AN INTRODUCTION TO THE FOREIGN EXCHANGE MARKET

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1 DUKASCOPY BANK SA AN INTRODUCTION TO THE FOREIGN EXCHANGE MARKET DUKASCOPY BANK EDUCATIONAL GUIDE

2 AN INTRODUCTION TO THE FOREIGN EXCHANGE MARKET

3 CONTENTS INTRODUCTION TO FOREX CURRENCY TRADING FOREX MARKET MECHANICS FOREX MARKET ANALYSIS HOW TO START TRADING FOREX DUKASCOPY BANK EDUCATIONAL GUIDE 03

4 INTRODUCTION TO FOREX FOREX foreign exchange The Foreign exchange market, or simply FOREX, is a financial market in which currencies are traded. Unlike other financial markets that operate from a centralised location (i.e. the stock exchange), the Forex market is decentralised. It is a global network of banking institutions of all sizes, buy-side or sell-side financial institutions, high net-worth individuals, retail clientele, hedge funds and so forth, all involved in the buying and selling of national currencies. The variety and number of market participants increases the Forex market liquidity and efficiency making it extremely active. Unlike stock trading, currency trading takes place continuously throughout the day excluding weekends. It is the largest and the most liquid market in the world. 04 DUKASCOPY BANK EDUCATIONAL GUIDE

5 INTRODUCTION TO FOREX NEW YORK LONDON TOKYO SYDNEY THE LARGEST AND THE MOST LIQUID MARKET IN THE WORLD DUKASCOPY BANK EDUCATIONAL GUIDE 05

6 CURRENCY TRADING In order to express the value of a particular currency, it is compared with another currency. Thus, currencies are traded one against another and presented in pairs. For instance, the quotation EUR/USD is the price of the Euro expressed in US Dollars, suggesting one Euro equals US Dollars. CURRENCIES ARE TRADED IN PAIRS EUR / USD BASE CURRENCY QUOTE CURRENCY While trading currencies, traders may expect the value of one currency to appreciate or depreciate against another. Traders can generate profits (or losses), whether the currency is rising or falling, by buying one currency which is anticipated to gain value against another currency, or by selling one currency which is anticipated to lose value against another currency. Taking a long position is one in which a bullish trader buys a currency at one price and aims to sell it later at a higher price. Alternatively, a short position is one in which a bearish trader sells a currency that he anticipates to depreciate and aims to buy the currency back later at a lower price. 06 DUKASCOPY BANK EDUCATIONAL GUIDE

7 CURRENCY TRADING BULLISH TRADER B U Y BULLISH TRADER BEARISH TRADER SELL DUKASCOPY BANK EDUCATIONAL GUIDE 07

8 CURRENCY TRADING An almost endless set of factors and economic variables may have a potential impact on the market price of a currency. Growth prospects, interest rates, geopolitical environment, government policy, money aggregates, inflation expectations, and many other factors account for the market valuation of a currency. Due to the fact that the value of the currency is influenced by many economic, political, and even psychological factors, one currency is always strengthening against another, and therefore one currency is always weakening against another. Because of this, traders have equal opportunity to buy or sell to enter the market. Price Demand Increased Demand Qty Supply Besides fundamental criterion used to estimate the relative value of a currency, the market first obeys to the law of supply and demand, especially on free floating currencies. A currency price will change because there is more or less demand for it. More demand means the currency pair will experience a higher price. Less demand means the currency pair price will fall. 08 DUKASCOPY BANK EDUCATIONAL GUIDE

9 CURRENCY TRADING CAD GBP NOK SEK USD CHF EUR JPY SGD AUD NZD Dukascopy Bank provides the access to the spot market in the 11 main trading currencies. Clients can take and maintain exposures in these currencies: USD EUR GBP JPY CHF CAD AUD NZD SEK NOK SGD U.S. Dollar Euro British Pound Japanese Yen Swiss Franc Canadian Dollar Australian Dollar New Zealand Dollar Swedish Krona Norwegian Krone Singapore Dollar U S D THE UNITED STATES DOLLAR Each currency has its unique code. Codes always contain three letters. The first two letters indicate the country name and the last letter identifies the currency name. EUR is an exception as it is the official currency of the Eurozone countries. DUKASCOPY BANK EDUCATIONAL GUIDE 09

10 FOREX MARKET MECHANICS In Forex trading, currency price is usually displayed with four decimal places, except the Japanese Yen which has only two decimal places. The last digit represents a pip the smallest commonly quoted change of an exchange rate of a currency pair. However, the Dukascopy platform displays currency price with an additional digit indicating the decimal precision for a pip: 1.33 EUR/USD decimal precision for a pip decimal precision for a pip Sell EUR Buy EUR pip As you may notice, the sell price is different from the buy price. Currency pairs are usually quoted in bid-ask spreads. For example, in this case a EUR/USD is quoted as / The firs price (bid) is the price to sell, whereas the the second price represents the price at which investors may buy the currency pair. Spread = Ask price Bid price Bid EUR/USD 1 Ask price to sell spread price to buy 10 DUKASCOPY BANK EDUCATIONAL GUIDE

