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Archive | Forex Guide

Foreign Exchange Trading Explained

Forex is the name generally applied to the currency exchange market (or forex market), it’s the value of a currency crossed against another. When an exchange is made of one currency into another it’s carried out at the current rate of the two related currencies. For example if the value of the Euro versus the US Dollar is currently at 1.3738 then it might take 0.7279 Euros to puchase just 1 US Dollar.

When a dealer receives your cash and makes atransaction in the market in your behalf it is known as a forex trade. They will exchange the currency for you often at a value of spread between the current bid and offer price or for a fee based on the worth of the transaction.

That’s foreign exchange at it’s most basic, but wait just a moment, it will get much more complicated than that when you are trading forex for real.

The foreign exchange market is the biggest and most liquid monetary market with trillions of exchange transactions taking place each day around the world. The foreign exchange market doesn’t sleep and 24 hours a day , 5 days every week individuals from all nations convert currency for business, private acccounts and lots of extra unknown reasons. The most widely used way to trade the forex market place for the typical man is by utilizing a forex broker.

Online today there are hundreds of forex trading platforms offering great rates of commission and spreads, or tools to help the beginner trade through the pitfalls of foreign exchange trading. Most countries have a dealers who will open an account for you and let you start trading forex direct from your laptop at home.

There is now no need to visit a broker in person, like the old days, and talk about terms for the trade. These days it’s as simple as applying on-line, making a small money deposit from your credit card and off you go. Within minutes you are trading forex like a pro. Or not as the case is for many!

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The Euro, British Pound and US Dollar: A closer look

The Euro, British Pound and US dollar are three of the most heavily held, exchanged and speculated currencies in the world. They account for billions of dollars in business trade and foreign exchange every day.

The euro (EUR) is the official currency of the Eurozone, which is made up of 16 of the 27 member countries in the European Union. It is also the recognized currency in five others. It represents the second largest reserve currency and is also the second most speculated, both behind the US. The Euro took over as the official Eurozone currency in 1999, taking over for the “European Currency Unit”. Prior to the formation of the European Union, most member countries held their own currencies.

Trading of the Euro has many more potential economic catalysts given the number of countries that hold and exchange Euros as an official currency. Significantly positive or negative economic developments in prominent European countries can either boost or reduce the perceived and traded value of the Euro. Uniquely, member countries tend to be more open to support of struggling brethren countries for this reason.

The British Pound (GBP), also known as the pound sterling, is the official currency of the United Kingdom and other territories under the “crown”. The British currency is the oldest formally recognized currency in the world, with origins to the Bank of England’s establishment in 1694. It is the third largest reserve currency and third most heavily traded in foreign exchange behind the Euro and dollar. Pound movement is somewhat affected by the general European marketplace, but is more impacted by the relative strength of British economic conditions.

The US dollar is not only the most held (in reserve) currency and the most heavily traded through foreign exchange, but it is generally perceived as the most unflappable based on the prominence of the US in the global economy. The US dollar evolved naturally in the late 18th and early 19th century following the American Revolution. Early currency used for barter in the US included Spanish dollars and other currency of value with early settlers from Europe.

The dollar’s direction strongly correlates with the stability and direction of the US economy. The dollar is also known to often share an inverse directional relationship with oil and gold since these commodities are often used to hedge against slumping markets. Aside from other factors higher oil prices tends to lead to higher Euro and Pound values against the dollar.

Interest rate yields have a general affect on all foreign currencies and foreign exchange. When an economy is stable and growing, countries tend to take a hawkish or higher interest rate approach to monetary policy. This leads to more traders buying one currency with a higher yield leveraging the low borrowing costs of the lower rate currency. This is often referred to as the “carry trade”, and led to each of these major currencies rising firmly against the low interest yen during much of the early 21st century.

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Economic data and its affect on foreign exchange rates

Important economic data announcements can have significant effects on foreign exchange rates. This is evidenced by the fact that immediately preceding and following major anticipated economic events, trading becomes more volatile and price swings can be intense.

There are a number of expected economic data announcements that take place in major countries every morning. Expected events usually produce some pre-announcement speculation with trading direction determined by the overall weight of expectation among traders. If traders believe the event is likely to be positive for a given currency, it is likely to trend positively ahead of the announcements. The opposite would be true if a more negative announcement is anticipated.

Major economic data reports that are issued monthly, or in some cases weekly, in major countries include: Unemployment reports, retail sales data, housing data, durable goods and manufacturing reports, price indexes, consumer confidence readings, and more. There are also more infrequent events that can have major effects on currencies, including Central Bank board meeting announcements and rate policy changes and quarterly gross domestic product (GDP) changes.

