Foreign Exchange, also known as Forex, or FX, is more commonly referred to as Currency Exchange. Quite simply, the trading of one currency for another. The FX market is the world’s largest market, daily trading volumes exceed $1.5 trillion per day, easily dwarfing markets such as the NYSE (about $30 billion in daily volume).
The Foreign Exchange markets trade 24 hours per day, as the market moves from time zone to time zone, with major dealing centers today in London, New York, Paris, Hong Kong, Tokyo, Zurich, Frankfurt, Singapore, and Sydney. Easily the most liquid market in the world, investors, fund managers, corporations, banks and investment houses are able to take advantage of the 24 hour Forex market, in order to profit by and hedge their financial positions worldwide.
The Foreign Exchange market began in 1971, when the United States moved away from the Gold Standard. Floating exchange rates began and most currencies are traded against the US dollar (USD), the world’s largest free economy. The FX market is an over the counter market (OTC), an inter bank, inter dealer market, whereby trades are executed by telephone or by electronic networks between any two counter parties that agree to transact. Banks and Dealers negotiate and trade based upon exchange rates obtained via distribution networks, such as Reuters. Until recently, typical trades were executed at $1 million dollars and above, these participants are known as Institutional players. The demand of the Retail trader (under $1 million) has brought minimum trade amounts down considerably.
Who’s participating in FOREX?
Banks/Investment Banks account for the most significant portion of Forex volumes. The biggest banks often trade billions of dollars per day. They trade as a service to their customers and also for their own benefit.
Governments/Central Banks control a country’s money supply and thereby try to effect and maintain financial stability.
International Businesses are an important backbone to the Forex market. International trade demands the exchange of one country’s currency for another.
Travelers who travel to another country naturally will need that country’s currency to pay for goods and services.
Investors and Speculators are becoming more and more aware of the opportunities existing in the Forex markets. Day traders are attracted to Forex because of the sheer liquidity, 24 hr access, and leveraging abilities. Until very recently only high net indiviuals had access to the markets.
Benefits of Currency Trading vs. Equity Trading
Historically, smaller-scale, individual investors have had limited access to the Forex market. Major banks, multinational corporations and other participants, trading in large transaction sizes and volumes, have dominated this market for decades. Technology, however, has lowered the barriers of entry and opened up this attractive marketplace to a new breed of Forex investors and speculators. Increasingly, Forex trading is winning favor as an alternative investment opportunity. The following are some of the benefits of trading currencies vs. trading equities:
Continuous, 24-hour trading on FOREX
The Forex market is a true 24-hour market. Equity trading is restricted to the operating hours of the various equity exchanges. While after-hours trading has become available through Electronic Communication Networks (ECNs), there are no guarantees that the market will be liquid at all times, or that trades will be executed at “market prices”.
High liquidity and greater efficiency
Trading volume in the Forex can be 50-100 times larger than the New York Stock Exchange. Twenty-four hour, five day per week accessibility greatly increases the probability of finding dealers willing to buy or sell currencies at fair market price. Equities are more vulnerable to liquidity risks due to limited trading volumes and market accessibility. In the less liquid equity markets, large price movements may occur when individual transactions take place.
Intra-day volatility on FOREX market
Large volume and liquidity combined with fewer instruments generates greater intra-day volatility in the FOREX than exists in the equity markets. This volatility can be profitably exploited by day-traders.
Low spreads on FOREX market
FOREX trading offers spreads that are much lower than what can be obtained when buying or selling equities (especially in after-hour markets). Although the tight currency spreads of 5 pips historically have only been available for transaction sizes of $1M or higher, a shift towards offering these tighter spreads for smaller transaction sizes is occurring.
Leverage on FOREX market
Typically, margin ratios associated with trading currencies are higher than those associated with trading equities. This is primarily attributed to the higher levels of liquidity within the currency markets. Margin trading allows Forex market participants to trade much larger amounts than they have deposited. For example, with a margin ratio of 20:1 and a deposit of $10,000, an investor/speculator can trade amounts up to $200,000. Trading in larger volumes, in turn, allows these investors/speculators to take better advantage of small price movements.
