It is important to clearly understand how the forex market. In this lesson we will review all basic concepts related to the operation of the Forex market, you will learn: everything about the contributions, as does the leverage, when we charge and when we pay interest, and more.
In currencies, like other financial instruments, is more practical to write in standard codes. The International Standardization Organization (ISO) has developed what is known as the ISO codes for currencies. These codes consist of three letters:
– The first two represent an abbreviation of the country of the currency.
– The last letter represents the first letter of the name of the currency.
The couple also can be called by his “nickname”.
* CHF, CH means Helvetic Confederation (the Latin translation). This eliminates the need to use one of the four official languages in Switzerland.
The Seven Major Currencies
Care of all transactions in the currency market, 85% of them are care in the seven major pairs.
Volume Generated by Currency
[Table 2]
Source: Bank of International Settlements
* As each currency pair involved 2 the total is 200%
Driving Pairs as Instruments
It is much more practical to consider the peers as instruments. For example, if you expect the euro to appreciate, you buy EUR (EUR / USD). Whatever you are doing here is simultaneously buy EUR and sell USD. But it is not practical to see it from that standpoint. It’s much simpler to consider the “Euro” as the main instrument, so you will be “long in Euros.
Continuing the example, if instead you expect the USD to appreciate whatever it is you sell EUR (EUR / USD), here you are selling and buying simultaneously EUR USD. Here you are “short in Euros.
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Section III: Direct and Indirect Rates and Quotes Anti and Base
Direct and Indirect Rates
Each currency can be traded directly or indirectly against other currencies (most of the time with the USD).
Direct Quote: Number of local currency needed to buy one unit of foreign currency (usually USD).
Indirect Quotation: Number of local currency is received when a unit of foreign currency sold.
For simplicity, most of the time the USD is the foreign currency, then for the 7 main pairs we have:
Pairs with direct quote
– USD / JPY
– USD / CAD
– USD / CHF
Indirect Pairs With Quote
– EUR / USD
– GBP / USD
– AUD / USD
Base and Counter Rates
The first currency of a currency pair is always called base. The second pair is called currency against. The contributions of the pairs are always expressed in units of the currency against which they can buy a base currency unit.
EUR / USD = base currency / currency against
This is how many USD are required to purchase a EUR
If the price of EUR / USD is 1.2550, then we need 1.2550 USD to buy EUR … and the same applies to other pairs.
If the price of USD / JPY is 110.05, then 110.05 is required to obtain a USD JPY.
TIP: The EUR is always the dominant currency against all other currencies. All pairs that involve the EUR are identified as: EUR / USD, EUR / JPY, EUR / CHF, etc.. The next coin in the hierarchy is the GBP, which is always less than the base currency against the EUR.
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Section IV: Lots, Pips and Spreads
Lots
Transactions in foreign exchange can be of different sizes: standard, mini, micro or variable contracts.
Lots standard: The standard lots are 100,000 units of base currency. (the amount of money needed to open a standard operation varies with leverage, we see this in a moment).
Mini lots: The lots are mini size trades of 10,000 units of base currency (10 times less than standard operations).
Micro lots: Each lot has a value of micro 1,000 units of base currency (ten times smaller mini lots and one hundred times lower than the standard lots).
Lot variable: Some brokers let you open batch operations variables, this based on the needs of the operator. For example, you can open a transaction size: 234.644 and 5.328.
Consider some numbers:
A trader buys EURUSD at 1.4530
Standard lot: the operator is buying 100,000 EUR 145.300 USD
Lot Mini: the operator is buying USD 10,000 to USD 14.530
Lot Micro: the operator is buying 1,000 EUR to USD 1.453
Lot variable: the operator is buying a ¿234.644? (see answer below).
Fuel for Thought 1 – few dollars to buy our operator use 234.644 Euros. Hint: lots used variables.
Pips
A pip is the smallest increment that can have a couple. Pip stands for “price interest point. For most couples an IPSP is the 10,000 ma part of the exchange rate (1 / 10, 000). The only exceptions are those pairs that are involved in the JPY, where the value of each pip is the 100th part of the exchange rate (1 / 100).
In the EUR / USD 1.2532 a movement to 1.2553 is equivalent to 21 pips, while the USD / JPY, a move from 110.05 to 111.10 equals 105 pips.
Calculated pip value
While most online platforms calculate the pip value automatically, it is important to know how to get the value.
