CommSeC CFDS: IntroDuCtIon to FX

Transcription

1 CommSec CFDs: Introduction to FX

2 Important Information This brochure has been prepared without taking account of the objectives, financial and taxation situation or needs of any particular individual. Because of that, before acting on the information in this brochure, you should consider its appropriateness to your circumstances, having regard to your objectives, financial and taxation situation and needs. OTC CFDs are not suitable for all clients. OTC CFDs involve leverage and it is possible to lose more than your initial investment. You need to consider your own circumstances and should seek independent advice if CFDs are approriate for you. You must read and consider the CommSec CFDs before taking up this product. Commonwealth Securities Limited ABN AFSL (CommSec) is a wholly owned but non guaranteed subsidiary of Commonwealth Bank of Australia ABN and a Participant of the ASX Group and Chi-X (Australia). Examples used in this brochure are for illustrative purposes only.

3 CONTENTS Foreign Exchange: an introduction 2 What are FX CFDs? 3 Key concepts 3 Currency pairs 3 Pips 4 Forward vs spot 4 Tom Next 4 Base currency and reference currency 5 Cross rate 5 Full contract vs mini contract 5 Spread 5 Interest adjustments 5 Why trade FX CFDs? 6 Benefits of trading FX CFDs with CommSec 7 Factors to consider when trading FX CFDs 8 Exchange rate risk 8 Interest rates and the economy 8 Trade balance 8 Central bank action 8 Leverage 8 Examples 9 Selling EUR/USD 9 Opening the position 9 Interest adjustments 9 Closing the position: profit on trade 9 Buying AUD/USD 10 Opening the position 10 Interest adjustments 10 Closing the position: loss on trade 10 Glossary 11

4 2 Introduction to CommSec CFDs Foreign Exchange: an introduction The foreign exchange market (also known as Forex, FX and currency trading) is one of the world s most traded markets, with average daily turnover of over $4 trillion. Its recent rapid increase in popularity can be attributed to a combination of factors, including innovations in technology, product development and the liberalisation of cross-border financial flows. FX is an over-the-counter market (which means that it is decentralised with no central exchange) for trading currencies, and can be traded 24 hours a day. The FX market involves trading currencies in pairs. FX traders anticipate market movements profits are made when the prediction that one currency will either rise or fall in value against another is correct.

5 Introduction to CommSec CFDs 3 What are FX CFDs? A FX CFD is an agreement where two parties agree to exchange money according to the change in value of one currency against another between the point at which the contract is opened and when it is closed. CFD trading on currencies is very similar to trading currencies with a bank or online FX broker, with the main difference being that your deal is structured as a trade. FX CFDs are quoted as a currency pair, such as AUD/USD. The buyer opens (buys) a position in the expectation that the first currency quoted in the pair will appreciate against the second currency. If this happens, the buyer will receive a profit; if the first quoted currency falls, the buyer agrees to pay the value of the loss to the seller. The seller, on the other hand, is expecting that the first quoted currency will fall in value relative to the second currency, in which case they will receive a profit. If the first currency increases, the seller will make a loss. As for any CFD trade, you need to deposit initial margin to open your position. Margin requirements are calculated as a percentage of the overall position value and are available on our website at commsec.com.au While your FX CFD position remains open, your account is debited or credited to the current Tom Next rate, which is the difference between the interest paid to borrow the currency that is being notionally sold overnight, and the interest received from holding the currency that is being notionally bought overnight. When you trade in a currency other than Australian dollars, your profit or loss will be realised in that currency. As standard practice, we will then immediately convert this back to Australian dollars. Key concepts Currency pairs A currency pair is the value of one currency quoted against that of another currency in the foreign exchange market. Exchange rates are quoted with a bid price (at which you can sell) and an ask price (at which you can buy). The difference between the bid and ask is called the spread. Quotes are normally given to four decimal places, so the quote for an Australian dollar/us dollar pair might look like this: AUD/USD / The price represents how much of the reference currency is needed to acquire one unit of the base currency, so in this case USD are required to buy 1 AUD. Major pairs are those most heavily trade in global FX markets.

