Chapter 2: Getting Started
Now it is time to learn more about currency market, terms, order types and such important details.
Currencies are always quoted in pairs, such as EUR/USD or USD/CAD. The reason they are quoted in pairs is because in every foreign exchange transaction, you are simultaneously buying one currency and selling another.
The first listed currency to the left of the slash “/” is known as the base currency, while the second one on the right is called the counter currency. The base currency is the “basis” for the buy or the sell. If you buy GBP/USD this simply means that you are buying the base currency and simultaneously selling the counter currency. In other words, “buy GBP, sell USD”.
- What is “pip”?
A “pip” is the smallest increment in any currency pair. In EUR/USD, a movement from 1.0054 to 1.0055 is one pip, so a pip is .0001. In USD/JPY, a movement from 120.57 to 120.58 is one pip, so a pip is .01.
-How much in dollars is this movement worth, for example, per 100,000 Euros in EUR/USD?
-How much is one pip worth per 100,000 Dollars in USD/JPY?
(one pip, with proper decimal placement / currency exchange rate) x 100,000
Using USD/JPY as an example, this yields:
(.01/120.58) x USD100,000 = $8.30 or $8.30 cents per pip.
Using EUR/USD as an example, we have:
(.0001/1.0055) x EUR100,000 = EUR 9.93
But we want the pip value in USD, so we then must multiply EUR 9.93 x (EUR/USD exchange rate): EUR 9.93 x 1.0055 = $10
This is in fact a phenomenon you will see with any currency in which the currency is quoted first (such as EUR/USD, GBP/USD, or AUD/USD): the pip value is always $10 per 100,000 currency units. This is why pip (or “tick”) values in currency futures, where the currency is quoted first, are always fixed.
-What is “spread”?
Spread is the difference in prices between bid and offer rates. Spreads vary from bank to bank (or broker to broker). This difference also varies for each of the currency pairs. Once you get familiar with the FX market, you will learn for sure.
-Leverage, trading size, profit and loss
Leverage is a mechanism which, a small margin deposit can control a much larger total contract value. This is a good but also a deadly tool. Leverage gives you to opportunity to buy/sell $100,000 with only $1,000. Amazing huh? Yes it is amazing that you may lose everything in your account within a few minutes.
In forex, 1 lot is basically 100,000 currency units. Some brokers allow you trade lots or mini lots (10.000 units) or even micro lots (1.000 units). Since the amounts are huge, you should never risk your savings completely. Risk management is a must in any type of investing.
The object of forex trading is to exchange one currency for another in the expectation that the price will change, so that the currency you bought will increase in value compared to the one you sold. So how does it work, how do you make money? Let’s give you an example:
You buy 10,000 euros at the EUR/USD exchange rate of 1.4000, thinking that EUR will get stronger against the USD.
That means you are paying 10,000*1.4000=14,000 USD in order to buy 10,000 EUR.
A couple of days later, you see that the EUR/USD exchange rate is 1.4120.
This means that now you have 10,000*1.4120=14,120 USD.
So the profit you made is 14,120-14,000=120 USD
If a couple of days later, the EUR/USD exchange rate is 1.3880
This means that now you have 10,000*1.3880=13,880 USD
So your loss is 14,000-13,800=120 USD
-Types of orders
Market Order: A market order is an order to buy or sell at the best available price at that moment.
Limit and Stop Orders: A stop-entry order is an order placed to buy above the market or sell below the market at a certain price. A limit entry is an order placed to either buy below the market or sell above the market at a certain price.
Close Position Order: To close an open position at the market
Hedging: Hedging an open position involves placing an exactly opposite trade. Normally, the opposing trades cancel each other out, closing the position. But with hedging feature, both trades remain active. For example, let’s say you bought GBP/USD. You can hedge your position by selling GBP/USD. Both will remain separate active positions, rather than canceling each other out. Hedging gives the trader upside potential, whichever direction the market heads. It is important that you fully understand how hedging works and how to properly use it before placing any hedge orders.
-Factors affecting the market
Currency prices are affected by a variety of economic and political conditions, most importantly interest rates, inflation and political stability. Moreover, governments sometimes participate in the Forex market to influence the value of their currencies, either by flooding the market with their domestic currency in an attempt to lower the price, or conversely buying in order to raise the price. This is known as Central Bank intervention. Any of these factors, as well as large market orders, can cause volatility in currency prices. However, the size and volume of the Forex market makes it impossible for any one entity to “drive” the market for any length of time.