What is the Forex Market

The Foreign Exchange market is also referred to as the "Forex",  "FX" market, "Cash" Forex and Spot Forex market and is the largest financial market in the world, with a daily average turnover of well over US$1 trillion -- 30 times larger than the combined volume of all U.S. equity markets.

"Foreign Exchange" is the simultaneous buying of one currency and selling of another. Currencies are traded in pairs, for example Euro/US Dollar (EUR/USD) or US Dollar/Japanese Yen (USD/JPY).

There are two reasons to buy and sell currencies. About 5% of daily turnover is from companies and governments that buy or sell products and services in a foreign country or must convert profits made in foreign currencies into their domestic currency. The other 95% is trading for profit, or speculation. And that's where Forex.ca can help!

The most commonly traded (and therefore most liquid) currencies are called "the Majors." Today, more than 85% of all daily transactions involve trading of the Majors, which include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar.

Forex trading begins each day in Sydney, and moves around the globe as the business day begins in each financial center, first to Tokyo, London, and New York. Unlike any other financial market, investors can respond to currency fluctuations caused by economic, social and political events at the time they occur - day or night.

The Cash Forex market is considered an Over The Counter (OTC) or 'interbank' market, due to the fact that transactions are conducted between two counterparts over the telephone or via an electronic network. Forex trading is not centralized on an exchange like the stock and futures markets.

More information

For more background information about the Foreign Exchange market,

review  "All About the Foreign Exchange Markets"

Understanding Forex Quotes

Reading a foreign exchange quote may seem a bit confusing at first. However, it's really quite simple if you remember two things:

1) The first currency listed is the base currency and

2) the value of the base currency is always 1.

The US dollar is the centerpiece of the Forex market and is normally considered the 'base' currency for quotes. In the "Majors", this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the second currency quoted in the pair. For example, a quote of USD/JPY 120.01 means that one U.S. dollar is equal to 120.01 Japanese yen.

When the U.S. dollar is the base unit and a currency quote goes up, it means the U.S. dollar has appreciated in value and the other currency has weakened. If the USD/JPY quote we previously mentioned increases to 123.01, the dollar is stronger because it will now buy more yen than before. The three exceptions to this rule are the British pound (GBP), the Australian dollar (AUD) and the Euro (EUR). In these cases, you might see a quote such as GBP/USD 1.4366, meaning that one British pound equals 1.4366 U.S. dollars.  In these three currency pairs, where the U.S. dollar is not the base rate, a rising quote means a weakening dollar, as it now takes more U.S. dollars to equal one pound, euro or Australian dollar.

In other words, if a currency quote goes higher, that increases the value of the base currency. A lower quote means the base currency is weakening.

Currency pairs that do not involve the U.S. dollar are called cross currencies, but the premise is the same. For example, a quote of EUR/JPY 127.95 signifies that one Euro is equal to 127.95 Japanese yen.

Understanding Spreads

When trading foreign exchange, you are always quoted a 2-sided dealing price where you can buy or sell the trade currency.  The difference between the buy and sell price is the spread.  Forex.ca and/or Gain Capital / Forex.com is compensated through the bid/ask spread.

BID and ASK Prices

When trading forex you will often see a two-sided quote, consisting of a 'bid' and 'ask'. The 'bid' is the price at which you can sell the base currency (at the same time buying the counter currency). The 'ask' is the price at which you can buy the base currency (at the same time selling the counter currency).

Factors affecting the market

Currency prices are affected by a variety of economic and political conditions, most importantly interest rates, inflation and political stability. 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.

Fundamental vs. Technical Analysis

Currency traders make decisions using both technical factors and economic fundamentals. Technical traders use charts, trend lines, support and resistance levels, and numerous patterns and mathematical analysis to identify trading opportunities.  Fundamentalists predict price movements by interpreting a wide variety of economic information, including news, government-issued indicators and reports, and even rumor.

The most dramatic price movements however, occur when unexpected events happen.  The event can range from a Central Bank raising domestic interest rates to the outcome of a political election or even an act of war.  Nonetheless, more often it is the expectations surrounding an event that drives the market rather than the event itself.