6 4 Introduction to CommSec CFDs Pips The smallest movement in a currency s value is a change in the last decimal point (eg to ) this increment is known as one pip. Using the example above, AUD/USD /1.0105, this means each 1 AUD is worth $ USD. A trader takes a $100,000 AUD position which is equivalent to $101,040 USD. 1 pip increase 10 pip increase 100 pip increase (1 cent) Quote Up to 40,000 40, , ,001-5,500,000 5,500,000+ Position Value (USD) 5% 20% 40% 90% Value Increase 5% 10% 25% 90% Forward vs spot In the FX market there are two types of contracts: forward contracts and spot contracts. A forward contract locks in the exchange rate now for a future date. Forward contracts can be used to hedge FX exposure by protecting from the risk of changing exchange rates between now and a future foreign exchange transaction. A spot trade is one that is settled immediately. Delivery occurs two business days after the spot FX transaction, but in reality most trades are about speculation that is, they are about profiting from the changes in value of currencies rather than taking physical delivery of the currency. Tom Next If you are trading FX and still hold your position at the close of the current business day, your open position is netted off and then re-established for the next day at a new rate. This new rate is calculated as the closing level of the old position, with a positive or negative adjustment determined by the difference in interest rates between the two currencies concerned. This process is known as a Tomorrow Next Day or Tom Next. With CommSec, spot FX is simpler as there is no expiry or rollover your position remains open until you close it. How much you make or lose on your trade is determined by the change in the exchange rate that occurs while your position is open. For every day that your position is open, adjustments are made to replicate the effect of the Tom Next calculations described above.

7 Introduction to CommSec CFDs 5 Base currency and reference currency The AUD/USD example shown above is: AUD/USD / The first currency (in this case AUD) is always known as the base currency, and the second currency (USD) the reference currency. So here 1 Australian dollar (the base currency) is US dollars (the reference currency). Cross rate A cross rate is a pair of currencies that does not include the US dollar, such as AUD/HKD In the past, if you wished to exchange a sum of money into a different currency, you had to first convert that money into US dollars and then into the desired currency. A cross rate bypasses this step. Full contract vs mini contract The standard lot size for a FX pair is 100,000 of the base currency. This is known as a full contract. For example, a full contract in the EUR/GBP pair is 100,000. A mini contract is 10,000 of the base currency, so a mini contract in the EUR/GBP pair gives exposure to 10,000. CommSec offers both full and mini contracts for each currency pair. Spread The difference between the bid and the ask price quoted is known as the spread. When you trade FX there is no commission to pay; the main cost of trading is the spread. Interest adjustments In FX transactions, adjustments to reflect the relative interest rates of the currencies concerned are calculated and posted to your account daily. These interest adjustments (also known as funding charges) are calculated as follows: A = V x R Where: A = the funding cost V = number of contracts x Contract size R = current Tom Next rate If the Tom Next rate is less than zero, you will be debited for running a short position and credited for running a long position. If the Tom Next rate is greater than zero, you will be credited for running a short position and debited for running a long position. The Tom Next rate includes an administration charge, not exceeding 0.3% pa. A funding charge is calculated for any position opened before that is still open after (London time).

8 6 Introduction to CommSec CFDs Why trade FX CFDs? CFDs have become a popular investment product in recent years for many reasons; some of these are to do with changing attitudes to investing, while some relate to the specific benefits of CFDs as an investment product. FX CFDs offer all the advantages of equity CFDs, with some additional benefits is calculated for any position opened before that is still open after (London time). Market access As a retail trader, you cannot participate directly in the interbank FX market, but FX CFDs offer low-cost access to FX markets for the retail investor. CommSec also offers mini contracts that give 10,000 of exposure to the first named currency in the pair instead of the standard 100,000 of exposure, making it even easier to access FX markets. Leverage CFDs in the FX Market have very low initial margins compared to CFDs over other instruments. Margins can be as low as 1 per cent of the value of the currency being traded. For example, a $10,000 currency contract will require a minimum initial margin of $100. The ability to go short Low cost When you trade a currency CFD you are effectively taking both a short and long position. For example, if you buy a CFD over the AUD/USD pair, you anticipate that the AUD, the base currency, will rise against the USD. This is the equivalent of taking a short position in the reference currency, where you expect the USD to fall in relation to the AUD. The is no commission payable on FX CFD trades the cost is effectively the difference between the buying and selling price, known as the spread. CommSec offers narrow spreads on many popular FX contracts, starting from just two pips. 24 hour customer service Share trading is limited to stock exchange hours, but the FX market is open for trading 24 hours a day during the week (with CommSec support staff available from 8am Monday to 6am Saturday ). Because the market trades almost continuously it is unusual to see gapping.

