Forex Trading Basics

Well, Labor Day has come and gone and the kids are back in school. The market continues to cause some nervousness as uncertainty remains the watch word.

I took some time off the last part of August, and my trading reflected the fact that I was not at the computer each day. Nonetheless, with implied volatility levels inflated I have been having some good success trading credit spreads on the indexes which invariably turn into iron condors as the market rises and falls.

The stock market is not the only game in town, however. A few years ago, I became very interested in the Forex market. It offers some significant advantages over the equity market, but there are also some real pitfalls. While I was relaxing on my short break, I thought I might share some information about the Forex market for those who have found themselves wondering what it is all about.

Forex is an abbreviation for the foreign exchange market, which is the largest financial market in the world. The foreign exchange market is an "over the counter" market, meaning that there is no centralized exchange. Currencies are traded directly through a network of banks and brokers, via an electronic network or through the telephone.

The Forex is a 24 hour market, with the first "trading day" starting at 5:00 p.m. EST on Sunday. Trading starts in Sydney, Australia, then transitions throughout the trading day to other financial centers in the world. From Sydney, the trading next moves to Tokyo, then London, and finally to New York where the trading session "ends" at 5:00 p.m. EST.

While one trading session ends at 5:00 p.m. EST in New York, the next session is getting started in Sydney, at the same time. As such, the Forex market does not actually close.

The most commonly traded currencies include the U.S. Dollar, the Euro, Japanese Yen, British Pound, Swiss Franc, Canadian Dollar, and the Australian Dollar. These currencies are considered the "major" currencies in the Forex market.

Trading in the Forex market involves the trading of currency pairs. One currency for another. The common method of denoting which currencies are being traded utilizes a short, three letter abbreviation for each currency in the pair, separated by a slash. For example, EUR/USD denotes the Euro / U.S. Dollar pair. The other recognized pairs include GBP/USD, USD/JPY, USD/CHF, USD/CAD, and AUD/USD.

These recognized pairs of the major currencies are the most highly traded currency pairs in the the world. They are highly liquid and they are traded on a 24 hour basis. Of the majors, the EUR/USD and GBP/USD are the most prolific.

The order in which the currencies are denoted does have significance. The first three letter symbol identifies the "base" currency while the second three letter symbol identifies the "counter" currency. Quotes are given for the cost of the counter currency against the base. For example, if you are quoted 1.3855 for the EUR/USD you are being told that it will cost you 1.3855 U.S. Dollars to buy one Euro. A quote of 0.8644 on the USD/AUD pair, indicates that one Australian dollar will cost 0.8644 U.S. Dollars.

With the exception of the Japanese Yen, all of the major currencies are quoted out to four decimal points. The smallest unit by which a currency can be quoted is called a "pip." The Yen is quoted out to just two decimal points, so one "pip" for the yen is equal to .01, while a "pip" for any other of the major currencies would equal .0001.

The bid price is the price the market is willing to pay a seller of the currency pair. The ask price is the price the market is willing to sell a currency pair to a buyer.

The difference between the bid and ask price is known as the "bid/ask spread" and the difference between the two is how the market maker is compensated. Because they are compensated from the spread, there is no commission paid for the transaction. The bid/ask spread is not fixed, but will change with prevailing trading conditions.

Lot sizes are 100,000 units for a standard lot and 10,000 for a mini-lot. One pip on a standard lot equals $10. On a mini-lot, one pip is equal to $1.

Forex dealers offer leverage as high as 100:1, sometimes even higher. Assuming 100:1 leverage, 1 standard lot would require $1,000 in margin. A mini-lot would require $100 in margin. If your account value falls below the required margin on a position, the dealer will automatically and immediately close out the trade.

This is just a brief overview of Forex basics. While the Forex market is not something you would want to jump into on a casual basis, it can offer you some tremendous benefits. If you do choose to pursue trading in this market, take the time to first learn more about about how Forex works and how it can be traded safely. With 100:1 leverage, you can lose money just as fast as you earn it.

Good trading!

Christopher Smith
TheOptionClub.com