11 FOREX MARKET MECHANICS When you buy or sell a currency pair, you are performing that action on the base currency. Thus, traders expect to gain profits by buying the base currency which is anticipated to gain value against the quote currency, or by selling the base currency which is anticipated to lose value against the quote currency. Thus, there are four possible trade outcomes: BUY EUR/USD AT DOWN = LOSS UP = PROFIT SELL EUR/USD AT DOWN = PROFIT UP = LOSS However, many beginner traders are confused by how they can sell Euros when they have US dollars on their account. When trading Forex, you are speculating on the change in rates. You do this by borrowing Euros and selling them to someone else in the market, earning the equivalent in US Dollars. Thus, all trades are executed using borrowed money. This allows traders to take advantage of leverage. Dukascopy Bank offers its clients the maximum leverage of 100:1 meaning you to trade with $10,000 in the market by setting aside only $100 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. While leverage can be advantageous in increasing your profits, it can also significantly increase your losses when trading, so it should be used with caution. DUKASCOPY BANK EDUCATIONAL GUIDE 11

12 FOREX MARKET MECHANICS In order to calculate the profit (loss), the amount of pips your trade has gained (lost) should be multiplied by the transaction size. PROFIT/LOSS Formula ( Price where you sell the currency Price where you buy the currency ( The transaction size profit/loss Consider the following example: You place a buy EUR/USD order at $ using your $1,000 with 100:1 leverage which enables you to trade with $100,000. You wait for the price to move up and later you sell EUR/USD at $ You gain 25 pips: ( ) x 100,000 = x 100,000 = $250 or 25% of your initial deposit This is an example of 'going long' on the EUR/USD meaning you bought EUR and it appreciated against USD. Of course, if you went short (if you sold the Euro, but it appreciated against the US Dollar) you would have lost $250! Many traders find the leverage that most Forex dealers offer very appealing. Nonetheless, you should know that trading this way can also be risky. It can cause substantial losses as easily as it can produce significant profits. 12 DUKASCOPY BANK EDUCATIONAL GUIDE

13 FOREX MARKET ANALYSIS Using fundamental and technical analysis, the individual currency trader attempts to determine price movement trends, and by buying or selling currency pairs, attempts to earn profits. LINE CHARTS BAR CHARTS CANDLESTICK CHARTS DUKASCOPY BANK EDUCATIONAL GUIDE 13

14 FOREX MARKET ANALYSIS FUNDAMENTAL and TECHNICAL ANALYSIS Fundamental analysis involves examining the intrinsic value of the currency based on economic news releases that reflect the strength, or weakness, of a country s economy. Fundamental traders follow these news announcements, known as 'fundamental indicators', because they paint a picture of a currency's strength in relation to other countries. Fundamental indicators are reports that include statistical data on things such as employment, gross domestic product (GDP), international trade, retail sales, housing, manufacturing, and interest rates. The stability, growth, or decline in any of these sectors may have an effect directly or indirectly on the value of the currency. EXAMPLE 14 DUKASCOPY BANK EDUCATIONAL GUIDE

15 FOREX MARKET ANALYSIS Unemployment rate jumped by 2.3% during the first quarter Central Bank cut the interest rate by 0.5% Consumer Price Index (CPI) released DUKASCOPY BANK EDUCATIONAL GUIDE 15

16 FOREX MARKET ANALYSIS Traders using fundamental analysis constantly track the economic calendar to be aware of incoming news regarding the health of national economies. Economic Calendar Powered by Dukascopy Data provided by Date Curr. Event Imp. Act. Cons. Prev. 15 Nov 04:30 JP JPY Capacity Utilization (MoM) LOW -3.6% 2.4% 15 Nov 05:45 JP JPY Industrial Production (MoM) LOW -3.3% -4.0% 15 Nov 07:30 JP JPY Industrial Production (YoY) MED -3.3% -4.0% 15 Nov 07:45 EU EUR French Current Account (euros) LOW -4.0%B -2.4B 15 Nov 08:00 CH CHF Producer & Import Prices (MoM) LOW -0.2% -0.3% -0.10% 15 Nov 08:15 CH CHF Producer & Import Prices (YoY) LOW -1.8% -1.9% -2.0% 15 Nov 10:00 EU EUR Euro-Zone Industrial Production s.a. (MoM) LOW -2.0% -2.3% 1.4% 15 Nov 10:00 EU EUR Euro-Zone Industrial Production w.d.a. (YoY) MED 2.2% 3.5% 6.0% The technical trader is concerned with studying price movement patterns on a chart in order to predict the direction of current and future trends in the Forex market. The decision to buy, sell, or hedge a current position or to stay out of the market entirely is made upon this analysis. RESISTANCE SUPPORT Using various chart types (line, bar, or candlestick) and technical indicators, more accurate predictions can be made from better analysis of the Forex market. Technical indicators use price, volume, volatility, and other factors to create measures of how the market is behaving. Trend lines, support and resistance levels, reversals, and numerous other patterns are used to track and identify trends. BOLLINGER BANDS 16 DUKASCOPY BANK EDUCATIONAL GUIDE

17 HOW TO START TRADING FOREX Open a demo account in order to start trading with a trial portfolio. Start learning by trying to interpret and react to real time prices while identifying price trends. live LOGIN demo LOGIN

18 ICC, Route de Pré-Bois 20 CH-1215 Geneva 15, Switzerland Phone: Fax:

The purpose of this ebook is to introduce newcomers to the forex marketplace and CMTRADING. Remember that trading in forex is inherently risky, and

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