In the case of USD / JPY (and the indirect exchange) the calculation is as follows:
In Yen, .01 a pip equals (1 / 100)
If the price is 116.87 yen, then a pip equivalent to:
.01/116.87 =. $ 000,086 *
* The result of this exercise is based on a contract size 1. If we worked are standard lots, then 000,086 x 100,000 = 8.6 USD per pip
In the EUR (and direct exchange) the calculation is as follows:
At the Euro, one pip equals 0001
If the Euro rate is 1.2316, then a pip equivalent to:
.0001/1.2316 = .000081 Euros
Note: The result of this exercise is € (always in base currency terms). To convert it to USD have to add a step:
000,081 x 1.2316 = .000099 or .0001 (because we left out some previous operations decimal)
Again, the outcome of this exercise is based on a contract size 1. If we are batch operations mini, then: .0001 x 10,000 = 1 USD per pip (for standard lots would be 10 USD per pip).
HINT: when making direct foreign exchange transactions, each pip always has a value of $ 10 for standard lots and $ 1 for mini lots.
Thinking 2 – Just to be sure he understood the mechanics of correct calculation of each pip, what price do we buy USD / JPY to get a pip value of USD 10 pips for each? (Operations in standard lots).
Bid and Ask Spread
The price of the currencies are quoted with a spread, the difference of the purchase price and selling a currency.
The Bid is the price at which our broker is ready to buy, we the traders sell at this price.
The Ask is the price at which our broker is prepared to sell, we, operators buy at this price
Currencies are usually quoted as follows:
EUR / USD 1.2528/31 Spread = 3 pips
The bid is 1.2528
If we replace the last two digits (31) in the right price (bid) we obtain the ask price:
The ask is 1.2531
For couples where the JPY is involved, the prices change a little:
USD / JPY 116.45/48, 3 pips spread =
Bid: 116.45
Ask: 116.48
Now, the spreads can be variable or fixed. Most of the time, in normal market conditions the spreads are fixed (for example, 3 pips constant). But when market conditions become very volatile (eg in a fundamentally important announcement) the spread may increase (for example, changing from 3 to 8 pips pips), therefore, harder for us to open such an operation.
Well, now that we understand the last three concepts, we will review what is a typical scenario of operation, but before … a question.
Thinking 3 – Why do you think that different pairs have different spreads? For example, the EUR / USD usually has 2 or 3 pips spread, while the GBP / JPY are about 5 to 7 pips spread. Or exotic pairs like the USD / MXN often have 40 pips spread.
Typical scenario of operation
The contribution of the EUR / USD is: 1.2315/18
This means we can buy one Euro for 1.2318 USD or we can sell at 1.2315 USD. But we will not buy just “a” euro, we need more, we will buy 100,000 Euros.
Based on our analysis we think the EUR is undervalued, then we go long EUR / USD (buy EUR and sell USD) on a standard lot. Then buy 100,000 Euros and paid 123.180 USD for them (remember to use the quote “ask”).
Just as we hope, the EUR / USD gains value (moves up) and decided to close our operation to the current quotation: 1.2360/60. Now we need to close our operation and sell the 100,000 Euros that we have to get profits. We sell 100,000 Euros at 1.2360 (now use the quote “bid”) and received 123.600 USD for them.
If we bought 1.2318 (123.180) and sold back to 1.2360 (123.600), we obtain a gain of 42 pips, which in dollar terms are: 123.600 to 123.180 = U.S. $ 420 in winnings.
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Section V: Leverage (margin)
Ok, if you feel tired by the material seen so far, take a break, you’ll need in this section.
Operations Margin
Unlike other financial markets where you require the deposit of the total business done in the forex market you only require a partial deposit. The rest is “lent” his broker. This is known as leverage.
The leverage can be as high as up to 400:1 (depending on their risk profile and the broker chosen). 400:1 means you only need 1 / 400 of the total value of the transaction on your account, to open such an operation (floating more losses if they have them). Under this scheme of leverage, you only need 0.25% of total transaction open.
For example, if you were to operate with a standard lot (100,000 base currency units) using a 400:1 leverage, you only need $ 250 to open surgery ($ 100.000 / 400 = $ 250).
But be careful: SENIOR APANAC SUBSTANTIAL LOSSES CAN GIVE AS WELL AS GAINS SUBSTANTIAL. We will talk about this a little later.
Comparison of Leverage
[Table 3]
There are two things to consider about the operation margin (leverage):
1 – The operations room enables us to have our venture capital to a minimum, this because a small amount of capital allows us to open a bigger operation.
2 – The greater leverage, more capital in your account will be at risk. This brings us to the next item …
Margin Call
A margin call is the worst enemy of an operator. Unfortunately, this happens to many operators, some because they used poor techniques of capital management (or without using any technique) and other carriers is because they do not even know what a margin call.
A margin call occurs when the equity in your account falls below maintenance margin (which is equal to the capital required to open an operation, ie $ 250 if using 400:1 or $ 1,000 if used in standard operations 100:1). Refer to the table above.
