Although the foreign exchange market is the largest traded market in the world, its reach to the retail sector pales in comparison to the Equity and Fixed Income markets. This is in large part due to a general lack of awareness of FX in the investor community, along with as a lack of understanding of how and why currencies move. Adding to the mystique of this market is the lack of a physical central exchange akin to the NYSE or the CME. It is this very lack of structure that enables the FX markets to operate on a 24-hour basis, beginning the trading day in New Zealand and continuing through the time zones.
Traditionally, access to the FX market was limited to the bank community that traded large blocks of currencies for commercial, hedging, or speculative purposes. The creation of well-capitalized firms like FXDD has opened the door of Forex trading to such institutions as funds and money managers, as well as to the individual retail trader. This sector of the market has grown exponentially over the past several years.
For active traders and investors, foreign exchange should be no different than other investment products such as equities, commodities or fixed-income. Because of globalization in the economic world and consolidation of whole economic regions (i.e., the European Union), including currencies in a portfolio helps to diversify assets and can reduce risk.
Just like other investment alternatives, foreign exchange offers traders/investors a market where they can buy or sell an investment product. In this case it is a specific Currency Pair. The currency pair may be the Euro versus the US Dollar, the US Dollar versus the Japanese Yen, the British Pound versus the US Dollar, the Euro versus British Pound, or a number of other currency combinations.
The different currency combinations represent nothing more than the value of one currency versus the value of another. That relationship is represented by a single price. In foreign exchange, the price of a currency pair is the market’s expectations (at that time) of the value of that currency measured against another currency given the current and expected economic and political situation in the two economies. In equity terms, it is the price of the stock.
If, for example, an economy’s inflation/interest rates are low and stable, if its output is growing strongly, or if its politics are stable and expectations are for more of the same, then one can expect (in general) for that country's currency to remain strong versus a less fundamentally favorable currency.
Contrasting that with an equity, if the domestic and global economy is strong, if inflation is not rampant, if competition is not taking away market share or eating into margins, if product demand and growth are strong, of if the companies internal "politics" are such that the workers are happy and productive, and expectations are for more of the same, then you can expect that company’s stock to remain strong versus a company with less favorable fundamentals.
Similar to equities there are other factors that determine the short term value of a product including technical analysis, short term supply and demand, seasonal capital flow patterns, the current price of the instrument, etc. It is these universal dynamics that will move a currency’s value up or down. By analyzing the pricing dynamics and combining that with sound money management and discipline, the investor can ensure greater success in his or her foreign exchange trading.
Currencies, like equities and bonds, have pairs that are very
liquid and those that are not so liquid. The liquid currencies
can be characterized as those that are the most stable economically
and politically. They include the countries that form the
G7 - the United States, Japan, Great Britain, France, Germany,
Italy, and Canada.
Since the unification of the European currencies into the EURO,
the currencies that are most liquid now include the US Dollar,
the Japanese Yen, the British Pound, the Euro, and the Canadian
Dollar. It is estimated that activities in these currencies
comprise more than 80% of the daily foreign exchange volume.
Currencies, like equities, have their own symbols that distinguish one from another. Since currencies are quoted in terms of the value of one against the value of another, a currency pair includes the "name" for both currencies, separated by a "/". The "name" is a three letter acronym. The first two letters are in most cases reserved for identification of the country. The last letter is the first letter of the unit of currency for that country. For example,
USD = United States Dollar
GBP = Great Britain Pound
JPY = Japanese Yen
CAD = Canadian Dollar
CHF = Confederatio Helvetica (Latin for Swiss Confederation) Franc
NZD = New Zealand Dollar
AUD = Australian Dollar
NOK = Norwegian Krona
SEK = Swedish Krona
Since the European Euro has no specific country attached to
it, it goes simply by the acronym EUR.
By combining one currency, EUR, with another USD, you create a
currency pair EUR/USD.
One currency in a currency pair is always dominant. It is
called the Base Currency. The base currency is identified
as the first currency in a currency pair. It also is
the currency that remains constant when determining a currency
The Euro is the dominant base currency against all other global
currencies. As a result, currency pairs against the
EUR will be identified as EUR/USD, EUR/GBP, EUR/CHF, EUR/JPY, EUR/CAD,
etc. All have the EUR acronym as the first in
The British Pound is next in the hierarchy of currency name domination.
The major currency pairs versus the GBP would, therefore be identified
as GBP/USD, GBP/CHF, GBP/JPY, GBP/CAD. Apart from the EUR/GBP,
expect to see GBP as the first currency in a currency pair.
The USD is the next dominant base currency. USD/CAD, USD/JPY,
USD/CHF would be the normal currency pair convention for the major
currencies. Since the EUR and the GBP are more dominant in
terms of base currencies, the dollar is quoted as EUR/USD and GBP/USD.
Knowing the base currency is important as it determines the values
of currencies (notional or real) exchanged when a foreign exchange
deal is transacted.