Profit potential regardless of market direction
By definition, an investor with an open position is long one currency and short another. If a trader believes a currency is about to depreciate, he/she sells that currency short and goes long another currency. In the currency markets, selling or shorting is a necessary component of completing a trade. Profit potential exists in the Forex market regardless of whether a trader is buying or selling and regardless of whether the market is moving up or down. In the U.S equity markets, short-selling is less common and more difficult to transact due to certain market rules and regulations. This makes it more difficult to profit when the stock market and/or the share price for a particular stock begins to head south.
No commissions or transaction costs on Forex markets
A currency transaction typically incurs no commission or transaction fee outside of the quoted spread. This is in stark contrast to the equity market, where commissions for stock trades range from $8 to $70 and higher in addition to the quoted spread.
Equal access to market information
Professional traders and analysts in the equity market have a definitive competitive advantage by virtue of that fact that they have first access to important corporate information, such as earning estimates and press releases, before it is released to the general public. In contrast, in the Forex market, pertinent information is equally accessible, ensuring that all market participants can take advantage of market-moving news as soon as it becomes available.
Benefits of Trading Forex on the Internet
Deal directly from live price quotes
Very few on-line brokers are able to offer their clients real-time bid/ask quotes, which facilitates instantaneous deal execution – no missed market opportunities. Real-time prices also allow investors to compare an on-line broker’s dealing spread with that of other pricing services, to ensure they are receiving the best possible price on all their Forex transactions.
Many on-line Forex brokers require their clients to request a price before dealing. This is disadvantageous for a number of reasons, primarily because it significantly lengthens the execution process from just a few seconds to possibly as long as a minute. In a fast paced market, this could make a significant difference in an investor’s profit potential. Also, some of the more unscrupulous brokers may use the opportunity to look at an investor’s current position. Once they have determined whether the investor is a buyer or a seller, they ‘shade’ the price to increase their own profit on the transaction.
Instantaneous trade execution and confirmation
Timing is everything in the fast-paced Forex market. On-line trades are executed and confirmed within seconds, which ensures that traders do not miss market opportunities. Even the incremental extra time it takes to complete a transaction over the phone can mean a big difference in profit potential.
Lower transaction costs
Simply, executing trades electronically reduces manual effort, thereby lowering the costs of doing business. On-line brokers are then able to pass along the savings to their client base.
Real-time profit and loss analysis
The fast-paced nature of the Forex market compels traders to execute multiple trades each day. It is vital for each client to have real-time information about their current position in order to make well-informed trading decisions.
Full access to market information
Access to timely and relevant information is critical. Professional traders pay thousands of dollars each month for access to major information providers. However, the very nature of the Internet affords users free access to reliable market information from a variety of sources, including real-time price quotes, international news, government-issued economic indicators and reports, as well as subjective information such as expert commentary and analysis, trader chat forums etc.
How Can Individuals Participate in the Spot Currency Market as a Forex Trader?
From 1971 until recent years the virtual owners of this market were the banks, multinational corporations and large brokerage firms. If an individual wanted to invest in this market, he could invest with a bank with a one million dollar cash deposit backed by the requirement of a 5-10 million dollar net worth. A slightly better option was provided by the brokerage firms, which asked a lower minimum deposit on average of a quarter million dollars.
But now the Forex market has been opened up to Individual investors. Unlike the huge sums of money previously required by the banks and brokerage firms, comparatively far lower margin requirements are finally available that now allows virtually any individual to trade along with the professionals and institutions. In addition, individual investors have the opportunity to take advantage of the growing boom in computer and communication technologies that has made this market accessible in ways previously exclusive only to large players.
Currency Trading Basics
Exchange Rates and Spreads:
All currencies are assigned an International Standards Organization (ISO) code abbreviation. In currency trading, these codes are often used to express which specific currencies make up a currency pair. For example, USD/JPY refers to two currencies: the US Dollar and the Japanese Yen.
An exchange rate is simply the ratio of one currency valued against another. The first currency is referred to as the base currency and the second as the counter or quote currency. If buying, an exchange rate specifies how much you have to pay in the counter or quote currency to obtain one unit of the base currency. If selling, the exchange rate specifies how much you get in the counter or quote currency when selling one unit of the base currency.
base currency/quote currency
Most currencies are traded directly against the US Dollar. The market rates that are expressed for such currency pairs are called direct rates. In most cases, the US Dollar is the base currency pair whereby the quote currency is expressed as a certain number of units per 1 US Dollar. For example, the following rate USD/CAD=1.4500 indicates that 1 USD (US Dollars)= 1.4500 CAD (Canadian Dollars). For some currency pairs, the US Dollar is not the base currency but the counter or quote currency.
