Posotions and Understandings in Forex Trade

Understanding the Trades : -o

The best way to understand what happens in a forex trade is to demonstrate by way of example. In this case we will outline a trade in which we buy EUR/USD at 1.2100.

Remember, when buying or selling in the forex market you are doing so in regards to the base currency (the first one listed in the pair). That means for EUR/USD we are long the Euro, and by extension, short the USD.

This diagram shows the way the transaction runs it's course:

Simple Spot Forex Trade :-o

Buy 100,000 EUR/USD at 1.2100

Borrow 121,000 USD (100,000 x $1.21)

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Convert USD to EUR at 1.2100

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Deposit 100,000 EUR

When we close out this trade, it is a simple reversal process. The EUR position is converted back in to USD and we pay-off the USD loan we took out. If the exchange rate increased, then we would have Dollars left over, which would be our profit. For example, if the rate went to 1.25 we would have $4000 left over after paying back our loan (100,000 x $1.25 = $125,000 - $121,000 = $4000) If the rate had dropped, we would have a shortfall on our loan repayment, and thus a loss on the trade.

For a trader whose account is denominated in US Dollars, the above example is pretty straightforward. There is only one exchange happening each way. When one is trading cross-rates, however, things get more complex.

Everything remains essentially the same when we enter the trade. If, for example, we were buying 100,000 EUR/JPY at 131.00 we would borrow 13,100,000 JPY (100,000 x 131), exchange that in to EUR, and deposit it. We would pay interest on the JPY loan and earn it on the EUR deposit, just like we did in the EUR/USD example.

The complexity of a cross trade comes when unwinding the trade. Assume EUR/JPY rises to 132.00, and see how the long position unwind would look:

Cross-Rate Trade :-o

Unwind 100,000 EUR/JPY long

(Entered trade at 131.00)

100,000 EUR

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Convert EUR back to JPY at 132.00

(100,000 x 132 = 13,200,000 JPY)

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Repay 13,100,000 JPY

(13,200,000 - 13,100,000 = 100,000 JPY remains)

You will note that there are 100,000 JPY remaining after the original JPY loan is repaid. That is our profit, but as USD-based traders we need to convert that back in to USD for our accounting purposes. That happens by exchanging the JPY for USD at the current USD/JPY rate. If that rate is 107.00, then we have a gain of $934.58 on the trade (100,000/107.00). Of course, we must also take in to account the interest carry when determining our net profit.

Calculating Profits & Losses :-o

The above outlines of forex trades may seem complicated, but as an individual trader, you don't see all that stuff. When it comes down to determining your profit or loss (P&L), it's pretty simple. The essence of determining one's P&L boils down to starting value and ending value (as set by the market).

Here are the formulas for calculating your profit or loss on a forex trade:

Non-USD Base (i.e. EUR/USD):

Long: (Units x R2) - (Units x R1) or Units x (R2—R1)

Short: (Units x R1) - (Units x R2) or Units x (R1—R2)

Where R1 is the starting rate and R2 is the ending one.

Ex: Buy 100,000 EUR/USD at 1.3000 and sell at 1.3100:

(100,000 x 1.31 = $131,000)—(100,000 x 1.30 = $130,000) = $1000

USD Base (i.e. USD/JPY):

Long: ((R2/R1) - 1) x Units

Short: ((R1/R2) - 1) x Units

Long Ex: Buy 100,000 USD/JPY at 110.00 and sell at 111.00:

(( 111.00 / 110.00 ) - 1) x $100,000 = $909.09

Short Ex: Short 100,000 USD/JPY at 110.00 and cover at 109.00:

(( 110.00 / 109.00 ) - 1) x $100,000 = $917.43

As we know from the EUR/JPY example, cross trades require an additional step. The same calculation can be used as above (the non-USD base is probably the easiest, though either could be used), but the Profit/Loss figure would then have to be converted using one of the currencies involved to get it back to the account currency as demonstrated earlier.

Remember, forex trades have an interest rate carry based on the interest rate differentials. This can be either positive or negative. For longer-term trades, this can be a significant influence on the final P&L.

Multiple Open Positions :-o

A common piece of advice offered by experienced forex traders to novices is to focus on one currency pair and stick to that. There are two reasons. One is to develop a good understanding of one forex relationship and not spreading things too thin. The other reason is to avoid some of the issues which can crop up when a trader has positions open in multiple currency pairs.

The first of those issues is creating excessive exposure to one currency. This is done by going long or short the same currency in different pairs. For example, I you were to sell EUR/USD and at the same time buy USD/JPY you would have two USD long positions. In shorting EUR/USD you are going long USD, and obviously in buying USD/JPY you are doing the same thing. This is a very quick way to put your trading account at serious risk if you are not aware of your total exposure. If the USD were to suffer a decline you would likely lose on both those positions.

The other issue in holding positions in multiple currency pairs is that you can accidentally create a position completely different than what you intended. For example, if you were to buy EUR/USD and buy USD/JPY the USD exposure in those trades would at least partially offset each other (you are selling USD in the first trade and buying it in the second), depending on the values of the two trades in question. What you are left with is a long EUR/JPY position, which has very different trading characteristics than either EUR/USD or USD/JPY.

The combination of the risk factor and the offsets that can happen is why even experienced traders often will only carry one open forex position at a time. It just keeps things simpler.

Top Countries Globally in Forex Trading

Trading in foreign exchange, which saw global daily volumes of more than $3 trillion (Dh11trn) last year, has been drawing interest from investors across the world. Estimated to be 20 times higher than the daily volume of the New York Stock Exchange, providers of online forex trading platform are quite buoyant on the growth of this asset class in spite of the global economic crisis.

