FOREX Basics

Forex is an acronym for FOReign EXchange and is the worldwide currency inter-bank or inter-dealer market that uses a floating exchange rate system. Foreign exchange is the world’s most liquid market and is more than 45 times larger than all the futures markets combined with over $1.9 trillion estimated in daily foreign exchange transactions. With the development of online trading platforms, what once used to be a market dominated by enormous money center banks and other institutional traders, has now become accessible to smaller traders who have access to take advantage of trading foreign currencies with FOREX.

FX Liquidity

The FOREX market is not dramatically affected by buying programs that allow it to be easily manipulated because the foreign exchange market gaps are very limited. The FOREX market offers some of the smoothest trends available in any market. No other market can come close to the amount of monetary volume and participation as the FOREX market making it a haven for traders not having to deal with gaps and price movements, erratic spikes and other choppy market conditions more commonly experienced in the lower volume markets, like futures or options.

Currencies can be bought or sold and are subject to the laws of supply and demand just like any other commodity. When the demand is greater for one currency the cost of that currency in terms of other currencies will go up. Factors that affect the supply and demand for a currency include economic growth, interest rates and political stability amongst other things. The objective of FOREX currency trading is to exchange one currency for another in the expectation that the market rate or price will change so that the currency purchased has increased its value relative to the one sold.

Currency Pairs

Currencies are always priced and traded in pairs in the FOREX market. One currency is simultaneously purchased while another is sold. Traders can determine which pair of currencies they wish to trade. If price of the currency purchased appreciates in value, then that currency must be sold back in order to lock in the profit. An open trade or position is one in which a trader has either bought/sold one currency pair and has not sold/bought back the equivalent amount to effectively close the position. The mechanics of a trade are virtually identical to those found in other markets, hence placing a trade in the FOREX market is relatively simple. The transition for many traders is often seamless. Below is an example of placing trades in the FOREX market.

Buying or Selling

The first thing that a trader decides is whether to buy or sell a particular currency relative to another currency. If a trader is speculating that the exchange rate will fall he/she will enter a short order with an expectation to profit from the trade and he/she will enter the SELL rate. The exact opposite is true for a trader speculating that the exchange rate will rise. In this instance the trader will enter the BUY rate with an expectation to make a profit from the rise of the exchange rate relative to the currencies he/she is trading.

Zero commissions*

* vCap FX is compensated through a portion the bid / ask spread.

Just like in other markets there are two rates for all currency pairs: the bid, or the rate at which traders can sell, and the ask, or the rate at which traders can buy. There is a small difference between the two. This difference, known as the spread, defines the cost of the trade. For example, if EUR/USD is trading at 42/46 respectively the spread is four pips. In a mini account, a pip on the EUR/USD currency pair is worth $1. Spreads are a part of all markets, but are typically "hidden" in the broker-based equities and futures markets.

Leverage

Simply put, leverage is the ability to trade with borrowed funds. It is the process in which a trader can take a market position much larger than the value of the trader's account. Leverage is a tool by which traders can determine the level of risk -- and thus, the potential reward they assume in the market. The more leverage used, the more volatile the trader's percentage return of profit or loss can be. Trader’s leverage ration is the value of the position assumed divided by the amount of money deposited in the account.

For example, if trader’s position size is $100,000 and the account balance is $10,000, the leverage ratio is 10:1. FOREX trading offers 100:1 leverage and in some instances 200:1 leverage. However, we do not recommend using leverage of more than 10 times the account value. Using leverage exaggerates both gains and losses. Using leverage can generate large gains or losses even when market conditions are relatively calm. In cases where a trader surpasses the maximum leverage allowed we may close all open positions in the account. This may result when account equity diminishes as a result of trading losses.

Low margin requirements and limited risk

The margin deposit can be described as a performance bond, or good faith deposit, to ensure against trading losses. It is not a down payment on a purchase. Therefore low margin requirements and sophisticated trading platforms allow for high leverage with limited risk. vCap FX offers a variety of platforms that perform automatic margin availability pre-trade checks allowing the execution of a trade only with sufficient margin funds in the account.

With vCap FX, there is no risk of debit balances to your account. In the event that funds in an account fall below margin requirements, we will simply close all open positions. That means that, even if a trader is dead wrong and there is a catastrophic market move against the position, he/she cannot lose more than the amount of money he/she has in the account. This provides for a tremendous peace of mind. By using stop loss orders risk can be further be limited and defined.

Rollover

In the spot FOREX market, trades must be settled in two business days. If a trader sells 200,000 euros on Monday, he/she must deliver 200,000 euros on Wednesday, unless this position is rolled over. For positions open at 5pm EST there is a daily rollover (interest payment) a trader either pays or earns on an open position depending on the established margin level and position in the market. In any spot rollover transaction, there is a difference in interest rates between the two currencies that will be reflected in the overnight "loan." If the trader is long the currency with the higher interest rate in the pair, the trader should gain on-the-spot rollover through the premium relationship of that currency relative to the short currency. The amount of the gain is determined by the interest rate differential between the two currencies, and fluctuates day-to-day with the movement of prices.

For positions that are open on Wednesday and held through 5 p.m. ET, the amount added or subtracted to an account as a result of rolling over a position tends to be around three times the usual amount. This type of rollover accounts for settlement of trades through the weekend period. If a trader does not wish to earn or pay interest on open positions they should close their positions by 5pm EST which is the established end of the market day. Most FOREX platforms automatically roll over (exchanged the trade forward to the next settlement date which is two business days at 5pm EST) all open positions.