An Introduction to the Forex Market

The Forex market is one in which participants are able to buy, sell, exchange and speculate on currencies. The forex markets is made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors. The currency market is considered to be the largest financial market in the world, processing trillions of dollars worth of transactions each day.

The foreign exchange markets isn't dominated by a single market exchange, but involves a global network of computers and brokers from around the world. Central banks use their massive buying and selling capabilities to alter exchange rates through their open market activities and in many cases will do so not with profit in mind, but rather for any number of policy reasons. Forex brokers act as market makers as well, and may post bid and ask prices for a currency pair that differs from the most competitive bid in the market.

Daily currency fluctuations are usually very small. Most currency pairs move less than one cent per day, representing a less than 1% change in the value of the currency. This makes foreign exchange one of the least volatile financial markets around. Therefore, many speculators rely on the availability of enormous leverage to increase the value of potential movements.

Here are a few terms associated with the forex market which one should understand if one is to be sucessful at X-Change

  • Broker - An individual or firm that charges a fee or commission for executing buy and sell orders submitted by an investor. Traditionally, only the wealthy could afford a broker and access the stock market. The internet triggered an explosion of discount brokers, which allow investors to trade at a lower cost, but don't provide personalized advice. Because of discount brokers, almost anybody can afford to invest in the market. The Broker lends money to you at a special rate. We function as your brokers. We lend money to you at an extra surcharge of 1% of the amount lent.
  • Currency Pair - All forex trades involve the simultaneous buying of one currency and selling of another, but the currency pair itself can be thought of as a single unit, an instrument that is bought or sold. If you buy a currency pair, you buy the base currency and sell the quote currency. The bid (buy price) represents how much of the quote currency is needed for you to get one unit of the base currency. Conversely, when you sell the currency pair, you sell the base currency and receive the quote currency. The ask (sell price) for the currency pair represents how much you will get in the quote currency for selling one unit of base currency.
  • Exchange Rate - The price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another.
  • Lot - In the financial markets, a lot represents the standardized quantity of a financial instrument as set out by an exchange or similar regulatory body. With such standardization, investors always know exactly how many units they are buying with each contract and can easily assess what price per unit they are paying. X-Change defines one lot to be worth 100000 USD
  • Bid Price - The price a buyer is willing to pay for a security. This is one part of the bid with the other being the bid size, which details the amount of currency the investor is willing to purchase at the bid price.
  • Ask Price - The price a seller is willing to sell his security for. This is one part of the sale with the other being the bid size, which details the amount of currency the investor is willing to purchase at the bid price.
  • Current Price - The use of bid and ask is a fundamental part of the market system, as it details the exact amount that you could buy or sell at any point in time. Remember that the current price is not the price for which you can purchase the security, but the price at which the shares last traded hands. If you want to get an idea of the price for which you can buy a security, you need to look at the bid and ask prices because they will often differ from the current price.
  • Long - Long or Long Position refers to the buying of a security such as a stock, commodity or currency, with the expectation that the asset will rise in value.
  • Short - Short The sale of a borrowed security, commodity or currency with the expectation that the asset will fall in value.
  • Leverage - The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. Leverage helps both the investor and the firm to invest or operate. However, it comes with greater risk. If an investor uses leverage to make an investment and the investment moves against the investor, his or her loss is much greater than it would've been if the investment had not been leveraged - leverage magnifies both gains and losses.
  • Balance - The current balance of your bank account.
  • Margin - The amount of equity contributed by a customer as a percentage of the current market value of the securities held in a margin account. It is the amount that you have to pay up if you long a pair or the amount that you will get on shorting a pair. In a nutshell, margin is the minimum required balance to place a trade.
  • Equity - The term's meaning depends very much on the context. In finance, in general, you can think of equity as ownership in any asset after all debts associated with that asset are paid off. It will be your balance if all the transactions are closed just at that point of time taking into account all the profit or loss that you make.

Profit & Loss Calculations

Calculation of Profit When Transaction is of Type Long

Profit/Loss = SalePrice - (BrokerInvestment + BrokerInterest)

Example
Say the price of 1 USD is 46.68 INR. Anticipating a rise in the prices, you long 1 lot of USD at a leverage of 1%. This means that a broker pays 99% of the money required to make the transaction(46680 INR) at a certain rate of ineterst, say 10%pa and you pay the remaining 1% of the amount out of your bank account.
Now if the price of 1 USD rises to 46.98 INR and you decide to close your transaction at this price. You will be paid a sum of 4698 INR. Out of this money you are required to pay the broker back his initial investment(46213.20 INR) and the interest on the transaction. The amount remaining in your hands after you have paid back the broker is the profit or loss you have made in the transaction. This amount will be added to your bank account balance.



Calculation of Profit When Transaction is of Type Short

Profit/Loss = CostPrice - (BrokerInvestment + BrokerInterest)

Example
Say the price of 1 USD is 46.98 INR. Anticipating a fall in the prices, you short 1 lot of USD at a leverage of 1%. This means that a broker gives you 99% of the money to be sold to make the transaction(46980 INR) at a certain rate of ineterst, say 10%pa and you pay the remaining 1% of the money to be sold is taken from your account.
Now if the price of 1 USD falls to 46.68 INR and you decide to close your transaction at this price. You will have to pay a sum of 4668 INR. Out of this money you are required to pay the broker back his initial investment(46510.20 INR) and the interest on the transaction. The amount remaining in your hands after you have paid back the broker is the profit or loss you have made in the transaction. This amount will be added to your bank account balance.



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