The Forex Participant (2)

Central banks – they provide the currency security from its exchange rates considerable leaps causing economical crises as well as monitors the balance of export-import processes that can be generally called currency regulation. Exchange markets are under direct pressure from central banks. It can affect the market either by direct currency pressure which is the straight line affection or by varying the interest rates and money assets which is called indirect affection. As far as they can be interested in uptrends as well as downtrends due to the certain targets, they can not be called either bulls or bears. In case the aim of the central bank is to affect the national currency it acts alone in the forex market, but if it cooperates with other central banks their goal is likely a joint intervention or common currency policy. The key players in the sphere having the greatest influence are: Bundesbank (the central bank of Germany), Bank of England (the Great Britain), the central bank of the USA and Federal Reserve System (US Federal Reserve or just FED).

Foreign exchange markets are dependent on national central banks as well as the inflation, the interest rates, as well as the money support are under control of the latter. Sometimes there are some certain goals for the national central banks concerning their national currencies target exchange rates. As well as they possess their own substantial foreign exchange reserves, they can use these reserves for the purpose of economy stabilization. The stabilization strategy for the central banks offered by Milton Friedman is trading for profit which means buy as soon as the exchange rate gets too low and to sell in order it is too high. Though while the central banks do not have any risk of the bankruptcy in case of large losses, there is no reason for them to follow this strategy.

It is enough for the central banks to provide some rumor or expectations in order to make the currency stable but to the countries with an unstable currency policy it is possible to apply such methods as an aggressive intervention. Still, it doesn’t always let the central banks achieve their goals. Any central bank can be easily defeated by the combination of market resources. The 1992-93 ERM collapse has suffered various kinds of these operations as well as the South East Asia later.

Currency stock exchanges are the reality for the transitive economies. Legal person currency exchange and Forex exchange rate shaping are realized by the currency stock exchanges. Forex exchange rate is usually widely affected by the state due to the market density.

Forex broker firms – they provide the currency conversion or credit-depositary processes between the foreign currency purchaser and seller as well as the meeting of the above mentioned ones. The broker firms have their fee by charging the percent out of the operation sum.

The share of the retail brokers is insignificant in accordance with the general amount of foreign exchange market. A daily retail volume estimated by one broker is from $25 to $50 billion according to CNN-provided data which makes only about 2% of the whole volume. According to the National Futures Association official cited by CNN as well, “Retail forex trading has increased dramatically over the past few years. Unfortunately, the amount of forex fraud has also increased dramatically.” The retail forex makers generally work with two different trading desks. The first one called “non-dealing” desk is used for the actual foreign exchange trading and is generally traded by the proprietary. The second one called “dealing desk” or “trading desk” is used for traiding off-exchange with retail customers. As far as a great number of retail speculators of the currency are beginners and are hardly profit-making the “offset” of the clients’ trades on the interbank market is impossible as it’s asked by the makers that have to take the same position with the clients. The interbank market would have a stable income from the market makers in case all trades were offset. In case the market maker considers the net positions of its clients to be quite insecure it usually applies offsetting.

The dealing desk has roughly the same functions as currency exchange counter does in the bank. The retail customer sees the interbank exchange rates at a dealing desk (in the bank lobby as well) only after the rates coming from the interbank system are adjusted at a non-dealing desk in order to preserve the market makers’ (or the banks’) profit. That’s why the prices of dealing desks can’t be considered as a direct currency exchange index being the value substituted by the originating broker.

The off-market pricing done by retail market makers on the retail trading platforms gives sense to the arbitrage which is still effectively avoided by makers by moving the pickers (which is a widely used name for arbitrages) off from their systems as well as by a sharp reduction of market activity of the latter.

Most Forex brokers, excluding rather small number of them, do not provide a direct access to the interbank trading for their customers due to two obvious reasons. First reason is a limited number of banks which are ready to deal with private investors’ orders and the inability for the brokers to offer this service as a result. The second is that as far as the traders’ losses transform directly into the market makers’ profit while using the dealing desk model, it is very profitable for such firms as Gain Capital, SaxoBank, FXCM, GFT, and FX Solutions to follow it.

Dealing desk brokers can not only be in charge of the trading but the pricing as well and they can adjust it in any way and any moment to raise the income while non-dealing desk brokers earnings come only out of transaction commissions (fees). To prove this some traders try to make a requotation of a counteroffer done by a market maker by satisfying the execution order of the trader that rejects the order based on the defined terms instead of accepting the offer and places another one that is thought to meet the interests of the market maker.

It is worth mentioning that the retail speculators are not actually in beneficial conditions due to the “rules of the game”. Possible large profits are the bait for the inexperienced and moreover low-capitalized (because of the account minimum of 250-500 USD) speculators. What is more, some traders are compelled to take unreasonably large positions because of low position size varying from 10,000 to 100,000 units on major platforms. Very high leverage at the amount of 1:100 or even 1:200 is considered to be the worst thing about retail Forex firms. The average leverage used by professional traders generally doesn’t exceed 1:10 whether retail Forex firm use such a high leverage without any notification. Such account defaulting may lead to a margin call that would be profitable for the market maker in order the trade is not offset.

