What are Currency CFD's (Forex)?
What am I doing when I trade Currency CFD's (Forex)?
Currency CFD's (Forex) is a commonly used abbreviation for "foreign exchange" and is typically used to describe trading in the foreign exchange market by investors and speculators.
For example, imagine a situation where the U.S. dollar is expected to weaken in value relative to the euro. In this situation, a Currency CFD's (Forex) trader will sell dollars and buy euros. If the euro strengthens, the purchasing power to buy dollars has now increased. The trader can now buy back more dollars than they had to begin with, making a profit.
This is similar to stock trading. A stock trader will buy a stock if they think its price will rise in the future and sell a stock if they think its price will fall in the future. Similarly, a Currency CFD's (Forex) trader will buy a currency pair if they expect its exchange rate will rise in the future and sell a currency pair if they expect its exchange rate will fall in the future.
What is an exchange rate?
The foreign exchange market is a global, decentralised marketplace that determines the relative values of different currencies. Unlike other markets, there is no centralised depository or exchange where transactions are conducted. Instead, these transactions are conducted by several market participants in several locations. It is rare that any two currencies will be identical to one another in value and it's also rare that any two currencies will maintain the same relative value for more than a short period of time. In Currency CFD's (Forex), the exchange rate between two currencies constantly changes.
For example, on January 3rd 2011, one euro was worth about $1.33. By May 3rd 2011, one euro was worth about $1.48. The euro increased in value by about 10% relative to the U.S. dollar during this time.
Why do exchange rates change?
Currencies trade on an open market just like stocks, bonds, computers, cars and many other goods and services. A currency's value fluctuates as its supply and demand fluctuates, just like anything else.
- An increase in supply or a decrease in demand for a currency can cause the value of that currency to fall.
- A decrease in the supply or an increase in demand for a currency can cause the value of that currency to rise.
A big benefit to Currency CFD's (Forex) trading is that you can buy or sell any currency pair, at any time, subject to available liquidity. So if you think the Eurozone is going to break apart, you can sell the euro and buy the dollar (sell EUR/USD). If you think the price of gold is going to go up, based on historical correlation patterns you can buy the Australian dollar and sell the U.S. dollar (buy AUD/USD).
This also means that there really is no such thing as a "bear market," in the traditional sense. You can make (or lose) money when the market is trending up or down.
Why Trade Currency CFD's (Forex)?
Online Currency CFD's (Forex) trading has become very popular in the past decade because it offers traders several advantages:
Currency CFD's (Forex) never sleeps
Trading goes on all around the world during different countries' business hours. You can therefore trade major currencies at any time, 24 hours per day. Since there are no set exchange hours, it means that there is also something happening at almost any time of the day or night.1
Go long or short
Unlike many other financial markets, where it can be difficult to sell short, there are no limitations on shorting currencies. If you think a currency will go up, buy it. If you think it will fall, sell it. This means there is no such thing as a "bear market" in Currency CFD's (Forex) - you can make (or lose) money any time.
Low trading costs
Most Currency CFD's (Forex) accounts trade without a commission and there are no expensive exchange fees or data licenses. The cost of trading is the spread between the buy price and the sell price, which is always displayed on your trading screen.
Because Currency CFD's (Forex) is a $4 trillion a day market, with most trading concentrated in only a few currencies, there are always a lot of people trading. This makes it typically very easy to get into and out of trades at any time, even in large sizes.
Because of the deep liquidity available in the Currency CFD's (Forex) market, you can trade Currency CFD's (Forex) with considerable leverage (typically 200:1). This can allow you to take advantage of even the smallest moves in the market. Leverage is a double-edged sword of course, as it can significantly increase your losses as well as your gains.
As the world becomes more and more global, investors hunt for opportunities anywhere they can. If you want to take a broad opinion and invest in another country (or sell it short!), Currency CFD's (Forex) is an easy way to gain exposure while avoiding vagaries such as foreign securities laws and financial statements in other languages.
1 Subject to available liquidity, the trading desk opens on Sundays between 5:00 PM ET and 5:15 PM ET. The trading desk closes on Fridays at 4:55 PM ET. Orders placed prior may be filled until 5 pm (ET).
Learning to trade in a new market is like learning to speak a new language. It's easier when you have a good vocabulary and understand some basic ideas and concepts.
What is currency CFD's (FOREX)?
Currency CFD's (Forex) is a commonly used abbreviation for "foreign exchange". It typically describes the buying and selling of currency in the foreign exchange market, especially by investors and speculators. The familiar expression, "buy low and sell high", certainly applies to currency trading. A Currency CFD's (Forex) trader purchases currencies that are undervalued and sells currencies that are overvalued, just as a stock trader purchases stock that is undervalued and sells stock that is overvalued.
How do you read a quote?
Because you are always comparing one currency to another, Currency CFD's (Forex) is quoted in pairs. This may seem confusing at first, but it is actually pretty straightforward. For example, the EUR/USD at 1.4022 shows how much one euro (EUR) is worth in US dollars (USD).
What is a PIP?
A pip is the unit you count profit or loss in. Most currency pairs, except Japanese yen pairs, are quoted to four decimal places. This fourth spot after the decimal point (at one 100th of a cent) is typically what one watches to count "pips". Every point that the place in the quote moves is 1 pip of movement. For example, if the EUR/USD rises from 1.4022 to 1.4027, the EUR/USD has risen 5 pips.
What is leverage/margin?
As mentioned before, all trades are executed using borrowed money. This allows you to take advantage of leverage. Leverage of 200:1 allows you to trade with $1,000 in the market by setting aside only $5 as a security deposit. This means that you can take advantage of even the smallest movements in currencies by controlling more money in the market than you have in your account. On the other hand, leverage can significantly increase your losses. Trading foreign exchange with any level of leverage may not be suitable for all investors.
The specific amount that you are required to put aside to hold a position is referred to as your margin requirement. Margin can be thought of as a good faith deposit required to maintain open positions. This is not a fee or a transaction cost, it is simply a portion of your account equity set aside and allocated as a margin deposit.
Spread/ Trade Costs
The spread/trade costs are calculated by taking the difference between the Buy and Sell price at execution of the trade.
Please see below for an example on a EUR/USD trade.
Spread/Trade Cost: 2.5 pips
Buy 0.01 contract size, 1 pip is equal to R1.30
Cost to trade: R3.25
Spreads vary depending on instruments, market conditions, exchange rates, fundamental or political involvement and the above cannot be construed as a quote. All spreads / trade costs will be visible in the Market Watch window on the MetaTrader 4 platform.
Spreads are negotiable depending on volume traded or amount deposited.