9 Introduction to CommSec CFDs 7 Benefits of Trading FX CFDs with CommSec Trading FX CFDs with CommSec offers you a range of advantages, including: Fast execution Advanced trading platform Range of order types Real-time funds transfer 24 hour customer service Whether you are dealing over the telephone or via the internet, transactions are executed quickly, with internet deals typically transacted in just fractions of a second. Launch our web-based trading platform direct from the CommSec website, with no requirement to download software. The CommSec CFD Trading Platform offers ease of use along with professional tools such as real-time charting and pattern recognition software. The customisable layout means that every trader can design a layout to match their needs. CommSec offers a range of order types that help you manage the risks of leverage trading. Stop losses can be added to your order to close your position if the market moves against you. Guaranteed stops ensure that your position is closed at exactly the price you specify, even if the market gaps. Trailing stops move with your profit, so you don t have to keep checking your trade and adjusting the stop loss when things are going well. Using our real-time funds transfer you can fund your CommSec CFD account instantly using your linked bank account. This means you can meet margin requirements or top up your account to place a trade without waiting for funds to clear overnight. Log onto the CommSec website at commsec.com.au to take advantage of this feature. Our CommSec CFD dealing desk is available 24 hours a day from 8am Monday to 6am Saturday to assist with any questions. Whenever the market is trading we have a dealer available to take your calls. Contact us on or via at cfds@commsec.com.au

10 8 Introduction to CommSec CFDs Factors to consider when trading FX CFDs Exchange rate risk Trading FX is about profiting from movements in exchange rates, but rates may move against your position as well as in favour of it. The value of one currency relative to another currency is constantly shifting. Political and economic conditions and their perceived impact in the market place can all affect exchange rates. Some of the major drivers which should be considered when trading FX include the following. Interest rates and the economy When an economy is underperforming, central banks may lower interest rates to encourage borrowing and investment. If inflation is higher than the desired rate, central banks may raise interest rates to make borrowing more expensive and help to slow inflation. When interest rates rise, so do yields for assets denominated in that currency this leads to increased demand for that particular currency. Conversely, if interest rates go down, this may cause investors to sell that currency and look for a better yield in another currency. Trade balance A country s balance of trade is the total value of its exports minus the total value of its imports. When a country is running a trade surplus there is increased demand for its currency as foreign buyers must exchange more of their home currency to buy goods in the purchased currency. A trade deficit has the opposite effect, as it increases the supply of a country s currency and may result in devaluation if supply greatly exceeds demand. Central bank action Central bank action, such as quantitative easing, where the central bank increases the supply of a currency, may result in devaluation of the currency. Leverage FX CFDs can have small initial margin requirements beginning at 1%. As with all CFDs Traders need to be aware that the use of leverage can lead to large losses as well as large gains.