Dealing desk brokers being market makers besides creating made-up, off-exchange pricing, also correspond liquidity sources, completely independent and competing, for the banks that take part in the trading by acing as interbank system market makers. Brokers are defenseless before possible off-exchange trade taking out that is thought as a ground for interests conflict.

The insurrection that took place more than 35 years ago forced the minor investors leave the big stock brokerage firms due to possible discounts. The companies like Schwab, E-trade, Ameritrade, Datek, and Fidelity dealing with on-line brokerage, are sure that’s it’s the possible way of retail Forex market development. The reason for the investors to abandon their brokers is that the latter used to trade for their own benefit (leading so-called churning accounts), or the benefit of the corporate customer, nut not the private investor. It is possible as well to make the traders work without non-dealing desks offering the direct access to the market accordingly.

The Wall Street Journal says that “Even people running the trading shops warn clients against trying to time the market. ‘If 15% of day traders are profitable,’ says Drew Niv, chief executive of FXCM, ‘I’d be surprised.’ ” in Currency Markets Draw Speculation of July 26, 2005. It was also said that for the United States “it is unlawful to offer foreign currency futures and option contracts to retail customers unless the offeror is a regulated financial entity” relied on the data of Commodity Futures Trading Commission. The NFA (National Futures Association) members are legitimate retail brokers having the FCMs (or “futures commission merchants”) registration with CFTC. NFA gives he possible customer a possibility to the FCM status of the broker. The Securities Investor Protection Corporation controlling stock brokers doesn’t have any power concerning retail Forex brokers that are hardly regulated at all. An increasing number of Forex frauds was announced by the CFTC.

Interbank brokers: Some time ago, making the interbank trading easier and providing anonymous deals were the job of the foreign exchange brokers who had a modest income out of these operations. The electronic systems which are now used by the majority of this business’ participants are seen to be as a sphere adapted for banks only. The traders are still listening in on ongoing interbank trading through the brokers’ box but the trading amount got much smaller lately.

Customer brokers. A specialized services related to the foreign exchange are demanded by private and commercial clients. Analysts and strategic offer the clients to use the dealing services proposed by non-banks. The private clients are mostly not supported by the banks that can’t offer an adequate dealing for the commercial clients of a medium size as well as don’t possess the necessary resources. The nature of the services provided by these brokers, such as Saxo Bank, is generally oriented to the service but is close to the investment brokers.

Physical persons. They make a wide range of transactions concerning foreign tourism, translations of wages, fees, pensions, sales and purchases of cash currency seen as uncommercial operations. The Forex market trading first introduced in 1986 gave a chance for physical persons to deposit the available money resources in order to gain the profit.

The Forex Participant (1)

According to the BIS study Triennial Central Bank Survey 2004

53% of the transactions were interbank or interdealer strictly

33% of the transactions dealt with a fund manager or an kind of financial institution not associated with banks and a dealer (like bank for instance).

14% were held between non financial organizations and dealers.

Commercial banks take the majority of currency deals. Accumulating the markets exchange conversion cumulative needs due to clients’ operations as well as means accommodation or attraction and their movement to other banks are the main bank activities. Banks can carry out their independent deals for their own purpose aside from customers. Large international banks such as Deutsche Bank, Barclays Bank, Union Bank of Switzerland, Citibank, Chase Manhattan Bank, Standard Chartered Bank affect the exchange markets in the world considerably by the daily operations at the amount of billions dollars. Such dramatic volumes can have an influence on the currency price or the quotation. Such large players usually contain the groups of bulls and bears.

The interbank market deals with the commercial turnover majority as well as speculative trading considerable amounts carried out daily. Billions of dollars is possible turnover for a large bank. Besides the customers’ transactions, the majority of the operations are made for the bank’s own account and by proprietary desks.

The exchange brokers from abroad led the major part of their business by creating low-paid anonymous counterparts and facilitating interbank transactions some time ago. Recently the majority of this business got down to using such electronic systems as EBS, Reuters Dealing 3000 Matching (D2), the Chicago Mercantile Exchange, Bloomberg and TradeBook(R). The traders are still listening in on ongoing interbank trading through the brokers squawk box but the trading amount got much smaller lately.

“Bulls” is the name for the participants of the Forex market who try to make the currency price higher.

Bears are supposed to be concerned with the currency price reduction in the Forex market. The common market process is a balance between bulls and bears market and in case of a currency price change it is mostly not very significant. Though when either bulls or bears take the lead the exchange prices may change dramatically.

Commercial companies are one of the key financial players as far as they are interested in foreign exchange in order to pay for goods produced or services provided. These companies usually deal with small trading amount comparable with the banks or speculators but can have a brief effect on the market rates. Still, the streams of foreign trade are the important factors affecting the permanent currency rates. The exposures of some multinational companies happened due to covering very large positions can have a strong effect of the market in case the players are not aware of these processes.

