Lesson 2: Still packing the tools…

Welcome again!
Of course having ploughed through a boring list of definitions is nobody's idea of fun however by now we have some Lingo under our belts and can now look at what Forex is, and its role in the market, Forex order types, and then have a cursory view of the systems used by Traders.

So what is Forex Essentially?

Forex, or FX, of course stands for the FOReign EXchange market.
This is a 24-hour or spot market in which currencies are traded in cash.
Stock trading has long been associated with investment strategies on world markets.
This trend is changing and in many traders eyes the stock market has become speculative. As essentially speculators then, traditional “investors" and traders now view Forex as a more viable and profitable alternative.
The general market expectation is that as a result of the difficulties in finding profitable stocks to trade in, as a result of the negative impact that the Global crisis has had especially on equities, the forex markets will benefit as traders view them as increasingly alluring.
The Forex markets are not a daily market event, they are THE EVENT!
What many Traders realize is that the global foreign exchange market is now the largest, most active market in the world.
Trading in the forex markets takes place nearly round the clock with about $2 trillion changing hands every day.
The reasons for the excitement and huge conversion to this market are many as currency trading offers benefits that the traditional stock markets don't. Here are a few:

• Greater leverage.

  With proper risk management, for example, traders control larger positions with smaller amounts of capital, thus also allowing trades of the same size positions you might take with a stock broker, which should leave you with more available capital to trade more markets , In currency trading you can use profits to trade and to add to you're positions.
  

• Costs savings on fees and commissions and quick access

  With no broker and exchange to deal with, currency traders access the markets online quickly and deal directly with the buyer or seller of the currency pair. In currency trading you do not have to worry about extra charges. All the Trader pays is the spread!
  

• A large liquid market

  Large volumes translate to reduced exposure to susceptibility of large purchases and sales of a stock as is the case with stock trades, as the likelihood is slimmer of any particular fund or entity taking control of a currency. Incomparable liquidity is one of many advantages that forex markets hold over for example, currency futures.
  

• A simplified range of trade.

  In spot currency trading, Traders generally concentrate on buying or selling 4 major currency pairs – EUR/USD, GBP/USD, USD/JPY and USD/CHF. Of course there are second-tier currencies too.  A trader can concentrate for example on the EUR/USD whereas a stock trader would have to really research 1000's of stocks on the traditional exchanges. Most traders though are likely to be more profitable with less volatile range-bound pairs like EUR/CHF, EUR/ GBP and AUD/NZD rather than trade pairs with larger swings such as the GBP/USD. Remember too, that when trading cash markets, you have access to the same margin rates day and night.
  

Forex markets utilize easily understood and universally used terms and price quotes

Trades require no forward component that takes into account a time factor, interest rates and the interest differentials between various currencies, adjustments, mathematical manipulation or consideration for the interest rate component such as is the case with of futures contracts.
Forex trade is conducted "over-the-counter" through an international network of dealers with no standard trading center.
In recent times the forex market was confined to larger traders and limited to international commercial and investment banks and corporations and international money brokers and currency traders.

What are Exchange rates?

The rate at which currencies are exchanged is called the exchange rate.
Currencies are traded in pairs and exchanged one against the other when traded.
Most currencies are traded against the US dollar (USD). Then we have the next four next-most traded currencies being: The Euro (EUR), the Japanese yen (JPY), the British pound sterling (GBP) and the Swiss franc (CHF). A few Traders would also include the Australian dollar (AUD) within this group.
All told these currencies make up the majority of the market. For this reason they're referred to as the major currencies or "the Majors".
Bearing in mind the exchange pair is made up of two currencies:
The first currency in the pair is known as the base currency;
The second currency is known as the counter term or quote currency.
The quote currency is the numerator in the ratio, and the base currency is the denominator.
It is essential to know that the value of the base currency (denominator) is always 1.
A buyer will know how much of the counter term or quote currency must be paid to obtain one unit of the base currency by referring to the exchange rate.
A seller will know how much is received in the counter term or quote currency, when selling one unit of the base currency, by referring to the exchange rate.
For example, an exchange rate for USD/JYP of 1.301 specifies to the buyer of Japanese Yen that 1.301 USD must be paid to obtain 1 Yen.
An important point to remember, dear traveler, is that should  an investor buy any currency and immediately sell it, irrespective of any given point, time and place, and no change in the exchange rate has occurred, that hapless investor will lose money.
There's a simple explanation for this:  the bid price, representing how much will be received in the counter or quote currency when selling one unit of the base currency, will always be lower than the ask price,  representing how much must be paid in the counter or quote currency when buying one unit of the base currency.
Let's look at an example to wrap our heads around this:
The USD/JPY bid/ask currency rates at the bank may be 1.3030/1.4030, representing a spread of 1000 pips (also referred to as points, one pip being 0.0001).
In this example the spread would be very high when compared to the bid/ask currency rates that online Forex investors would normally encounter, such as 1.2025/1.2030, with a spread of 5 pips.
As a Forex Trader you would be inclined to consider smaller spreads as better than the larger spreads since they would require a smaller movement in exchange rates in order for the investor to profit from a trade.

