Trading with currencies

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Currency Market

Contents

Daily, hourly, minutely, continuously, from the Eastern to Western hemisphere, operations with foreign currency are carried out: purchase and sale transactions, operations with currency payment documents, as well as capital movement in foreign currencies. The system that helps carry out those operations is named currency market. Being a part of financial market, currency market is characterized, first of all, by its volume: it is the largest segment of financial market, and its size is continuously growing. Currency market consists of two important components: interbank operations market (Forex) and exchange market. Trading takes place at one and the other market, only in case of exchange currency market, exchanges are its participants. At interbank market, operations with foreign currencies are carried out by central and commercial banks, as well as by other counterparties.

Trade participants at currency market

All main currency market participants can be divided into the following categories:

National central banks. The main goals that a central bank pursues when participating in currency trade is management of the country’s currency reserves and regulation of exchange rates.

Commercial banks. The main bulk of currency operations is carried out, in particular, by commercial banks. They operate at markets both by means of their own money and at their clients’ expense, thus satisfying orders of the latter. In this case, the main clients are companies that carry out foreign trade: both importing and exporting. In essence, the aggregate amount of importers’ orders creates demand for foreign currency; and exporters’ orders form the market offer. By virtue of their activity specifics, these companies, as a rule, do not have direct access to currency markets; that is why they conduct currency operations through intermediary of commercial banks.

Large international and transnational investment companies, funds, insurance companies. They work predominantly with securities, both state and issued by private corporations. The main goal of those currency market participants is diversified management of their own assets.

Currency exchanges. Purchase and sale operations at the exchange are carried out on the basis of quotations – which is the correlation of currency rates. Quotations themselves are formed under the influence of demand and offer; that is why, in this case, the issue involves classical exchange trade. Economic situation in the issuing country makes significant influence on the quotation level of this or another currency. As a rule, the government is active in regulating an on-exchange exchange rate, since these exchanges have domestic, national character. Globalization that has been characteristic of the global economy for the last decades resulted in the situation that the role of national currency exchanges decreased significantly. Exchanges are ousted by the currency exchange market Forex.

Currency brokers. These are intermediaries whose main task is to bring together sellers and buyers of foreign currency. Broker’s offices charge their clients a certain fee for intermediary activity. The extent of that fee often depends on the transaction amount.

Individuals. If other foreign currency exchange market participants may actively influence quotation amounts because of the volume of operations that they carry out in the market, individuals are passive participants. They don’t have an opportunity to put up their own quotation and have to trade according to the prices determined by active participants. Nevertheless, when combined, individuals form quite a significant demand or offer in the currency market.

Main operation at currency market

The following types of currency market transactions are identified:

Spot deals. These are operations in regard to foreign currency purchase and sale on condition of immediate currency delivery, i.e. carrying out the operation within two banking days from the moment of closing a deal. Depending on the term of delivery, these transactions are divided into three categories:

  • Delivery takes place on the day of closing a deal. That type of spot deals is called TOD Deal: TOD comes from the English word “today”.
  • Delivery takes place within the working day following the transaction day. Such deals are called TOM Deals: TOM comes from the English word “tomorrow”.
  • Delivery takes place on the last day allowable by spot deal terms, i.e. on the second day after the transaction day.

Forward contracts. Forward contracts, in turn, are divided into the following categories:

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Forward contracts. As in the case with spot deals, forward deals are operations for buying and selling foreign currency, when currency price is set at the moment of making a deal. However, different from spot deals, currency delivery takes place not immediately after the transaction but within a term specified by contract conditions. Those contract conditions are not standardized, and they are individual for each separate case. The rate under this type of deals is called forward rate.

Futures. Here, it deals with standard contracts for purchase and sale of a foreign currency or currencies that are subject matter of exchange trade. The terms of making such deals are elaborated by the exchange and are binding. Different from forward deals, the execution periods of futures deals terms, i.e. currency delivery are standard. Essentially, forwards are one-time exchange deals, and futures are repeating offers that are the subject matter of exchange trade.