Investment Management Firms. They usually deal with considerable accounts being the assets of such customers as pension funds and endowments. are quite important players for the exchange market as far as they use it to make the transactions of their foreign securities easier. For instance in order to pay for and redeem foreign equities purchases and sales the manager of an investment company having an international equity portfolio will have to deal with the certain market that will force him to sell or buy foreign currencies. The purpose of such transactions is profit increase and they are not considered as speculative, being secondary for the investment decisions. There are special Currency Overlay units included in the investment management firms that try to make profit of customers’ assets with a minimum risk using currency operations. These transactions may have an affection on large trades as far as the number of the dedicated currency managers in not high whether amount of their AUM (assets under management) is considerable.

Companies with foreign investments: These companies use Forex market for their foreign trading operations. The companies being the participants of international Forex market such as regarding importers have a stable foreign currency demand whether the exporters have large amounts of the currency on offer. Both these kinds of the companies have short-term deposits to hold their currency. That’s why these companies don’t use the Forex market directly due to using commercial banks for conversion and depositary operations.

The companies carrying out foreign investments of assets, such as Investment Funds, International Corporations, Money Market Funds. These kinds of companies contain a number of international investment funds that are following the policy of their investments diversification by placing the assets in various governmental and company securities. Georges Soros’s “Quantum”, and ” Dean Witter” fund are well-known funds of this kind. Xerox, Nestle, General Motors, British Petroleum and others are the kind of companies that deal with the international industrial investments for purposes of joint ventures, creating branches and others.

Hedge Funds: These funds, known due to George Soros’s Quantum fund, have raised their importance during the 1990s currency speculation in an aggressive form. Billions of dollars at the disposal of these funds along with the billions that can be borrowed make Hedge Funds the possible better support for the currencies of the countries welcoming Hedge Funds than central banks are.

The reputation of the Hedge Funds has raised due to their recent aggressive currency speculations. As far as the amounts of money in such funds are increasing they are very attractive for foreign exchange markets. These markets can speculate with tens billions of dollars due to their leverage so consolidation of the players known as the “herd instinct” of these funds can be very unpleasant. Though, these funds are not thought to be successful without the strategy that sounds. It is also thought that the actual functioning of these funds is instable financial weakness using and uncovering for the purpose of returning the normal values to realignment.

Speculation: Currency speculators and the influence they cause to the currencies depreciations are widely and regularly disputed. Thought the speculators are considered to carry out such important functions as supporting hedgers for the market and entrusting the risks with suitable people from the point of view of some economists like Milton Friedman. Others (for instance Joseph Stiglitz) consider this not an economical approach, but mostly a political or dedicated to the free market one.

The key speculators provided by professionals are the well-capitalized “position traders” as well as the major hedge funds.

Many countries are quite suspicious to such operations as currency speculations. From this point of view, the traditional forms of investment including stocks and bonds bring more effective economic rise by supplying the capital unlike currency speculations. This is considered just as gambling that often doesn’t go along with the economic policy. The currency speculations obliged the Central Bank of Sweden make a short-term rise of the interest rates up to the value of 150% a year that has been followed by krona devaluation. One of the most determined advocates of this point of view, Mahathir Mohamad who used to be the Prime Minister of Malaysia, called George Soros and other speculators the main culprits of the Malaysian ringgit devaluation in 1997.

The follower of the opposite opinion, Gregory Millman, argues that speculators make the international agreements to be “enforced” as well as forecast the consequences of the main economic “law” for the purpose of making profit being compared to “vigilantes”.

Simply speaking, the speculators of the forex market just accelerate the economical process bringing the economy to an unavoidable collapse in case the instable financial masses occur or the economy is carried out badly. A soon collapse is supposed to be better way out than a prolonged depression. Thus, it is supposed that in order to distract the public attention from putting the economy into decline Mahathir Mohamad along with the other critics blame the speculators.

Forex Trading Examples (4)

Example 23

When you close out a trade, you can calculate your profits and losses using the following formula:

Price (exchange rate) when selling the base currency’s price when buying the base currency X transaction size = profit or loss
Assume you buy Euros (EUR/USD) at 1.2178 and sell Euros at 1.2188. If the transaction size is 100,000 Euros, you will have a $100 profit.

($1.2188 – $1.2178) X 100,000 = $.001 X 100,000 = $100
Similarly, if you sell Euros (EUR/USD) at 1.2170 and buy Euros at 1.2180, you will have a $100 loss.

($1.2170 – $1.2180) X 100,000 = – $.001 X 100,000 = – $100
You can also calculate your unrealized profits and losses on open positions. Just substitute the current bid or ask rate for the action you will take when closing out the position. For example, if you bought Euros at 1.2178 and the current bid rate is 1.2173, you have an unrealized loss of $50.