What are Margins?

The collateral that Banks and/or online trading providers need to ensure that the investor can pay in case of a loss is called the margin. Forex markets also refer to it as minimum security.
When trading a deposit is made by the Trader to it's account with the intention to cover any currency trading losses in the future.
The advantage for private Traders or investors is that a Margin will allow such Traders to trade in markets with high minimum units of trading by enabling traders to hold a much larger position than their account value.
Margin trading can also benefit theTrader by increasing it's rate of profit, however this form of trading can also increase the rate of loss should the trader make the wrong decision.

What is Leveraged financing?

Leveraged financing is commonly used in the Forex Market and is the use of credit, such as a trade purchased on a margin.
The Traders initial deposit in the margined account is used as collateral thus leveraging the Loan.
Through leveraging, USD 2,000 for instance, could be used to control USD 200,000.

How do Private investors/Traders like ourselves Trade in Forex?

We can trade in Forex directly or indirectly in three ways:

1. The spot market

   A straightforward exchange of one currency for another is called a spot transaction.
   The current market price is called the spot rate or the benchmark price.
   One might think that spot transactions require immediate settlement, or payment "on the spot." This is not so.
   The second business day after the "deal date" (or "trade date") is called the settlement date, or "value date", as this is the date on which the transaction is agreed to by the two traders.
   This delay by two days, allows the parties time to confirm the agreement and arrange the clearing and necessary debiting and crediting of bank accounts in various international locations.
   

2. Forwards and futures

   An agreement between two parties in terms of which one buys a currency at a particular price by a certain date that is greater than a spot transaction (two business days), is called a forward transaction.
   A forward contract with fixed currency amounts and maturity dates is called a future contract.
   These contracts are not traded through the interbank foreign exchange market but rather, on future exchanges.
   Forwards are estimated to make up about just under half of all currency trading.
   

3. Options

   Currency Options involve a fixed currency transaction at some future date in time, and in this respect are similar to futures contracts.
   Unlike a futures contract though, the buyer of the currency option is only purchasing the right but not the obligation to purchase a fixed amount of currency at a fixed price by a certain date in future.
   Remember, that should the buyer not exercise the option, the price (also known as the premium) is lost.
   

What are the Risks when we Trade Forex?

Forex trading can be very profitable but there are definitely risks such as Exchange rate risks, Interest rate risks, Credit risks, and Country risks.
A typical trade has a very short lifespan. It is for this reason that Technical indicators heavily influence entry, exit and order placement decisions.
Bear in mind that this is a market best suited to people less averse to risk. This course will attempt to equip you with tools necessary to avert risk with varying degrees of success and in the final analysis, your decisions, based on your trade experience, will guide you as to the possible degree of risk you face with each trade.
It is estimated that more than 40% of all currency transactions last fewer than two days, while approximately 80% last a period of seven days or less.
As a FOREX trader you need to define your personal financial objectives and if necessary be able to absorb financial losses and not have to invest any money you are not able to lose.
It is of course imperative that you know the market, the systems and platforms in order to trade profitably.
At this point I must congratulate your persistence! As we are learning we get closer to our ultimate goal, having taken a few necessary steps in our journey.
I look forward to our next lesson eagerly as we can now tie down our travel kit with the necessary bands and zips and whatever else we need use to set ourselves on course.