Foreign Exchange Trading
International currency trading began in 1880 with the option of having foreign payments credited to a foreign bank account. The liberalization of exchange rates in 1972 led to global economic changes on the international financial markets. Stock, foreign exchange, and interest rate markets experienced unprecedented price fluctuations. As a result, there has been a noticeable increase in the need for tools for effective and efficient capital management. The economy in general, finance, and state governments were looking for ways to minimize price fluctuation and risk.
Banks started trading through telephone, through which these institutions traded the strongest currencies on earth among themselves for 24 hours around the globe. So, this formed a market independent of the actual stock market.
Meanwhile, all trades are displayed on computer screens, the actual business is still completed on the phone and can be traced at any time; all corresponding conversations are recorded on tape. Official rates do not exist, the brokers are guided by the standard rates, which, for example, are constantly updated by the Reuters agency around the clock every second to the current market rates.
Until 1991, this market was a domain for only big banks and players. Today, things are different and include the following types of traders:
Foreign exchange brokers
Private forex traders
All participants are subject to strict banking supervision of their country. It is common to see currencies trade mainly against the US dollar. The foreign exchange broker replaces the trading floor and serves as a central point of for supply and demand. On request, quotes and prices are given to the market that are valid for only a small moment, so these prices are constantly changing.
Cash trades | Types of cash transaction
Forex trading can be divided into the following types of cash trading:
Customer business (sources of foreign exchange trading)
Arbitrage business (difference, time or quote arbitrage)
Foreign exchange speculation (strategic positions)
Examples of how foreign exchange trading works
Traders typically trade five days a week. If an analytical tools show a clear trend, is it worthwhile for them to take action which can mean selling or buying a currency. This means that on uncertain days, trading should simply be suspended and thus avoiding the risk of loss. In trading, the trader constantly observes the changes in ten thousand digit range every second. Fourth point after the decimal point is referred to as a “Pip.” Since foreign exchange trading usually resells positions within a short time, often within hours, the bank has only the risk of relatively low price fluctuations in this short time; such sale is called “smooth placement.”
A trade example
Let’s assume that based on analyses and a trend, a rise in euro is expected. A forex trader enters the foreign exchange market via a broker with $100,000 deposit and buys euro for that amount. The introductory price is, for example, 1.20000 Euro/USD. Assume that the price rises rapidly within 2 hours. At the price of 1.20500, the forex trader decides to “sell off” the purchased position and thus exit the market position.
Example calculation 1
The euro rate vs dollar = 1.20000
The foreign exchange trader buys $100,000 worth of EUR
The price rises
The forex trader sells
Price gain (0.00500) = 500 pips
Profit = 500 USD
With a use of 100,000 US dollars, a daily gain of 500 USD is not worth it. Due to the above-mentioned “margin” system, the use is only ten percent of this sum. This means that profit 500 USD is realized with a capital investment of 10,000 US dollars! In this above example, a daily return of ~5 percent was achieved in less than 24 hours.
Let’s assume that due to certain tendencies, a falling euro is expected. The forex trader enters the foreign exchange market via a broker with $100,000. He enters a trade. The selling price is 1.20000 EUR/USD. Assume that the actually drops within few hours. The currency trader then decides to “close” the position by buying at 1.19500 and thus getting out of the trade.
Example calculation 2
The euro rate at dollar = 1.20000
The Forex trader sells one lot
The price falls to 1.19500
The trader closes the position by buying Euro at 0.19500
Price difference = 500 pips
Total Profit = 500 USD
Even though the forex trader does not own any euros, he can place a sell order in the above manner using a broker because the repurchase will “close out” the position within a given time. This means that foreign exchange or even forex trading profits can be made both at rising and falling prices. In the last example, the actual capital employed is only one-tenth of the trading volume. It can thus be achieved with a $10,000 deposit.