In a margin call, the broker closes all its operations.
Let’s see an example for all this to be a little clearer.
Calculating the maintenance margin
Again, most brokers calculate this value, but still good to know how to calculate and give us an idea of the figure before launching the operation.
A trader buys EUR / USD at 1.2318 on a standard lot. You are using 100:1 leverage (margin of 1%).
He bought 100,000 Euros to 123.180 USD, then the maintenance margin is USD 1231.80 USD (123.180 x 1%).
If the operator was using 200:1 (or a margin of 0.5%), the maintenance margin would have been 615.9 USD (123.180 x 0.5%).
For direct pair (or pairs where the USD is the base currency) calculation is a little simpler:
Since the transaction is in USD, we need only calculate the percentage as follows:
If we are long on USD / CHF at 1.1445 to one standard lot, and use 100:1 leverage
We bought 100,000 USD and CHF 114.450 pay for them, then the maintenance margin is USD $ 1,000 (100,000 x 1%).
Consider a more concrete example
An operator opens an account to trade the forex market. She made a deposit of $ 4,000 to your account. The next morning she decides to open a purchase transaction of EUR (EUR / USD) at 1.2318 with two standard lots (the transaction is U.S. $ 246,360 = 2 x U.S. $ 123,180).
She is using 100:1 leverage, then the maintenance margin is $ 2,463.6 (U.S. $ 246,360 / 100 = U.S. $ 2,463.6).
The next morning, right after you open up your graphics and dang!! The EUR / USD has fallen like a rock. When you open your platform, your account balance is at U.S. $ 2463.6. The adverse market movement had made a call on margin.
When our operator entered the market with two standard lots, the maintenance margin rose to U.S. $ 2463.60, thus he only had U.S. $ 1,536 to support the floating losses (in case of an adverse movement). A move of 100 pips in the EUR / USD would be equivalent to $ 2,000. That night, the EUR / USD fell 113 pips, and all positions were closed by their broker, staying only with your maintenance margin.
Thinking 4 – What would have happened to our operator with different levels of leverage?
400:1 -?
200:1 -?
100:1 – He earned a margin call
50:1 -?
25:1 -?
This last example demonstrates the danger of not properly use leverage.
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Section VI: Rollover or Interest
Rollover
The currency market operates at a valuation of 2 days. A new valuation date occurs after 17:00 EST. The rollover occurs when the establishment of an operation is moved to the next valuation date (the transaction is kept open during the “night”), the cost of this is the difference in the rate of interest of the two currencies.
For example, if an operator opens an operation on Monday and remains open until Tuesday (closed on Tuesday), in this case the date of valuation would be on Thursday (because it operates at a valuation of 2 days).
Triple Rollover
However, if a trader opens a position on Wednesday and continues until Thursday, the day of valuation would be on Saturday, but markets are not working as the transaction is closed Saturday through Monday. This is called interest or triple triple rollover.
When we pay and when they took Interests
[Table 4]
Here is an Example
A trader buys two standard lots of USD / JPY at 111.50 at 13:00 EST. The position closes the next day.
Interest Rates:
U.S. – 3.5%
Japan – 0.15%
Interest calculated in USD
U.S. $ 200,000 [(.035 -. 0015) / 360] = U.S. $ 18.61
We use 200,000 units because we open two standard operations: 100,000 x 2 = 200.000, 360 wanted to see what we get per day. As we kept operational operated only for a day, divide by 360 (financial transactions are rounded to 360 days per day).
Interest calculated at JPY
[Image 2]
U.S. $ 100.000 = 11,150,000 JPY per batch, 11,150,000 x 2 = 22,300,000, 360 wanted to see what we get per day. As we kept operational operated only for a day, divide by 360 (financial transactions are rounded to 360 days per day).
Interest Rates April 2008
[Table 5]
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Section VII: Type of Orders
Orders
There are several ways to enter and exit the market operations. Different types of strategies require different ways to enter and exit the market.
Orders for market entry
Market order (market order) – An order to enter the market at current market value. If the price of EUR / USD is 1.2538/41, a buy market order to sell at 1.2541 and 1.2538
Limit order (limit order) – This command lets us enter the market at a price below the current price (if you’re buying) or above the current price if we are to sell. Such orders are used to gang strategies or delays (retracements)
Strategies band, buy the smallest one channel and sell at the top of a channel.
Strategies delays: Expect the lowest price to buy or sell higher.
Stop command (stop entry order) – In this type of purchase order at a price higher than the market or sell at a price lower than the market. Such orders are used for breaking strategies.
Strategies break: Expect the market prices reach new highs or lows to enter the market in the direction of the breakup.