($1.2173 – $1.2178) X 100,000 = – $.0005 X 100,000 = – $50
Similarly, if you sold Euros at 1.2170 and the current ask rate is 1.2165, you have an unrealized profit of $50.

($1.2170 – $1.2165) X 100,000 = $.0005 X 100,000 = $50
If the quote currency is not in US dollars, you will have to con- vert the profit or loss to US dollars at the dealer’s rate. Further, if the dealer charges commissions or other fees, you must subtract those commissions and fees from your profits and add them to your losses to determine your true profits and losses.

Example 24

The formula for calculating the security deposit is:

Current price of base currency X transaction size X security deposit % = security deposit requirement given in quote currency
Returning to our Euro example with an initial price of $1.2178 for each Euro and a transaction size of 100,000 Euros, a 1% security deposit would be $1,217.80.
$1.2178 X 100,000 X .01 = $1,217.80

Security deposits allow customers to control transactions with a value many times larger than the funds in their accounts. In this example, $1,217.80 would control $121,780 worth of Euros.
Value of Euros = $1.2178 X 100,000 = $121,780

This ability to control a large amount of one currency, in this case the Euro, using a very small percentage of its value is called leverage or gearing. In our example, the leverage is 100:1 because the security deposit controls Euros worth 100 times the amount of the deposit.

Since leverage allows you to control large amounts of currency for a very small amount, it magnifies the percentage amount of your profits and losses. A profit or loss of $1,217.80 on the Euro trans- action is 1% of the full price (with leverage of 1:1) but is 100% of the 1% security deposit. The dollar amount of profits and losses does not change with leverage, however. The profit or loss is $1,217.80 whether the leverage is 100:1 or 25:1 or 1:1.

Example 25

The following examples illustrate long and short positions, the benefits and risks of margin trading and the workings of the margin account.

Going Long

Assume that you start with a clean slate and that the current GPB/USD (“cable”) rate is 1.5847/52.

You expect the pound to appreciate against the US dollar, so you buy a single lot of 100,000 GBP at 1.5852 USD.

The value of the contract is 100,000 X 1.5852 USD = 158, 520 USD. The broker wants margin of 2.5% in USD, so you must ensure that you deposit at least 2.5% of 158,520 USD = 3,963 USD in your margin account

GBP/USD appreciates to 1.6000/05 and you decide to close out by selling your sterling for US dollars at the bid rate. Your gain is:
– 100,000 X (1.6000 – 1.5852) USD = 1,480 USD

Your rate of return is 1,480/3,963 = 37.35%, on an exchange rate movement of less than 1%. This illustrates the positive effect of buying on margin.

Had GBP/USD fallen to 1.5700/75, your loss would have been-
100,000 X (1.5852 – 1.5700) USD = 1,520 USD, a return of –38.35% illustrating the disadvantage of margin trading.

Example 26

Going Short

You expect sterling to fall from GBP/USD = 1.5847/52 so you decide to sell one lot of GBP/USD.
The value of the contract is 100,000 X 1.5847 USD = 158,470 USD.
Your broker requires 2.5% of 158,470 USD as margin = 3,961.75 USD in cash
GBP/USD falls to 1.5555/60 and you are sitting on a paper gain of: -
100,000 X (1.5847 – 1.5560 USD) = 2,870 USD

Your 2,870 USD paper gain is credited to your margin account (“variation in margin”) where you now have 6,831.75 USD. This enables you to maintain open positions worth 273,270 USD

GBP/USD starts to rise. When it reaches 1.6000/05, you are sitting on a paper loss of:
100,000 X (1.6005 – 1.5847) USD = 1,580 USD.

Your margin account is debited by 1,580 USD (“variation in margin”), taking it down to 2,381.75 USD which is sufficient to support 2,381.75 USD/0.025 = 95,270 USD worth of open positions. Your current exposure, however, is:
100,000 X 1.6005 USD = 160,050 USD
Your “shortage in equity” is therefore 160,050 USD – 95,270 USD= 64,780 USD
The broker makes a margin call for 2.5% of 64,780 USD = 1,619.50 USD.

You eventually close out your position at GBP/USD = 1.5720/25. Your gain is:
100,000 X (1.5847 – 1.5725) USD = 1,220 USD.
You have no more open positions, so you can withdraw the full 5,181.75 USD from your trading account in cash. Alternatively, you have enough margin to support 207,270 USD worth of new positions.

Forex Trading Examples (3)

Example 16

Below is an example of a negative Risk/Reward ratio:
Buy USD/JPY 100,000 at 110.00
T/P Sell USD/JPY 100,000 at 110.30
S/L Sell USD/JPY 100,000 at 108.00

In the above example the take-profit is 30 pips higher than the level at which the position was entered, and the stop-loss is 200 pips lower than the level at which the position was entered. The Risk/Reward ratio is 1:0.15.

