Spot Currencies

OVERVIEW

Foreign exchange is the simultaneous buying of one currency and selling of another. Currencies are traded through a broker or dealer and are executed in pairs, for example, the Euro and the U.S. dollar (EUR/USD) or the British pound and the Japanese yen (GBP/JPY). The foreign exchange market (Forex) is the largest financial market in the world, with a volume of over $2 trillion daily. This is more than three times the total amount of the stocks, options, and futures markets combined.

Unlike other financial markets, the Forex spot market has no physical location, nor a central exchange. It perates through an electronic network of banks, corporations, and individuals trading one currency for another. The lack of a physical exchange enables the Forex to operate on a 24-hour basis, spanning from one time zone to another across the major financial centers. This fact has a number of ramifications that we will discuss throughout

this book.

A spot market is any market that deals in the current price of a financial instrument. Futures markets, such as the Chicago Board of Trade (CBOT), offer commodity contracts whose delivery date may span several months into the future. Settlement of Forex spot transactions usually occurs within two business days.

CURRENCY PAIRS

Every Forex trade involves the simultaneous buying of one currency and the selling of another currency. These two currencies are always referred to as the currency pair in a trade.

BASE CURRENCY

The base currency is the first currency in any currency pair. It shows how much the base currency is worth, as measured against the second currency. For example, if the USD/CHF rate is 1.6215, then one U.S. dollar is worth 1.6215 Swiss francs. In the Forex markets, the U.S. dollar normally is considered the base currency for quotes, meaning that quotes are expressed as a unit of US$1 per the other currency quoted in the pair. The primary exceptions to this rule are the British pound, the Euro, and the Australian dollar.

QUOTE CURRENCY

The quote currency is the second currency in any currency pair. This is frequently called the pip currency, and any unrealized profit or loss is expressed in this currency.

PIPS AND TICKS

A pip is the smallest unit of price for any foreign currency. Nearly all currency pairs consist of five significant digits, and most pairs have the decimal point immediately after the first digit; that is, EUR/USD equals 1.2812. In this instance, a single pip equals the smallest change in the fourth decimal place, that is, 0.0001. Therefore, if the quote currency in any pair is USD, then one pip always equals 1/100 of a cent. One notable exception is the USD/JPY pair, where a pip equals US$0.01 (one U.S. dollar equals approximately 107.19 Japanese yen). Pips sometimes are called points. Just as a pip is the smallest price movement (the y axis), a tick is the smallest interval of time along the x axis that occurs between

two trades. (Occasionally, the term tick is also used as a synonym for pip.) When trading the most active currency pairs (such as EUR/USD and USD/JPY) during peak trading periods, multiple ticks may (and will) occur within the span of one second. When trading a low-activity minor cross-pair (such as the Mexican peso

and the Singapore dollar), a tick may occur only once every two or three hours (Figure 1-1). Ticks, therefore, do not occur at uniform intervals of time. Fortunately, most historical data vendors will group sequences of

streaming data and calculate the open, high, low, and close over regular time intervals (1, 5, and 30 minutes, 1 hour, daily, and so forth).

BID PRICE

The bid is the price at which the market is prepared to buy a specific currency pair in the Forex market. At this price, the trader can sell the base currency. The bid price is shown on the left side of the quotation. For example, in the quote USD/CHF 1.4527/32, the bid price is 1.4527, meaning that you can sell one U.S. dollar

for 1.4527 Swiss francs.

ASK PRICE

This ask is the price at which the market is prepared to sell a specific currency pair in the Forex market. At this price, the trader can buy the base currency. The ask price is shown on the right side of the quotation. For example, in the quote USD/CHF 1.4527/32, the ask price is 1.4532, meaning that you can buy one U.S. dollar for 1.4532 Swiss francs. The ask price is also called the offer price.

BID/ASK SPREAD

The difference between the bid price and ask price is called the spread. The big-figure quote is a dealer expression referring to the first few digits of an exchange rate. These digits often are omitted in dealer quotes. For example, a USD/JPY rate might be 117.30/117.35 but would be quoted verbally without the first three digits as 30/35. The critical characteristic of the bid/ask spread is that it is also the transaction cost for a round-turn trade. Round turn means both a buy (or sell) trade and an offsetting sell (or buy) trade of the same size in the same currency pair. In the case of the EUR/USD rate above, the transaction cost is 3 pips (Figure 1-2).

