Forex Education

forex-education

History

Forex, or FX, is a shortened term that describes the Foreign Exchange Market, a marketplace where the world’s various currencies are traded. It is an interbank market which was created in 1971 when international trade transitioned from fixed to floating exchange rates. As a result of its incredible volume and fluidity, the FX market has become the largest and most significant financial market in the world.It means that it is a decentralized, self-regulated market with no central exchange or clearing house, unlike stocks and futures markets. This structure eliminates fees for exchange and clearing, thereby reducing transaction costs.The Forex OTC market is formed by different participants – with varying needs and interests – that trade directly with each other. These participants can be divided in two groups: the interbank market and the retail market.

• Forex markets operate 24 hours a day.

• Superior liquidity: the daily turnover of the FX market – over 4 Trillion Dollars – makes it easy to trade most currencies instantaneously.

• There are standard instruments available to help you control risk exposure.

• Excellent Transparency: the Forex Market is transparent… you just need to keep yourself informed.

The Exchange Rate.

Forex plays the indispensable role of determining global exchange rates. The exchange rate is the number of units of one nation’s currency that must be exchanged in order to acquire one unit of another nation’s currency. A market exchange rate between two currencies is determined by the interaction of the official and private participants in the foreign exchange rate market.

Market Participants.

The main participants in the Forex market are: central banks, commercial banks, financial institutions, hedge funds, commercial companies and individual investors.

The Interbank Market.

The interbank market designates Forex transactions that occur between central banks, commercial banks and financial institutions.

  • Central Banks – National central banks (such as the US Fed and the ECB) play an important role in the Forex market. As principal monetary authority, their role consists in achieving price stability and economic growth. To do so, they regulate the entire money supply in the economy by setting interest rates and reserve requirements. They also manage the country’s foreign exchange reserves that they can use in order to influence market conditions and exchange rates.
  • Commercial Banks – Commercial banks (such as Deutsche Bank and Barclays) provide liquidity to the Forex market due to the trading volume they handle every day. Some of this trading represents foreign currency conversions on behalf of customers’ needs while some is carried out by the banks’ proprietary trading desk for speculative purpose.
  • Financial Institutions – Financial institutions such as money managers, investment funds, pension funds and brokerage companies trade foreign currencies as part of their obligations to seek the best investment opportunities for their clients. For example, a manager of an international equity portfolio will have to engage in currency trading in order to buy and sell foreign stocks.

The Retail Market

The retail market designates transactions made by smaller speculators and investors. These transactions are executed through Forex brokers who act as a mediator between the retail market and the interbank market. The participants of the retail market are hedge funds, corporations and individuals.

  • Hedge Funds – Hedge funds are private investment funds that speculate in various assets classes using leverage. Macro Hedge Funds pursue trading opportunities in the Forex Market. They design and execute trades after conducting a macroeconomic analysis that reviews the challenges affecting a country and its currency. Due to their large amounts of liquidity and their aggressive strategies, they are a major contributor to the dynamic of Forex Market.
  • Corporations – They represent the companies that are engaged in import/export activities with foreign counterparts. Their primary business requires them to purchase and sell foreign currencies in exchange for goods, exposing them to currency risks. Through the Forex market, they convert currencies and hedge themselves against future fluctuations.
  • Individuals – Individual traders or investors trade Forex on their own capital in order to profit from speculation on future exchange rates. They mainly operate through Forex platforms that offer tight spreads, immediate execution and highly leveraged margin accounts.

FOREX TRADING EXAMPLES.

Compiled below are Forex trading examples. Please note that these are just examples; be aware that trading Forex is speculative and involves significant risk.

USD/CHF Trading Example

An investor deposits $10,000 in a IBR Broker Trading Account.

The account is set to 0.5% margin or 200:1 Leverage. This means that for one lot opened of 100,000 the investor must maintain at least $500 in Margin (= 100,000 x 0.5%).

The investor expects the US dollar to rise against the Swiss franc and therefore decides to buy $ 100,000 of the USD/CHF pair.

Day 1 – USD/CHF Quotes = 1.0147-1.0150

The market quotes USDCHF 1.0147-1.0150. The investor buys USD at 1.0150 against CHF.

By doing this, he commits in the simultaneous buying of USD 100,000 (1 lot of $100,000) and the selling of CHF 101,500 (= $100,000 x 1.0150) by using $500 as a Margin (= $100,000 x 0.5%) and borrowing USD 99,500 from IBR Broker (= $100,000-$500)

  • Transaction Flows Report – Day 1

    Account NameCredit/DebitDay 1Comment
    USD AccountCUSD +100,000$100,000 Investment
    CHF AccountDCHF -101,500# lots (1) x lot value ($100,000) x USDCHF Quote (1.0150)

  • Client Account Report – Day 1

    Balance (USD)Equity (USD)Lots Open #Used Margin (USD)Usable Margin (USD)
    $10,000$10,00020$500$9,500
    (1)(2)(3) (4)(5)

(1) Balance = Deposit ($10,000) + Sum of Realized Profit & Loss ($0) = $10,000

(2) Equity = Balance ($10,000) + Sum of Unrealized Profit & Loss ($0) = $10,000

(3) # Lots open = Investment ($100,000) / Value of one lot ($100,000) = 1 lot

(4) Used Margin = # Lots open (1) x Value of one lot ($100,000) x Margin (0.5%) = $500

(5) Usable Margin = Equity ($10,000) – Used Margin ($500) = $9,500

Day 2-USD/CHF Quotes = 1.0300-1.0303

  • The US dollar has risen and the USD/CHF quotes 1.0300-1.0303.

The investor decides to take his profit and enters a sell market order in the Market trading platform. The order is  executed instantaneously and the investor sells 1 lot of USDCHF at 1.0300.

By doing this, he commits in the simultaneous selling of USD 100,000 (1 lot at $100,000) and the buying of CHF 103,000 (= $100,000 x 1.0300).

  • Transaction Flows Report – Day 2

Account NameCredit/DebitDay 1Day 2Comment
USD AccountDUSD +100,000USD -100,000Sell # lots (1) x lot value ($100,000)
CHF AccountCCHF -101,500CHF +103,000Buy # lots (1) x lot value ($100,000) x USDCHF Quote (1.0300)

The dollar side of the transaction involves a credit and a debit of USD 100,000, the investor’s USD account will show no  change.

The CHF account will show a debit of CHF 101,500 and a credit of CHF 103,000. This results in a profit of CHF 1,500 =  approx. USD 1,456 (= CHF 1,500 / 1.0303) which represents a 14.56% profit on the deposit of USD 10,000.

  •  Client Account Report– Day 2 (AFTER TRADE EXECUTION)

Balance (USD)Equity (USD)Lots Open #Used Margin (USD)Usable Margin (USD)
$11,456$11,4560$0$11,456
(1)(2)(3) (4)(5)

(1) Balance = Deposit ($10,000) + Sum of Realized Profit & Loss ($ 1,456)= $11,456

(2) Equity = Balance ($11,456) + Sum of Unrealized Profit & Loss ($0) = $11,456

(3) All positions are closed, therefore # Lots open = 0

(4) Used Margin = # Lots open (0) x Value of one lot ($5,000) x Margin (0.5%) = $0

(5) Usable Margin = Equity ($11,456) – Used Margin ($0) = $11,456

Note: For simplicity’s sake, we have disregarded the effect of difference in interest rate between USD and CHF over the 2-day period which would have marginally altered the profit calculation.

 


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