Example 17

Below are examples of both a winning trade and losing trade when trading for a 10 pip profit or loss:

Winning Trade:
Buy EUR/USD at 1.2020 (price = 17/20)
Sell EUR/USD at 1.2030 (price = 30/33)

Market moves 13 pips before taking profit

Losing Trade:
Buy EUR/USD at 1.2020 (price = 17/20)
Sell EUR/USD at 1.2010 (price = 10/13)

Market moves 7 pips before taking loss

The above example highlights that the risk/reward of trading for a 10 pip profit or loss is very poor. For the same 10 pips P&L, the market must move 13 pips for your winning position, but only 7 pips for your losing position. For currency pairs quoted in 5-10 pip prices, obviously the risk/reward is even worse.

Example 18

Here is an example of a reasonably profitable month for a successful trader. Let’s imagine that his total capital is $20,000 and risk appetite per trade is 5%. This would mean he is willing to lose upto $1000 per trade. He always trades using a 100% Risk/Reward ratio (meaning that his stop-loss orders are the same distance as his profit-take orders, from the position entry level):
No. of Trades = 20
Winning Trades = 12
Losing Trades = 8

Total Profit = $4000

REO/month (Return on Equity) = 20%

The example shows that he got 60% of his trades right and made an REO of 20% for the month and he only risked 5% of his capital on every trade.

Example 19

An investor has a margin deposit with Saxo Bank of USD100,000.
The investor expects the US dollar to rise against the Swiss franc and therefore decides to buy USD2,000,000 – his maximum possible exposure.
The dealer quotes him 1.5515-20. The investor buys USD at 1.5520.

Day 1: Buy USD2,000,000 vs CHF 1.5520 = Sell CHF3,104,000.
Four days later, the dollar has actually risen to CHF1.5745 and the investor decides to take his profit.
Upon his request, the Saxo Bank dealer quotes him 1.5745-50. The investor sells at 1.5745.

Day 5: Sell USD2,000,000 vs CHF 1.5745 = Buy CHF3,149,000.
As the dollar side of the transaction involves a credit and a debit of USD2,000,000, the investor’s USD account will show no change. The CHF account will show a debit of CHF3,104,000 and a credit of CHF3,149,000. Due to the simplicity of the example and the short time horizon of the forex market trading, we have disregarded the interest forex rate swap that would marginally alter the profit calculation.

This results in a profit of CHF45,000 = approx. USD28,600 = 28.6% profit on the deposit of USD100,000.

Example 20

The investor follows the cross forex rate between the Euro and the Japanese yen. He believes that this market is headed for a fall. As he is less confident of this forex market trading, he does not fully use the leverage available on his deposit. He chooses to ask the dealer for a quote in EUR1,000,000. This requires a margin of EUR1,000,000 x 5% = EUR50,000 = approx. USD52,500 (EUR/USD1.05).
The dealer quotes 112.05-10. The investor sells EUR at 112.05.

Day 1: Sell EUR1,000,000 vs JPY 112.05 = Buy JPY112,050,000.
He protects his position with a stop-loss order to buy back the euro at 112.60. Two days later, this stop is triggered as the euro strengthens short term in spite of the investor’s expectations.

Day 3: Buy EUR1,000,000 vs JPY 112.60 = Sell JPY112,600,000.
The EUR side involves a credit and a debit of EUR1,000,000. Therefore, the EUR account shows no change. The JPY account is credited JPY112.05m and debited JPY112.6m for a loss of JPY0.55m. Due to the simplicity of the example and the short time horizon of the forex market trading, we have disregarded the interest forex rate swap that would marginally alter the loss calculation.

This results in a loss of JPY0.55m = approx.USD5,300 (USD/JPY 105) = 5.3% loss on the original deposit of USD100,000.

Example 21

The investor believes the Canadian dollar will strengthen against the US dollar. It is a long term view, so he takes a small position to allow for wider swings in the forex rate:

He asks dealer for a quote in USD1,000,000 against the Canadian dollar. The dealer quotes 1.5390-95 and the investors sells USD at 1.5390. Selling USD is the equivalent of buying the Canadian dollar.

Day 1: Sell USD 1,000,000 vs CAD 1.5390. He swaps the position out for two months receiving a forward forex rate of CAD1.5357 = Buy CAD1,535,700 for Day 61 due to the interest forex rate differential.

After a month, the desired move has occurred. The investor buys back the US dollars at 1.4880. He has to swap the position forward for a month to match the original sale. The forward forex rate is agreed at 1.4865.

Day 31: Buy USD1,000,000 vs CAD 1.4865 = Sell CAD1,486,500 for Day 61.

Day 61: The two forex market trades are settled and the forex market trades go off the books. The profit secured on Day 31 can be used for margin purposes before Day 61.

The USD account receives a credit and debit of USD1,000,000 and shows no change on the account. The CAD account is credited CAD 1,535,700 and debited CAD 1,486,500 for a profit of CAD49,200 = approx. USD33,100 = profit of 33.1% on the original deposit of USD100,000.