Options. Options are agreements for the right to purchase or sell foreign currency, when both currency amount and purchase or sale price are determined by the terms of concluded agreement. Besides, the same agreement also defines the term during which the option buyer may implement that right. It is understood that when the option buyer has that right, the seller has the corresponding obligation. Essentially, if the buyer, in this case, may use his right to buy or sell currency but not obliged to do that, the seller is obliged to fulfill agreement conditions if the buyer decides to utilize them. Options that are the subjects of exchange trade are very similar to futures deals: contract terms are standardized and determined by the exchange. Transaction participants are independent only in determining premium amounts that the option buyer will pay to the seller for the right to implement contract terms. Off-exchange options are not carried out on standardized terms as in the case with forward deals. Both these and the other options can be as for currency sale so for currency purchase. If question is related to currency purchase, then this is a call option, and if it is related to sale, it is a put option. The rate defined by the option contract terms is called strike rate.

Currency swap. A currency swap is a combination of two opposite currency exchange transactions – one for another- when currency amount is the same. Only dates of transaction terms fulfillment – value dates – are different. Depending on what deal must be made first – currency purchase or sale – swaps are called “buy/sell” or “sell/buy”. Besides that, swaps are divided into pure and engineered swaps. In the first case, both operations: currency purchase and sale are carried out by the same counterparty. In case of an engineered swap, two different banks may act as counterparties.

Forex market and currency exchanges

Many people often make mistakes calling Forex a currency exchange. Forex is an off-exchange market, where currencies are exchanged at free prices determined only by current market conditions. This market has no definite physical place, trading takes place at virtual platforms, and that gives an opportunity to make deals at Forex operating from any location in the world. Forex may be used as a platform for operations of banks that buy or sell currency for both fulfilling their clients’ obligations under export-import contracts and fulfilling their own obligations to their clients or counterparties. However, except central banks operations, the main volume of transactions at Forex market has a different nature: that is making profit by means of playing on the difference of currency exchange rates.

Currency Futures Trading and Markets

Currency futures are a trading instrument in which the underlying asset is a currency exchange rate, such as the euro to US Dollar exchange rate, or the British Pound to US Dollar exchange rate. Currency futures are essentially the same as all other futures markets (index and commodity futures markets) and are traded in the same manner.

Futures based upon currencies are similar to the actual currency markets (often known as Forex), but there are some significant differences. For example, currency futures are traded via exchanges, such as the CME (Chicago Mercantile Exchange); currency markets are traded via currency brokers and are therefore not as regulated as currency futures.

There are some day traders who prefer the currency markets while others prefer currency futures. If you are considering trading in the currency futures, you should understand what they are based on, how transactions work, what margins are, and know some of the popular futures.

Currency Futures Background

Currency futures are based on the exchange rates of two different currencies. For example, the euro and the dollar (EUR/USD) is a pair of currencies that have an exchange rate. The controlling currency is the first currency listed in the pair—in this case, it is the euro price that futures traders are concerned with. Traders buy a contract worth a set amount, and the value of the contract goes up or down with the value of the euro.

Currency futures only trade in one contract size, so traders must trade in multiples of that. As an example, buying a Euro FX contract means the trader is effectively holding $125,000 worth of euros.

Currency futures do not suffer from some of the problems that currency markets suffer from, such as currency brokers trading against their clients, and non-centralized pricing. On the flip side, forex trading is much more flexible, allowing traders access to high leverage and trading in very specific position sizes.

Since markets move in ticks, each tick is worth a certain amount of money for each type of investment and market. The Euro FX market moves in tick sizes of .00005 dollars per euro, or price movements of $6.25 ($125,000 X .0005). In other words, you purchase one Euro FX contract for $125,000, and the value then moves up or down a certain number of ticks per day. If the change in price for the day was $.0051 per euro, you would have made $637.50.

In the forex market, a trader can trade in multiples of $1000, which allows them to fine-tune their position size to a much greater degree. One market isn’t better than another, but one may suit a trader (and their account size) better than the other.