The market rates that are expressed for such currency pairs are called indirect rates. This is the case with GBP (British Pound or “Cable”), NZD (New Zealand Dollar), EUR (Euro), and AUD (Australian Dollar). For example, the following rate GBP/USD=1.5800 indicates that 1 GBP (British Pound)= 1.5800 USD (US Dollars).
When one currency is traded against any currency other than the USD, the market rate for this currency pair is called a cross rate. Cross rate is the exchange rate between two currencies not involving the US Dollar. Although the US dollar rates do not appear in the final cross rate, they are usually used in the calculation and so must be known. Trading between two non-US Dollar currencies usually occurs by first trading one against the US Dollar and then trading the US Dollar against the second non-US Dollar currency. There are a few non-US Dollar currencies that are traded directly, such as GBP/EUR or EUR/CHF.
The base currency for the following currency pairs is the Euro (EUR): EUR/GBP, EUR/JPG, EUR/CHF, EUR/CAD. The base currency used when GBP is traded against the JPY (Japanese Yen) is GBP, hence the quotation GBP/JPY.
A currency exchange rate is typically given as a bid price and an ask price. The bid price is always lower than the ask price. The bid price represents what will be obtained in the quote currency when selling one unit of the base currency. The ask price represents what has to be paid in the quote currency to obtain one unit of the base currency. The following USD/JPY price quote is an example of bid/ask notation:
The first component (before the slash) refers to the bid price (what you obtain in JPY when you sell USD). In this example, the bid price is 118.48. The second component (after the slash) is used to obtain the ask price (what you have to pay in JPY if you buy USD). In this example, the ask price is 118.53.
The difference between the bid and the ask price is referred to as the spread. In the example above, the spread is .05 or 5 pips. Unlike the USD/JPY, most currency pair quotes are carried out to the 4th decimal place (i.e. EUR/USD may be quoted at 0.9517/22), in which case 5 pips represents a difference of .0005. Although a pip may seem small, a movement of one pip in either direction can translate into thousands of dollars in gains or losses in the inter-bank market.
Buying and Selling
All trades result in the buying of one currency and the selling of another, simultaneously.
Buying (“going long”) the currency pair implies buying the first, base currency and selling an equivalent amount of the second, quote currency (to pay for the base currency). It is not necessary to own the quote currency prior to selling, as it is sold short. A trader buys a currency pair if he/she believes the base currency will go up relative to the quote currency, or equivalently that the corresponding exchange rate will go up.
Selling (“going short”) the currency pair implies selling the first, base currency, and buying the second, quote currency. A trader sells a currency pair if he/she believes the base currency will go down relative to the quote currency, or equivalently, that the quote currency will go up relative to the base currency.
An open trade or position is one in which a trader has either bought or sold one currency pair and has not sold or bought back an adequate amount of that currency pair to effectively close the trade. When a trader has an open trade or position, he/she stands to profit or lose from fluctuations in the price of that currency pair.
How to Calculate a Profit or Loss
2003.11.26 at 14:37 GMT you see that the rate for EUR/USD is 1.1845/50 and decide to buy 100,000 EUR. Your trade is executed at 1.1850.
100,000 EUR Х 1.1850 = 118,500 USD
You bought 100,000 EUR and sold 118,500 USD
2003.12.01 at 15:55 GMT the market rate of EUR/USD increases to EUR/USD=1.1968/73. You decide to sell back100,000 EUR at 1.1968.
100,000 EUR Х 1.1968 = 119,680 USD
You bought 100,000 EUR for 118,500 USD and sold 100,000 EUR back for 119,680 USD. The difference is your profit:
119,680 – 118,500 = 1,180 USD.
Types Of Orders
Limit and stop orders will no longer be associated with any particular opened position held within the market. Instead, each stop or limit order will be a stand alone order that the Deal Desk will be obligated to execute once the appropriate level is reached and your overall position within the market duly adjusted to reflect. OCO orders (One Cancels Other) is an exception in that if one level is reached, the other level associated with the order will be cancelled.
