FX Tutorial
General
Trading margined FX allows you to speculate on what is going to happen to one foreign currency in relation to another one. You do this by buy or selling the base currency against the other currency. The base or principle currency is the first currency in the quoted pair.
So for example in GBP/USD, which is the Great British Pound versus the US Dollar, the GBP is the base currency, so if you bought this then you would at the same time be automatically be selling the US Dollar, as you cannot buy or sell something without having done the complete opposite on the other side. Because you are buying or selling the base currency in fixed amounts, when the exchange rate changes your profit or loss is always in the secondary currency. Thus if you traded GBP/USD then your profit or loss would be in USD.
If you buy a currency you are expecting the value of that currency to increase against the value of the currency that it is quoted against. In other words you expect that at some time in the future you will be able to get more of the second currency than you could before, with a given amount of the base currency.
So if GBP/USD is at 1.6500 this means you can get $1.65 for every £1.00. If you bought GBP/USD and it went up to 1.7500 then this means you could get $1.75 for every £1.00.
What is SPOT FX?
In simple terms 'spot' simply means two business days forward. Before the advent of margin trading all FX trades had to be settled and so were traded with 2 days breathing space so the parties concerned could confirm their payment details to the other party. This was of particular importance when dealing with institutions in different time zones.
For example if a bank in Japan bought some GBP/USD with a bank in Germany then the Japanese bank would have two days to let it know where it needed the GBP to be paid to and the German bank would have two days to let the Japanese bank know which bank and account in the US it wanted the dollars paid to.
What is the Bid/Offer?
Every FX price quoted, even in a Bureau de Change, has a two way price. This is the price that you can buy and sell at the currency at. As mentioned you trade FX in terms of the base currency, so if you want to buy the base currency (and sell the second currency) then you deal on the offer price which is the more expensive of the two on the right hand side. If you want to sell the base currency (and buy the second currency) you would deal on the bid price which is the lower price on the left hand side.
What is Margin Trading?
Margin trading mirrors spot FX trading. The prices are exactly the same because you are trading on exactly the same exchange rate, except you will never be allowed to let the trade mature and have to exchange any currencies.
Every day, any open FX trades from the day before, will be rolled forward to 'spot' again so that they are always kept two business days from settlement. This roll creates a debit or credit on your account depending on different circumstances, which is discussed later.
Because you are never actually going to have to settle a trade or come up with the full amount of the initial transaction, margin trading has evolved to allow clients to trade in a larger amount than they are holding as collateral or deposit, known as margin.
This can vary depending on which currency pairs you are trading, due to volatility issues, and also on which trading company you trade with. A company that lets you trade with massive leverage is not necessarily doing you any favours as you are potentially exposing yourself to large losses, which can accrue very quickly in a volatile market.
As an example, if the margin of GBP/USD is 2%, then this means that you only need to have in your account 2% of the value of the trade that you want to place. So if you wanted to trade 100,000 of GBP/USD then you would need £2,000 or equivalent in whatever currency your account is set up in.
If your trade starts to lose money, then in this example, you will go on margin call, meaning you need to add funds to your account as you would have negative trading resources (Cash Balance - Margin Profit/Loss).
Our system will close your positions out if they are losing 90% of the funds available in your account, although it is always your responsibility to ensure that this has been done and that you are not left with positions you are not aware of or that are costing you more money than you have.
What happens when you go long?
When you buy one currency at a given exchange rate you are selling the other currency. So if we use GBP/USD as an example and you buy 100,000 GBP at an exchange rate of 1.6500 then you are selling 165,000 USD at the same time (100,000 x 1.6500).
In the real world of interbank trading where banks physically exchange currencies then you would have to pay that amount of dollars into the account of the person you have dealt with and they would pay the Sterling amount into your UK account.
As we are just speculating on the price using margin trading there is no transfer of funds, as the trade is never allowed to go to delivery. If you keep the position open then it is automatically rolled for you, and when you close it the resulting profit or loss is debited or credited from or to your account. This will be explained later.