Settlement, Delivery, and Profits

Currency futures are based on the exchange rate of a currency pair and are settled in cash in the underlying currency. For example, the EUR futures market is based upon the euro to dollar exchange rate and has the euro as its underlying currency.

Settlement and delivery occurs when a EUR/USD futures contract expires—the holder receives delivery of $125,000 worth of euros in cash to their brokerage account.

Note that this only happens when the contract expires. Day traders do not usually hold futures contracts until they expire. Therefore, they should not be involved in the settlement, and will not receive delivery of the underlying currency.

Day traders, or anyone who is trading currency futures for speculation and profit, reap rewards based on the price difference between purchase and sale price. With futures, you can also sell first and then buy later, collecting a profit if the price drops.

To determine the profit made on a currency pair, you first calculate the expiration amount and the tick values for the entry and exit amount.

For example, assume a trader buys a Euro FX contract at 1.2525 and then sells it at 1.2545. That is a 20 tick profit, and each tick in that contract is worth $12.50. Therefore, the profit is $12.50 x 20, multiplied by the number of contracts the trader had bought.

( Tick ValueENTER – Tick ValueEXIT ) = Tick Movement

( Tick Movement * Tick Value ) * Number of Contracts = Profit

Each currency contract may have a different tick value. This can be checked on the exchange’s website (CME, for example).

Margins on Futures

Currency futures margin should not be confused with margin/leverage as it applies to stocks or the underlying currency market.

With currency futures (or any futures contract), margin refers to how much the trader must have in their account to open a one contract trade. To trade a Euro FX contract, a broker may require the trader have at least $2,310 to $3,000 in their account, as margins vary by currency broker (although the minimum is set by the exchange).

This margin is designed to hold a position overnight. If day trading, brokers usually provide preferential margin, often only requiring a $500 balance be maintained in the account while holding the position.

The margin is not a cost. Think of it as money that is held by the broker to offset any losses you may incur on a trade. Once the trade is closed, you will be able to use those margined funds again.

Many of the most popular futures markets that are based upon currencies are offered by the CME (Chicago Mercantile Exchange), including the following :

  • EUR—The Euro to US Dollar currency future
  • GBP—The British Pound to US Dollar currency future
  • CHF—The Swiss Franc to US Dollar currency future
  • AUD—The Australian Dollar to US Dollar currency future
  • CAD—The Canadian Dollar to US Dollar currency future
  • RP—The Euro to British Pound currency future
  • RF—The Euro to Swiss Franc currency future

Many other currency pairs are also offered for trading via a futures contract.

Some Final Words

Currency futures are a regulated and centralized way to participate in currency market movements. Currency futures move in increments called ticks, and each tick of movement has a value. The number of ticks made or lost on a trade determines the loss/profit of the trade. To open a currency futures trade, the trader must have a set minimum amount of capital in their account, called the margin. There are many currency futures contracts to trade, and specifications for each one should be checked on the exchange website before trading it.

Forex Glossary

The price at which the market is prepared to sell a product. Prices are quoted two-way as Bid/Ask. The Ask price is also known as the Offer.

In FX trading, the Ask represents the price at which a trader can buy the base currency, shown to the left in a currency pair. For example, in the quote USD/CHF 1.4527/32, the base currency is USD, and the Ask price is 1.4532, meaning you can buy one US dollar for 1.4532 Swiss francs.

In CFD trading, the Ask also represents the price at which a trader can buy the product. For example, in the quote for UK OIL 111.13/111.16, the product quoted is UK OIL and the Ask price is £111.16 for one unit of the underlying market.*

At best An instruction given to a dealer to buy or sell at the best rate that can be obtained at a specific time. At or better An instruction given to a dealer to buy or sell at a specific price or better. AUS 200 A term for the Australian Securities Exchange (ASX 200), which is an index of the top 200 companies (by market capitalization) listed on the Australian stock exchange. Aussie Refers to the AUD/USD (Australian Dollar/U.S. Dollar) pair. Also “Oz” or “Ozzie”.

