Saturday, June 14, 2014

Basic Terms of Forex Trading

What Is Forex?
Foreign exchange, commonly known as forex, is the trading of currencies in the foreign market, primarily by speculators and investors. The trading and exchange of currency goes back to ancient times. It was a vital practice that allowed people to buy and sell food and other materials. Averaging over $4 trillion in turnover per day, foreign exchange is the world's largest market. Working through international financial institutions, forex operates on different levels. By enabling currency conversion, the forex market helps international trade and investments. There is plenty of opportunity in forex trading for investors. However, success is contingent upon an understanding of the basics behind currency movements.

The Basics of Forex Trading
There are several theories explaining exchange rate fluctuations in a floating exchange rate regime. One is international parity conditions which include interest rate parity, International Fisher effect, and Relative Purchasing Power Parity. Second, there is the balance of model which mostly focuses on tradable goods and services. Finally, there is the asset market model, which considers currencies to be an important asset class for putting together investment portfolios. The aforementioned models have not successfully exchange rates and their volatility in a large time frame. Algorithms can be used to predict prices in a shorter time frame.

A simple example of forex tradings is as follows: There's a situation in which the value of the U.S. dollar is expected to weaken relative to the euro. In this situation, a forex trader will sell dollars and purchase euros. If the value of the euro strengthens, there is increased purchasing power to buy dollars. Now the trader can profit because they can buy back more dollars than they had to begin with. This shows some similarity to stock trading as a stock trader will typically buy stock if they think it will increase in price in the future and sell if the price is likely to fall in the future. A forex trader buys a currency pair if they expect the exchange rate to rise and will sell if they expect the rate to fall.

Key Terms And Concepts
When it comes to forex trading, there are some basic terms and concepts that should be understood:
  • Exchange rate: Exchange rate is simply the price of one currency in terms of another's. There are two components, the domestic currency and the foreign currency.
  • Pips: A pip is the smallest price change that a given exchange rate can make.
  • Spread: The spread is the difference between the two prices on a currency pair. You have the ask price and the bid price.
  • Leverage: This concept is used by both companies and investors. Companies use it for the financing of their assets. Investors use leverage to increase the returns they can get on an investment.
  • Forex broker: Forex brokers are firms that provide forex traders with access to a platform that for the trading of foreign currencies. Brokers are used for access to the 24-hour currency market. They are usually compensated the spread of a currency pair.
  • Face value: A familiar concept throughout investing and securities, face value is the stated dollar value of a security. In the case of stocks, it is the original cost of the stock as shown on the certificate.
  • Rollover: This rate is the the net interest return on a trader's currency position. This rate converts net currency interest sales into a cash return for the position.