Forex

Foreign Exchange Market (Forex) is the arena where a nation's currency is exchanged for that of another at a mutually agreed rate. It was created in the 70's when international trade transitioned from fixed to floating exchange rates, and nowadays is considered to be the largest financial market in the world because of its tremendous turnover.

Probability of earning on Forex is based on the fact that every national currency is a good, as well as wheat or sugar, and a medium of exchange, as gold or silver. As the world is changing so fast, economic conditions of every country (production, inflation, unemployment etc) are getting more and more dependant on each other, as a result, the rate of a currency changes against other currencies. This is the main reason of the process of rate fluctuations.

All currencies are traded in pairs and each is assigned with an abbreviation.

Table 1. Currency Abbreviations

Currency exchange rate is the rate at which currencies are exchanged one for another. For example, «EUR/USD exchange rate is 1.2505» means that one Euro is exchanged for 1.2505 US Dollars.

The exchange rate of any currency is usually given as the Bid price (left) and the Ask price (right). The Bid price represents what will be obtained in the quote currency (US Dollar in our example) when selling one unit of the base currency (Euro in our example). The Ask price represents what has to be paid in the quote currency (US Dollar in our example) to obtain one unit of the base currency (Euro in our example). The difference between the Bid and the Ask price is referred to as the spread.

Table 2. 1.0 lot size for different currency pairs

Let’s assume that exchange rate for EUR/USD is 1.2505/1.2509. You may have made market analysis and decide the EUR/USD rate is moving higher (at least to 1.2600). You buy 0.1 lot (minimum contract size) of EUR/USD at the 1.2509 (ask price). Table 1 will help you to define what the contract size is: i.e. 1.0 lot for EUR/USD is 100 000 EUR, then 0.1 lot (our contract size) is 10 000 EUR.

This means that you bought 10 000 EUR and sold 10 000×1.2509=12,509 USD. So, in order to make a deal you don’t have to sell total amount of 12.509 USD but 100 times less just $125.09. The rest sum of the money (in our example $12,383.91) is leveraged to you by a broker (a company you entered the contract with to enter the market).

Leverage is the term used to describe margin requirements: the ratio between the collateral and borrowed funds: 1:20, 1:40, 1:50, 1:100. Leverage 1:100 means then when you wish to open a new position, then you must have deposit 100 times less then the contract size.

So, you forecast that EUR/USD is moving higher and you buy 10.000 EUR and sell 12.509 USD. Assume you are right and EUR/USD reaches 1.2599/1.2603. You close the open position by the opposite one, in our example, you close short position (sell position) by long position (buy position), i.e. you sell 10.000 EUR (0.1 lot* 1.0 lot size for EUR/USD) and buy 12.599 USD:

You get a profit of 90 dollars. And you didn’t operate with 10.000 EUR ($12,509), but only $125. So, the profit is 90 pips. Pips or point is a minimal rate fluctuation. For EUR/USD 1 pips is 0.0001 of the price (see table 2). Our profit is 1.2599-1.2509=0.0090, i.e. 90 pips.

So, you invested $125 and take a profit of $90. The time period for this can take from 10 minutes to several days. But anyway to make profit of $90 for several hours isn’t a bad return at all. But be aware, that all this can work against you and magnify your losses. Only money management will help you to minimize the risks, moreover to reduce them to zero, and increase the return of your funds from 10% to 20-30% and higher per month.

One question is left: what is broker’s charge for the leverage he provides? If you open and close a position till 2:00 Moscow time, a broker provides the leverage for free. If you leave your position after 2:00 Moscow Time, he credits to your account or debits from you account a storage — charge for the overnight position. It can be both positive (credited to your account!) and negative (debited from your account). It depends on the interest rates in those counties which currencies you trade.

For example, ECB interest rate is 4.25%, FED interest rate is 3.5%. Assume, you have a short position on EUR/USD per 1.0 lot. You sell 100.000 EUR. This means you borrow them at 4,25% per annum. You sell euro and buy dollars, which can be deposited at 3.5% per annum. As a result, the costs are (4.25-3.5)% per annum or 937.5 dollars per year (if EUR/USD rate is 1.2500), or $2.57 per day. This means that your account will be debited on $2.57 everyday per one lot if you have a short position (selling position) on EUR/USD. And your account will be credited $2.57 everyday per one lot if you have a long position (buying position) on EUR/USD.

In practice the debited amount is a bit higher than 2.57%, and the credited amount is a bit lower than 2.57%. The difference goes to a broker as a payment for the rollover (see Contract Specification).

Note: the storage for the rollover from Wednesday to Thursday is three time higher as a value date for a position opened on Wednesday is Friday. When you rollover your position from Wednesday to Thursday the value date should be in 3, but not 1 day, so it will be Monday.