Bid/Ask Spread
All Forex quotes include a two-way price, the
bid and ask. The
bid is always lower than the ask price.
The bid is the price in which
the dealer is willing to buy the base currency in
exchange for the quote currency. This means the bid
is the price at which you (as the trader) will sell.
The ask is the price at which the dealer
will sell the base currency in exchange for the
quote currency. This means the ask is the price at
which you will buy.
The difference between the bid and the ask price
is popularly known as the spread.
Let's take a look at an example of a price quote
taken from a trading platform:
On this GBP/USD quote, the bid price is 1.7445
and the ask price is 1.7449. Look at how this
broker makes it so easy for you to trade away
your money.
If you want to sell GBP, you click "Sell" and
you will sell pounds at 1.7445. If you want to
buy GBP, you click "Buy" and you will buy pounds
at 1.7449.
In the following examples, we're going to use
fundamental analysis to help us decide whether to
buy or sell a specific currency pair. If you always
fell asleep during your economics class or just flat
out skipped economics class, don?t worry! We will
cover fundamental analysis in a later lesson. For
right now, try to pretend you know what?s going on?
EUR/USD
In this example Euro is the base currency and thus
the ?basis? for the buy/sell.
If you believe that the US economy will
continue to weaken, which is bad for the US
dollar, you would execute a BUY
EUR/USD order. By doing so you have bought euros
in the expectation that they will rise
versus the US dollar.
If you believe that the US economy is strong
and the euro will weaken against the US dollar
you would execute a SELL
EUR/USD order. By doing so you have sold Euros
in the expectation that they will fall
versus the US dollar.
USD/JPY
In this example the US dollar is the base currency
and thus the ?basis? for the buy/sell.
If you think that the Japanese government is
going to weaken the Yen in order to help its
export industry, you would execute a BUY
USD/JPY order. By doing so you have bought U.S
dollars in the expectation that they will rise
versus the Japanese yen.
If you believe that Japanese investors are
pulling money out of U.S. financial markets and
converting all their U.S. dollars back to Yen,
and this will hurt the US dollar, you would
execute a SELL USD/JPY order.
By doing so you have sold U.S dollars in the
expectation that they will depreciate against
the Japanese yen.
GBP/USD
In this example the GBP is the base currency and
thus the ?basis? for the buy/sell.
If you think the British economy will
continue to do better than the United States in
terms of economic growth, you would execute a
BUY GBP/USD order. By doing so
you have bought pounds in the expectation that
they will rise versus the US dollar.
If you believe the British's economy is
slowing while the United State's economy remains
strong like bull, you would execute a
SELL GBP/USD order. By doing so you
have sold pounds in the expectation that they
will depreciate against the US dollar.
USD/CHF
In this example the USD is the base currency and
thus the ?basis? for the buy/sell.
If you think the Swiss franc is overvalued,
you would execute a BUY USD/CHF
order. By doing so you have bought US dollars in
the expectation that they will appreciate versus
the Swiss Franc.
If you believe that the US housing market
bubble burst will hurt future economic growth,
which will weaken the dollar, you would execute
a SELL USD/CHF order. By doing
so you have sold US dollars in the expectation
that they will depreciate against the Swiss
franc.
I don't have enough money to buy $10,000
euros. Can I still trade?
You can with margin trading! Margin trading is
simply the term used for trading with borrowed
capital. This is how you're able to open $10,000 or
$100,000 positions with as little as $50 or $1,000.
You can conduct relatively large transactions, very
quickly and cheaply, with a small amount of initial
capital.
Margin trading in the foreign exchange market is
quantified in ?lots?. We will be discussing these in
depth in our next lesson. For now, just think of the
term "lot" as the minimum amount of currency you
have to buy. When you go to the grocery store and
want to buy an egg, you can't just buy a single egg;
they come in dozens or "lots" of 12. In Forex, it
would be just as foolish to buy or sell $1 EUR, so
they usually come in "lots" of $10,000 or $100,000
depending on the type of account you have.
For Example:
- You believe that signals in the market
are indicating that the British Pound will
go up against the US Dollar.
- You open 1 lot ($100,000) for buying the
Pound with a 1% margin at the price of
1.5000 and wait for the exchange rate to
climb. This means you now control $100,000
worth of British Pound with $1,000. Your
predictions come true and you decide to
sell.
- You close the position at 1.5050. You
earn 50 pips or about $500. (A pip is the
smallest price movement available in a
currency). So for an initial capital
investment of $1,000, you have made 50%
return. Return equals your $500 profit
divided by your $1,000 you risked to trade.
| Your Actions |
GBP |
USD |
Your Money |
| You buy 100,000 pounds at the GBP/USD
exchange rate of 1.5000 |
+100,000 |
-150,000 |
$1,000 |
| You blink for two seconds and the
GBP/USD exchange rate rises to
1.5050 and you sell. |
-100,000 |
+150,500** |
$1,500 |
| You have earned a profit of
$500. |
0 |
+500 |
|
When you decide to close a position, the deposit
that you originally made is returned to you and a
calculation of your profits or losses is done. This
profit or loss is then credited to your account.
We will also be discussing margin more in-depth
in the next lesson, but hopefully you're able to get
a basic idea of how margin works.
Rollover
No, this is not the same as rollover minutes from
your cell phone carrier! For positions open at your
broker's "cut-off time" usually 5pm EST, there is a
daily rollover interest rate that a trader either
pays or earns, depending on your established margin
and position in the market. If you do not want to
earn or pay interest on your positions, simply make
sure they are all closed before 5pm EST, the
established end of the market day.
Since every currency trade involves borrowing one
currency to buy another, interest rollover charges
are part of forex trading. Interest is paid on the
currency that is borrowed, and earned on the one
that is bought. If a client is buying a currency
with a higher interest rate than the one he/she is
borrowing, the net differential will be positive
(i.e. USD/JPY) ? and the client will earn funds as a
result. Ask your broker or dealer about specific
details regarding rollover.
Don't know what the interest rates are for each
currency? Here is a chart to help you out. Accurate
as of 03/19/07.
Demo Trading
You can open a demo account for free with most
Forex brokers. This account has the full
capabilities of a "real" account. Why is it free?
It?s because the broker wants you to learn the ins
and outs of their trading platform, and have a good
time trading without risk, so you?ll fall in love
with them and deposit real money. The demo account
allows you to learn about the Forex markets and test
your trading skills with ZERO risk.
YOU SHOULD DEMO TRADE FOR AT LEAST 2
MONTHS BEFORE YOU EVEN THINK ABOUT PUTTING REAL
MONEY ON THE LINE.
I REPEAT - YOU SHOULD DEMO TRADE FOR AT
LEAST 2 MONTHS BEFORE YOU EVEN THINK ABOUT PUTTING
REAL MONEY ON THE LINE.
"Don't Lose Your Money" Declaration
Place your hand on your heart and say...
"I will demo trade for at least 2 months
before I trade with real money."
Now touch your head with your index finger and
say...
"I am a smart and patient Forex trader!"