Example 22

Foreign currency exchange rates are what it costs to exchange one country’s currency for another country’s currency. For example, if you go to England on vacation, you will have to pay for your hotel, meals, admissions fees, souvenirs and other expenses in British pounds. Since your money is all in US dollars, you will have to use (sell) some of your dollars to buy British pounds.

Assume you go to your bank before you leave and buy $1,000 worth of British pounds. If you get 565.83 British pounds (£565.83) for your $1,000, each dollar is worth .56583 British pounds. This is the exchange rate for converting dollars to pounds.

If £565.83 isn’t enough cash for your trip, you will have to exchange more US dollars for pounds while in England. Assume you buy another $1,000 worth of British pounds from a bank in England and get only £557.02 for your $1,000. The exchange rate for converting dollars to pounds has dropped from .56583 to .55702. This means that US dollars are worth less compared to the British pound than they were before you left on vacation.

Assume that you have ??100 left when you return home. You go to your bank and use the pounds to buy US dollars. If the bank gives you $179.31, each British pound is worth 1.7931 dollars. This is the exchange rate for converting pounds to dollars.

Theoretically, you can convert the exchange rate for buying a currency to the exchange rate for selling a currency, and vice versa, by dividing 1 by the known rate. For example, if the exchange rate for buying British pounds with US dollars is .56011, the exchange rate for buying US dollars with British pounds is 1.78536 (1 ?·.56011 = 1.78536). Similarly, if the exchange rate for buying US dollars with British pounds is 1.78536, the exchange rate for buying British pounds with US dollars is .56011 (1?·1.78536 = .56011). This is how newspapers often report currency exchange rates.

Forex Trading Examples (2)

Example 7

You believe that signals in the market are indicating that the British Pound will go up against the US Dollar. You open 1 lot for buying the Pound with a 1% margin at the price of 1.49889 and wait for the exchange rate to climb. At some point in the future, your predictions come true and you decide to sell. You close the position at 1.5050 and earn 61 pips or about $405. Thus, on an initial capital investment of $1,000, you have made over 40% in profits. (Just as an example of how exchange rates change in the course of a day, an average daily change of the Euro (in Dollars) is about 70 to 100 pips.)

When you decide to close a position, the deposit sum that you originally made is returned to you and a calculation of your profits or losses is done. This profit or loss is then credited to your account.

Example 8

Prices of foreign exchange are indicated by FOREX quotes in pairs of currencies. The first currency is the ‘base’ and the second is the ‘quote’ currency. In this example:
USD/EUR = 0.8419

…the currency pair is US dollars and European euros. The base currency (USD) is always at ‘1′ and the quote currency shows how much it costs to buy one unit of the base currency. In this example, 1 US dollar costs 0.8419 euros.

Conversely…
EUR/USD = 1.1882
…tells us that it costs 1.1882 US dollars to buy 1 euro.

Example 9

Example OCO Transaction:

Buy: 1 standard lot EUR/USD @ 1.3228 = $132,280
Pip Value: 1 pip = $10
Stop-Loss: 1.3203
Limit: 1.3328

This is an order to buy US dollars at 1.3328 and to sell them if they fall to 1.3203 (resulting in a loss of 25 pips or $250) or to sell them if they rise to 1.3328 (resulting in a profit of 100 pips or $1,000).

Example 10

Here’s another example:

The current bid/ask price for US dollars and Canadian dollars is
USD/CDN 1.2152/57
…meaning you can buy $1 US for 1.2152 CDN or sell 1.2157 CDN for $1 US.

If you think that the US dollar (USD) is undervalued against the Canadian dollar (CDN) you would buy USD (simultaneously selling CDN) and wait for the US dollar to rise.

This is the transaction:
Buy USD: 1 standard lot USD/CDN @ 1.2157 = $121,570 CDN
Pip Value: 1 pip = $10
Stop-Loss: 1.2147
Margin: $1,000 (1%)

You are buying US$100,000 and selling CDN$121,570. Your stop loss order will be executed if the dollar falls below 1.2147, in which case you will lose $100.

However, USD/CDN rises to 1.2192/87. You can now sell $1 US for 1.2192 CDN or sell 1.2187 CDN for $1 US.

Because you entered the transaction by buying US dollars (buying long), you must now sell US dollars and buy back CDN dollars to realize your profit.

You sell US$100,000 at the current USD/CDN rate of 1.2192, and receive 121,920 CDN for which you originally paid CDN$121,570. Your profit is $350 Canadian dollars or US$287.19 (350 divided by the current exchange rate of 1.2187).

Example 11

The US dollar is normally considered the ‘base’ currency for Forex quotes. In the major pairs, this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the second currency quoted in the pair. For example, a quote of USD/CAD 1.193 means that one U.S. dollar is equal to 1.193 Canadian dollars.

When the U.S. dollar is the base unit and a currency quote goes up, it means the dollar has appreciated in value and the other currency has weakened. If the USD/CAD quote increases to 1.231, the dollar is stronger because it will now buy more Canadian dollars than before.