Market Order – An order to buy or sell which is to be filled at the price immediately available; the current rates at which the market is dealing.
Example: If you are looking to place an order for JPY when the dealing price is 104.00/05, a market order will request to buy JPY at 104.00 or will request to sell JPY at 104.05.
Stop Order – An order that becomes a market order when a particular price level is reached and broken. A stop order is placed below the current market value of that currency.
Example: If you have an open buy JPY position, which you bought at 104.00 and you want to set a stop order in case JPY’s value starts to depreciate (to stop your loss). Since the JPY’s currency appreciates when the dealing rate moves from 104.00 closer to parity with the USD (102 JPY/1USD), a movement in the opposite direction would necessitate a stop order. For instance, you could set a stop order rate to sell JPY at 104.50, thus closing your position at a 50-pip loss.
Limit Order – An order that becomes a market order when a particular price level is reached. A limit order is placed above the current market value of that currency.
Example: If you have an open buy JPY position, which you bought at 104.00, and you want to set a limit order to protect your profit, you would set a limit order at a number, which indicates that JPY has appreciated, such as 103.5. When the market reaches 103.5, your position will automatically be closed, resulting in a 50-pip gain.
OCO Order – One Cancels Other. An order placed so as to take advantage of price movement, which consists of both a Stop and a Limit price. Once one level is reached, one half of the order will be executed (either Stop or Limit) and the remaining order canceled (either Stop or Limit). This type of order would close your position if the market moved to either the stop rate or the limit rate, thereby closing your trade, and, at the same time, canceling the other entry order.
Example: If you have an open buy JPY position, which you bought at 104.00, and you want to set a limit and a stop order, you could place an OCO order. If your OCO limit rate was 103.5 and OCO stop rate was 104.50, once the market rate reaches 103.5, the original JPY position would be closed and the stop rate would be canceled.
If Done Order – If Done Orders are supplementary orders whose placement in the market is contingent upon the execution of the order to which it is associated.
Orders can be used to either square up (close) open trades or enter the market at various market prices. Should you decide to close your open trade(s) via market order(s), your open order(s) will still remain active until cancelled or executed by the dealing desk. Beware not to let these open orders become open trades if that is not your intention. You can cancel open orders by clicking on the order number and confirming that you wish to cancel these orders.
Glossary of Terms
Appreciation – A rise in the price or value of a currency (or other asset) over time.
Arbitrage – The purchase of securities on one market for simultaneous or immediate resale on another market with the goal of profiting from a price discrepancy. Currency traders often arbitrage against exchange risk by buying a currency for immediate delivery but also selling that currency on the forward market at the same time.
Ask Rate – The price at which sellers offer currencies to buyers.
Asset Allocation – The division of funds between different assets (items of value such as property, financial instruments, commodities and cash) with the goal of diversifying ones personal holdings to manage specific risk / reward expectations.
Back Office – The departments and processes related to the settlement of financial transactions.
Bank Wire – A computer message system linking major banks. It is used as a mechanism to advise the receiving bank of some action that has occurred, i.e., the payment by a customer of funds into that bank’s account.
Base Currency – In the following pair USD/EUR, the first currency (in this case USD) is referred to as the base currency. The primary base currency is the US dollar, meaning that quotes are most commonly expressed as a unit of $1 USD per the other currency quoted in the pair.
Basis Point – One hundredth of a percentage point – 0.01%.
Bear (bearish) – Someone who expects the price of a given financial instrument or the overall value of a given financial marketplace to decline in value and thereby is a seller of the instrument(s). This individual is said to be bearish on the instrument / marketplace. Opposite of bull (bullish).
Bear Market – A market distinguished by declining prices.
Big Figure – Dealer expression referring to the first few digits of an exchange rate. These digits rarely change in normal market fluctuations, and therefore are omitted in dealer quotes, especially in times of high market activity. For example, a USD/Yen rate might be 107.30/107.35, but would be quoted verbally without the first three digits i.e. “30/35”.
Bid Rate – The price at which buyers offer to buy currencies from sellers.
Bid / Ask Spread – The difference between the buy (bid) and sell (ask) price. In the following example – 0.8423/28 the spread is 0.0005 or 5 PIPs.
Book – In a professional trading environment, a ‘book’ is the summary of a trader’s or desk’s total positions.
