Beginners of Forex Currency Trading Need to be Familiar with the Basics

So you are a beginner and you want to learn how to trade currency on the foreign exchange market? The process of forex currency trading appears very straight forward however the beginner will require serious further study to be able to trade successfully. This site will give the beginner a basic idea of how things work.

In the beginning forex currency traders will need to learn the basic concepts and terms that will help them in their currency trading process. For the beginner this may seem a little confusing but it's really fairly simple. The beginner should also have a basic understanding of how to calculate a profit. The more familiar you are with the forex basics the easier it is for the beginner to get started in forex currency trading.

Currency Pairs: Every currency has a three letter abbreviation. The currency rates are always quoted in pairs and expressed as a five digit number. The first currency in the pair is the base currency and it is always equal to 1. The base currency is the currency you intend to purchase. For example, if EUR/USD = 1.4100 then every 1 Euro is worth US $1.41. The second currency in the pair is the quote currency and is the currency you intend to use to purchase the base currency.

Pips: currencies are traded on a price interest point (pip) system. The last digit in the currency pair represents one pip. For example if the GBP/USD rate moved from 1.6374 to 1.6375 this represents one pip movement. It also means that the GBP has appreciated by one point and the USD has depreciated by one point. Each currency has its own pip value. Similarly if the USD/JPY rate moved from 130.45 to 130.46 it has appreciated by one pip.

Pip Value: In any currency pair the base currency has a pip value of $1 per every 10,000 currency units. Therefore in a standard 100k account the base currency has a pip value of $10 for every 100,000 currency units.


Bid/Ask Price: The 'bid' price is shown at the left side of the quotation and is the price at which the trader can sell the base currency. The 'ask' price is shown at the right side of the quotation and is the price at which the trader can buy the base currency. For example EUR/USD is 1.4426/1.4428

Bid/Ask Spread: Is the difference between the bid and ask price for every currency pair. Forex traders are subject to spreads when opening or closing trades in the buying position. In other words, you are always subject to a spread when you buy, regardless of whether you are opening or closing the trade. The lower the spread the lower the broker's fees. The narrowest spreads are quoted on the most liquid currency pairs, the majors.

Margin: The beginner needs to understand that forex currency trading is conducted on margin. This means that you only need to use a small cash deposit to trade a much larger amount of currency. The margin deposit is required as collateral to cover any losses that might be incurred. For example a broker might require only $1,000 in your trading account in order to trade a $100,000 trading position. In effect the broker loans you $99,000 for $1,000 in security.

Lot Sizes: Trading is done in lots, either standard lots or mini lots. A standard lot size is equivalent to 100,000 units of currency. With 100:1 leverage you will need $1,000 to trade one standard lot. A mini lot size is 10,000 units of currency, with 200:1 leverage you will need $50 to trade one lot.

Rollover: When a trader has an open position at 5.00pm EST it will automatically be rolled over to the next day resulting in your trading account to either earn daily interest or pay daily interest. This is determined by the 'interest rate differential' which is the difference between the short-term interest rates of the two economies comprised in the currency pair.


For example, with GBP/USD, if Britains interest rates are 5.0% and U.S. interest rates are 2.0%, the interest rate differential is 3.0% (5% - 2%). Therefore if you were to buy GBP/USD you would receive interest at 3.0% per year. If you initially sell GBP/USD you would have to pay interest at 3.0% per year.

Carry Trade: the purpose is to earn extra income from the daily interest payments when you hold on to a currency pair. Selection of the right currency pair is essential for this to work. You will need to buy the currency with the higher interest rate and sell the currency with the lower interest rate.

Cross Currencies: currency pairs that do not involve the U.S. Dollar.

Long Position: occurs when a trader initially buys currency with the expectation that the currency will increase in price and then selling it later at a higher price.

Short Position: occurs when a trader initially sells currency with the expectation that the currency will decrease in price and then buying it back later at a cheaper price.

How to Trade Currency
Illustrated below for the beginner is an example of how to calculate a profit in forex currency trading.

Say for example you believe that the Euro might appreciate in value against the US Dollar in the near future and the current exchange rate is EUR/USD = 1.4210. You then decide to exchange US$ 100,000 to purchase Euros.

US$ 1.00 = EUR 1.4210
US$ 100,000/1.4210
You will get: EUR 70,373

Profit
Later on, as expected, the Euro appreciates by 75 pips to EUR/USD = 1.4285. You then decide to sell your Euros and exchange them back into US Dollars.


US$ 1.00 = EUR 1.4285
EUR 70,373 x 1.4285
You will get: US$ 100,528
Your profit = US$ 528