12+ FX or Forex Trading questions & answers

Q1. What do you understand by the terms symbol and currency pairs in relation to FX trading?
A1. Every traded instrument has a “symbol”. For example, in stocks “IBM” is a symbol and you can buy or sell “IBM” stocks. In the FIX protocol, the symbol is represented by tag number “55”. So, “55=IBM”. In the FX world the instruments are defined in pairs as

The FX symbols are traded in pair. The one on the LHS (i.e. USD) is known as the “base” currency and the one on the RHS (i.e. AUD) is known as the “quote” or secondary or counter currency. When you BUY/SELL, it applies to the “base” currency. For example

1) When you BUY: You are buying USD and selling AUD.

2) When you SELL: You are selling USD and buying AUD.

So, when you are trading on FOREX, you are buying one currency and selling another currency.

Q2. What does it mean to have a ‘long’ or ‘short’ position?
A2. When a currency pair is long, the base currency is bought while the quote currency is sold short. To go long on a currency means that you buy it with the view that the price will rise. In other words, a long position is expressed in terms of buying the base currency.

A short position occurs when the base currency is sold while the quote currency is bought. To go short on a currency means that you sell it with the vie that there will be a decline in the market price.

In FX trading position requires a trader to go long (i.e. buy) in one position while simultaneously going short (i.e sell) in another.

Q3. What do you understand by the terms “spot rate” and “forward rate” in relation to FX trading?
A3. The “spot rate” is the current exchange rate at which a currency pair can be bought or sold. The forward rate is the exchange rate at some time in the future.

Q4. What is the “pip” in FX trading?
A4. A “pip” is a small hard seed in a fruit. In FX, “PIP” stands for Point In Percentage. A “PIP” is used for calculating profits and losses in FX trading.

In Japanese yen, a pip is the 1/100th place, which is 2 places to the right of the decimal. In all other currency pairs, a pip is the 1/10,000 the place, which is 4 places to the right of the decimal. So, in US dollars it 0.00001 and Japanese yen it is .01.

"PIP" in FX trading

“PIP” in FX trading

The pip is highlighted in red a box. Some traders provide transparency to the 1/10th of a PIP.

Q5. How would you go about calculating profits & losses in FX trading?
A5.

Example 1: Profit

Symbol: USD/GBP
Exchange Rate at close: 0.8714
Change in pips: +20 (i.e. profit)
Trading Amount: 100,000 EUR

Number of GBP per pip: 1000,000 × 0.0001 = 10 pounds/pip
Number of EUR per pip: 10/0.8714 = 11.4754 euros/pip.
Trade profit for +20 pip change: 20 pips * 11.4754 euros/pip = 229.5157 euros.

Example 2: Loss

Symbol: USD/GBP
Exchange Rate at close: 0.8714
Change in pips: -15 (i.e. loss)
Trading Amount: 100,000 EUR

Number of GBP per pip: 1000,000 × 0.0001 = 10 pounds/pip
Number of EUR per pip: 10/0.8714 = 11.4754 euros/pip.
Trade profit for -15 pip change: -15 pips * 11.4754 euros/pip = 172.131 euros.

Q6. What is the spread in FX trading?
A6. The spread is the difference between the buy (also called bid) price and the sell (also called ask) price. In the diagram shown below, the spread is 2.6 pips. Which is 1.37997 – 1.37971 = 0.00026. As we know 0.0001 is 1 pip. Hence, 0.00026 = 0.00026/0.0001 = 2.6.

"PIP" in FX trading

“spread” in FX trading

Every market has a spread. Spread is where the traders make their money. Some traders also charge a commission on top of the spread. It can be fixed charge or a charge of $1 per $100,000 of a currency pairing that is bought or sold.

Q7. What is a margin in FX trading?
A7. Firstly, you need to know what a “margin account” is. It is an account operated by the investor’s broker and are settled daily in cash. This allows an investor to trade with a borrowed money to get a better leverage. In other words, an investor uses a margin account to increase the possible return on investment. The margin accounts are not limited to equities, and they are also used by currency traders in the FX market.

The concepts of margin and leverage are related. Leverage means using borrowed money for investment. The term “trading on margin” means you need to only deposit a percentage of the total funds required for a trade. These small movements can result in larger profits, or larger losses.

Forex trading can offer up to 50 to 1 margin, which means a deposit of $100 will let you buy currency symbols to the amount of $5000.00.

versus

Stock trading can offer 2 to 1 margin, which means a deposit of $100 will let you buy stocks to the amount of $200. Not much leverage.

Q8. What is a “margin call”?
A8. If the FX market moves against a trader resulting in losses such that the trader is eating into his/her amount of margin, there will be an automatic margin call. The Forex broker/dealer closes the trader’s positions and limits the losses to prevent the account from turning into a negative balance.

Q9. Can you explain FX swaps?
A9. The FX swaps can be viewed as risk-free collateralized borrowing/lending.

FX Swap

FX Swap

At the start of the contract, party “A” borrows “X” AUD @Spot Rate from, and lends “X” USD to, B. When the contract expires, “A” returns “X” AUD @Forward Rate to B, and B returns “X” USD to A, where F is the FX forward rate as of the start.

FX swaps help raise foreign currencies for both financial institutions and their customers. It also serves institutional investors who wish to hedge their positions as well. They are also frequently used for speculative trading, typically by combining two offsetting positions with different original maturities. FX swaps are liquid at terms shorter than one year, but transactions with longer maturities have been increasing in recent years.

Q10. What do you understand by the term “price action” in FX trading?
A10. “Price Action” is a form of technical analysis that focuses solely on past prices that have traded in the market. Charts are used for the analysis.

Q11. What do you understand by the terms channel, resistance, and support with respect to FX price action?
A11. Support is the level at which the price seldom falls below and the resistance is the level the price seldom exceeds. Each time the price hits the resistance or support, the price appears to hit a wall and reverses. The “channel” is the blue horizontal line drawn as shown below. Usually the channel lines will be horizontal for the “trading range” as shown below. It will be on an angle for “trends” depending on they are upward or downward trends.

FX trading Channel, Support, and Resistance.

FX trading Channel, Support, and Resistance.

Q12. What do you understand by the terms trend, trading range, consolidation, reversal, retrace, and “two attempts rule” with regards to FX price action?
A12.

#1 Trend: Uptrend & Downtrend

FX Trend - downwards

FX Trend – downwards

#2 Trading Range:

FX Trading range

FX Trading range

#3 Consolidation:

The range of price movement constricts as the market loses its direction.

FX consolidation

FX consolidation

#4 Reversal:

The upward trend becomes the downward trend or vice versa.

FX Reversals

FX Reversals

#5 FX Retrace:

A temporary reversal in the direction of a stock’s price that goes against the prevailing trend.

FX Retrace. source: Investopedia

FX Retrace. source: Investopedia

#6 FX Two Attempts Rule:

If the market attempts something twice and fails, then the opposite will happen.

FX trading two attempts rule

FX trading two attempts rule


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