A type of chart which consists of four significant points: the high and the low prices, which form the vertical bar; the opening price, which is marked with a horizontal line to the left of the bar; and the closing price, which is marked with a horizontal line to the right of the bar.

Barrier level A certain price of great importance included in the structure of a Barrier Option. If a Barrier Level price is reached, the terms of a specific Barrier Option call for a series of events to occur. Barrier option Any number of different option structures (such as knock-in, knock-out, no touch, double-no-touch-DNT) that attaches great importance to a specific price trading. In a no-touch barrier, a large defined payout is awarded to the buyer of the option by the seller if the strike price is not ‘touched’ before expiry. This creates an incentive for the option seller to drive prices through the strike level and creates an incentive for the option buyer to defend the strike level. Base currency The first currency in a currency pair. It shows how much the base currency is worth as measured against the second currency. For example, if the USD/CHF (U.S. Dollar/Swiss Franc) rate equals 1.6215, then one USD is worth CHF 1.6215. In the forex market, the US dollar is normally considered the base currency for quotes, meaning that quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The primary exceptions to this rule are the British pound, the euro and the Australian dollar. Base rate The lending rate of the central bank of a given country. Basing A chart pattern used in technical analysis that shows when demand and supply of a product are almost equal. It results in a narrow trading range and the merging of support and resistance levels. Basis point A unit of measurement used to describe the minimum change in the price of a product. Bearish/Bear market Negative for price direction; favoring a declining market. For example, “We are bearish EUR/USD” means that we think the euro will weaken against the dollar. Bears Traders who expect prices to decline and may be holding short positions. Bid/ask spread The difference between the bid and the ask (offer) price. Bid price The price at which the market is prepared to buy a product. Prices are quoted two-way as Bid/Ask. In FX trading, the Bid represents the price at which a trader can sell the base currency, shown to the left in a currency pair. For example, in the quote USD/CHF 1.4527/32, the base currency is USD, and the Bid price is 1.4527, meaning you can sell one US Dollar for 1.4527 Swiss francs. In CFD trading, the Bid also represents the price at which a trader can sell the product. For example, in the quote for UK OIL 111.13/111.16, the Bid price is £111.13 for one unit of the underlying market.* Big figure Refers to the first three digits of a currency quote, such as 117 USD/JPY or 1.26 in EUR/USD. If the price moves by 1.5 big figures, it has moved 150 pips. BIS The Bank for International Settlements located in Basel, Switzerland, is the central bank for central banks. The BIS frequently acts as the market intermediary between national central banks and the market. The BIS has become increasingly active as central banks have increased their currency reserve management. When the BIS is reported to be buying or selling at a level, it is usually for a central bank and thus the amounts can be large. The BIS is used to avoid markets mistaking buying or selling interest for official government intervention. Black box The term used for systematic, model-based or technical traders. Blow off The upside equivalent of capitulation. When shorts throw in the towel and cover any remaining short positions. BOC Bank of Canada, the central bank of Canada. BOE Bank of England, the central bank of the UK. BOJ Bank of Japan, the central bank of Japan. Bollinger bands A tool used by technical analysts. A band plotted two standard deviations on either side of a simple moving average, which often indicates support and resistance levels. Bond A name for debt which is issued for a specified period of time. Book In a professional trading environment, a book is the summary of a trader’s or desk’s total positions. British Retail Consortium (BRC) shop price index A British measure of the rate of inflation at various surveyed retailers. This index only looks at price changes in goods purchased in retail outlets. Broker An individual or firm that acts as an intermediary, bringing buyers and sellers together for a fee or commission. In contrast, a dealer commits capital and takes one side of a position, hoping to earn a spread (profit) by closing out the position in a subsequent trade with another party. Buck Market slang for one million units of a dollar-based currency pair, or for the US dollar in general. Bullish/Bull market Favoring a strengthening market and rising prices. For example, “We are bullish EUR/USD” means that we think the euro will strengthen against the dollar. Bulls Traders who expect prices to rise and who may be holding long positions. Bundesbank Germany’s central bank. Buy Taking a long position on a product. Buy dips Looking to buy 20-30-pip/point pullbacks in the course of an intra-day trend.