The three exceptions to this rule are the British pound (GBP), the Australian dollar (AUD) and the Euro (EUR). In these cases, you might see a quote such as EUR/USD 1.3027, meaning that one Euro equal 1.3027 U.S. dollars.

Example 12

The initial margin to enter into a forex currency pair at Terra Nova is 3%. For example, an account is funded with $100,000 USD. A Forex currency trader feels that the US dollar is undervalued compared to the Canadian dollar. To capitalize on this strategy, the trader buys US dollars and simultaneously sells Canadian dollars. The current bid/ask for USD/CAD is 1.1835/1.1843 (purchase $1 US for $1.1843 CAD or sell $1 US for $1.1835 CAD).

The available leverage is 100:3 or 3%. To purchase a one lot, this trader buys $100,000 USD and sells $118,430 CAD. Using the above leverage, the initial margin is $3000 ($100,000 x 3%).

Example 13

Trading on margin means that you can buy and sell assets that represent more value than the capital in your account. Forex trading is usually done with relatively little margin since currency exchange rate fluctuations tend to be less than one or two percent on any given day. To take an example, a margin of 2.0% means you can trade up to $500,000 even though you only have $10,000 in your account.

In terms of leverage this corresponds to 50:1, because 50 times $10,000 is $500,000, or put another way, $10,000 is 2.0% of $500.000. Using this much leverage gives you the possibility to make profits very quickly, but there is also a greater risk of incurring large losses and even being completely wiped out. Therefore, it is inadvisable to maximise your leveraging as the risks can be very high.

Example 14

A pip is the smallest unit by which a cross price quote changes. When trading forex you will often hear that there is a 5-pip spread when you trade the majors. This spread is revealed when you compare the bid and the ask price, for example EURUSD is quoted at a bid price of 0.9875 and an ask price of 0.9880. The difference is USD 0.0005, which is equal to 5 “pips”. On a contract or position, the value of a pip can easily be calculated. You know that the EURUSD is quoted with four decimals, so all you have to do is the cancel-out the four zeros on the amount you trade and you will have one pip. Thus, on a EURUSD 100,000 contract, one pip is USD 10. On a USDJPY 100,000 contract, one pip is equal to 1000 yen, because USDJPY is quoted with only two decimals.

Example 15

A very common mistake made by novice forex traders is that they do not use a positive Risk/Reward ratio. By positive Risk/Reward ratio we mean the difference between the take-profit trade and the level of trade entry is greater than the difference between the stop-loss trade and the level of trade entry. In other words it means that you should not be willing to lose more than you want to make on a single trade.

Here is an example of a positive Risk/Reward ratio:
Buy EUR/USD 100,000 at 1.1500
T/P Sell EUR/USD 100,000 at 1.1600
S/L Sell EUR/USD 100,000 at 1.1440

In the above example the take-profit is 100 pips higher than the level at which the position was entered, and the stop-loss is 60 pips lower than the level at which the position was entered. The Risk/Reward ratio is 1:1.66.

Forex Trading Examples

Example 1

Many beginning traders don’t fully understand the concept of leverage. Basically, if you have a start up capital of $5,000 and if you trade on a 1:50 margin you can effectively control a capital of $250,000. However, a two percent move against you and your capital is completely wiped out. If you are a beginning trader you should not use more than 1:20 margin until you get comfortable and profitable and then and only then you can attempt to use higher margins.

What does 1:20 margin mean? It means that with your $5,000 you will control a capital of $100,000. Let’s say you are trading EUR/USD and by using our entry strategy you have decided to enter the trade on a long side. That means that you are betting that USD will depreciate against Euro.

Let’s say current EUR/USD rate is 1.305. Again, if your trading capital is $5,000 and you are using 1:20 leverage you will effectively be exchanging $100,000 to Euros. If the current rate is 1.305 you will receive 100,000/1.305 = 76,628 Euros.

If the trade goes in your direction margin will work in your favour and 1% decline in USD will mean 20% increase in your start up capital. So if EUR/USD rate moves from 1.305 to 1.318 you will be able to exchange your 76, 628 Euros back to $101,000 for a profit of $1,000. Since your start up capital was $5,000 it is effectively a 20% increase in your account. However, if the trade went against you and USD appreciated 1% vs. Euro your account would be reduced to $4,000. That would not have happened as our strategy has built in hard stops to prevent such outcome.

Example 2

The most frequently asked question of aspiring traders is “How much money can I make?” Unfortunately there’s no easy answer, because it depends how much you are willing to risk.

Trading is a function of risk and reward: The more you risk, the more you can make. Here’s an easy example: Let’s say you start with a $5,000 account and you’re willing to risk $1,000. Now you could place a trade to go long at the opening, set a profit goal of $1,000 and a stop loss of $1,000. Let’s say you investigated the market behavior in the past couple of months and realized that your chances of achieving your profit goal are 60%.

