Operating in the FOREX Market

Although the purpose is the same, trading and operations of the FOREX market are slightly different from those of other equity markets. There are a few things which the new FOREX investor must become familiar with. For instance, concerning the specifics of buying and selling on FOREX, it’s important to note that currencies are always priced in pairs. All trades, therefore, will result in the simultaneous purchase of one currency and the sale of another. When operating in the FOREX market, you would execute a trade only at a time when you expect the currency which you are buying to increase in value in relation to the one that you are selling. If the currency that you bought does increase in value, you must then sell the other currency back in order to lock-in your profit. Therefore, an open trade, or open position, is a trade in which the investor has bought or sold a particular currency pair but has not yet sold or bought back the equivalent amount in order to close the position.

Currency traders must also become familiar with the way in which currencies are quoted. The first currency in the pair is considered the base currency; the second one is the counter- or quote currency. The majority of the time, the U.S. dollar is considered the base currency, and quotes are expressed in units of “US$1 per counter currency” (for example, USD/JPY or USD/CAD). The only exceptions to this are quotes given for the euro, the pound sterling and the Australian dollar; these three are quoted as “dollars per foreign currency”.

FOREX quotes always include a bid- and an ask price. The bid is the price at which a market maker (or broker/dealer) is willing to buy the base currency in exchange for the counter currency. The ask price is the price at which the market maker is willing to sell the base currency in exchange for the counter currency. The difference between the bid and the ask prices is called the spread.

The cost of establishing a position in the market is determined by the spread, and prices are always quoted using five figures (136.70, for example). The final digit of the price is referred to as a point, or pip, which is the smallest price change that a given exchange rate can make. For instance, if USD/CAD was quoted with a bid price of 136.70 and an ask price of 136.75, that five-pip spread is the cost of trading into this position. The trader, therefore, must recover the five-pip cost from his or her profits, necessitating a favorable move in the position in order to simply break even.

Margin on the FOREX is not a down payment on a future purchase of equity as in other markets, but a deposit made to the trader's account that will cover against any losses in the future. A typical currency trading system will allow for a very high degree of leverage in its margin requirements, up to 100:1 or more. The system will automatically calculate the funds necessary for current positions and will check for margin availability before executing any trade.

As you can see, trading in FOREX requires a slightly different mindset than that which is needed for equity markets. Yet, for its extreme liquidity, the multitude of opportunities for large profits and high levels of available leverage, the currency markets are quickly growing in popularity among investors. Traders should always be aware, though, that with such potential for gain there is also significant risk for loss; they should therefore quickly become familiar with various methods of risk management.