One of approximately five times during the forex trading day when a large amount of currency must be bought or sold to fill a commercial customer’s orders. Typically these times are associated with market volatility. The regular fixes are as follows (all times NY):

10:00am – WMHCO (World Market House Company)

11:00am – WMHCO (World Market House Company) – more important

Flat or flat reading Economic data readings matching the previous period’s levels that are unchanged. Flat/square Dealer jargon used to describe a position that has been completely reversed, e.g. you bought $500,000 and then sold $500,000, thereby creating a neutral (flat) position. Follow-through Fresh buying or selling interest after a directional break of a particular price level. The lack of follow-through usually indicates a directional move will not be sustained and may reverse. FOMC Federal Open Market Committee, the policy-setting committee of the US Federal Reserve. FOMC minutes Written record of FOMC policy-setting meetings are released three weeks following a meeting. The minutes provide more insight into the FOMC’s deliberations and can generate significant market reactions. Foreign exchange/forex/FX The simultaneous buying of one currency and selling of another. The global market for such transactions is referred to as the forex or FX market. Forward The pre-specified exchange rate for a foreign exchange contract settling at some agreed future date, based on the interest rate differential between the two currencies involved. Forward points The pips added to or subtracted from the current exchange rate in order to calculate a forward price. FRA40 A name for the index of the top 40 companies (by market capitalization) listed on the French stock exchange. FRA40 is also known as CAC40. FTSE 100 The name of the UK 100 index. Fundamental analysis The assessment of all information available on a tradable product to determine its future outlook and therefore predict where the price is heading. Often non-measurable and subjective assessments, as well as quantifiable measurements, are made in fundamental analysis. Funds Refers to hedge fund types active in the market. Also used as another term for the USD/CAD (U.S. Dollar/Canadian Dollar) pair. Future An agreement between two parties to execute a transaction at a specified time in the future when the price is agreed in the present. Futures contract An obligation to exchange a good or instrument at a set price and specified quantity grade at a future date. The primary difference between a Future and a Forward is that Futures are typically traded over an exchange (Exchange- Traded Contacts – ETC), versus Forwards, which are considered Over The Counter (OTC) contracts. An OTC is any contract NOT traded on an exchange.

Illiquid Little volume being traded in the market; a lack of liquidity often creates choppy market conditions.

Illiquid Little volume being traded in the market; a lack of liquidity often creates choppy market conditions.

IMM International Monetary Market, the Chicago-based currency futures market, that is part of the Chicago Mercantile Exchange. IMM futures A traditional futures contract based on major currencies against the US dollar. IMM futures are traded on the floor of the Chicago Mercantile Exchange. IMM session 8:00am – 3:00pm New York. INDU Abbreviation for the Dow Jones Industrial Average. Industrial production Measures the total value of output produced by manufacturers, mines and utilities. This data tends to react quickly to the expansions and contractions of the business cycle and can act as a leading indicator of employment and personal income data. Inflation An economic condition whereby prices for consumer goods rise, eroding purchasing power. Initial margin requirement The initial deposit of collateral required to enter into a position. Interbank rates The foreign exchange rates which large international banks quote to each other. Interest Adjustments in cash to reflect the effect of owing or receiving the notional amount of equity of a CFD position. Intervention Action by a central bank to affect the value of its currency by entering the market. Concerted intervention refers to action by a number of central banks to control exchange rates. Introducing broker A person or corporate entity which introduces accounts to a broker in return for a fee. INX Symbol for S&P 500 index. IPO A private company’s initial offer of stock to the public. Short for initial public offering. ISM manufacturing index An index that assesses the state of the US manufacturing sector by surveying executives on expectations for future production, new orders, inventories, employment and deliveries. Values over 50 generally indicate an expansion, while values below 50 indicate contraction. ISM non-manufacturing An index that surveys service sector firms for their outlook, representing the other 80% of the US economy not covered by the ISM Manufacturing Report. Values over 50 generally indicate an expansion, while values below 50 indicate contraction.