FORWARDS AND SWAPS

Outright forwards are structurally similar to spot transactions in that once the exchange rate for a forward deal has been agreed, the confirmation and settlement procedures are the same as in the cash market. Forwards are spot transactions that have been held over 48 hours but less than 180 days when they mature and are

liquidated at the prevailing spot price.

Forex swaps are transactions involving the exchange of two currency amounts on a specific date and a reverse exchange of the same amounts at a later date. Their purpose is to manage liquidity and currency risk by executing foreign exchange transactions at the most appropriate moment. Effectively, the underlying

amount is borrowed and lent simultaneously in two currencies, for example, by selling U.S. dollars for the Euro for spot value and agreeing to reverse the deal at a later date. Since currency risk is replaced by credit risk, such transactions are different conceptually from Forex spot transactions. They are, however, closely linked because Forex swaps often are initiated to move the delivery date of a foreign currency originating from spot

or outright forward transactions to a more optimal moment in time. By keeping maturities to less than a week and renewing swaps continuously, market participants maximize their flexibility in reacting to market events. For this reason, swaps tend to have shorter maturities than outright forwards. Swaps with maturities of up to one week account for 71 percent of deals, compared with 53 percent for outright forwards. For additional information, see www.aforextrust.com/spot-forex-forex-forwards-forex-swaps.htm.

Currency Futures

FUTURES CONTRACTS

A futures contract is an agreement between two parties: a short position, the party who agrees to deliver a commodity, and a long position, the party who agrees to receive a commodity. For example, a grain farmer would be the holder of the short position (agreeing to sell the grain), whereas the bakery would be the holder of the long position (agreeing to buy the grain). In every futures contract, everything is specified precisely: the quantity and quality of the underlying commodity, the specific price per unit, and the date and method of delivery. The price of a futures contract is represented by the agreed-on price of the underlying commodity or financial instrument that will be delivered in the future. For example, in the preceding scenario, the price of the contract is 5,000 bushels of grain at a price of $4 per bushel, and the delivery date may be the third Wednesday in

September of the current year. The Forex market is essentially a cash or spot market in which over 90 percent of the trades are liquidated within 48 hours. Currency trades held longer than this normally are routed through

an authorized commodity futures exchange such as the International Monetary Market (IMM). IMM was founded in 1972 and is a division of the Chicago Mercantile Exchange (CME) that specializes in currency futures, interest-rate futures, and stock index futures, as well as options on futures. Clearinghouses (the futures exchange) and introducing brokers are subject to more stringent regulations from the Securities and Exchange

Commission (SEC), Commodity Futures Trading Commission (CFTC), and National Futures Association (NFA) than the Forex spot market (see www.cme.com for more details). It also should be noted that Forex traders are charged only a single transaction cost per trade, which is simply the difference between the current bid and ask prices. Currency futures traders are charged a round-turn commission that varies from brokerage house to brokerage house. In addition, margin requirements for futures contracts usually are slightly higher than the requirementsfor the Forex spot market.

CONTRACT SPECIFICATIONS

Table 2-1 presents a list of currencies traded through the IMM at the CME and their contract specifications.

CURRENCY TRADING VOLUME

Table 2-2 summarizes the trading activity of selected futures contracts in currencies, precious metals, and some financial instruments. The volume and open interest (OI) readings are not trading signals. They are intended only to provide a brief synopsis of each market’s liquidity and volatility based on the average of 30

trading days.

U.S. DOLLAR INDEX

The U.S. Dollar Index (ticker symbol DX) is an openly traded futures contract offered by the New York Board of Trade (NYBOT). It is computed using a trade-weighted geometric averageof the six currencies listed in Table 2-3.

IMM currency futures traders monitor the U.S. Dollar Index to gauge the dollar’s overall performance in world currency markets. If the U.S. Dollar Index is trending lower, then it is very likely that a major currency that is a component of the U.S. Dollar Index is trading higher. When a currency trader takes a quick glance at the

price of the U.S. Dollar Index, it gives the trader a good feel for what is going on in the Forex market worldwide.

