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Beginner’s Guide to Forex

Chapters 1.1 - 1.6

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Forex
Chapter 1.1 / A Basic Description

The foreign exchange, forex or FX, market has the highest turnover of all investment
instruments that a re used by market participants, such as banks and investors. The
bulk of the FX trade volume – what is popularly known as the “flow” – is mainly fo-
cused on the world’s leading currencies.

Currencies are divided into different categories, depending on their importance and
type. The most common currencies, which have the largest trade volumes, are called
the ‘majors’. These are the largest currencies of the G10 countries. Other types of cat-
egorisation could be for example ‘emerging currencies’ and ‘Scandinavian currencies’.

A large difference between FX spot and some other financial instruments, for ex-
ample, stocks, is that FX is traded over-the-counter (OTC). This means that it is not
traded on an exchange. Instead it is sourced from several large market makers around
the world, which quote two-way prices for the market to trade on.

The FX market is open 24/5, which means that it is possible to trade currencies around
the clock on weekdays. The market officially opens on Monday morning at 5am in
Sydney, Australia, and closes on Friday afternoon at 5pm Eastern Standard Time in
Year York. Even though the market is open 24/5, opening hours will vary across bro-
kers. Each currency also has its ‘prime time’. This is the time during the day when a
currency is most liquid. The less important that a currency is to the world economy,
the fewer the investors who will have an interest in trading it, resulting in reduced
flow and wider prices. That is one reason why certain currencies have limited opening
hours.

With a forex trade, you are buying one currency and simultaneously selling another
currency in the attempt to predict a future difference in price between two currencies.
So FX is always traded as a currency pair. The first currency in the pair is the base
currency, and the second currency being the variable currency, also called quote cur-
rency. The second currency is valued as X amount of units compared with 1 unit of
the first currency. The variable currency amount is the exchange rate of the pair. In
other words, it is the price for a pair.

All currencies have a three-letter currency code assigned to them. For example, the
code for the US dollar is USD, the code for the euro is EUR and the code for the Japa-
nese yen is JPY. The combinations of two codes make up a currency pair.
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Pairs are typically ranked in a certain hierarchy, which determines the order in which
the two currencies in a pair are named. For example, when euros are traded against
US dollars, they are always traded as EURUSD. So, if you wanted to speculate that the
euro would increase in value against the US dollar, you would buy EURUSD (mean-
ing you buy euros while simultaneously selling the converted amount of US dollars).
Meanwhile, if you wanted to speculate that US dollars would rise against euros, you
would sell EURUSD

Forex
Chapter 1.2 / Key Terminology

Market Taker
A market taker is participating in the market by hitting a bid –selling, or lifting an of-
fer –buying. In other words; a market taker is the client trading on a quote provided
by a market maker.

Market Maker
A market maker is actively creating the markets by taking on risk of quoting two-way
prices, for clients to trade on.

Quote
A quote is a price for a financial instrument, such as FX. For transparent pricing, a
quote should include two prices – a bid and an offer.

Bid
The bid is the left-hand, or the first, price in a quote. It is the price at which the market
taker – the client- sells at. It is therefore the price at which the market maker buys the
pair in question.

Offer
The offer is the right-hand, or the second price in a quote. It is the price at which the
market taker buys the quoted pair. It is therefore the price at which the market maker
sells. Pip: A pip is the standard increment that is used when defining a price move-
ment of a currency pair. A profit or loss is commonly determined in X amount of pips
in the quote currency.
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Pip
A pip is the standard increment that is used when defining a price movement of a cur-
rency pair. A profit or loss is commonly determined in X amount of pips in the quote
currency.

Generally, one pip refers to the fourth decimal of the price. EURUSD is an example of
this. But, in some currency pairs, a pip can refer to the second, third or even the fifth
decimal. The most notable example of an exception to the fourth decimal rule is the
currency pair USDJPY, where the pip refers to the second decimal of the price. But
most FX platforms nowadays offer pricing with an extra decimal, for instance, in one-
tenth or pip increments. This is more commonly seen in the major currency pairs than
in the non-major pairs.

100 pips is referred to as ‘one big figure’.

Amount
This is the nominal amount of the trade and it is determined in the base (first) cur-
rency of a pair. For example, if a trader has bought a position of 100,000 EURUSD,
what he has done is buy the amount 100,000 euros and pay for them with US dollars.

