Introductory Currency Trading

Foreign Currency Trading
Forex Introduction Presentation
By
Currency Investors Group

Let’s start with a definition of foreign currency exchange rates. Simply put, foreign
currency exchange rates are what it costs to exchange one country’s currency for
another country’s currency.
On your next trip to England, you’ll stop at the first ATM for cash for cabs, snacks,
tips, etc.
Your ATM transaction will be a foreign exchange transaction.
You’ll take money out of your US account in dollars and receive it in pounds. Let’s
look at an example.
At the preparation of this presentation, each dollar you take out of your account will
deliver .67 GPD.
This would be considered the spot market conversion rate for converting dollars to
pounds.
What are foreign currency exchange rates?

After spending a few days in England you find you need more ready cash to spend
on the trip. You visit another ATM and discover that your dollar now converts to .65
GPD.
This means that the dollar is worth less than the pound or “weaker” against the
pound than it was just days earlier.
When you arrive back home, you will need to convert your remaining pounds to
dollars for use in the US. This process will serve as another spot market
transaction and your dollar’s value will be determined by the market’s conversion
rate on that day.
The intermediary associated with your transaction, i.e. the bank, keeps a fee
associated with the exchange.
What are foreign currency exchange rates?

You can convert the exchange rate for buying a currency to the exchange rate for
selling a currency, and vice versa, by dividing 1 by the known rate.
Example:
The exchange rate for buying British pounds with US dollars is .56011, the
exchange rate for buying US dollars with British pounds is 1.78536.
In other words, one divided by .56011 equals 1.78536.
Similarly, if the exchange rate for buying US dollars with British pounds is 1.78536,
the exchange rate for buying British pounds with US dollars is .56011 (or one
divided by 1.78536 equals .56011).
This is how newspapers and your trading platform will often report currency
exchange rates. **Know however, that this will not be exactly what you pay or
receive in the exchange.
This is how we do the math

You should know, however, that you will not receive the price quoted in the
newspaper if you trade forex.
That’s because Futures Commission Merchants or FCM’s where you will open
your live account, and other market participants make money by selling the
currency to customers for more than they paid to buy it and by buying the currency
from customers for less than they will receive when they sell it.
This difference is called a spread and we’ll talk more about spreads later in this
program.
As you see, currency exchange rates fluctuate. Retail customers who trade in the
forex market hope to profit from those fluctuations. Our goal is to teach you how to
profit consistently with satisfactory risk management.
How do dealers and traders make money?

You should know, however, that you will not receive the price quoted in the
newspaper if you trade forex.
That’s because Futures Commission Merchants or FCM’s where you will open
your live account, and other market participants make money by selling the
currency to customers for more than they paid to buy it and by buying the currency
from customers for less than they will receive when they sell it.
This difference is called a spread and we’ll talk more about spreads later in this
program.
As you see, currency exchange rates fluctuate. Retail customers who trade in the
forex market hope to profit from those fluctuations. Your goal is to profit
consistently with satisfactory risk management.
How do dealers and traders make money?

Now let’s take a look at how foreign currencies are quoted and priced.
Currencies are designated by three-letter symbols. The standard symbols for
some of the most commonly traded currencies are shown below.
EUR Euro
USD United States dollar
CAD Canadian dollar
GBP British pound
JPY Japanese yen
AUD Australian dollar
CHF Swiss franc
How foreign currencies quoted and priced

Currency pairs are often quoted as bid-ask spreads.
The first part of the quote is the amount of the quote currency you will receive in
exchange for one unit of the base currency (the bid price).
The second part of the quote is the amount of the quote currency you must spend
for one unit of the base currency (the ask or offer price).
For example, a EUR/USD spread of 1.2170/1.2178 means that you can sell one
Euro for $1.2170 and buy one Euro for $1.2178.
This spread could also be quoted as 1.2170/78.

At first glance, the bid and ask prices may seem backwards to you.
That is because they are listed from the dealer’s point of view, not from your point
of view.
The first part of the spread, or the bid, is what the dealer is willing to pay to buy the
base currency. So this is the price you will get if you SELL the base currency.
In the same way, the second part of the spread, or the ask, is what the dealer is
willing to sell the base currency at, so this is the price you will get if you BUY the
base currency.

As we look at another example, make a note of this important point.
**The forex market has no central market place as does the equities market.
There is no NASDAQ or NYSE for the forex market.
Example:
If the USD/CHF spread is listed as 1.2440/1.2443, you can sell one US dollar for
1.2440 Swiss francs and buy one US dollar for 1.2443 Swiss francs.
The forex dealer determines the execution price, so you are relying on the dealer’s
integrity for a fair price.
**The Base currency in the first currency listed in a currency pair.

Using this USD/JPY spread (110.45/55), how many Japanese yen would it take to
buy one US dollar?
Remember, the first part of the quote is the sell quote so the dealer will the USD
for 110.45. The second part of the quote is the dealer buy quote so you can buy
one USD for 110.55 Japanese yen.
Who determines the execution price—the trader, the dealer or the exchange?
The correct answer is the dealer.
** Remember that the forex markets we are discussing have no central exchange
on which the contracts are traded, and you as the trader, have no control over the
execution price.