In CFD trading, the Ask represents the price a trader can buy the product. For example, in the quote for UK OIL 111.13/111.16, the product quoted is UK OIL and the ask price is £111.16 for one unit of the underlying market.*

Offered If a market is said to be trading offered, it means a pair is attracting heavy selling interest, or offers. Offsetting transaction A trade that cancels or offsets some or all of the market risk of an open position. On top Attempting to sell at the current market order price. One cancels the other order (OCO) A designation for two orders whereby if one part of the two orders is executed, then the other is automatically cancelled. One touch An option that pays a fixed amount to the holder if the market touches the predetermined Barrier Level. Open order An order that will be executed when a market moves to its designated price. Normally associated with good ’til cancelled orders. Open position An active trade with corresponding unrealized P&L, which has not been offset by an equal and opposite deal. Option A derivative which gives the right, but not the obligation, to buy or sell a product at a specific price before a specified date. Order An instruction to execute a trade. Order book A system used to show market depth of traders willing to buy and sell at prices beyond the best available. Over the counter (OTC) Used to describe any transaction that is not conducted via an exchange. Overnight position A trade that remains open until the next business day.

A rollover is the simultaneous closing of an open position for today’s value date and the opening of the same position for the next day’s value date at a price reflecting the interest rate differential between the two currencies.

In the spot forex market, trades must be settled in two business days. For example, if a trader sells 100,000 Euros on Tuesday, then the trader must deliver 100,000 Euros on Thursday, unless the position is rolled over. As a service to customers, all open forex positions at the end of the day (5:00 PM New York time) are automatically rolled over to the next settlement date. The rollover adjustment is simply the accounting of the cost-of-carry on a day-to-day basis. Learn more about FOREX.com’s rollover policy

Round trip A trade that has been opened and subsequently closed by an equal and opposite deal. Running profit/loss An indicator of the status of your open positions; that is, unrealized money that you would gain or lose should you close all your open positions at that point in time. RUT Symbol for Russell 2000 index.

The time remaining until a contract expires.

Tokyo session 09:00 – 18:00 (Tokyo). Tomorrow next (tom/next) Simultaneous buying and selling of a currency for delivery the following day. T/P Stands for “take profit.” Refers to limit orders that look to sell above the level that was bought, or buy back below the level that was sold. Trade balance Measures the difference in value between imported and exported goods and services. Nations with trade surpluses (exports greater than imports), such as Japan, tend to see their currencies appreciate, while countries with trade deficits (imports greater than exports), such as the US, tend to see their currencies weaken. Trade size The number of units of product in a contract or lot. Trading bid A pair is acting strong and/or moving higher; bids keep entering the market and pushing prices up. Trading halt A postponement to trading that is not a suspension from trading. Trading heavy A market that feels like it wants to move lower, usually associated with an offered market that will not rally despite buying attempts. Trading offered A pair is acting weak and/or moving lower, and offers to sell keep coming into the market. Trading range The range between the highest and lowest price of a stock usually expressed with reference to a period of time. For example: 52-week trading range. Trailing stop A trailing stop allows a trade to continue to gain in value when the market price moves in a favorable direction, but automatically closes the trade if the market price suddenly moves in an unfavorable direction by a specified distance. Placing contingent orders may not necessarily limit your losses. Transaction cost The cost of buying or selling a financial product. Transaction date The date on which a trade occurs. Trend Price movement that produces a net change in value. An uptrend is identified by higher highs and higher lows. A downtrend is identified by lower highs and lower lows. Turnover The total money value or volume of all executed transactions in a given time period. Two-way price When both a bid and offer rate is quoted for a forex transaction. TYO10 Symbol for CBOE 10-Year Treasury Yield Index.

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