Forex Trading Guide
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A guide to trading the forex markets sponsered by Spreadex. |
Forex Trading Guide
The forex market is both the largest and the most volatile financial market in the world.
According to the Bank for International Settlements, it has an average daily turnover estimated at $3.98 trillion. The forex trading market – also known as currency trading, foreign exchange or FX – was originally closed to individual traders, and was reserved for multi-national corporations and global banks.
That has now changed and with Spreadex, as well as nearly all other spread trading companies and CFD brokers, you can trade on a broad range of forex pairs.
Forex Trading Guide: The Global Forex Market
According to the 2010 BIS forex survey:
- In April 2010 global forex turnover was 20% higher than in April 2007, with the average daily turnover rising from $3.3 trillion to $4.0 trillion.
- The primary increase was driven by short-term trading which, in terms of turnover, grew by 48%. ‘Spot’ transactions now represent 37% of global turnover, rising from $1.0 trillion in April 2007 to $1.5 trillion in April 2010. In relation to spread trading and CFDs, read ‘spot’ as a daily market rather than a futures market.
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With regards to the various parties trading the forex markets, the higher turnover is associated with the increased activity of ’other financial institutions’ - these include, but are not limited to, non-reporting banks, pension funds, hedge funds, insurance companies, mutual funds and central banks.
Turnover by this group of ’other financial institutions’ grew by 42%, increasing from $1.3 trillion in April 2007 to $1.9 trillion in April 2010.
- The 2010 survey showed how the EUR/USD market eclipsed all other currency pairs:
- EUR/USD: accounted for 28% of all forex turnover
- USD/JPY: 14%
- GBP/USD: 9%
- No other pair accounted for more than 6%
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As a percentage share of overall turnover, the US dollar has continued its decline since the April 2001 survey. The euro and Japanese yen have gained relative to April 2007.
Looking at the 10 most traded currencies, the Canadian and Australian dollars both increased market share and the Swiss franc and sterling lost ground. Certain emerging market currencies became far more popular and the largest increases were seen with the Korean won and Turkish lira based pairs.
- Forex trading activity has become increasingly global. Cross-border transactions represented 65% of trading activity in April 2010 and local transactions accounted for 35%.
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The UK remains the number one forex market with UK based banks accounting for 36.7% of the entire market. This is a small increase on 2007 when the UK accounted for 34.6%.
- UK: accounted for 36.7% of turnover
- US: 18%
- Japan: 6%
- Singapore: 5%
- Switzerland: 5%
- Hong Kong: 5%
- Australia: 4%
- All other countries accounted for 3% or less
Forex Trading Guide: What Markets Can You Trade?
You can trade many forex spreads pairings however it’s estimated that 95% of trading is carried out on the 10 major currency pairings of: EUR/USD, GBP/USD, USD/JPY, AUD/USD, USD/CHF, NZD/USD, USD/CAD, GBP/JPY, EUR/JPY and EUR/GBP.
It’s also worth noting that some currencies such as the Chinese Yuan (aka Renminbi) are not free floating. Therefore whilst China is the second largest economy in the World, as of 2011, it is difficult to trade Yuan based pairs.
Forex Trading Companies
Forex spread trading does come with risks (see below) however it also offers a convenient way of accessing a huge range of FX pairs. The companies detailed below all offer a wide range of forex markets.