Before trading forex, you will have to open a trading account with a forex dealer.
There are no rules about how a dealer charges a customer for the services the
dealer provides or that limit how much the dealer can charge.
Some firms charge a per trade commission, while other firms make their money on
the spread between the bid and ask prices they give their customers.
In the earlier example, the amount of the Euro spread is .0008 (the 1.2178 ask
price minus the 1.2170 bid price). This means that if you bought (or sold) the Euro
and immediately turned around and sold (or bought) it before the prices changed,
you would have a $.0008 loss on each Euro, or an $80 loss on a 100,000 Euro
transaction. The wider the spread, the more the price has to move before you
break even.
While some forex firms advertise “commission free” trading, they are still making
money from your trades through the bid/ask spread.
The price you pay to trade foreign currency

Retail forex transactions are normally closed out by entering into an equal but
opposite transaction with the dealer.
For example, if you bought Euros with US dollars, you would close out the trade by
selling Euros for US dollars. This also is called an offsetting or liquidating
transaction.
Many retail forex transactions have a settlement date when the currencies are due
to be delivered. If you want to keep your position open beyond the settlement date,
you must roll the position over to the next settlement date.
Most forex dealers in the Spot Forex market roll open positions over automatically.
The price you pay to trade foreign currency

Now that you know how forex is traded, it’s time to learn how to calculate your
profits and losses.
When you close out a trade, take the price (exchange rate) when selling the base
currency and subtract the price when buying the base currency, then multiply the
difference by the transaction size. That will give you your profit or loss.
The Equation:
Price (exchange rate) when selling the base currency – price when buying the
base currency X transaction size = profit or loss
Let’s look at an example.
Calculating Profits and Losses

Assume you buy Euros at $1.2178 per Euro and sell Euros at $1.2188 per Euro.
The transaction size is 100,000 Euros.
The Equation:
To calculate your profit or loss, you take the selling price of $1.2188, subtract the
buying price of $1.2178 and multiply the difference by the transaction size of
100,000.
($1.2188 – 1.2178) X 100,000 = $100
In this example, you would have a $100 profit from this transaction.

Let’s try it again using a different currency.
Assume you buy British pounds at $1.8384 and sell them at $1.8389. The
transaction size is 10,000.
By following the formula we discussed earlier, you should be able to determine
that you would see a $5.00 gain from this transaction.
($1.8389 – $1.8384) X 10,000 = $5.00

Now you try it.
If you sell 100,000 Euros at $1.2170 per Euro and buy 100,000 Euros at 1.2180
per Euro, would you have a profit or loss on the transaction and how much would it
be?
Remember The Equation:
Price (exchange rate) when selling the base currency – price when buying the
base currency X transaction size = profit or loss
1.2170 – 1.2180 = .- 001
1.2170 – 1.2180 x 100,000 = -100 for a $100 loss

You can also calculate your unrealized profits and losses on open positions.
Just substitute the current bid or ask rate for the action you will take when closing
out the position.
For example, if you bought 100,000 Euros at 1.2178 and the current bid rate is
1.2173, you have an unrealized loss of $50.
($1.2173 – $1.2178) X 100,000 = –$50
Similarly, if you sold 100,000 Euros at 1.2170 and the current ask rate is 1.2165,
you have an unrealized profit of $50.
($1.2170 – $1.2165) X 100,000 = $50

If the quote currency is not in US dollars, you will have to convert the profit or loss
to US dollars at the dealer’s rate.
Let’s look at an example using a USD/JPY spread. If you lost 50,000 Japanese
yen on the transaction and the dealer’s rate is $.0091 for each yen, what is your
loss in dollars?
By multiplying the transaction size (50,000) by the dealer's rate ($.0091), you will
find that your loss is $455.
50,000 X $.0091 = $455
Remember that you must also subtract any dealer commissions or other fees from
your profits or add them to your losses to determine your true profits and losses.
Also, remember that the dealer makes money from the spread. If you immediately
liquidate your position using the same spread, you will automatically lose money.

As stated at the beginning of this program, off-exchange foreign currency trading
carries a high level of risk and may not be suitable for all customers.
The only funds that should ever be used to speculate in foreign currency trading,
or any type of highly speculative investment, are funds that represent risk capital;
in other words, funds you can afford to lose without affecting your financial
situation.
Let’s proceed on the assumption that you have risk capital you would like to use in
trading forex. The next question is how much you need to open an account.
This will vary according to the forex dealer with some requiring balances of
$5000.00 and others opening accounts for specific marketing campaigns for as
low as $25.00.
How Leverage Impacts Foreign Currency Trading

Most dealers will also require you to have a certain amount of money in your
account for each transaction.
This security deposit, sometimes called margin, is a percentage of the transaction
value and may be different for different currencies.
Keep in mind that a security deposit acts as a performance bond and is not a down
payment or partial payment for the transaction.
Let’s use an example of a dealer requiring a 1% security deposit. The formula for
calculating the security deposit is:
The current price of the base currency X transaction size X security deposit %
= security deposit requirement given in quote currency

Looking at the Euro example we used earlier, multiply the current price of the base
currency ($1.2178) times the transaction size of 100,000 times 1%. Your security
deposit would be $1,217.80.
$1.2178 X 100,000 X .01 = $1,217.80
Security deposits allow customers to control transactions with a value many times
larger than the funds in their accounts. In the previous example, $1,217.80 would
control $121,780 worth of Euros.
This ability to control a large amount of one currency using a very small
percentage of its value is called leverage.
In our example, the leverage is 100:1 because the security deposit controls Euros
worth 100 times the amount of the deposit.