Output Orders
Order limit (limit order). A limit order or order of profit taking (take profit order) specifies that level we will exit the market by the side of profits. If a trader buys this order is higher than the market price. If the trader sells, the order must be lower than the market price.
Order Stop (stop order). Specifies which is the maximum amount of pips that we are risking in a position. If we buy this order must be below the market price, if we sell this order must be above the market price.
Duration of Orders
Expiration Date Cancellation (GTC, by its initials in English: “good till canceled).
This order remains active or “valid” until the market reaches a certain level or canceled by the operator.
Valid until “N” (GTN, by its initials in English: “Good Hill N”), where N is a period of time as one hour a day, week, etc.).
This order remains active until the market reaches a certain level or a certain time.
One Cancels Other (OCO, for its initials in English: “One cancells the other”).
An OCO order is a combination of two orders: a limit order and a stop (SL). An order is placed below the market, and another is set above the market (no matter if they are orders to buy or sell) when the market reaches a warrant, the other is automatically canceled.
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Summary of Lesson No. 2
Finally finished this lesson, can become tedious and even a little confusing at times, we finally understand for each basic concept of the Forex market.
Before proceeding, make sure you understand the following concepts:
– How to calculate the pip value for each of the major pairs
– The difference between “bid” and “ask” where we buy and we sell
– What is the margin, as calculated
– Because the margin can result in significant gains, but also in substantial loss
– What is the Rollover, when we pay and charge interest when
Ok, this lesson we bastentes sections in “To Think” truth …
Fuel for Thought 1 – In the instance where our trader buys EUR / USD at 1.4530, we asked about the amount we use to buy USD 234.644 Euros (batch were variable). To reach the result we simply need to do the following calculation:
234.644 x 1.4530, this amounted to 340,937.73,
So we bought 234.644 Euros to U.S. $ 340,937.73
Thinking 2 – In the second section of thinking, we asked what price we buy USD / JPY for the value of each pip is $ 10 per pip.
Normally we calculate the pip value by using two variables: a few decimal equivalent per pip in USD / JPY (0.01) and the current price (ie 116.47), in this case, however, we know the pip value is $ 10 also know how much each pip is equal, and what we need to calculate is the value of the contribution, so the equation would be:
0.01 / X = 0.0001, solving for X we get:
0.01/0.0001 = X, therefore X = 100
Then the answer would be to get a pip value of $ 10 in the USD / JPY, the quotation should be 100.00
Thinking 3 – Here we are asked to give a reason why we believe that there are different spreads for different pairs, would not it be easier to have a single spread for all pairs?
The answer is because the forex market is like any other market, remember the example we used in Lesson 1 about the used car market? Well, so does the currency market, the pairs that are operated more frequently tend to have smaller spreads, and those that are not so operators tend to have larger spreads. As a result, those who undergo surgery more frequently tend to have smoother movements while those with wider spreads tend to be more volatile movements. Thus, it is a bit more risky to operate even more spread than those with smaller spreads.
Thinking 4 – In the fourth section to think of this lesson, we had to calculate the levels of leverage and see what would happen with the operation we did in the example.
What would have happened with different levels of leverage?
400:1 – With this level of leverage, the maintenance margin is U.S. $ 615.9 (246.360 x 0.25%). For this case we have enough capital to withstand adverse movement.
200:1 – Here the maintenance margin amount to U.S. $ 1,231.8 (246.360 x 0.50%). So was U.S. $ 2768.2 to bear the losses floats, and guess what, if spared the margin call by little, the adverse movement was U.S. $ 2,260, so if he had capital to withstand adverse movement.
100:1 – This scenario discussed in the course material
50:1 – With this level of leverage can not open the operation, as the maintenance margin is greater than what you have in your account: U.S. $ 4927.2 vs. maintenance margin. U.S. $ 4,000 in your account.
25:1 – you can not open the operation, as the maintenance margin is greater than the equity in your account: U.S. $ 9854.4 vs. maintenance margin. U.S. $ 4,000 in your account.
Wait a second … so what we are saying is that it really is better to have high leverage? Not at all. High levels of leverage is always equal to greater risk. Put it this way, imagine you have two accounts, one using another using 100:1 and 200:1 and that instead of having a movement of 113 pips, the movement out of 150 pips, so it had a margin call on both accounts.
In the account you used 200:1, she ended up with $ 1,231.8 (equivalent to the maintenance margin), while the account where 100:1 has used U.S. $ 2463.60. This is where we can see that while we use more leverage, more than our own is at risk.
Also remember that the operation margin allows us to open operations with just a fraction of the investment, and the size of the transaction, earnings are also higher, but when the market goes against us, also the losses are greater. Never forget this.