For traders who are interested in more details on commodity futures, we recommend Todd Lofton’s paperbound book, Getting Started in Futures (Wiley, 1993).

Getting Started in Forex-Dompyong Wetan

Getting started in forex, If you are new to Forex trading, there are several key pieces of information

you need to know:

• How and where to open a Forex trading account
• Demo trading and when to go “live”
• Essential reading material for your growth as a trader
• Money management and leverage, stop losses and targets
• How to read a candlestick chart

We will go through these items for the benefit of new traders. If you are an experienced trader already, please skip these pages and go straight to the page headed “G7 System”

How and where to open a Forex trading account This depends a lot on how much capital you have to start with your trading. We highly recommend that all new traders “demo” trade for at least 1-3 months before committing real money to the account. There are now literally 100’s of Forex brokers available to the retail trader, but we must warn you that not all of them are “above board” We have had experience with several brokers and can recommend the following: (Please note that our recommendation does not in anyway endorse these brokers, only that we

have had good experience with them in the past) www.oanda.com This broker allows traders with smaller accounts to trade extremely small lot sizes thereby minimizing the risk of losses for beginners. They allow micro-lots which move about $0.10 per pip www.fxcm.com FXCM is one of the largest brokers and allows mini lots which move about $1.00 per pip. More information on Forex trading in general can be obtained from the two websites above and from other sites such as www.forexnews.com and www.fxstreet.com

Forex Trading Course-More On Market Mechanics-Dompyong Wetan

Forex Trading, More On Market Mechanics-Dompyong Wetan.

Spot Forex is traditionally traded in lots also referred to as contracts. The standard size for a lot is $100,000. In the last few years a mini lot size has been introduced of $10,000 and this again may change in the years to come. As we mentioned on the previous page currencies are measured in pips, which is the smallest increment of that currency. To take advantage of these tiny increments it is desirable to trade large amounts of a particular currency in order to see any significant profit or loss. We shall cover leverage later but for the time being let's assume we will be using $100,000 lot size. We will now recalculate some examples to see how it effects the pip value.

USD/JPY at an exchange rate of 116.73 (.01/116.73) X $100,000 = $8.56 per pip

USD/CHF at an exchange rate of 1.4840 (0.0001/1.4840) X $100,000 = $6.73 per pip

In cases where the US Dollar is not quoted first the formula is slightly different. EUR/USD at an exchange rate of 0.9887

(0.0001/ 0.9887) X EUR 100,000 = EUR 10.11 to get back to US Dollars we add a further step

EUR 10.11 X Exchange rate which looks like EUR 10.11 X 0.9887 = $9.9957 rounded up will be $10 per pip.

GBP/USD at an exchange rate of 1.5506 (0.0001/1.5506) X GBP 100,000 = GBP 6.44 to get back to US Dollars we add a further step

GBP 6.44 X Exchange rate which looks like GBP 6.44 X 1.5506 = $9.9858864 rounded up will be $10 per pip. As we said earlier your broker may have a different convention for calculating pip value relative to lot size but however they do it they will be able to tell you what the pip value for the currency you are trading is at that particular time. Remember that as the market moves so will the pip value depending on what currency you trade. So now we know how to calculate pip value lets have a look at how you work out your profit or loss. Let's assume you want to buy US Dollars and Sell Japanese Yen. The rate you are quoted is 116.70/116.75 because you are buying the US you will be working on the116.75, the rate at which traders are prepared to sell. So you buy 1 lot of $100,000 at 116.75. A few hours later the price moves to 116.95 and you decide to close your trade. You ask for a new quote and are quoted 116.95/117.00 as you are now closing your trade and you initially bought to enter the trade you now sell in order to close the trade and you take 116.95 the price traders are prepared to buy at. The difference between 116.75 and 116.95 is .20 or 20 pips. Using our formula from before, we now have (.01/116.95) X $100,000 = $8.55 per pip X 20 pips =$171 In the case of the EUR/USD you decide to sell the EUR and are quoted 0.9885/0.9890 you take 0.9885. Now don't get confused here. Remember you are now selling and you need a buyer. The buyer is biding 0.9885 and that is what you take. A few hours later the EUR moves to 0.9805 and you ask for a quote. You are quoted 0.9805/0.9810 and you take 0.9810. You originally sold EUR to open the trade and now to close the trade you must buy back your position. In order to buy back your position you take the price traders are prepared to sell at which is 0.9810. The difference between 0.9810 and 0.9885 is 0.0075 or 75 pips. Using the formula from before, we now have (.0001/0.9810) X EUR 100,000 = EUR10.19: EUR 10.19 X Exchange rate 0.9810 =$9.99($10) so 75 X $10 = $750. To reiterate what has gone before, when you enter or exit a trade at some point your are subject to the spread in the bid/offer quote. As a rule of thumb when you buy a currency you will use the offer price and when you sell you will use the bid price. So when you buy a currency you pay the spread as you enter the trade but not as you exit and when you sell a currency you pay no spread when you enter but only when you exit.