11 Introduction to CommSec CFDs 9 Examples Selling EUR/USD Opening the position You decide to open a short trade on the Euro against the US dollar (USD), anticipating that the Euro will decline in value against the USD. In September 2012 our quote is / and you sell 5 contracts (the equivalent of 500,000) at The value of your position is 500,000 x = US$693,305. To open the position you supply a deposit (initial margin) 1% of the position. Your deposit is therefore 1% x US$693,305 = US$6, There is no commission payable on FX trades. Interest adjustments While the position remains open, your account is debited or credited to the current Tom Next rate. (Tom Next expresses in pips the difference between the interest paid to borrow the currency that is being notionally sold overnight and the interest received from holding the currency that is being notionally bought overnight.) An administrative charge not exceeding 0.3% pa applies on either side of the current Tom Next spread. This maximum charge will apply to both regular and mini-contracts. Closing the position: profit on trade One week later EUR/USD has fallen to / , and you take your profit by buying 5 contracts at Your gross profit on the trade is calculated as follows: Opening transaction 500,000 (5 contracts) x = US$693,305 Closing transaction 500,000 (5 contracts) x = US$685,605 Gross profit on trade: US$7,700 To calculate the net result you also have to include interest adjustments. Of course, if the market had moved in the opposite direction, you would have made a loss that may have exceeded your initial deposit.

12 10 Introduction to CommSec CFDs Buying AUD/USD Opening the position You decide to trade long on the Australian dollar against the US dollar, anticipating that the AUD will appreciate against the USD. Our quote in December 2012 is / , and you buy 5 contracts (the equivalent of A$500,000) at The value of your FX position is A$500,000 x = US$505,245. To open the position you supply a deposit (initial margin) of 1% of the position. Your deposit is therefore 1% x US$505,245 = US$5, There is no commission payable on FX trades. Interest adjustments While the position remains open, your account is debited or credited to the current Tom Next rate. (Tom Next expresses in pips the difference between the interest paid to borrow the currency that is being notionally sold overnight and the interest received from holding the currency that is being notionally bought overnight.) An administrative charge not exceeding 0.3% per annum applies on either side of the current Tom/ Next spread. This maximum charge applies to both full and mini contracts, for further details please refer to the CommSec CFDs PDS available on our website at commsec.com.au Closing the position: loss on trade Two days later, AUD/USD has fallen to / , and you decide to cut your losses and close the trade by selling 5 contracts at Your loss on the trade is calculated as follows: Opening transaction A$500,000 (5 contracts) x = US$505,245 Closing transaction A$500,000 (5 contracts) x = US$498,640 Gross loss on trade: US$6,605 To calculate the net result you also have to include interest adjustments.

13 Introduction to CommSec CFDs 11 Glossary Base Currency: The first-named currency in the currency pair. CFD: See Contract-for-Difference. Contract-for-Difference: A CFD is a deal where two parties agree to exchange money according to the change in value of the underlying asset between the point at which the contract is opened and when it is closed. Cross Rate: A pair of currencies traded in FX that does not include the US dollar. Currency Pair: The quotation and pricing structure of the currencies traded in the FX market: the value of a currency is determined by its comparison to another currency. Exotic Pair: A currency pair that is not common in the FX Market. Exotic pairs usually involve the currency of a developing country. Foreign Exchange: The market in which currencies are traded. FX: See Foreign Exchange. Forward: A contract where the exchange rate is locked in now for a future date. Full Contract: One full contract equals 100,000 of the base currency in the currency pair. Gapping: Where the opening price is some distance from the previous closing price. Leverage: The use of margin to increase the potential return of an investment. Long: Taking a position to profit from an expected increase in the value of the base currency relative to the reference currency. Major Pair: A currency pair that is one of the most heavily traded in global FX markets. Mini Contract: One mini contract equals 10,000 of the base currency in the currency pair. OTC: See Over-the-counter. Over-the-counter: Refers to instruments that are not traded on an exchange, rather they are traded directly with another institution or counterparty. Pip: The smallest movement in a currency s value, a movement in the fourth decimal place of a quote. Reference Currency: The second-named currency in the currency pair. Short: Taking a position to profit from an expected decrease in the value of the base currency relative to the reference currency. Spot: A FX contract that settles 2 business days after the transaction. Spread: The difference between the quoted bid and ask. The cost of trading a FX CFD. Tom Next: The difference in pips between the interest rate paid to borrow the currency that is being notionally sold overnight and that received from holding the currency being notionally bought.

14 12 Introduction to CommSec CFDs We re here to help To find out more, call us on , from 8am Monday to 6am Saturday, us at or visit our website at commsec.com.au.

15 MKTG960 10/ commsec.com.au