Margin and Leverage

Speculative FX trading is traded on margin. This means that you are able to leverage
your investment by opening positions that are larger in size than the cash on your
account.

Liquidity providers (banks, brokers etc.) will have a defined minimum margin require-
ment for each tradable instrument. This requirement will be based on the liquidity
available in the pair, volatility and other market conditions. Therefore, margin require-
ments may vary from instrument to instrument and can be changed at any time to
reflect new market conditions. The requirements might also differ greatly from one
broker to another.

The margin amount withheld, or reserved, for your margin positions, will limit the
maximum leverage that you can use on your account. The margin is what funds are
reserved on your account for margin – or leveraged – trading. It is, however, important
to note that losses can extend beyond your account size, and you are responsible for
monitoring your positions closely.

Long
A long position is a bought position. This refers to the direction of the first currency in
the pair. For example, if you are long EURUSD, then you have bought euros and sold
US dollars.
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Short
A short position is a sold position. For example, if you are short EURUSD, then you
have sold euros and bought US dollars.

Forex
Chapter 1.3 / Profit & Loss calculation

Your profit, or loss, is the difference between your entry and your exit price. If you
bought EURUSD at 1.3500 and sold it at 1.3600, you would have made a profit of a
big figure (100 pips).
When trading FX, you can make money on currencies irrespective of whether a pair is
rising or falling in value. This is because you always trade two currencies against each
other. You can either choose to buy (i.e. to go long), or to sell (i.e. to go short).
You can calculate the profit or loss that you made during your trade by using this
calculation:

Profit calculation = (buy price - sell price)* nominal value* (-1)

Subtract the sell price from the buy price. Multiply this number by the nominal amount
that you traded. Then multiply the new number by -1 to adjust for the fact that the
sell price might be higher than the buy price. The profit or loss is always expressed in
the variable (second) currency of the currency pair.

Let’s see an example of how this would work in practice. The EURUSD price is cur-
rently quoted 1.3532/ 1.3533. This means that 1 euro can be sold for 1.3532 US dollars,
or 1 euro could be bought for 1.3533 US dollars.

You always sell at the left price, which is the ‘bid’, and buy at the right price, which is
the ‘ask’ or ‘offer’ price. If you decide to buy 100,000 euros and pay with US dollars,
the price of each euro would be 1.3533 US dollars.

After you have bought the euros, the euro continues to increase in value against the
dollar – in other words, the EURUSD rate is rising. So you sell the euros and buy back
the dollars at a point when EURUSD is priced at 1.3580 / 1.3581. Each euro you wish
to sell is worth 1.3580 dollars. The difference between your entry and exit point is 47
pips. If you multiply this by the nominal value of your trade - 100,000 euros – you will
make a profit of $470 as a result of these two transactions.
CONTINUED
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(1.3533 - 1.3580)* 100,000*(-1) = $470

The monetary value of your profit, or loss, depends on the nominal amount that you
trade. If you have gained 50 pips in EURUSD for a trade in 1 million euros, you mul-
tiply the million with 0.0050 and your profit in this case is 5,000 US dollars. Pips are
valued in the quote currency of a pair. Therefore 50 pips in EURJPY are not worth the
same as 50 pips in EURUSD.

Forex
Chapter 1.4 / Orders

You can enter a new FX position either by trading on live quotes, which is possible
through some brokers with one-click trading via electronic platforms. The other alter-
native is to place an order. This entails placing an order at a given price, which would
convert to a trade if and when the price is reached within the defined validation of
the order. The most common order types used in the market are: market orders, limit
orders and stop orders. These are traditionally used in different scenarios.

A market order could be an order to either buy or sell a pair ‘at market’, in other words
where the market is now trading.

Limit orders are traditionally used to enter the market at a specific level that is bet-
ter than the current market level. For example, if you are interested in buying EU-
RUSD, but only at a price that is 50 pips cheaper than the current market level, you
can place a limit order to buy at your preferred level, which is lower than the current
market level. Limit orders can also be used to take profit. To lock in a future potential
profit for a long position, you would place a limit order to sell higher than where the
market is currently trading.

