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Forex is a market where the foreign currencies are traded (Forex = Foreign Exchange). It consists of a large number of banks, investors, brokerage firms, funds, companies and so on. The market is not centralized. It is formed by bringing together a number of trading subjects and computers. It is an example of an OTC (Over the counter) market. The world's main financial centers are in following cities: Tokyo, Singapore, Hong Kong, Sydney, Frankfurt, Zurich, Paris, London, New York.
Forex is considered to be the largest and most liquid market in the world. The enourmous liquidity is also its biggest advantage. Daily operations are carried out in the volume of several trillion U.S. dollars (an average of 1.5 to 2.5 trillion USD). It is traded 24 hours a day and 5 days a week. A new trading day starts at 17.00 EST.
Prices in Forex markets are an expression of the relationship of two currencies - eg. EUR/USD. The first one is called. "Base currency" and the second one "Qoute currency" (also "Counter currency"). The price indicates how much of the quote currency is needed to purchase the base currency. If the price of EUR/USD is for example 1.3700, it means that we need 1.37 USD to buy 1 EUR. If you are buying a currency pair, that means you are buying the Base currency and selling the Qoute currency. If you sell a currency pair, that means you sell the Base currency and buy the Qoute currency.
Example: If you Buy EUR/USD and the price is set at $ 1.3700, it means that you buy EUR and sell USD. For every sold 1.37 USD you get 1 EUR. If you Sell the pair, than it would mean that for every 1 EUR sold you would receive 1.37 USD.
Currency pairs are traded in Lots - a standardized amount of currency, or through Minilots and Microlots. Minimum price shift in the currency pair is called a "pip". Profits and losses on Forex are therefore expressed through the "Pips". As the currency pair is expressed by a relationship of 2 prices and rounded to 4 decimal places, the minimum price move is in most cases, 0.0001 - i.e. 1/100 percent. That makes up 1 pip (1 base point). Current profit at 1 pip is $ 10 per Lot and $ 1 per Minilot (standard lot is 100,000 dollars, minilot is 10,000 dollars, microlot 1,000 dollars). This is true as far as USD is your Qoute currency.
How to calculate the profit?
Assuming that you want to recount your earnings to the U.S. dollar. If the USD is your Quote currency, the calculation is simple. Each price shift of 1 pip equals $ 10 profit or loss (for 1 lot). Should you trade Minilot, then it would be just $ 1 USD respectively $ 0,10 USD/Microlot. However, if USD is your base currency - eg. USD/EUR, then the formula for your profit looks like follows:
(minimum price shift / price of the pair) * contract size
In our case, it would be (0.0001 / 0.73) * 100 000 = 13.70 USD profit or loss at 1 pip. In other words, the profit of 1 pip is 10 EUR (Base currency), which is just 13.70 USD (Quote currency).
The basic traded currencies are:
- U.S. dollar (USD)
- Canadian Dollar (CAD)
- Australian dollar (AUD)
- British Pound Sterling (GBP)
- European Euro (EUR)
- Swiss franc (CHF)
- Japanese Yen (JPY).
Trading is not limited only to the basic currencies and their pairs. Other currencies can be traded as well (the currencies and their abbreviations can be found here). A currency pair that does not include the USD tends to be referred to as a "cross currency".
The following 4 basic currency pairs are marked as "major pairs":
- EUR / USD (Euro)
- USD / JPY (Gopher)
- USD / CHF (Swiss)
- GBP / USD (Cable)
Indications for another 3 important currency pairs are:
- GBP / JPY (Geppy)
- USD / CAD (Loonie, Beaver)
- NZD / USD (Kiwi)
If you hold the pair Overnight (through 17:00 EST), you are receiving or paying interest, depending on the currency traded. E.g. if you buy EUR, sell USD and the EUR interest rate is 3.0% while 2.5% for USD, their difference of 0.5% is paid to your trading account.
Forex market is traded via the leverage. If your broker offers you the leverage of 100:1, it means that he offers $ 100 USD for every dollar of your own capital. Brokers usualy don't charge the commissions. Instead, they make money through spreads - the difference of Bid and Ask prices (e.g. 2 Pips). Too large spread can significantly deplete your trading account. It is therefore important that this difference would be as low as possible.
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