Forex Trading Guide

All Forex Trading (FX Trading) is determined by a rate of exchange. FX traders simultaneously buy one currency and sell the other, with the hope of making a profit when the value of the currencies change.

An example of FX trading

• The US dollar is trading against the Japanese Yen at 116.99/117.02
• You think the US dollar will strengthen against the Yen so you decide to buy 500,000 USD at 117.02
• Later that day you see that the dollar has risen to 117.65/117.68 and you decide to sell your dollars at 117.65

Your revenue is calculated as follows:

$500,000 (size of position) x (117.65 [sell price] - 117.02 [buy price]) = ¥315,000. This is converted back into dollars ¥315,000 ÷ 117.65 = $2,677 – at the end of the day using the mid-close price.

FX quotes currencies in pairs, e.g. Euro vs. US Dollar.

When one currency increases in value, it strengthens against another and the value of the other decreases. FX is a popular way to trade on financial markets as it is a true 24-hour market.

You must have a Contracts for Difference (CFD) or Financial Spread Betting Account to trade in Foreign Exchange.

Initial margin

When you open an FX position, you are not required to pay the full value of the trade. Instead you need to deposit collateral of a percentage of the position value. This is known as 'initial margin'.

Example of how to calculate margin

You buy £100,000 spot EUR/USD @ 1.2000 and you need to have a minimum of 1% margin in your account. This would be calculated as follows:

• 0.5% of £100,000 primary currency £500
• 0.5% of $120,000 secondary currency = $600 (or £500)
• To hold the position you are required to deposit £1,000 as initial margin

Financing chargers

Spot positions that are rolled over will incur a financing cost based upon the interest rate differential of the two currencies.

The interest rate applied is 'TomNext' which is an abbreviation for tomorrow/next. The first value date is tomorrow (Tom) and maturity falls on the next working day (Spot/Next).

At a certain time each day, your provider will settle all spot positions by closing the trade at the current market rate and re-opening it for the following day’s spot date at a rate that will reflect the interest rate differential.

Example

• USD/JPY: 111.000
• Trade date: 18 January
• You buy: 500,000 USD (value date 20 January) @ 111.00
• You sell: 55,500,000 JPY (value date 20 January) @ 111.00

At settlement on 19 January (2200), the USD/JPY has moved to 111.50, realising a profit of 250,000 yen. Should you decide to roll the position overnight, your provider will automatically execute the following trades on your behalf:

• Sell: 500,000 USD (value date 20 January) @ 111.50
• Buy: 55.750,000 JPY (value date 20 January) @ 111.50
• You buy: 500,000 USD (value date 21 January) @ 111.4922
• You sell: 55,746,100 JPY (value date 21 January) @ 111.4922

If, based on this example, the USD/JPY rate moved against you, you would lose money on this trade.

There are a number of risk management tools that can help you manage your risk including:

• Guaranteed stops
• Limit orders
• Stop loss orders
• 'If-done' order
• 'One cancels the other' (OCO) order

With a guaranteed stop-loss facility, your position is closed at a level pre-selected by you, despite dramatic market movements. Guaranteed stops carry a small premium.

Example of a guaranteed stop

• You believe ABC Corporation will strengthen from its current level of 350.00, but you want to be sure of your maximum downside on the trade.
• You place a guaranteed stop order to sell 1,000 ABC Corporation CFDs at 320.00
• To do so, you will need to pay a premium of, say, 2 points. The premium paid depends on the instrument you trade upon.
• So to buy, the price of ABC Corporation is 353.00. The market begins trading lower and deals at 321.00, then 'gaps'. This means that the next available bid price you can sell at is 312.00
• In the case of a standard stop, the order would be executed at 312.00. However, because you have guaranteed your stop loss and despite the gap in the market, your provider executes the order at 320.00.

A limit order lets you pre-determine either a price higher than the current price at which you wish to sell, or a level below at which you wish to buy. This means you can pre-define the level at which you want to sell to take a profit, or the level at which you want to buy below the current price of an instrument.

Example of a limit order

• You have bought a long position of 1,000 BP CFDs at an opening price of 530.00
• You believe BP will strengthen to 550.000
• You therefore place a limit order to sell 1,000 BP CFDs at 550.00

Limits can also be used to open positions.

You don't have to set up limits and stops with every trade you do. However, as a beginner, we recommend you use them.

Stop loss orders can be used to limit your trading risk and are an essential part of disciplined trading. Using stops means you are automatically taken out of a position if the market moves against you, which limits your loss.

Stop losses can also be used to lock in profit. If the market moves in your favour, you can move your stop order with the prevailing price, which locks in profit if the market suddenly moves against you.

Example of a stop loss order

You have placed a bet (buy) at £10 per point on XYZ at an opening price of 150p. You believe that XYZ price will strengthen. However, you want to limit any potential loss and place a stop order to sell £10 per point at 130p. This limits your loss should XYZ fall to 130p or below.

An 'if-done' order is a combination of two orders and can be used if you are unable to continually monitor the market but want to participate in market movements in your favour and/or exit a move against you.

Example of 'If-done' order

• ABC is trading 1200.00 and you wish to buy if the price falls to 1190.00 but exit if the price continues to fall to 1180.00.
• You would place a limit order to buy ABC at 1190.00 and a stop loss order to sell at 1180.00.
• The stop loss order is only activated once the limit order is filled - hence 'if-done'

A one cancels the other (OCO) order offers a number of advantages for those wishing to get in and out of the market without having to watch it constantly. It is the combination of both a 'link' and a 'stop' order and can be used to take a profit if the market moved in your favour or to limit losses if the market moves against you. For example:

An OCO is the combination of both a limit and a stop. It can be used to take a profit if the market moves in your favour or to limit loses if the market moves against you.

Example of OCO order:

FX trading stands for foreign exchange trading. It's also known as forex trading.

In FX trading you buy one currency at the same time as you sell another with the hope of making a profit when the value of the currencies change.

You can trade FX via a Financial Spread Betting account, a Contract for Difference account - known as a CFD, or via a Covered Warrant.

Currently, investors don’t pay UK tax on profits made from Financial Spread Betting. So if you trade FX via a Financial Spread Betting Account you won’t have to pay UK tax on any profits but tax laws can change.

There are also low transaction costs when you trade via a Financial Spread Betting Account, with no stamp duty and no commissions to pay.

FX trading involves margin trading. This means that investors can buy and sell assets that have a greater value than the amount they are investing.

However this means an investor can suffer substantial losses if the market moves against their position and you could lose more money than your initial investment.

FX trading carries a high level of risk to your capital and may not be suitable for all investors. You should only speculate with money that you can afford to lose.

Keep an eye on the market and your position. Foreign exchange markets can move very quickly.

Make sure that you understand the risks involved and get expert help, if you need it.

For more information on FX trading visit the Learning & Research pages on natweststockbrokers.com