Understanding Pips And Calculating that Value

Every currency pair has a corresponding value and hence a quote. For example, a GBP/USD quote could be 1.5776. This means that the exchange rate for every GBP is USD 1.5776. In other words, it would cost the trader USD 1.5776 to buy a single GBP. A pip is the smallest price change that a given exchange rate can make.

In our example a move from 1.5776 to 1.5777 would indicate a 1 pip increase. Since most major currency pairs (but not all, example of an important exception is the USD/JPY pair) are priced to four decimal places (.0000), the smallest change is obviously that of the last decimal point, or one basis point.

Reading A Currency Quote

Currencies are quoted in pairs, e.g. GBP/USD, USD/CHF etc. The first listed currency is called the “base” currency. The base currency is the basis for the buy or sell transaction. The second listed currency is called the “counter” or “quote” currency. As an example, if you place a buy GBP/USD order with your broker what you have effectively done is sell US dollars and bought Great British pounds (GBP). By definition, the first currency is the stronger between the two.

Let’s look at another example:

USD/CAD
If you believe that the Canadian government is going to weaken its currency (Canadian dollar) in order to help its export industry you would BUY USD/CAD (in trading terms: GO LONG). Why? Because you want to own US dollars while they appreciate against the Canadian dollar.

FOREX MARKET PARTICIPANTS

There are various entities in the FX market arena. Each trades for its own financial objective. The following are the main FX participants.

Central Banks
Within the foreign exchange market national central banks play a very important role. Ultimately, the objective of central banks is to keep inflation low and steady by controlling money supply. One of the most important responsibilities of a central bank is the restoration of an orderly market in times of excessive currency rate
volatility.

Many times, the mere speculation of central bank intervention is enough to stabilize a currency. However, in the event of aggressive intervention the actual impact on the short term supply/demand balance can lead to the desired moves in exchange rates.

Banks
The inter-bank market provides for both the greater part of commercial turnover as well as huge amounts of speculative trading on a daily basis. The type or trading that banks do can be divided into two. First, trading on behalf of the banks customers.

Spot and Forward Outrights Of the Forex Market

The most important forex market is the spot market, it also has the largest trading volume and it is the market you will be dealing with should you chose to trade forex. It is called “spot” simply because the trade is settled instantaneously.

Another part of the forex market is called forward outright. Don’t panic! You will not be dealing with it and in essence you do not even need to know about it but it is always good to understand the whole picture.

Several pro’s and con’s for the individual trader

Pro's:1. The trader can respond to currency moves caused by economic, social and political events at the time they occur. This is a huge advantage the forex market has over any other markets. If a company listed on the NYSE is scheduled to release quarterly earnings after the close of the market (as they almost always do), owners of the stock cannot react to the data (since there is no after hours trading) and may suffer
huge losses depending if they are short or long the stock once the market opens again the day after.

2. A trader has the opportunity to have an active market no matter what part of the world he or she lives in. As an example, if someone living in Australia would like to trade the US stock market they would have to be awake all night because of the time differences. Not so with the FX market.

Background of Foreign Exchange

Foreign exchange, or as it is referred to many times: “forex”, “fx”, or “currency exchange market”, is the term used to describe the trading of world currencies. A currency trade is the simultaneous buying of one currency and selling of another one, e.g. Buying US dollars with euros, buying British pounds with US dollars, selling Swiss francs for Japanese yens etc. The currency combination used in the trade is called a pair. We will dive more into this later on.

The foreign exchange market is by far the largest financial market in the world. Just to put things into perspective, the New York Stock Exchange (NYSE) daily volume fluctuates around US$30 billion per day. Forex market daily volume is estimated to be
around US$1.5 trillion! In fact, daily world stock and bond market volume added up is only a fraction of the daily forex trading volume.