It is extremely important that savvy traders be aware of when these major anticipated reports are expected to be issues so that you can invest accordingly in anticipation of, or response to, the news. More aggressive traders sometimes like to buy or sell into the momentum of trade following announcements. However, some prominent currency traders encourage speculators to stay away from trading around major events, and prefer to trade when exchange rates are more stable and predictable.

Looking at the results of some of these announcements, unemployment data is often a sign of overall economic direction. If jobless claims and unemployment are low, it is usually a positive for the reporting country’s currency. Manufacturing reports that show increases in orders are perceived as a sign of business growth and market expansion, also currency positive. Generally, any positive economic data report produces a positive view of that currency based on the expectation of its future worth in the successful economy.

Interest rates and monetary policy tend to have major short and long term affects on currency rates and foreign exchange rates. An economy that is perceived as being in a growth phase is anticipated to see a tightening of monetary policy to avoid inflation. Higher interest rates mean greater interest yields relative to other currencies. Conversely, a struggling economy may cause Central Bank leaders to reduce rates to stimulate an economy. This produces a lower yield for that currency.

Carry trade is when speculators use one low interest currency as leverage to buy into a higher interest yielding currency. This was especially evident during the first part of the 21st century when the Japanese Yen maintained a low to no interest policy while most other major currencies held a more significant interest yield. When the global economy is stable, speculators take on more risk and many sold off yen to buy into higher interest currencies. As the global economic finds trouble, a carry trade ‘unwind’ often results as speculators flee their risky carry trade positions producing a quick reversal of the carry trade.

Whether you choose to take on the risk of trading ahead of and into economic announcements, or simply follow them for signals of emerging or continue long-range trends, most experts agree that any foreign exchange trader should follow global economic news.

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An introduction to foreign exchange rates

In order to conduct business in multiple international markets, those in charge of financial decision making at a company have to have a solid understand of foreign exchange rates and how they affect revenue and profit. Similarly, a novice investor in currencies needs to have a good understanding of rates of exchange, how to read currency pair prices, and what the difference is between bid and offer exchange rates.

In general, exchange rates are relational ratios of currency values between two currencies, known as a currency pair. While there are index measures that help you assess the basic trend and direction of a single currency against a basket of major currencies, you have to compare one specific currency versus the next to know how those currencies are interacting.

There are certain events and factors that can positively or negatively impact a single currency and affects its value relative to most other currencies. However, similarly positive or negative effects can also be influencing those other currencies, meaning the overall direction of each trading pair is dynamic.
Currency pair ratios are expressed as the value of one unit of one currency versus one unit of the other currency in the pair. This ratio can be inverted. For instance, most brokerages tend to express the value of the Euro versus the dollar in terms of one Euro’s worth in dollars.

Thus, you might see this ratio quotes as something like EUR/USD=$1.1965. This is telling you that one Euro is currently worth just under $1.20. Values are stated to the fourth decimal position. This could be inverted to show USD/EUR=.8358. This is showing that one US dollar is equal to less than .84 Euros. The acronyms EUR and USD are each three letters symbols of currencies, similar to stock symbols. Each currency has its own three letter trading symbol.

Currency brokers offer a trading platform for speculators to buy and sell. Similar to other brokers, they make their money off of transaction fees. Rather than charging a per transaction fee, most brokers make money by taking a commission from the difference between the bid and offer prices on transactions.
If you are looking at an electronic trading platform with a broker, they might offer a bid price of EUR/USD = $1.1965 and an offer price of $1.1967. A buyer would pay the high price and a seller would collect the lower price. The .0002 difference is known as the trading spread. This amount is what the broker takes as a commission from each transaction. Traders obviously prefer smaller spreads as this reduces the amount of price to be made up as currencies move in the direction you are trading in.

One final unique thing about currency speculation is that unlike buying a stock, you are not necessarily buying the Euro or the dollar when you speculate in foreign currencies. If you buy the EUR/USD trading pair, you are expressing a belief that the EUR will increase in value relative to the dollar in the short or long term. If you sell this pair, you are shorting the EUR/USD and expressing a belief that the EUR will decrease in value relative to the dollar.

Businesses must be aware of foreign exchange rates because they affect the value of doing business in one country and bringing the earnings back to the domestic market. Buying goods in one market and selling them in another is impacted by the fluctuation of exchange rates between the buy and sell transaction points, among other currency rate factors.

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