In the following examples, we are going to use fundamental analysis to help us decide whether to buy or sell a specific currency pair.
If you
always fell asleep during your economics class or just flat out skipped
economics class, don't worry! We will cover fundamental analysis in a later
lesson.
But right
now, try to pretend you know what's going on...
EUR/USD
In this
example, the euro is the base currency and thus the "basis" for the
buy/sell.
If you believe that the U.S. economy will continue to weaken, which is bad for the U.S. dollar, you
would execute a BUY EUR/USD
order. By doing so, you have bought euros in the expectation that they will
rise versus the U.S. dollar.
If you believe that the U.S. economy is strong and the euro will
weaken against the U.S. dollar you would execute a SELL EUR/USD order. By doing so
you have sold euros in the expectation that they will fall versus the US
dollar.
USD/JPY
In this
example, the U.S. dollar is the base currency and thus the "basis"
for the buy/sell.
If you think that the Japanese government is going to weaken the
yen in order to help its export industry, you would execute a BUY USD/JPY order. By doing so
you have bought U.S dollars in the expectation that they will rise versus the
Japanese yen.
If you believe that Japanese investors are pulling money out of
U.S. financial markets and converting all their U.S. dollars back to yen, and
this will hurt the U.S. dollar, you would execute a SELL USD/JPY order. By doing so
you have sold U.S dollars in the expectation that they will depreciate against
the Japanese yen.
GBP/USD
In this
example, the pound is the base currency and thus the "basis" for the
buy/sell.
If you think the British economy will continue to do better than
the U.S. in terms of economic growth, you would execute a BUY GBP/USD order. By doing so
you have bought pounds in the expectation that they will rise versus the U.S.
dollar.
If you believe the British's economy is slowing while the United
States' economy remains strong like Jack Bauer, you would execute a SELL GBP/USD order. By doing so
you have sold pounds in the expectation that they will depreciate against the
U.S. dollar.
USD/CHF
In this
example, the U.S. dollar is the base currency and thus the "basis"
for the buy/sell.
If you think the Swiss franc is overvalued, you would execute a BUY USD/CHF order. By doing so
you have bought U.S. dollars in the expectation that they will appreciate
versus the Swiss Franc.
If you believe that the U.S. housing market weakness will hurt
future economic growth, which will weaken the dollar, you would execute a SELL USD/CHF order. By doing so
you have sold U.S. dollars in the expectation that they will depreciate against
the Swiss franc.
Margin Trading
When you
go to the grocery store and want to buy an egg, you can't just buy a single
egg; they come in dozens or "lots" of 12.
In forex,
it would be just as foolish to buy or sell 1 euro, so they usually come in
"lots" of 1,000 units of currency (Micro), 10,000 units (Mini), or
100,000 units (Standard) depending on your broker and the type of account you
have (more on "lots" later).
"But I don't have enough money to buy
10,000 euros! Can I still trade?"
You can
with margin trading!
Margin
trading is simply the term used for trading with borrowed capital. This is how
you're able to open $1,250 or $50,000 positions with as little as $25 or
$1,000. You can conduct relatively large transactions, very quickly and
cheaply, with a small amount of initial capital.
Let us
explain.
Listen
carefully because this is very important!
1. You
believe that signals in the market are indicating that the British pound will
go up against the U.S. dollar.
2. You open
one standard lot (100,000 units GBP/USD), buying with the British pound at 2%
margin and wait for the exchange rate to climb. When you buy one lot (100,000
units) of GBP/USD at a price of 1.50000, you are buying 100,000 pounds, which
is worth US$150,000 (100,000 units of GBP * 1.50000).
If the margin requirement was 2%, then US$3,000 would be set aside in your account to open up the trade (US$150,000 * 2%). You now control 100,000 pounds with just US$3,000.
We will
be discussing margin more in-depth later, but hopefully you're able to get a
basic idea of how it works.
3. Your
predictions come true and you decide to sell. You close the position at
1.50500. You earn about $500.
|
Your Actions
|
GBP
|
USD
|
|
You buy 100,000 pounds at the
exchange rate of 1.5000
|
+100,000
|
-150,000
|
|
You blink for two seconds and the
GBP/USD exchange rates rises to 1.5050 and you sell.
|
-100,000
|
+150,500
|
|
You have earned a profit
of $500.
|
0
|
+500
|
When you decide to close a position, the deposit that you originally made is returned to you and a calculation of your profits or losses is done.
This
profit or loss is then credited to your account.
What's
even better is that, with the development of retail forex trading, there are
some brokers who allow traders to have custom lots. This means that you don't
need to trade in micro, mini or standard lots! If 1,542 is your favorite number
and that's how many units you want trade, then you can!
Rollover
No, this is not the same as rollover minutes from your cell phone
carrier! For positions open at your broker's "cut-off time" (usually
5:00 pm EST), there is a daily rollover interest rate that a trader either pays or earns, depending on your established
margin and position in the market.
If you do
not want to earn or pay interest on your positions, simply make sure they are
all closed before 5:00 pm EST, the established end of the market day.
Since
every currency trade involves borrowing one currency to buy another, interest
rollover charges are part of forex trading. Interest is paid on the currency
that is borrowed, and earned on the one that is bought.
If you
are buying a currency with a higher interest rate than the one you are
borrowing, then the net interest rate differential will be positive (i.e.
USD/JPY) and you will earn funds as a result.
Conversely,
if the interest rate differential is negative then you will have to pay.
Ask your
broker or dealer about specific details regarding rollover.
Also note
that many retail brokers do adjust their rollover rates based on different
factors (e.g., account leverage, interbank lending rates). Please check with
your broker for more information on rollover rates and crediting/debiting
procedures.
Here is a
chart to help you figure out the interest rate differentials of the major
currencies. Accurate as of 10/4/2010.
Benchmark Interest Rates
|
Country
|
Interest Rate
|
|
United
States
|
0.25%
|
|
Euro
zone
|
1.00%
|
|
United
Kingdom
|
0.50%
|
|
Japan
|
0.10%
|
|
Canada
|
1.00%
|
|
Australia
|
4.50%
|
|
New
Zealand
|
3.00%
|
|
Switzerland
|
0.25%
|