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| GBP / USD Daily - Spread Size |
2 |
2 |
2 |
2 |
3 |
0.8 |
2 |
2 |
| GBP / USD Daily - Min Stake |
£1 |
£0.50 |
£0.50 |
£1 |
£0.5 |
£1 |
£1 |
£1 |
| GBP / USD Future - Spread Size |
8 |
8 |
12 |
8 |
8 |
- |
8 |
8 |
| GBP / USD Future - Min Stake |
£1 |
$0.60 |
£1 |
£1 |
£1 |
- |
£1 |
£1 |
| EUR / GBP Daily - Spread Size |
1 |
2 |
2 |
1 |
1 |
1 |
1 |
1 |
| EUR / GBP Daily - Min Stake |
£1 |
£0.50 |
£0.50 |
£1 |
£0.5 |
£1 |
£1 |
£1 |
| EUR / GBP Future - Spread Size |
6 |
8 |
10 |
6 |
6 |
- |
6 |
6 |
| EUR / GBP Future - Min Stake |
£1 |
$0.60 |
£1 |
£1 |
£0.5 |
- |
£1 |
£1 |
| EUR / USD Daily - Spread Size |
1 |
1 |
1 |
1 |
2 |
0.8 |
1 |
1 |
| EUR / USD Daily - Min Stake |
£1 |
£0.50 |
£0.50 |
£1 |
£0.5 |
£1 |
£1 |
£1 |
| EUR / USD Future - Spread Size |
8 |
8 |
12 |
8 |
8 |
3 |
8 |
8 |
| EUR / USD Future - Min Stake |
£1 |
$0.60 |
£1 |
£1 |
£1 |
£1 |
£1 |
£1 |
| USD / JPY Daily - Spread Size |
1 |
2 |
1 |
1 |
2 |
0.8 |
1 |
1 |
| USD / JPY Daily - Min Stake |
£1 |
£0.50 |
£0.50 |
£1 |
£0.5 |
£1 |
£1 |
£1 |
| USD / JPY Future - Spread Size |
8 |
8 |
12 |
8 |
10 |
- |
8 |
8 |
| USD / JPY Future - Min Stake |
£1 |
¥100 |
£1 |
£1 |
£0.5 |
- |
£1 |
£1 |
Comparison Notes
Forex Trading Guide: The Basics of Forex Trading
According to Spreadex, “One of the most fundamental factors to remember when spread trading is that if you are speculating on the first named currency in the pair to rise in value, you would place ‘buy’ a trade on that forex pair. If you, however, expected the first named currency to fall in value then you would place a ‘sell’ trade on that pair.
For example, if you predict that the pound will rise versus the US dollar then you would ‘buy’ the sterling/dollar pair. Therefore you could place a £2 buy trade on a Spreadex quote of $1.5650-$1.5653 (ie buy the market at $1.5653).
If you predict sterling will fall versus the US Dollar then you would ‘sell’ sterling/dollar pair at $1.5650.
Another factor to remember is that the spread is often based on movements of 0.0001 of the currency. Note that dollar/yen market is based on movements of ¥0.01.
Given that forex movements can be particularly volatile, this can result in potentially large swings which would mean large profits, or of course large losses. You should, therefore, ensure that you have stop losses in place to help limit your potential downside.
With the sterling/dollar example above you would make a profit of £2 for every $0.0001 the currency pair moves up and lose £2 for every $0.0001 that the pair falls.
When trading Spreadex markets, you are required to have an available trading balance of 100 x the size of your stake to cover the potential downside. So, based on the £2 stake size in the example above, you would be required to have £206 available as a trading balance if you wish to place the trade (as it would be 100 x your £2 stake [£200], plus 3 pips x £2 [£6])”.
Forex Trading Guide: Spot, Rolling and Futures Markets
You can place forex trades on both Spreadex spot and future prices. Spot prices have tighter spreads (which gives you greater value on your spread trade), however will incur a rolling charge, should you wish to keep your trade open overnight.
With Spreadex prices you would need to ensure that you have your preferences set so your spot currency trade will roll overnight. Future forex spreads are wider, which normally suggests lower value, however you would not incur a rolling charge. It is therefore up to you to choose which represents better value to you and your spread trade.
Note that with spread trading firms like FinancialSpreads.com you trade ‘Rolling Daily’ markets rather than ‘Spot’ markets.
Rolling Daily markets normally also offer tighter spreads. With a rolling daily market there is no closing date for this market. If a trade is still open when the markets close at the end of the day, it simply keeps rolling over into the next trading session.
If you allow your trade to roll over and are speculating on the market to:
- Move higher - then you are usually charged a small overnight financing fee, or
- Move lower - then you will normally receive a small credit to your account
For a more detailed example see Rolling Daily trades.
Forex Trading Guide: How to Trade
Looking at the Capital Spreads website, they are valuing the euro/dollar rolling daily market at $1.44750 - $1.44760. As a result, you could take a position on the euro/dollar rate to:
- Rise above $1.44760, or
- Fall below $1.44750
When spread trading on euro/dollar you trade in £x per point where a point is $0.00010 of the pairs movement.
As a result, if you decide to have a stake of £4 per point and euro/dollar moves $0.00050 then that would make a difference to your P&L of £20. £4 per point x $0.00050 = £4 per point x 5.0 points = £20.
Euro/Dollar Trading Example
If we think about the spread of $1.44750 - $1.44760 and make the assumptions:
- you have done your analysis of the foreign exchange markets, and
- you think that the euro/dollar rate will push higher than $1.44760
then you may decide to buy at $1.44760 for a stake of, for example, £2 per point.