Forex Trading Course-Market Mechanics-Dompyong Wetan

Forex Trading, Market Mechanics-Dompyong Wetan.

So now we know that the FX market is the largest in the world and that your broker or institution that you are trading with is collecting quotes from a centralized feed or individual quotes comprising of interbank rates. So how are these quotes made up. Well, as we previously mentioned currencies are traded in pairs and are each assigned a symbol. For the Japanese Yen it is JPY, for the Pounds Sterling it is GBP, for Euro it is EUR and for the Swiss Frank it is CHF. So, EUR/USD would be Euro-Dollar pair. GBP/USD would be pounds Sterling-Dollar pair and USD/CHF would be Dollar-Swiss Franc pair and so on. You will always see the USD quoted first with few exceptions such as Pounds Sterling, Eurodollar, Australia Dollar and New Zealand Dollar. The first currency quoted is called the base currency. Have a look below for some examples. Currency Symbol Currency Pair 

When you see FX quotes you will actually see two numbers. The first number is called the bid and the second number is called the offer (sometimes called the ASK). If we use the EUR/USD as an example you might see 0.9950/0.9955 the first number 0.9950 is the bid price and is the price traders are prepared to buy Euros against the USD Dollar. The second number 0.9955 is the offer price and is the price traders are prepared to sell the Euro against the US Dollar. These quotes are sometimes abbreviated to the last two digits of the currency such as 50/55. Each broker has its own convention and some will quote the full number and others will show only the last two. You will also notice that there is a difference between the bid and the offer price and that is called the spread. For the four major currencies the spread is normally 5 give or take a pip (we will explain pips later). To carry on from the symbol conventions and using our previous EUR quote of 0.9950 bid, that means that 1 Euro = 0.9950 US Dollars. In another example if we used the USD/CAD 1.4500 that would mean that 1 US Dollar = 1.4500 Canadian Dollars. The most common increment of currencies is the PIP. If the EUR/USD moves from 0.9550 to 0.9551 that is one Pip. A pip is the last decimal place of a quotation. The Pip or POINT as it is sometimes referred to depending on context is how we will measure our profit or loss.

As each currency has its own value it is necessary to calculate the value of a pip for that particular currency. We also want a constant so we will assume that we want to convert everything to US Dollars. In currencies where the US Dollar is quoted first the calculation would be as follows.

Example JPY rate of 116.73 (notice the JPY only goes to two decimal places, most of the other currencies have four decimal places) In the case of the JPY 1 pip would be .01 therefore USD/JPY: (.01 divided by exchange rate = pip value) so .01/116.73=0.0000856 it looks like a big number but later we will discuss lot (contract) size.

USD/CHF: (.0001 divided by exchange rate = pip value) so .0001/1.4840 = 0.0000673

USD/CAD: (.0001 divided by exchange rate = pip value) so .0001/1.5223 = 0.0001522

In the case where the US Dollar is not quoted first and we want to get to the US Dollar value we have to add one more step.