The Counter Currency is the second currency in a Currency Pair
The base currency is ALWAYS equal to one of the currency's monetary
unit of exchange (i.e., 1 Euro, 1 Pound, and 1 Dollar). When
an investor buys 100,000 EUR/USD, he is said to be buying (or receiving)
the EURO or the Base Currency and selling (or paying for) the USD
or Counter Currency. The amount of the Base Currency he is
buying is equal to 100,000 Euros. Note that this is true
no matter the current exchange rate at the time. The base
currency amount remains constant.
The Counter Currency equivalent amount that the investor is selling
(or paying), on the other hand, will fluctuate with the exchange
rate for the Currency Pair. It is equal to:
(Amount of Base Currency x Market Foreign Exchange Rate)
Since the Counter Currency is the part of the currency pair that
fluctuates higher or lower, it determines the strength or weakness
of both currencies in a currency pair. As one currency goes up,
the other must go down.
Currencies trade in fractions of a full unit.
The smallest fraction is called a "pip". Currencies
trade in pips because exchanges of currencies for speculative reasons
are generally for large amounts. This is because of the leverage
that is available when trading Foreign Exchange.
FXDD provides a Maximum Trading Leverage Ratio of 100:1for standard accounts. At
that ratio, a 100,000 EUR position would require $1,200 of Margin at
an exchange rate of 1.2000. This is calculated by taking
the US$ equivalent of 100,000 EUR or US$120,000 and dividing
by the 100:1 leverage ratio.
Margin Required = $120,000 / 100 = $1,200
To determine the value of a pip for the deal above the following
calculation would be made:
Value in US$ = 1.20 x Par Amount of Base Currency = $120,000
Value in US$ + a pip = (1.20+.0001) x Par Amount of Base Currency = $120,000
The value of a pip in dollars is equal to $120,000 - $119,990
When a currency pair goes from a low price to a higher price,
the Base Currency is said to have strengthened or gotten stronger. The
converse is true for the Counter Currency. That is, it has
weakened or gotten weaker as the Base Currency has gotten stronger.
Since Exchange Rates represent what a fixed amount of currency
is equal to in terms of another currency, we have seen there
is just one price for the Currency Pair. The movement
of that price determines whether a currency is getting stronger
If the EUR/USD exchange rate goes from 1.2000 to 1.2024, we have
concluded that the EUR got stronger, the USD weaker. Why?
When looking at Foreign Exchange Rates (or prices) an action to
Buy the Currency Pair implies buying the Base Currency, or EUR,
and selling the Counter Currency, or USD. If the EUR/USD
exchange rate moves higher, as expected, the trader can now
sell the EUR/USD at a dearer/higher price. The difference
represents a Profit to the trader that was Long,
or who bought the EUR/USD Currency Pair.
Another way of looking at it is at 1.2000, an investor/trader could
exchange 1 EUR for $1.20. At 1.2100, however, that same
single EUR can now be exchanged for a higher amount of USD, in
this case $1.21 USD. The EUR has strengthened or gotten
What exactly do you buy or sell when you make a foreign currency
In reality, you are doing both actions - buying and selling. A
transaction of Buying the EUR/USD at 1.2000 is actually buying the
Euro and selling the Dollars at 1.2000 cents. If the Euro
increases in value in relation to the dollar, the price would increase
and the investor will make money.
If for whatever reason, a trader could not execute an order using
FXDD, a verbal order to a broker could be the following:
"I buy 100,000 Euros and sell the dollar at
"I buy 500,000 EUR/USD on a 1.2100 stop"
"I buy 100,000 Euros vs. the Dollar at the market"
What is required on all verbal orders is the amount, the Currency
Pair, the rate and/or the type of order. Simply saying "I
buy the Dollar at the Market" is not good enough as it does
not say what currency the trader wants to sell.
The Bid/Ask Price
Like equities, foreign exchange has a Bid price and an Ask price.
The bid is where the market maker will buy. The ask is where
the market maker will sell. For investors, the reverse
is true. The bid price is where an investor can sell,
while the ask is where an investor can buy.
The bid price is always less than the ask price. This makes
logical sense as a market maker, like any investor, wants to buy
low and sell high.
The spread between the bid and the ask is called the Bid/Ask Spread or Dealing Spread. The bid/ask spread is the premium that market makers charge to provide constant liquidity to a retail client base. For example, the bid and ask might be 1.2050/1.2055. The spread is 5 pips.
Paralleling foreign exchange trading to equities, a market maker,
like FXDD, is the equivalent of a specialist on the floor of the
A specialist is always willing and able to make a market (i.e.
provide liquidity) to the market/investor. For this service,
he will have a bid where he buys the stock and an offer or ask,
where he will sell the stock. The bid/ask spread the specialist
charges will fluctuate with the general liquidity of the underlying
That same principle applies to FXDD's Bid/Ask Spreads.
Dealing Spreads for the major currencies pairs on FXDD are 2-3
pips wide. Some less liquid currencies will be a bit wider. This
reflects the relative liquidity/risk in the professional market
for that particular currency pair. The dealing spreads that
we quote reflect a normal market making spread given the risks
we take and the costs we incur for servicing our clients' business.
Obviously, if the volatility and risk of making a market increase
because the markets become less liquid, it stands to reason that
our spreads will increase as well. These are universal
realities of market makers and should not come as a surprise to