Since leverage allows you to control large amounts of currency for a very small
amount, it magnifies the percentage amount of your profits and losses.
A profit or loss of $1,217.80 on the euro transaction is 1% of the full price but is
100% of the 1% security deposit.
The higher the leverage, the more likely you are to lose your entire investment if
exchange rates go down when you expect them to go up or go up when you
expect them to go down.
You should check your Account Agreement with the dealer to see if the Agreement
limits your losses.
Some dealers guarantee that you will not lose more than you invest, which
includes both the initial deposit and any subsequent deposits to keep the position
open. Other dealers may charge you for losses that are greater than your
investment.

Margin Based Leverage = Total Value of Transaction
Margin Required
For example:
If you are required to deposit 1% of the total transaction value as margin and you
intend to trade one standard lot of USD/CHF which is equivalent to US$100,000,
the margin required would be US$1,000.
Thus, your margin-based leverage will be 100:1 (100,000/1,000).
Forex trading does offer high leverage in the sense that for an initial margin
requirement, a trader can build up - and control - a huge amount of money.

An Example from Grace Cheng at http://gracecheng.com
Both Trader A and Trader B have a trading capital of US$10,000, and they trade
with a broker that requires a 1% margin deposit. After doing some analysis, both of
them agree that USD/JPY is hitting a top and should fall in value. Therefore, both
of them short the USD/JPY at 120.
Trader A chooses to apply 50 times real leverage on this trade by shorting
US$500,000 worth of USD/JPY (50 x $10,000) based on his $10,000 trading
capital. Because USD/JPY stands at 120, one pip of USD/JPY for one standard lot
is worth approximately US$8.30, so one pip of USD/JPY for five standard lots is
worth approximately US$41.50. If USD/JPY rises to 121, Trader A will lose 100
pips on this trade, which is equivalent to a loss of US$4,150. This single loss will
represent a whopping 41.5% of his total trading capital.
Trader B is a more careful trader and decides to apply five times real leverage on
this trade by shorting US$50,000 worth of USD/JPY (5 x $10,000) based on his
$10,000 trading capital. That $50,000 worth of USD/JPY equals to just one-half of
1 standard lot. If USD/JPY rises to 121, Trader B will lose 100 pips on this trade,
which is equivalent to a loss of $415. This single loss represents 4.15% of his
total trading capital.

Refer to the chart below to see how the trading accounts of these two
traders compare after the 100-pip loss.
An Example from Grace Cheng at http://gracecheng.com continued.
- Trader A Trader B
Trading Capital $10,000 $10,000
Real Leverage Used 50 times 5 times
Total Value of Transaction $500,000 $50,000
In the Case of a 100-Pip
Loss
-$4,150 -$415
% Loss of Trading Capital 41.5% 4.15%
% of Trading Capital
Remaining
58.5% 95.8%
Figure 1: All figures in U.S. dollars

Some final points as we wrap this introduction
What is a pip?
Pip stands for "percentage in point" and is the smallest increment of trade in
Forex. In the forex market, prices are quoted to the fourth decimal point. For
example, if a bar of soap in the drugstore was priced at $1.20, in the FX market
the same bar of soap would be quoted at 1.2000. The change in that fourth
decimal point is called 1 pip and is typically equal to 1/100th of 1%.
Among the major currencies, the only exception to that rule is the Japanese
yen. Because the Japanese yen has never been revalued since the Second
World War, 1 yen is now worth approximately US$0.08; so, in the USD/JPY
pair, the quotation is only taken out to two decimal points (i.e. to 1/100th of yen,
as opposed to 1/1000th with other major currencies).

Some final points as we wrap this introduction
What are you really selling or buying in the currency market?
The short answer is "nothing". The retail FX market is purely a speculative
market. No physical exchange of currencies ever takes place. All trades exist
simply as computer entries and are netted out depending on market price. For
dollar-denominated accounts, all profits or losses are calculated in dollars and
recorded as such on the trader's account.

Is there a next step for you?
Forex or currency trading is not for everyone. Currency Investors Group
and its training arm “YouCanTradeCurrency.com” deliver numerous
overviews, trainings, and demos for use by prospective traders. We would
like you to become a part of those sessions if you wish.
Visit http://currencyinvestorsgroup.com for information regarding
additional training opportunities, training packages, pre-approved
mechanical trading systems, and preferred forex dealer relationships.
If you are interested in a career in forex you will also find our site
extremely helpful in determining your next move.
Thank you for being with us today.

Glossary of Terms
Vocabulary in notes area

Introductory Currency Trading

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