What Every Currency Trader Should Know
The forex market is one of the most popular markets for speculation due to its enormous size, liquidity, and tendency for currencies to move in strong trends. An enticing aspect of trading currencies is the high degree of leverage available. Forex.ca allows positions to be leveraged up to 100:1. Without proper risk management, this high degree of leverage can lead to enormous swings between profit and loss. Knowing that even seasoned traders suffer losses, speculation in the forex market should only be conducted with risk capital funds that if lost will not significantly affect one's personal financial well being.

Rollover

What happens to my open positions at the end of the trading day?

Unless specific settlement instructions are provided, FOREX.ca will automatically roll forward all open positions to the next day's value date at the end of each business day, 5:00 pm EST. All rolls will be done at competitive rollover rates, and depending on the currency pairs involved, trades will be executed where the trader will either earn or pay interest, depending on the interest rate differential between the two currencies.  If you do not want to earn or pay interest on your positions, simply make sure it is closed at 5pm EST, the established end of the market day.

For details see the Dealing Handbook

Calculating Profit and Loss

For ease of use, our online trading platform automatically calculates the P&L of your open positions. However, it is useful to understand how this calculation is derived.

Understanding Margin

The margin deposit is not a down payment on a purchase of equity, as many perceive margins to be in the stock markets. Rather, the margin is a performance bond, or good faith deposit, to ensure against trading losses. The margin requirement allows traders to hold a position much larger than the account value. Forex.ca’ s online trading platform has margin management capabilities, which allow for this high leverage.

In the event that funds in the account fall below margin requirements, the Dealing Desk will close all open positions. This prevents clients' accounts from falling into a negative balance, even in a highly volatile, fast moving market.

Trading currencies on margin lets you increase your buying power. Here's a simplified example: If you have $2,000 cash in a margin account that allows 100:1 leverage, you could purchase up to $200,000 worth of currency-because you only have to post 1% of the purchase price as collateral. Another way of saying this is that you have $200,000 in buying power.

With more buying power, you can increase your total return on investment with less cash outlay. To be sure, trading on margin magnifies your profits AND your losses.

Here's a hypothetical example that demonstrates the upside of trading on margin:

With a US$5,000 balance in your margin account, you decide that the US Dollar (USD) is undervalued against the Swiss Franc (CHF).

To execute this strategy, you must buy Dollars (simultaneously selling Francs), and then wait for the exchange rate to rise.

The current bid/ask price for USD/CHF is 1.2322/1.2327 (meaning you can buy $1 US for 1.2327 Swiss Francs or sell $1 US for 1.2322 francs)

Your available leverage is 100:1 or 1%. You execute the trade, buying a one lot: buying 100,000 US dollars and selling 123,270 Swiss Francs.

At 100:1 leverage, your initial margin deposit for this trade is $1,000. Your account balance is now $4000.

As you expected, USD/CHF rises to 1.2415/20. You can now sell $1 US for 1.2415 Francs or buy $1 US for 1.2420 Francs. Since you're long dollars (and are short francs), you must now sell dollars and buy back the francs to realize any profit.

You close out the position, selling one lot (selling 100,000 US dollars and receiving 124,150 CHF) Since you originally sold (paid) 123,270 CHF, your profit is 880 CHF.

To calculate your P&L in terms of US dollars, simply divide 880 by the current USD/CHF rate of 1.2415. Your profit on this trade is $708.82

SUMMARY

If you had executed this trade without using leverage, your return on investment would be less than 1%.

Managing a Margin Account

Trading on margin can be a profitable investment strategy, but it's important that you take the time to understand the risks.

• You should make sure you fully understand how your margin account works. Be sure to read the margin agreement and talk to your account representative if you have any questions.
   

• The positions in your account could be partially or totally liquidated should the available margin in your account fall below a predetermined threshold.
   

• You may not receive a margin call before your positions are liquidated.

You should monitor your margin balance on a regular basis and utilize stop-loss orders on every open position to limit downside risk.  In fact, most traders place a stop-loss order at the same time of the entry order to limit risk. Placing Contingent Orders may not limit your losses to the intended amounts.

For information on managing margin in your

FOREX.ca account, click here.

To try our forex trading platform, risk-free!...click here.