs, the pip value depends on the exchange rate at the close of the transaction.

Pre-Calculated Pip Value:

• To speed up the calculation of financial results, most traders use a pre-calculated pip value for common currency pairs. For instance:
  • For USD/JPY, the pip value is often fixed at $10 for a standard lot.
  • For EUR/USD, the pip value changes with the exchange rate, so you might use a pip value table based on the current price level.

This universal calculation method ensures you can quickly and accurately determine your profit or loss in the quoted currency (often USD) without needing to perform multiple conversions manually.

currency pair	Point value calculation
USDCHF	10 / P_Close
USDCAD	10 / P_Close
USDJPY	1000 / P_Close USD
USDSEK	100/ P_Close

In FOREX trading, the calculation of financial results (profits or losses) based on the change in exchange rates, as described above, plays a vital role in determining whether a trade is successful. Let’s break down the key elements to ensure that you fully understand how these calculations work, the role of margin, and the types of orders that traders use to manage risk and lock in profits.

1. Margin and Leverage

To execute a trade on the FOREX market, a trader needs to have a sufficient level of margin in their account. This is essentially the collateral required by the broker to open a trading position.

• For reverse currency pairs (like USD/JPY), the margin requirement depends on the current exchange rate because the quote currency is variable.
• For direct currency pairs (like EUR/USD), the required margin is often fixed and set to a standard amount like $1,000 USD per standard lot (100,000 units).

Leverage and Credit in Margin Trading:

• Leverage allows traders to control larger positions than their actual account balance. For example, with 1:100 leverage, a trader can control a position size of $100,000 with just $1,000.
• If the required margin exceeds the trader’s available balance by up to $500, the FOREX broker may automatically extend credit to cover the missing amount and allow the trader to open the position.

2. Orders in FOREX Trading

Traders use various orders to control the entry and exit of positions in the market. Here are the main types of orders:

• Market Order: This is an instruction to buy or sell a currency pair at the current market price. It is executed immediately at the broker’s available quote.
• Limit Order (Take Profit): This order automatically closes the trade when the market reaches a specified profit target. For example, in a buy position, a limit order is placed above the current market price to lock in profits. For a sell position, the limit order would be set below the current price. The limit order is typically set at least 15 pips away from the current price to avoid premature closures.

3. Stop Orders (Stop Loss)

To protect against unnecessary losses, traders use stop orders (often called Stop Loss orders). These orders automatically close a position when the market moves against the trader by a specified number of pips.

• For a buy position, the stop order is set below the current market price.
• For a sell position, it is placed above the current price.

The use of stop orders allows traders to set a maximum risk on each trade, which is essential in managing their overall capital and risk exposure.

4. Example of Profit Calculation with Margin

Let’s assume a trader has an account balance of $1,300 USD and opens a buy position on EUR/USD at a rate of 1.1345 with a standard lot of 100,000 units. The margin required for this trade would be $1,134.50 USD.

• Initial Position: +100,000 EUR / -113,450 USD (buying 100,000 EUR for 113,450 USD).
• Closing Position: If the EUR/USD rate rises to 1.1410, the trader closes the position: -100,000 EUR / +114,100 USD.
• Profit: The difference is 114,100 USD – 113,450 USD = 650 USD profit. The final account balance would be $1,950 USD.

This example demonstrates how margin, leverage, and market orders work together to allow traders to manage large positions with relatively small initial capital, while also showcasing the critical importance of using limit and stop orders to manage risk and lock in profits.

A Stop Order is a crucial tool in managing risk in the FOREX market. It allows traders to set a predefined price level at which an open position will be automatically closed to minimize losses or lock in profits. Here’s a breakdown of how stop orders and other important trading mechanisms work:

1. Stop Order Details

• Buy Position: A stop order is set 15 points below the current price, ensuring that the trade is closed if the market moves against the buy position by 15 points.
• Sell Position: A stop order is set 15 points above the current price, providing protection if the market rises, moving against the sell position.

These stop orders remain in place either until they are executed (when the price is reached) or the client cancels the unexecuted order.

2. Pending Orders (GTC – Good Till Cancelled)

A pending order allows the trader to open a position at a specific price level. This order stays active indefinitely until it is either executed or cancelled by the trader. For pending orders:

• The set price must be at least 15 points away from the current market price to prevent immediate execution.
• Pending orders allow traders to target specific price levels without needing to monitor the market constantly.

3. Capital Management in FOREX

Proper capital management is fundamental to success in trading. It involves:

• Reasonable allocation of funds: This means not over-leveraging and ensuring that trades are proportionate to the account balance.
• Minimizing risk through hedging: Hedging is a technique where a trader opens a second position in the opposite direction to offset potential losses from the original position.
• Effective stop commands: Strategically placing stop orders ensures that traders can exit losing positions promptly to minimize damage to their capital.

4. Hedging in FOREX

Hedging is a technique that allows traders to neutralize risk by opening offsetting positions. Here’s how it works:

• A trader with an open buy position can hedge by opening a sell position of the same size on the same currency pair. This effectively locks in the current value, ensuring that no matter how the market moves, the trader’s overall risk is mitigated.
• No additional margin is required to open the hedging position, making it an accessible strategy for risk management.

