The purpose of this booklet is to give the novice foreign exchange investor an introduction into the fascinating world of foreign exchange. From understanding the basic principles of the FX market to guiding you on how to choose your investment strategies in practice, this publication serves as a useful reference tool.

1.INTRODUCTION

Foreign Exchange markets originated from the need of converting payments received in foreign currency into one’s home currency. Today’s natural foreign exchange participants include exporters, importers, investors in a foreign country as well as funds invested in securities abroad. All of these are labeled as ‘real money’, or money that is actually exchanged and delivered to make payments in the foreign currency. Exchange of real money creates a natural demand and offer, causing exchange rates to fluctuate by the law of supply and demand. A currency will lose value if there are more sellers while a currency will gain value if there is high demand in the form of many buyers. With the large flows that real money create, for which we use the term‘liquidity’, the foreign exchange market has become one of the biggest markets in the world.

2.TRADING BASICS

Currency Pairs This is the term used to express one currency against another. Currency pairs are named by combining the 3-letter ISO codes of two currencies. The price of a currency pair always expresses the amount of the 2nd named currency needed to exchange against one unit of the first named currency. Example:
USDSAR = 3.7500 means 3.75 SAR can be exchanged to 1 USD

ISO codes

Currency Key

Currency Nation

Currency Key

Currency Nation

EUR

European Euro

TRY

Turkish Lira

AUD

Australian Dollar

SEK

Swedish Krona

CAD

Canadian Dollar

SGD

Singapore Dollar

CHF

Swiss Franc

USD

US Dollar

DKK

Danish Krone

GBP

British Pound

XAG

Silver

JPY

Japanese YEN

XAU

Gold

NZD

New Zealand Dollar


Bid and Ask
A speculator may buy or sell any currency pair at any time; we say he is choosing ‘direction’. A price quote of any currency pair always includes two prices; a bid as well as an offer. The bid price which is always lower is quoted first or on the left, it is the price at which an investor can sell the currency pair. The ask is generally of a slightly higher value, quoted second and displayed on the right; it is the price at which a currency pair can be bought. Example:
USDJPY price quote is 120.60 / 120.63,
USDJPY can be sold at 120.60 (the bid) or bought at 120.63 (the ask).

Long and Short
long and short Are an expressions used to describe the direction of a trade. After taking the offer, the speculator is buying a currency pair and will be considered to be long. By selling USDJPY on the bid, he is effectively short. Going short on a currency pair expresses the view that the first named currency should lose value relative to the 2nd named currency. The seller is expecting a price drop, whereas the buyer or holder of a long position expects prices to rise.

Pips and Spreads
The word ‘pip’ is used to describe a price difference. 1 pip is the smallest possible price change; it is an increase or decrease of 1 unit of the last decimal shown in a price. Example:
USDJPY price change from 102.43 to 1002.44 is 1 pip
USDCHF price change from 0.7975 to 0.7976 is 1 pip
XAGUSD price change from 18.90 to 18.91 is 1pip

The ‘spread’ is the price difference of the bid and the ask, in above example of the USDJPY price quotation of 102.43 / 102.66, the spread was 3 pips. The more liquid the currency pair, the smaller or ‘tighter’ the spread will be quoted. A lot of investors ask us about the value of one pip. The answer is not a fixed amount in US Dollars or another specific currency. The value of one pip will depend on the currency pair and trade amount; we will be able to fully answer the question at the end of this chapter.


3.LEVERAGE

As we have seen in the previous chapter, an investor in the foreign exchange market will deposit cash with his financial intermediary in order to hold currency positions. The face amount he can trade usually exceeds the amount of cash on deposit; we say that he trades on leverage. The face and counter amounts of a trade are not credited or debited to the investor’s deposit once a trade is done; the exposure simply remains open until a closing trade is effectuated. While a trade is open, the cash deposit serves as a guarantee to cover potential losses. When the trade is closed, the profit or loss will be converted into the investors original deposit currency, 


The higher the leverage, the higher the potential risk or return. Choosing too high  leverage may put a very substantial amount of your investment at risk. On the other hand choosing too small a leverage may prohibit you from taking full advantage of the possibilities of the foreign exchange market.


4. DETECTING TRADE OPPORTUNITIES
So far we have covered the basics of foreign exchange in order to get an understanding of what it is all about. The chapter on leverage has shown that in order to successfully trade in the foreign exchange market, one needs an opinion or a view as to what kind of price movement a specific currency pair will experience over a coming time period. Only then can an investor decide on a trade strategy that will allow him to capture a benefit if this view was correct. So how does one analyze currency markets? How do you choose sensible entry and exit levels, how can someone forecast future price movements? Coupling good risk management with good forecasting must be the aim of any speculator. This chapter shall help you to understand how a view or opinion can be formed.