Stop orders are traditionally used as a risk management tool, in order to protect a po-
sition against an extensive loss. Stops are always placed at levels worse than where
the market is currently trading. For example, if you have a long position and want to
sell should the market drop you would place a stop order to sell, let’s say for example;
50 pips below the current market price.

The nature of stop orders allows you to use them to enter a position, for example, in
a break-out scenario.
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Both limit and stop orders are only executed and transformed into a position if and
when the market reaches the specific price at which the order is placed, within the
said run-time of the order.

Some providers with advanced trading platforms will allow you to choose the ‘trigger
price’. This means, for example, that you could place a stop offer to sell at a price level
of your choice, which would mean that the order is executed when the market is of-
fered at that level, rather than when it is bid at that level. Note, however, that your sell
orders as a market taker will always be executed at the bid price at the time. Being
able to choose the trigger price could prove beneficial if you choose to have orders
placed during illiquid markets or periods.

Forex
Chapter 1.5 / Value dates

An FX spot transaction is concluded at an agreed price on the settlement date, which

is known as the spot date. This is usually two business days after the trade has taken
place, although a few exceptions of only one business day do exist. Forward outright
transactions, however, allow you to choose a settlement date that extends beyond
spot.

For speculative traders, actual settlement often does not take place. Instead, posi-
tions are kept open by a daily end-of-day roll, should the position not be closed in-
traday. Although the FX market is open 24/5, the daily session closes at 5pm Eastern
Standard Time. An overnight roll will reflect a new value date until the position is
closed. The methodology applied to overnight rolls varies greatly between different
banks and brokers.

Trading FX spot is suitable for short-term traders. But if you intend to have an FX
position for a longer period – a month, for example – an FX forward outright might be
more suitable. With a forward, the interest rate differential between the two currency
pairs traded, for the chosen time horizon of your trade, is fixed and included in your
price at the time of trading. This means that your profit or loss will not be influenced
by any potential changes in interest rates during the period in which you hold the po-
sition. In contrast, if you had kept a spot position, the interest rate differential could
vary from day to day and would be reflected through the overnight roll of the trade
until closed.
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Forex
Chapter 1.6 / Analysis

Generally, short-term investors rely more on technical indicators, while long-term

speculators rely more on macro events.

Investors often use technical indicators to take short-term, informed decisions based
on technical analysis. They look at historical price developments and thereby identify
patterns and signals that can be used for trading. A common expression is that “his-
tory repeats itself”. Many indicators can be applied to different chart periods, thereby
trigger short term as well as long term signals.

Macro developments have large impact on currencies, so speculators value them as

a means of analysing the market. General elections, outbreaks of conflict, and eco-
nomic statistics put out by governments are examples of such events. The release of
important financial indicators, such as the non-farm payroll statistics in the US, can
have a large impact on prices in the FX market at the time of release.

DISCLAIMER

None of the information contained herein constitutes an offer (or solicitation of an offer) to buy or sell
any currency, product or financial instrument, to make any investment, or to participate in any particu-
lar trading strategy. This material is produced for marketing and/or informational purposes only and
JSC Galt & Taggart (“Galt&Taggart”) and its owners, subsidiaries and affiliates whether acting directly or
through branch offices make no representation or warranty, and assume no liability, for the accuracy or
completeness of the information provided herein. In providing this material Galt&Taggart has not taken
into account any particular recipient’s investment objectives, special investment goals, financial situa-
tion, and specific needs and demands and nothing herein is intended as a recommendation for any re-
cipient to invest or divest in a particular manner and Galt&Taggart assumes no liability for any recipient
sustaining a loss from trading in accordance with a perceived recommendation. All investments entail a
risk and may result in both profits and losses. In particular investments in leveraged products, such as
but not limited to foreign exchange, derivatives and commodities can be very speculative and profits and
losses may fluctuate both violently and rapidly. Speculative trading is not suitable for all investors and
all recipients should carefully consider their financial situation and consult financial advisor(s) in order
to understand the risks involved and ensure the suitability of their situation prior to making any invest-
ment, divestment or entering into any transaction. Any mentioning herein, if any, of any risk may not be,
and should not be considered to be, neither a comprehensive disclosure or risks nor a comprehensive
description such risks. Any expression of opinion may be personal to the author and may not reflect the
opinion of Galt&Taggart and all expressions of opinion are subject to change without notice (neither prior
nor subsequent).