What happens when you go short?
When you sell one currency at a given exchange rate you are buying the other currency. So if we use GBP/USD as an example and you sell 100,000 GBP at an exchange rate of 1.6500 then you are buying 165,000 USD at the same time (100,000 x 1.6500).
In the real world of interbank trading where banks physically exchange currencies then you would have to pay that amount of Sterling into the account of the person you have dealt with and they would pay the US Dollars amount into your US account.
As we are just speculating on the price using margin trading there is no transfer of funds, as the trade is never allowed to go to delivery. If you keep the position open then it is automatically rolled for you, and when you close it the resulting profit or loss is debited or credited from or to your account. This will be explained later.
How do you make or lose money?
If you buy something you want the price to go up. If you sell something so want the price to go down. In FX this is exactly how it works. You make or lose money if the exchange rates move in your favour, in relation to the base currency.
So if you bought 100,000 GBP/USD at 1.6500 and the exchange rate went up to 1.6525 then you would be making a profit. This is easy to calculate, as your profit or loss in an FX transaction is always in the secondary currency, in this case US Dollars.
In the above example your initial trade was to buy 100,000 GBP/USD at 1.6500.
This means that you have effectively sold US Dollars 165,000 (100,000 x 1.6500).
If the exchange rate went up to 1.6525 and you closed you position then you would be selling 100,000 GBP/USD at 1.6525. This means that you effectively bought US Dollars 165,250 (100,000 x 1.6525).
So overall in this example you would have made a profit of $250, because you have got back more US Dollars than you sold initially. If the exchange rate had gone down by this amount then you would have lost $250.
What is a point/pip/tick?
A point, pip or tick is the smallest unit that a currency usually moves in. So for example with GBP/USD, as it trades to 4 decimal places (0.0001), then a pip is that last decimal. So in the previous example where the exchange rate had moved from 1.6500 to 1.6525, that is a 25 point move.
If you were to trade USD/JPY, which is US Dollar versus Japanese Yen, then this only trades to two decimal places (For example 95.25). So a point is 0.01.
What is tick value?
It is often useful to know what the tick value of a trade is to help calculate what your profit or loss (P L) is or would be in a given situation. It simply represents the financial implication of a 1 tick move in the trade. So if you had bought 100,000 GBP/USD and you know that it moves in 0.0001 tick movements then for every tick it moves you would make or lose 100,000 x 0.0001 = $10 depending if it went up or down.
If you traded 100,000 USD/JPY at 95.50 then the tick value would be 100,000 x 0.01 = Yen 1,000, which is approximately $10.50 a tick (Y 1000 / 95.5).
What is lot size?
Some trading platforms have been designed to simplify trading for clients. Meta Trader for example uses a system known as 'lots' to enter the amount that you wish to trade. Basically on MT4 1 lot is equal to 100,000. So if you wanted to trade 100,000 GBP/USD then you would enter 1 as the amount.
You are able to trade fractions of lots, so you could trade 0.1 lots of something which would be 10,000.
What are Orders? (Risk Management)
An order is an instruction to open or close a position at a specific price chosen by you.
They are useful if you are unable to follow the live prices of that market, as you can choose at what price you wish to enter the market (by placing an opening order) or exit the market (by placing a closing order). Closing orders can be used for limiting your risk or taking profits.
An order can be valid over a specific time period and will either be triggered or will expire, whichever one comes first. They can be used to limit losses to a predetermined limit, although this is not necessarily guaranteed as markets can gap through levels.
What are Stops and Limits?
A stop order is an instruction that is executed only when the price of a market reaches a specified level that is less favorable than the current market level.
A stop loss order is an instruction that is executed only when the price of a market reaches a specified level that is less favorable than the current market level, this is typical used to close an open position.
