Introduction
The Foreign Exchange (Forex) Market is the largest financial market in the world, it does over 20 times the dollar volume than all the US equity markets combined each day.
The Forex market is an interbank or Over the Counter market. This means that all transactions take place between two parties directly through an electronic network or over the phone. There is no
standardized exchange like stocks (NYSE, NASDAQ etc.) or futures. (CME CBOT)
What Is a Pip?
Simply put, a pip is the smallest price change a currency pair can make. As an example when we see a quote of the USD/CAD at 1.0028, the minimum it could change to the upside would be .0001 making it 1.0029. The majority of currency pairs are priced with 4 decimal places (an exception is the USD/JPY pair which is quoted to 2 decimal places ie 108.84 )
Forex Quotes
Of all the Forex quotes available there are 6 that are considered the most important; (In no particular order)
USD/CAD = United States dollar/Canadian dollar
USD/JPY = United States dollar/Japanese yen
GBP/USD = Great British pound/United States dollar
AUD/USD = Australian dollar/United States dollar
EUR/USD = Euro/United States dollar
USD/CHF = United States dollar/Swiss franc
Forex quotes involve a pair of currencies. For example USD/CAD, AUD/USD, USD/JPY etc.
The currency listed first is what’s called the base currency and the second currency is called the counter. Using a buy order on the USD/CAD as an example, you have bought US
dollars and sold Canadian dollars.
Bid/Offer Spread
All quotes you will find on the Forex market are two-way, meaning there is a bid and offer. With the offer always being higher than the bid.
- The bid is the price the dealer is willing to buy the base currency. As a trader this is the price you will sell to. (We sell to the bid)
- The offer is the price the dealer is willing sell the base currency. As a trader this is the price you will buy from. (We buy the offer)
- The difference between the bid and offer is called the spread. As a trader the smaller the spread the better, so be sure shop around, as different brokers will have different spreads for different currency
pairs.
This is what a typical quote will look like.
USD/ CAD
Bid Offer
1.0022 / 1.0025
Sell / Buy
If we wanted to go long, using this quote as an example, we would click the buy button at 1.0025. And if we wanted to short or sell we would click the sell button at 1.0022.
- When buying we use the offer price.
- When selling we use the bid price.
Forex Market Hours
The Forex market is open 24 hours a day. There will always be someone anywhere in the world who is buying and selling currencies because when one market closes, another market opens.
Here are the open market times that you can use as reference:
• New York – 8am to 4pm EST
• London – 2am to 12nn EST
• Great Britain – 3am to 11am EST
• Tokyo – 8pm to 4am EST
• Australia – 7pm to 3am EST
Forex market transaction volume is always high during the whole day. However, it peaks the highest when the Asian market, the European market and the US market open at the same time. If you look at the schedule and study it, you will see that there are two instances where two of the major markets overlap on trading hours. These are between 2am and 4am EST with Asian and European markets and 8am to 12pm EST with European and North American.
These are the trading hours in the Forex market you have to trade in, in order to get the highest possible trades. These are the hours that are also the most profitable.
Lot Size and Pip Calculation
The Forex market is traded in lots, with the benchmark lot size being $100,000. There are also mini lots of $10,000.
Each currency will have a different pip value based on the standard $100,000 lot size. And as the price moves so will the pip value of the pair you are trading. Below is an example.
USD/CAD exchange rate of 1.0022
(.0001/1.0022) X $100,000 = $10.02/pip
USD/CAD exchange rate of 1.0652
(.0001/1.0652) X $100,000 = $10.65/pip
As you can see as the market fluctuates so to does the value of a pip.
How to Calculate Profit and Loss
We’ll go through a trade example using the USD/CAD to show how to calculate a profit or loss.
The quote of the USD/CAD is 1.0022/1.0025. We buy 1 lot of $100,000 at the offer price of 1.0025. Our position is now long 1.0025. 12 hours later the price goes up to 1.0085 with the new quote
showing a bid/offer of 1.0085/1.0088. For us to sell we have to sell at the bid price which is 1.0085. The difference from buy price (1.0025) and selling price (1.0085) is .0060 or 60 pips.
Using our calculation from the Pip Calculation section we can see how much profit we made;
(.0001/1.0085) X $100,000 = $9.91/pip
60 pips X $9.91/pip = $594.60
Margin
For most traders, coming up with $100,000 to trade one lot would be almost impossible. As an alternative, brokers will put up the required amount; in exchange you are required to deposit a certain amount of money as good faith. The broker holds this money in your account to cover any loss you may incur. This is what attracts most traders to the Forex market. The amount of margin will vary from broker to broker. Typically they require you deposit $1000 to trade one lot of $100,000 or 1%. Often you will notice brokers quoting margin rates at 100:1 and sometimes as high as 200:1.
While trading on margin amplifies profits, it does the same to losses as well. So one must be very careful when trading with too high a margin.
Types of Orders
There are 3 basic orders: Market, Limit and Stop loss
Market Order – This is simply an order to buy or sell at the current market price.
If we have a USD/CAD quote of 1.0030/1.0033 and we place a market order to buy, we will buy at 1.0033. If we place a market order to sell we would sell at the bid quote, in this case 1.0030.
Limit Order – This order is used when you want to enter at a certain price. Limit orders are used when a trader doesn’t want to sit and wait for the order to get filled. They can walk away from their screen knowing the limit order is in place.
Stoploss Order – This order relates to a trade that has already been taken to negate additional losses if the trade does not work in our favor. It will stay open until the order is hit or canceled. As an
example, if we were long the USD/CAD at 1.0056, we could place a stoploss order at 1.0036 to limit our loss to a max of 20 pips. With the stop loss order in place we don’t have to baby-sit the trade.
Additional orders used:
GFD (Good for day) Order – This order stays open until the end of the day, which is typically 5:00 pm EST (the close of US equities). To be sure ask your broker the details of when the cancel GFD
orders.
GTC (Good Till Canceled) – Pretty simple…this order stays open until you cancel it.
OCO (Orders Cancels Other) – This order lets the trader place a stoploss and profit limit order. Once one is triggered, the other order is then canceled.
For example, the USD/CAD quote is currently 1.0035/1.0038. We are anticipating a large move to come either to the upside or downside. So we place a buy limit above where we think the price will breakout and run up at 1.0050 and we want to place a limit short order at 1.0025 on the anticipation of a breakout to the downside. Once one of these orders is filled, the other is canceled automatically.
