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Currency pair:
Currencies are traded in pairs; for example the euro and the US dollar (EUR/USD).In this left
currency or EUR is the base currency and USD is counter or quote currency or pip currency. One
can buy or sell only the base currency.When we buy a base currency we sell quote currency and
when we sell a base currency we buy a quote currency.
Quote is the ratio of the value of base currency to quote currency.
Ex:quote for GBP/USD = 1.7500
Pip: It is the smallest price change that a given exchange rate can make. Most major currency
pairs are priced to four decimal places.
Ex: For GBP/USD
1 pip=0.0001
for USD/JPY
1pip =0.01
Bid and ask price: The bid or offer price is the price in which the dealer is willing to buy the
base currency in exchange for the quote currency. This means the bid is the price at which the
trader will sell. The ask is the price at which the dealer will sell the base currency in exchange for
the quote currency. This means the ask is the price at which the trader will buy.
Ask price is always higher than bid price.
Difference between ask and bid is called as spread.
This is the amount that a dealer charges for making the transaction. Spreads will vary among
dealers. The spread is only charged on one side of the transaction. In other words, there is no
need to pay the spread when we buy AND then again when we sell. It is usually only charged on
the "buy" side of the trades.
Long and short position:
When a currency rises in value then , this is called "going long" or taking a "long position". In long
position the currency has to be bought. When a currency depreciates in value then , this is called
"going short" or taking a "short position". In short position the currency has to be sold.
long = buy. Short = sell.
If the base currency is in long position then the quote currency is in short position and vice versa.
Starting a trade:
Before trading Forex we need to set up an account with a Forex broker. We have to choose a
broker registered with regulatory agencies. In simplest terms, a broker is an individual or a
company that buys and sells orders according to the trader's decisions. Brokers earn money by
charging a commission or a free for their services.
Lot:It is the minimum amount of currency you have to buy.
10,000 (Mini account) or 100,000 (Standard account) or micro account [1000].
Some brokers even offer fractional unit sizes (called odd lots) which allow you create your own
unit size.
Open a position—It means opening the lot in trade.
Holding a position—It means holding the lot in trade.
Close a position-It means closing the lot from trade.[full cycle-buying and selling a currency or
vice versa]
Margin and leverage:
Margin trading is simply the term used for trading with borrowed capital.
To open a position[say 1 standard lot] in trade there is no need to invest 100,000 units of
currencies in the trade.One can pay the margin to the dealer and open a position.
Leverage is denoted in terms of ratio and margin is denoted in terms of percentage or value.
Leverage varies from 1:1,1:100 to 1:400 etc
Ex: in 1:100 leverage or 1% margin
The trader can deposit 1 unit of currency to the dealer and can trade 100 units of same
currency.So.to open one unit of standard lot position ,the trader has to pay a margin of 1000
units of currency.
Interest rate:
It is the rate which a borrower pays for holding a lender’s money. An increase in interest rates in
a particular country encourages investment in that country since it offers higher returns. This
causes the demand for their currency to rise. As demand for that currency rises, it becomes
scarcer and thus more valuable. Countries that undergo interest rate cuts tend to experience a
depreciation of their currency.
The difference between the interest rates in the two countries is called the interest-rate
differential.
Costs involved under different positions:
Open a position—Margin
Holding a position— The costs associated with holding a position for several days are determined
by the short term interest rates of the currencies involved in the trade. This 'cost of carry' can
mean that interest is paid to you or taken from you, depending on which currencies have the
higher interest rate.
For ex: if the interest rate for holding USD is 7% and EUR is 5% then interest-rate differential is
2%.
At the end of the day if the trader holds USD then amount is credited to his account. At the end of
the day if the trader holds EUR then amount is debited from his account.
Cost in terms of pips
"pips = (spot-(((1+quoted currency interest rate)x days/days basis x 100)/((1+base currency
interest rate x days)/days basis x100))) x spot)) x -10000
Close a position-Spread cost
Trade and settlement date:
Date in which a trade is made is trade date.The settlement date is usually 2 business days for
most of the currenct pairs except USD and CAD which is 1 day.If a trade is made in 5pm EST to 5
pm EST in a 24 hr period then settlement date is usually 2 business days.Otherwise settlement
date is increased by 1 business day.If the selllement date falls on weekend then settlement date
is increased by 2 more business days.
Types of Orders
• Market — the order will be executed, but the price is not guaranteed---A market
order is a buy or sell order to be executed immediately at current market prices
• Limit order — Limit price are set for a favourable position i.e to gain profits.
Execution occurs if either ask (buy limit) OR bid (sell limit) quote reaches the order
price, depending on the direction of your limit order.-- A limit order is an order to buy a
security at no more, or sell at no less, than a specific price.
Stop loss order— Stop price are set for a unfavourable position i.e to reduce losses or to
prevent more loss.
Execution is guaranteed if either ask (buy stop) OR bid (sell stop) quote reaches the
order price, depending on the direction of your stop order.
• OCO Pair — One Cancels Other. If there are two orders, then execution of one of
them cancels the other.
• Parent and Contingents or if and then — a parent order (of Market, Stop, or
Limit types) issued simultaneously with the child (contingent) orders. The child orders
begin to work as standard stop or limit orders only when the parent order is accepted.You
can also make the contingent orders an OCO pair.
There are different kinds of forex softwares available based on usage such as a single interface for
multiple brokers,merchant-broker softwares with facilities to trade on two platforms etc.