Hedging enables traders to protect their positions from sudden adverse price movements, while stop orders and pending orders provide control over how and when positions are executed or exited. This blend of tools is essential for survival and success in the highly volatile and competitive FOREX market.

In FOREX trading, the Swap Tom/Next (also known simply as swap) refers to the process of transferring an open position from one trading day to the next, usually through an automatic rollover. This process can involve a fee or a credit, depending on the currencies involved and the direction of the trade.

How the Swap Works:

• Duration of Position: A position can remain open for as long as a trader desires, whether for a few minutes or several days. However, keeping a position open overnight can incur fees or provide credits, depending on the circumstances.
• Interest Rate Differential: When you hold a position overnight, you are essentially borrowing one currency to buy another. The swap rate reflects the difference between the interest rates of the two currencies involved in the trade.
  • If you buy a currency with a higher interest rate and sell a currency with a lower interest rate, you will receive a payment.
  • Conversely, if you sell a currency with a higher interest rate and buy a currency with a lower interest rate, you will pay a fee.

Swap Calculation and Timing:

• Daily Swap Fee: The fee or credit is calculated daily at 00:00 GMT+2 (broker server time). Even if the position is opened moments before midnight and closed just after, the swap fee will still be charged or credited.
• Triple Swap Wednesday to Thursday: When moving a position from Wednesday to Thursday, the swap fee or credit is tripled. This compensates for the fact that the market is closed on weekends, but interest rates still apply.

Example:

1. Long Position (Buy): If you go long on a currency pair where the base currency (the one you are buying) has a higher interest rate than the quoted currency (the one you are selling), you might earn a small interest payment for holding the position overnight.
2. Short Position (Sell): If you sell the currency with the higher interest rate and buy the one with the lower interest rate, you will likely have to pay to hold that position overnight.

Key Points:

• Accrual or Deduction: The swap is either deducted from or added to your account at 00:00 GMT+2, based on the interest rate differential of the currency pair.
• Trading from Wednesday to Thursday: The tripling of the swap rate accounts for the weekend when markets are closed but interest rates still accumulate.
• Time of Opening/Closing: The exact time a position is opened or closed can determine whether or not the swap applies. If the position is held past midnight (broker time), the swap fee is applied, regardless of how short the holding time is.

Understanding swap rates is crucial for traders who hold positions overnight. Knowing whether you’ll incur a charge or receive credit can help in strategic decision-making, especially when trading currency pairs with large interest rate differences.

Forced Closure of a Position in Forex

In the Forex market, a forced closure (also known as a margin call) occurs when your broker closes your open positions because your account equity (the value of your account) has fallen below the required margin level. This process is automatic and aims to protect both the trader and the broker from potential losses that exceed the trader’s initial deposit.

Key Points:

1. Equity and Account Monitoring:
   • Your equity is the value of your trading account, which fluctuates as the market moves. Equity includes your initial deposit plus any profits (or losses) from open positions.
   • Brokers constantly monitor your account to ensure that the equity is sufficient to cover the required margin for open positions.
   • If your equity falls too low due to market movements, the broker may forcibly close your positions to prevent further losses.
2. Required Margin:
   • The required margin is the amount of money you need to maintain an open position. This margin acts as collateral for the broker.
   • Each broker sets a minimum margin requirement, typically expressed as a percentage of the margin needed to maintain the position. For instance, if your margin requirement is 30%, your equity must be at least 30% of the total required margin to keep the position open.
3. Margin Call:
   • A margin call occurs when your account’s equity drops to the minimum margin requirement.
   • For example, if your open positions require $1,000 in margin and your broker has a 30% margin requirement, you need at least $300 in equity to maintain the position.
   • If your equity falls below this threshold, the broker may issue a margin call and either ask you to add more funds or automatically close your positions at the current market price.
4. Reasons for Forced Closure:
   • Insufficient Equity: If your account’s equity is not sufficient to meet the margin requirement due to adverse price movements, the broker will close positions to limit potential losses.
   • No Additional Funds: If you do not deposit additional funds when your margin level reaches critical limits, your broker will act to protect both your capital and theirs.
5. How to Avoid Forced Closure:
   • Position Size: Avoid opening positions that are too large relative to your deposit. Using excessive leverage increases the risk of rapid equity depletion.
   • Stop Orders: Set Stop Loss orders to automatically close positions if the market moves against you. This can help mitigate losses and prevent reaching the margin call level.
   • Timely Action: Monitor your trades regularly and close unprofitable positions before your account falls below the margin requirement.
   • Deposit Replenishment: Keep enough funds in your account to maintain a healthy margin level, especially if the market is volatile.

Example:

Suppose you open a position with a margin requirement of $1,000 and a margin level of 30%. If your account equity drops to $300 or below due to market fluctuations, the broker will either issue a margin call or automatically close your position to prevent further losses. This ensures that the broker is not liable for any excess losses beyond the funds in your account.

Forced closures are designed to protect traders from losing more than they have deposited, but managing risk through proper position sizing and stop-loss strategies can help prevent such situations.

To prevent forced closure, you should not open positions that are too large for your
deposit, you should close unprofitable positions in a timely manner; it is recommended to place Stop orders or replenish the deposit in a timely manner.

You can read other chapters.

This post is also available in: English Українська Portuguese Español Deutsch Chinese Русский Français Italiano Türkçe 日本語 한국어