Bretton Woods Agreement – An agreement signed by the original United Nations members in 1944 that established the International Monetary Fund (I.M.F.) and the post-World War II international monetary system of fixed exchange rates.
Broker – An individual or firm that acts as an intermediary, putting together buyers and sellers for a fee or commission. In contrast, a ‘dealer’ commits capital and takes one side of a position, hoping to earn a spread (profit) by closing out the position in a subsequent trade with another party.
Bull (bullish) – Someone who expects the price of a given financial instrument or the overall value of a given financial marketplace to rise in value and thereby is a purchaser of the instrument(s). This individual is said to be bullish on the instrument / marketplace. Opposite of bear (bearish).
Bull Market – A market distinguished by rising prices.
Buying / Selling FX – An investor/speculator buys a currency pair (takes a long position), if he/she believes the base currency will go up relative to the quote currency, or equivalently that the corresponding exchange rate will go up. Selling the currency pair implies selling the first, base currency, and buying the second, quote currency. An investor / speculator sells a currency pair (takes a short position), if he/she believes the base currency will go down relative to the quote currency, or equivalently, that the quote currency will go up relative to the base currency.
Cable – Refers to the Sterling/US Dollar exchange rate. Derived from mid-1800s practice of New York sending sterlings dollar rate to London via a transatlantic cable.
Candlestick Chart – A chart that indicates the trading range for the day as well as the opening and closing price. If the open price is higher than the close price, the rectangle between the open and close price is shaded. If the close price is higher than the open price, that area of the chart is not shaded
Chartist – An individual who uses charts and graphs and interprets historical data to find trends and predict future movements. Also referred to as Technical Trader
Clearing – The process of settling a trade.
Commission – Fee charged by a broker for executing a trade.
Confirmation – A document exchanged by counterparts to a transaction that states the terms of said transaction.
Contract – The standard unit of trading.
Counterparty – One of the participants in a financial transaction.
Cross Rate – Refers to an exchange rate between two non-US dollar currencies. Trading between two non-US dollar currencies usually occurs by first trading one currency against the US Dollar and then trading the US Dollar against the second non-US dollar currency.
Currency – Any form of money issued by a government or central bank and used as legal tender and a basis for trade.
Currency Risk – The probability of an adverse change in exchange rates.
Day Trader / Day Trading – Speculators trying to take advantage of market movements in very short time periods — buying a currency and then selling it again may happen within hours or even minutes. Day traders are attracted to currency trading because of the size, liquidity, volatility, and accessibility of the market.
Dealer – An individual who acts as a principal or counterpart to a transaction. Principals take one side of a position, hoping to earn a spread (profit) by closing out the position in a subsequent trade with another party. In contrast, a broker is an individual or firm that acts as an intermediary, putting together buyers and sellers for a fee or commission.
Delivery – A trade where both sides make and take actual delivery of the currencies traded. Delivery is not the norm in FX trading. More commonly, an FX trade involves cash settlement of the difference between spot and delivery prices. Spot refers to any delivery within two business days. Forward refers to delivery beyond two days and usually quoted one year out in increments of 30 days (i.e. 1 month, 2 month, etc.).
Directional Forecast – A projection of bid/ask prices for a currency pair for a point in the future. The forecast displays the most likely future direction of prices. This direction reflects the latest price fluctuations as they are influenced by economic and political events. Directional Forecasts are designed for: Investors and traders who trade small to large volumes in the foreign exchange markets daily Professionals who do business internationally and who want to minimize foreign exchange risk due to currency price fluctuations.
Dollar Rate – The exchange rate of a foreign currency as quoted against the US dollar (USD). Some currencies are typically only quoted against the US dollar, such as the Algerian dinar (DZD) and the Andorran franc (ADF). The exchange rate of the Algerian dinar against the Andorran franc is thus computed from DZD-USD and ADF-USD.
Entry Order – An order to buy/sell a currency pair when the market reaches a specified price.
EURO – The currency of the European Union (EU) since January 1, 1999. The following countries have adopted the EURO in addition to maintaining their own unique currency: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain.
Exchange Rate – The price of one country’s currency expressed in another country’s currency.
Exchange Rate Risk – The potential loss that could be incurred from a movement in bid/ask prices, or exchange rates.