A limit order is an instruction that is executed at a specified level when the price of a market reaches a level that is more favorable than the current market price. This type of order can be used to open or close a position.
The following three examples are of different types of orders. These are all in GBP/USD and assume that the current market price is 1.6502 - 1.6504.
An example of a stop order
You decide that if the market falls to 1.6450 then it is going to keep going down, and you want to sell 100,000 GBP/USD if it gets there. So you want to leave an order that will trigger if we get to that level and open a new position. The order you leave is Sell 100,000 GBP/USD at 1.6450 stop. As you have not specified a cancelation time for the order it will be worked until such time as it is executed or canceled manually.
An example of a stop loss order
You currently are short 100,000 GBP/USD at 1.6450 and losing money as it trading higher. You want to try and limit your potential loss to 75 pips. This would be 1.6450 0.0075 = 1.6525. If this was triggered at that price then you would lose $750 (100,000 x 0.0075). The order that you would attach to your open position is Buy 100,000 GBP/USD at 1.6525 Stop Loss.
How do I place an order?
You can place an order on the trading platform you will need to specify an order type, trade size, price and duration for the order.
What happens if the market gaps through my order level?
In volatile market conditions it may be possible for an order to be triggered at a level that is less favorable than the order price you specified. This is known as 'Gapping' In this situation GKFX will endeavor to execute the order at the first or most reasonable price available to us.
What happens to order that are attached to an open position when that position is closed?
If you have any order that are attached to a position that has been closed then these will automatically be cancelled. But it is your responsibility to ensure that this indeed has been done.
What is Financing?
Value dates
As mentioned earlier FX deals two working days ahead. So on a Monday it is dealing for value Wednesday and on a Tuesday for Thursday.
Therefore, as on a Wednesday the spot value date is Friday, on a Thursday the spot value date is Monday. So any positions which are open overnight (open at 5pm New York time) on Wednesday will be subject to 3 days financing, which includes the weekend.
You do not lose out, technically, because at exactly 5pm New York time the exchange rate will move to allow for this financing, although this is not normally noticeable.
If there are holidays involved in calculation the next value date then this can lead to several days financing being applied in one go.
As the FX market is so big and liquid there is actually a huge market in its own right that just looks after and trades financing in FX. This is part of the forwards and swaps market and is known as short dated FX swaps.
It is these rates that we at GKFX use to give to our clients, which are some of the most competitive in the industry. Some of our competitors do not follow this approach and clients end up suffering.
How is it calculated?
The financing is basically worked out using two interest rates and a calendar. If you are long one currency you are therefore short another. As you are not going to allow the trade to 'go to delivery' then it must be rolled. Therefore the currency that you have bought you put on 1 day deposit and the currency that you have sold you borrow for 1 day. If weekends or holidays are involved then the calculation will be for more than 1 day.
The result of what is a relatively simple calculation is known as the tom/next points, which are the points required to roll your position from value tomorrow to the next.
At the time of writing the example the tom/next (TN) points for GBP/USD are 0.8/0.3. It is market convention that if the swap rates go from high to low then you take these points off. So here these rates are in effect -0.8/-0.3. (If the rates were shown as 0.3/0.8 then they would be added).
So if you had bought 100,000 GBP/USD at 1.6504 and kept the position open, then as long as that position was open at 5pm New York time then the position would be subject to TN. Even if you closed the position at 5.01pm you would still be subject to TN for the position you had open at the time.
Here as you were long you would receive 0.3 of a tick. If you were short you would be charged 0.8 of a tick. So in this case you would receive 100,000 x 0.00003 = $3.
If you are unsure whether it is a charge or credit the simplest thing to do is think that because you were long then you are on the right hind side of the swap (the offer side) at -0.3. So you are buying something at a minus price, so that is a benefit.
If you had been short 100,000 GBP/USD you would be on the left side of the swap, -0.8. So in this case you would be selling at a minus price which is a cost. Here that would be 100,000 x 0.00008 = -$8.