With such a trade you make a profit of £2 for every point ($0.00010) that the euro/dollar forex pair pushes above $1.44760. Having said that, it also means that you will make a loss of £2 for every point that the euro/dollar market moves below $1.44760.
Looking at this from another angle, with spread trading, if you were to buy a market then your P&L is calculated by taking the difference between the final price of the market and the price you bought the spread at. You then multiply that difference in price by the stake.
With this in mind, if after a few trading sessions the FX pair rose then you might consider closing your trade so that you can guarantee your profit.
So if the market moved up then the spread could change to $1.45411 - $1.45421. To close your trade you would sell at $1.45411. Accordingly, with the same £2 stake you would make a profit of:
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Profits (or losses) = (Settlement Level - Initial Level) x stake
Profits (or losses) = ($1.45411 - $1.44760) x £2 per point stake
Profits (or losses) = $0.00651 x £2 per point stake
Profits (or losses) = 65.1 points x £2 per point stake
Profits (or losses) = £130.20 profit
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Speculating on FX, whether by CFD trading, spread trading or otherwise, is not straightforward. In this case, you wanted the forex rate to go up. Naturally, the currency rate can also decrease.
If the euro/dollar market had fallen then you could close your position to limit your losses.
So if the market pulled back to $1.44181 - $1.44191 you would sell back your position at $1.44181. Therefore, you would make a loss of:
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Profits (or losses) = (Settlement Level - Initial Level) x stake
Profits (or losses) = ($1.44181 - $1.44760) x £2 per point stake
Profits (or losses) = -$0.00579 x £2 per point stake
Profits (or losses) = -57.9 points x £2 per point stake
Profits (or losses) = -£115.80 loss
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Note: euro/dollar rolling daily market accurate as of 05-Jul-11.
Forex Guide to Technical Analysis
Many traders use technical analysis to predict whether a market is likely to rise or fall.
Companies like Spreadex and Financial Spreads offer free charting tools to help show Support and Resistance levels for different pairs.
There are a range of different signals that traders look out for including Reversal Patterns and Continuation Patterns.
- Reversal Patterns - these indicate the likelihood of a given trend reversing and typically involve the formation of:
- Head and Shoulders (Tops)
- Head and Shoulders (Bottoms)
- Double Tops
- Double Bottoms
- Triple Tops
- Triple Bottoms
- Continuation Patterns – these indicate whether a trend is likely to continue its current levels of momentum. Typical examples include the formation of:
- Flags
- Pennants
- Triangles
- Wedges.
For the latest technical analysis see Forex Technical Analysis.
Forex Trading Guide: Risks
If you are trading the forex markets through FX spread trading, CFDs or ‘margined Forex’ then be aware that these are all leveraged financial products and they come with high levels of risk.
You may incur losses which are greater than your original stake. Ensure that you only speculate with funds that you can afford to lose. Make sure you understand the risks involved when trading with these investment products. It is important to note that these products might not be suitable for your investment needs. Where appropriate, obtain independent investment guidance.
Forex Trading Guide: Daily News and Analysis
For the latest daily news, views and analysis of the forex markets see:
Forex Trading Guide: Market Influences
There are a wide variety of factors that can influence the value of one currency versus another, these include:
- Inflation - Countries with consistently lower levels of inflation will often experience a rising currency value. Likewise those countries with higher levels of inflation will typically see the value of their currency fall.
- Interest Rates - High interest rates will often attract overseas investment and capital if an opportunity exists for a higher return relative to other currencies. Therefore high interest rates can drive up the value of a given currency. Note however that high inflation can also counteract a rise in value.
- Public Debt - Countries with high levels of public debt are often less attractive to overseas investors. These countries will sometimes encourage inflation and run the risk of defaulting on their debt obligations, as such they end up with a poor debt rating. This can then devalue the local currency.
- Terms of Trade - This is linked to the country’s current account and its balance of payments. The terms of trade compares import and export prices. If the price of exports rises by more than the price of imports, a country may see its currency rise.
- Political Stability / Economic Performance - Countries that are stable and have a strong economic performance will be more likely to attract overseas investment than less stable countries. Political turmoil and/or instability will often result in the relevant currency losing value.
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Financial Spreads
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Risk Warning: Spread trading carries a high level of risk to your capital. You may lose more than your initial investment. It may not be suitable for all investors. Only speculate with money that you can afford to lose. Please ensure you fully understand the risks involved and seek independent financial advice where necessary.
'Forex Trading Guide' by DB, updated 17-May-12
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