Exposure – The risks that an investor accepts when holding an open position. When an investor buys EUR/USD, he exposes himself to risks associated with changes in the valuation of the EURO and/or USD markets.
Flat/square – Dealer jargon used to describe a position that has been completely reversed, e.g. you bought $500,000 then sold $500,000, thereby creating a neutral (flat) position.
Foreign Exchange Market – Market for trading currencies internationally. The foreign exchange market, also referred to as the Forex and FX market, is a decentralized market that has no physical exchange floor. Trading is done over the counter via phone, fax or electronic distribution networks. Turnover in this market is approximately $1.5 trillion USD daily, making it the largest, most liquid financial marketplace.
Forex – (see foreign exchange market)
Forward – The pre-set exchange rate for an FX contract that settles at a pre-determined future date. The forward rate is based upon the interest rate differential between the two currencies involved. Forward rates can be calculated easily given the fixed term interest rates of each currency and their current spot rates.
Forward Points – The PIPS added to or subtracted from the current exchange rate to calculate a forward price. If points are added, then the forward is priced at a premium. If points subtracted, then the forward is priced at a discount.
Fundamental Analysis – The study and analysis of economic, political and social data/events to predict the future movements of the market and guide ones FX trading decisions.
Gearing – (refer to margin trading or leverage)
Good ‘Til Cancelled Order (GTC) – An order to buy or sell at a specified price. This order remains open until filled or until the client cancels.
Hedging – A strategy used to offset market risk, whereby one position protects another. Traders and investors in foreign exchange hedge to protect their investment or portfolio against currency price fluctuations.
Initial margin – The initial deposit of collateral required to enter into a position as a guarantee on future performance.
Interbank Prices – Currency prices/rates quoted between the large international banks, typically on transactions of US $1 million or more. These rates differ and are often more favorable than those quoted for smaller, retail transactions.
Interest Rate – Differential In FX trading, interest rate charges are determined by the difference between the interest rate on the base currency less the interest rate on quote currency. Interest rates are only paid on positions held over night.
Leverage – Refers to margin trading or gearing. The use of credit or borrowed funds to increase ones buying power.
Limit Order – An order with restrictions on the maximum price to be paid or the minimum price to be received. As an example, if the current price of USD/YEN is 102.00/05, then a limit order to buy USD would be at a price below 102. (ie 101.50)
Liquidity – Refers to the ability to buy and sell with little or no impact on price stability. The number of players in a market/security has a direct impact on this ability. The FX market is the most liquid market in the world.
Long – To go long is to buy a currency / security. For example, if an investor believes that the Japanese economy is getting stronger and that, as a result, the Japanese Yen will appreciate in value, then he/she may want to buy Japanese Yen and take what is called a long position.
Margin – Collateral (could be cash, securities and/or unrealized profit) that an investor is required to keep on deposit to cover potential losses. If the margin requirement is 10% and a speculator wishes to buy $1 million EURO/USD, that speculator must have $100 thousand EUROS in value in his/her account.
Margin Call – A call for additional capital to bolster the equity in an investors margin account. Occurs when equity in the account is in danger of going below the required margin percentage threshold.
Market Maker – A pricing source that regularly quotes a two-sided market, meaning it supplies executable bid and ask prices.
Market Order – An order to buy/sell at the best price available when the order reaches the market.
Marking to Market – Common valuation method for calculating ones foreign exchange exposure at current market prices. Adjusting book value of holdings to reflect current market value.
Offer – The rate at which a dealer is willing to sell a currency.
One Cancels the Other Order (OCO) – A designation for two orders whereby one part of the two orders is executed the other is automatically cancelled.
Open position – A deal not yet reversed or settled with a physical payment.
Open Order – An open order is a request that a trade should be made automatically when the exchange rate of the specified currency pair crosses a specified threshold. The request will remain open until the specified threshold is reached. (see entry order)
Over-The-Counter Market (OTC) – A market, such as the FX market, in which counterparties trade via telephone, fax or electronic distribution network rather than from a physical exchange location.
Overnight – A trade that remains open until the next business day.
PIP – Typically stands for the smallest unit of measurement denoting price movement. One basis point (0.0001 or .01%) but depends on currency pair in reference. (see basis point)
Position – The aggregation of all trades made in a currency pair. If the position is open, it is exposed to market risk. If a position is closed, profit/loss has been realized.