Betsy Waters, Global Director, dbFX, an online margin foreign exchange trading platform launched by Deutsche Bank, says forex trading is in for massive growth. Excerpts from an interview:

What has been the impact of the ongoing volatility in global markets on forex trade?

Forex trading has gone up. If I look at our bank, we were 200 per cent of our normal weekly average this month [October] in volumes. The impact of volatility has been positive as people who do not want to trade other asset classes have been moving into forex. For instance, in case of equities, investors are not able to buy and hold at the moment, given the global financial turmoil.

In case of forex trading, volatility is good. It means one can always buy and sell and make a positive investment. Volatility is in fact good for trading of currencies unlike other asset classes, a factor that is making it much more attractive.

Has this been a good period?

It is proving to be the best period for volumes. As far as investments are concerned, it depends whether you are right or not.

How has forex trade grown in the Middle East? Where is maximum growth in the region coming from?

Of the four regions that we have categorised - the United States, Europe, Asia and Middle East - we see high potential in Middle East. We recorded a year-on-year growth of 70 per cent this year and countries in the Middle East have significantly contributed to it. The UAE and Jordan have been among the best performing countries in this region and we have a heavy clientele here.

What are the factors that are driving growth in this region and how would you describe investor behaviour here vis-á-vis other countries?

The driving factor is that people here like to trade and earn quick money. Investor behaviour is also unique. Unlike other countries where we saw investors focusing on a wider variety of currencies, Middle Eastern foreign currency traders have been trading heavily in the euro/dollar currency pair. As much as 60 per cent of our second quarter volume from the Middle East came from euro/dollar, whereas in other regions euro/dollar formed 25 per cent to 30 per cent of the volume. This is interesting and reflects that investors here are really looking to trade the currency that trades the most, which shows that they seek quick returns.

They are looking at this as purely a trading opportunity. Other factors that would push trade are the low entry costs for forex trading. We open accounts from as low as $5,000 (Dh18,350). The platform is easily accessible and understandable. Besides, technical analysis makes it easy for people to trade.

Deutsche Bank has a large share of forex trading globally. How was this been built and how is it maintained?

We have a 20 per cent market share, which is the highest. Backed by strong research team, good technicals have helped us to maintain this position. It has been built over a period of years. We launched our online products several years ago. As a bank and being in foreign exchange we always look forward to innovations and launching product and that has helped us to keep up.

How do you see the overall forex trading segment growing in 2009?

The scenario looks quite bright. Due to high volatility, people are not necessarily able to trade in asset classes such as equities. In our business, we had a 70 per cent year-on-year increase, and we look forward to maintaining at least a similar growth rate next year. As per the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity 2007, daily turnover of the world's currency markets is close to $3trn a day, compared to $500 billion for the US Government bond market and $70bn for the New York Stock Exchange.

The growth next year is expected to be quite high. The factor that would drive growth next year is the rising inclination towards forex trading.

What are the risks associated with forex trading and how can an investor minimise them?

Over-leveraging is the biggest risk. Using too much of leverage could lead to losses. Another risk is that one does not use the tools provided in the system like stop losses. One needs to plan the trade carefully before executing it.

Betsy Waters: Global Director, dbFX

Waters is the Global Director at dbFX, Deutsche Bank's market-leading online margin forex trading platform. In this role, she is responsible for overseeing sales and trading for dbFX's diverse retail client base - located in more than 70 countries around the world. Waters has had a long and established career in forex, with more than 20 years experience in sales and trading roles. Her experience - initially in an institutional capacity at Goldman Sachs and Citibank - has been instrumental in the development of dbFX as a trading platform of choice for retail investors.

Top Best Ways to Forex Trade

Forex is the acronym of Foreign Exchange. Typically, it denotes the exchange of one country’s money with another’s. Many use it as a kind of business. In fact currency trading can be an interesting area of investment. In it, a person has to take care that he or she is exchanging a currency with another that will earn the person money in future.

There are factors that can change the value of a currency. It can change from market news or from the financial developments around the globe. To give an example, a person will make profit if he or she closes the position when the price of a currency appreciates in value.
However, in that case, the person is only dealing with the counter currency. Thus in the currency markets, one currency is valued against another and consequently, a rate of worth can be found out. The reason of this is the fact that the value of the currency of a country is always relative and it can not be measured without comparing it to the currency of the other countries.

As one can clearly see; the trading needs a lot of understanding. The person must have a strong understanding and a simultaneously strong sense to judge the potential value of a currency. Most importantly, a successful trader must have the capability to interpret different Forex trade signals.

Fortunately, there are different tools available to solve the problem. There are different charting programs along with trading guides that are sure to help a person understand Forex systems better. There are also interactive training rooms with live video footages to teach an interested person the pros and cons of the business. The World Bank publishes Forex report every day. This report can be of great help in making the right decisions.

Launched in 1973, FOREX has now become one the most prolific areas of investment when it comes to currency trading. As far the report goes, as much as $1.2 trillion worth of exchange takes place everyday. Obviously, there are certain forex advantages that have lured investors into it. Unlike most securities, FOREX does not trade on a fix rate.

Here, the exchange is basically done between the banks, non-banking corporations, private investors and speculators. In the initial days, the large amount of investment would dissuade small investors. However, as the competition grew tougher, the requirements to take part in FOREX have come down too. Now, smaller investors can try it out as well.

Another major forex advantage is its accessibility. One can trade for 24 hours a day, 5 days a week. One can do their entire trading on computer as well.

Now, to make it a successful deal, one needs the help of experts who will help understand FX signals. And utilize tools that can present comprehensive market analysis right in front of your eyes. At the same time, it is important the information be updated on a regular basis.

The AFFX desktop is a tool that helps you get what you need. It offers all the essential information and much more. It provides forex alerts and other useful services. It is also offered at a reasonable price. No wonder why it has become one of the most preferred tools in this sector.