Unfortunately the trade you just placed is a loser, and you lose the whole $1,000. Since this was the amount you were wiling to risk, you close your account, transfer the remaining $4,000 back in to your checking account and that’s it for you.

Now let’s assume you wanted to risk only $100 per trade and you adjusted your profit goal to $100, too. Now you can make at least 10 trades, because only if all 10 trades are losers you’ll lose the $1,000 you are willing to risk. I don’t want to become too mathematical, but statistics says that the probability of having 10 losing trades in a row is less than 1%. Therefore it’s highly likely that you will have a couple of winners within the 10 trades. If your trading system shows the same performance as it did in the past (60% winning percentage), you should make $200: 4 losing trades * $100 = -$400 + 6 winning trades * $100 = $600. Make sense?

Compare these two options:

The risk of losing your money in scenario 1 is 40%. But if you won, you would have made $1,000.

In scenario 2 the risk of losing your money after 10 trades is less than 1%, but you have a fair chance of making $200. Therefore you need to define first how much you are willing to risk, since the amount you can make is a function of that risk. Make sense? I’ll give you more specific examples later in this chapter.

Keep in mind that there’s a difference between the amount you need to trade and the amount you’re willing to risk. Your broker is always asking your for a “margin”, and you need to fund your account with that margin requirement + your risk. In our previous example you funded your account with $5,000, but you only risked $1,000. More on that later.

Example 3

50:1 Leverage: what does it mean?

With a minimum account of USD 10,000, for example, you can trade up to USD 500,000. The USD 10,000 is posted on margin as a guarantee for the future performance of your position.

Example 4

The AUD/USD rate is quoted at ‘0.7500/04′. This quote represents the bid/offer spread for AUD vs USD. The offer rate of 0.7504 is the rate at which you can purchase AUD (or BUY AUD and SELL USD). The bid rate of 0.7500 is the rate at which you can Sell AUD to buy USD.

You believe that the Australian Dollar will strengthen against the US Dollar, and decide to BUY or ‘go long’ A$100,000 @ 0.7504 (the offer price).
Quote (bid/offer) 0.7500/04
Buy Price 0.7504
Volume A$100,000
Initial Outlay (1% margin) A$1,000

In the example above you have purchased A$100,000. But because FX is traded on margin with CMC Markets you will only need A$1,000 (1%) to maintain the same market exposure.

The risk on this AUD/USD trade is equivalent to US$10 per each point movement. Each point is valued at 0.0001. For example if the AUD/USD rate moves from 0.7504 to 0.7505 you will receive a profit of US$10.

Your prediction is correct and the Australian Dollar appreciates against the US Dollar. The quote on AUD/USD is now 0.7590/94. To close your position, you decide to SELL A$100,000 @ 0.7590 (the bid price).
Quote (bid/offer) 0.7590/94
Sell Price 0.7590
Volume A$100,000
Profit/Loss US$860 Profit

Your profit and loss is usually calculated in the secondary currency. Therefore the above AUD/USD trade profit/loss is calculated in US Dollars. With CMC Markets no brokerage or commission charges will be subtracted from your gross profit. You will only be charged a financing cost if you hold your position overnight.
Profit/loss Calculation:
Size of trade x (sell price – buy price) = profit & loss USD
100,000 x (0.7590 – 0.7504) = US$860 profit
Or, converting the US$860 back to A$ at a rate of 0.7590

(Profit/loss ? AUD rate) = profit & loss AUD
(860 ? 0.7590) = A$1,133.07 profit

By closing your position you realise a gross profit of A$1,133.07

If you anticipated incorrectly and sold AUD at 0.7500 and later bought AUD at 0.7594, a loss of US$940 would have been experienced.

Example 5

If you want to buy/sell a specific amount of GBP, first enter the symbol GBP as the transaction currency. Then choose USD as the settlement currency from the drop down menu. You will then receive the quote USD/GBP, e.g. Bid: 1.5300 Ask: 1.5310
This means that GBP 1 = US$1.53XX

If you want to buy GBP 10,000, click on the ask and enter 10,000 as the quantity of GBP that you wish to buy. You will pay $1.5300 for each GBP. Thus, you will pay $15,310.

If you want to sell GBP 10,000, click on the bid and enter 10,000 as the quantity of GBP that you wish to sell. You will receive $1.5300 for each GBP. Thus, you will receive $15,300.

Example 6

If you want to buy/sell a specific amount of USD. First enter the symbol USD as the transaction currency. Then choose GBP as the settlement currency from the drop down menu. You will then receive the quote GBP/USD, e.g. Bid: 0.6530 Ask: 0.6536

This means that USD 1 = GBP 0.653XX

If you want to buy USD 10,000, click on the ask and enter 10,000 as the quantity of USD that you wish to buy. You will pay GBP0.6536 for each USD. Thus, you will pay GBP 6,536.

If you want to sell USD 10,000, click on the bid and enter 10,000 as the quantity of USD that you wish to sell. You will receive GBP0.6530 for each USD. Thus, you will receive GBP 6,530.