EUR/USD: (0.0001 divided by exchange rate = pip value) so .0001/0.9887 = EUR 0.0001011 but we want to get back to US Dollars so we add another little calculation which is EUR X Exchange rate so 0.0001011 X 0.9887 = 0.0000999 when rounded up it would be 0.0001. GBP/USD: (0.0001 divided by exchange rate = pip value) so 0.0001/1.5506 = GBP 0.0000644 but we want to get back to US Dollars so we add another little calculation which is GBP X Exchange rate so 0.0000644 X 1.5506 = 0.0000998 when rounded up it would be 0.0001.

By this time you might be rolling your eyes back and thinking do I really need to work all this out and the answer is no. Nearly all the brokers you will deal with will work all this out for you. They may have slightly different conventions but it is all done automatically. It is good however for you to know how they work it out. In the next section we will be discussing how these seemingly insignificant amounts can add up.

The Forex Trading Course

A self-Study Guide to Becoming A Successful Currency Trader.

ver 30 years ago, Abe Cofnas was a student of mine at the University of California at Berkeley. At the time, I am certain to have delivered a long-held admonition: 95 percent of what you read in economics will be either wrong or irrelevant. I am pleased to report that The Forex Trading Course falls into the 5 percent residual category of materials that are worth reading.

In addition to satisfying those with a healthy obsession to work on improving their professional skills, The Forex Trading Course will force readers to think outside the box and to develop an appetite for the pursuit of knowledge about trading. This, of course, is the most important aspect of the book and reminds me of an observation made by Sir Hugh Rigby, surgeon to King George V. Sir Hugh was once asked, “What makes a great surgeon?” He replied, “There isn’t much to choose between surgeons in manual dexterity. What distinguishes a great surgeon is who knows more than other surgeons.” The same can be said for traders.

In the interest of putting the reader a leg up, an understanding of the structure of exchange-rate regimes is essential. There are three distinct types of exchange-rate regimes—floating, fixed, and pegged—each with different characteristics and different results.

CHAPTER ONE - Background

We're going to start by debunking a bunch of myths.

First off, you don't have to understand a lot about the currency markets. Most of us know there is a different in then exchange rate if we take a trip to Canada or Mexico or Japan or Dompyong. hehehe

If you were to go to Japan right now, a dollar would buy about 110 Yen. You go to a kiosk or money changer, perhaps at the airport, and purchase whatever amount you think you’ll need. That’s easy enough. But what if you’re a large bank doing business overseas. Your client has just purchased 1,000 new Toyota’s and they need to be paid for with Yen. That’s not so easy. That’s why the Forex markets exist.

Rather than try to teach you all about the Forex business in this guide, simply go to http://www.foreignexchangetrading.info and click on all the items on the left side. It’s a free site and well worth visiting. Or, if you prefer, download this excellent publication: http://www.forex-trading-made-ez.com/power_forex.pdf

Now for some facts. The market is huge. More money changes hands each day than nearly all the stock exchanges combined. That’s not that important to us as traders because we can trade with as little as $100.

There’s no commission charged, as there is at a stock exchange. That’s good. We don’t have to worry about paying extra if we get stopped out of our trade. (I’ll explain later what that means if you’re not an experienced trader.)

Instead of a commission, a small spread between prices is leveled just like when you change money at the airport. For example, my pizza trade entry price was actually 1.33562. I had to make slightly more than $10 dollars to net ten. 

The most important thing I want to impress upon you at this time is risk control.

You’re going to make money. But you’re also going to lose money. How much you lose will determine your net profit. Always keep that in mind. You must control your losses if you expect to make the kind of money we discussed earlier.

Lastly, this is a “hands-on” trading manual. I’m going to train you to make money the same way I trained many pilots to fly jetliners. That’s right. For many years, as an airline captain/instructor, trained by Boeing, I taught other airline pilots how to fly jetliners.

So what’s that got to do with trading? Just this. When it comes to flying airplanes, you want to do it in the safest way possible. And the same thing is true when trading! You want to do it in the safest way possible. Much of the material will be very specific. Much of it will be repetitious. But that’s how you learn. Don’t try to outguess the strategy. Everything you’ll learn has a purpose.

Keep an open mind and you’ll do just fine. You don’t have to be smart. You don’t have to have a degree in rocket science. You just have to follow the rules and procedures. Just like flying a jetliner!