Quotation – Often shortened to quote and also referred to as bid-asked. The highest bid or lowest offer price currently available on a security/commodity.
Quote – An indicative market price, normally used for information purposes only.
Rate – The price of one currency in terms of another, typically used for dealing purposes.
Realized and Unrealized P/L – Realized P/L is equal to the value in an investor/speculators balance minus the amount of funds he/she has transferred into the account. Unrealized P/L is the amount of profit or loss that is held in current open positions. If one were to clear all open positions, then this amount would be added to the Realized P/L amount.
Resistance – A term used in technical analysis indicating a specific price level at which analysis concludes people will sell.
Risk – The degree of uncertainty or exposure associated with an investment. Investments with greater inherent risk must promise higher expected returns if investors are to be attracted to them. The main types of foreign exchange risk are:
- 1) exchange rate risk
- 2) interest rate risk
- 3) credit risk (aka counterparty)
- 4) country risk (includes political). (each of these risks can be referred to in other sections of this document).
Risk Management – The process of actively monitoring /controlling exposure to various types of risks while attempting to maximize returns. Typically involves utilizing a variety of trading techniques, models and financial analyses.
Roll-Over – Process whereby the settlement of a deal is rolled forward to another value date. The cost of this process is based on the interest rate differential of the two currencies.
Settlement – A trade is settled when the trade and its counterparts have been entered into the books/records. In regards to FX trading, it is important to note that settlement may or may not involve the actual physical exchange of currencies.
Short (Short Position) – To go short is to sell a currency / security. For example, if an investor believes that the Japanese economy is getting weaker and that, as a result, the Japanese Yen will depreciate in value, then he/she may want to sell Japanese Yen and take what is called a short position. It is not necessary to own the quote currency prior to selling, as it is sold short.
Spot Market / Spot Rate – The spot market refers to instruments that are traded and settle within two business days of the transaction. The spot rate refers to the current market rate for a currency. Interest is either added on (premium) or subtracted from (discount) this rate to determine pricing for non-spot trades, which are referred to as forwards in the FX market.
Spread – (see bid / ask spread)
Stop-Loss Order – Order type whereby an open position is automatically liquidated at a specific price. Often used to minimize exposure to losses if the market moves against an investor’s position. As an example, if an investor is long USD at 156.27, they might wish to put in a stop loss order for 155.49, which would limit losses should the dollar depreciate, possibly below 155.49.
Support Levels – A technique used in technical analysis that indicates a specific price ceiling and floor at which a given exchange rate will automatically correct itself. Opposite of resistance.
Swap – A currency swap is the simultaneous sale and purchase of the same amount of a given currency at a forward exchange rate.
Swissy – Slang for Swiss Franc.
Take-Profit Order – An order to automatically liquidate a position if the exchange rate reaches a specified level. Take profit orders are typically used to lock-in profit.
Technical Analysis – Studying charts that display the historic behavior of market data/statistics (price open, high, low and close, volume, open interest, etc.) in order to forecast future performance.
Tick – A price movement.
Transaction Cost – The cost of buying or selling a financial instrument.
Turnover – The total money value of all executed transactions in a given time period; volume.
Two-Way Price – When both a bid and offer rate is quoted for a FX transaction.
Uptick – a new price quote at a price higher than the preceding quote.
Unrealized and Realized P/L – Unrealized P/L is the amount of profit or loss that is held in current open positions. If one were to clear all open positions, then this amount would be added to the Realized P/L amount. Realized P/L is equal to the value in an investor/speculators balance minus the amount of funds he/she has transferred into the account.
Value Date – The date on which counterparts to a financial transaction agree to settle their respective obligations, i.e., exchanging payments. For spot currency transactions, the value date is normally two business days forward. Also known as maturity date.
Variation Margin – Funds a broker must request from the client to have the required margin deposited. The term usually refers to additional funds that must be deposited as a result of unfavorable price movements.
Volatility – A measure by which an exchange rate is expected to fluctuate or has fluctuated over a given period. Volatility figures are often expressed as a percentage per annum.
Whipsaw – slang for a condition of a highly volatile market where a sharp price movement is quickly followed by a sharp reversal.
Yard – Slang for a billion.