HOW TO TRADE FOREX

Trading foreign exchange is exciting and potentially very profitable, but there are also significant risk factors. It is crucially important that you fully understand the implications of margin trading and the particular pitfalls and opportunities that foreign exchange trading offers. On these pages, we offer you a brief introduction to the Forex markets as well as their participants and some strategies that you can apply. However, if you are ever in doubt about any aspect of a trade, you can always discuss the matter in-depth with one of our dealers. They are available 24 hours a day on the Saxo Bank online trading system, SaxoTrader.
The benchmark of its service is efficient execution, concise analysis and expertise – all achieved whilst maintaining an attractive and competitive cost structure. Today, Saxo Bank offers one of Europe's premier all-round services for trading in derivative products and foreign exchange. We count amongst our employees numerous dealers and analysts, each of whom has many years experience and a wide and varied knowledge of the markets – gained both in our home countries and in international financial centres. When trading foreign exchange, futures and other derivative products, we offer 24-hour service, extensive daily analysis, individual access to our Research & Analysis department for specific queries, and immediate execution of trades through our international network of banks and brokers. All at a price considerably lower than that which most companies and private investors normally have access to.
The combination of our strong emphasis on customer service, our strategy and trading recommendations, our strategic and individual hedging programmes, along with the availability to our clients of the latest news and information builds a strong case for trading an individual account through Saxo Bank.
Terms of trading are agreed individually depending on the volume of your transactions, but are generally much lower in cost when compared to banks and brokers. Your margin deposit can be cash or government securities, bank guarantees etc. Large corporate or institutional clients may be offered trading facilities on the strength of their balance sheet. The minimum deposit accepted for an individual trading account depends on the account type. Trade confirmations and real-time account overview are built into SaxoTrader, while further account information can be produced in accordance with your specific requirements.

Introduction to Trading Forex

Foreign Exchange

This short introduction explains the basics of trading Forex online, a brief explanation of the markets and the major benefits of trading Forex online. There are also two scenarios describing the implications of trading in a bear as well as a bull market to better acquaint you with some of the risks and opportunities of the largest and most liquid market in the world.
As an additional aid for those who are new to Forex, there is also a glossary at the bottom of this text which explains some of the terms used in connection with currency trading.
Overview
Foreign exchange, Forex or just FX are all terms used to describe the trading of the world's many currencies. The Forex market is the largest market in the world, with trades amounting to more than USD 3 trillion every day. Most Forex trading is speculative, with only a low percentage of market activity representing governments' and companies' fundamental currency conversion needs.
Unlike trading on the stock market, the Forex market is not conducted by a central exchange, but on the “interbank” market, which is thought of as an OTC (over the counter) market. Trading takes place directly between the two counterparts necessary to make a trade, whether over the telephone or on electronic networks all over the world. The main centres for trading are Sydney, Tokyo, London, Frankfurt and New York. This worldwide distribution of trading centres means that the Forex market is a 24-hour market.

Trading Forex
A currency trade is the simultaneous buying of one currency and selling of another one. The currency combination used in the trade is called a cross (for example, the euro/US dollar, or the GB pound/Japanese yen.). The most commonly traded currencies are the so-called “majors” – EURUSD, USDJPY, USDCHF and GBPUSD.
The most important Forex market is the spot market as it has the largest volume. The market is called the spot market because trades are settled immediately, or “on the spot”. In practice this means two banking days.

Forward Outrights
For forward outrights, settlement on the value date selected in the trade means that even though the trade itself is carried out immediately, there is a small interest rate calculation left. The interest rate differential doesn't usually affect trade considerations unless you plan on holding a position with a large differential for a long period of time. The interest rate differential varies according to the cross you are trading. On the USDCHF, for example, the interest rate differential is quite small, whereas the differential on NOKJPY is large. This is because if you trade e.g. NOKJPY, you get almost 7% (annual) interest in Norway and close to 0% in Japan. So, if you borrow money in Japan, to finance the trade and buying NOK, you have a positive interest rate differential. This differential has to be calculated and added to your account. You can have both a positive and a negative interest rate differential, so it may work for or against you when you make a trade.

Trading on Margin
Trading on margin means that you can buy and sell assets that represent more value than the capital in your account. Forex trading is usually conducted with relatively small margin deposits. This is useful since it permits investors to exploit currency exchange rate fluctuations which tend to be very small. A margin of 1.0% means you can trade up to USD 1,000,000 even though you only have USD 10,000 in your account. A margin of 1% corresponds to a 100:1 leverage (or “gearing”). (Because USD 10,000 is 1% of USD 1,000,000.) Using this much leverage enables you to make profits very quickly, but there is also a greater risk of incurring large losses and even being completely wiped out. Therefore, it is inadvisable to maximise your leveraging as the risks can be very high. For more information on the trading conditions of Saxo Bank, go to the Account Summary on your SaxoTrader and open the section entitled “Trading Conditions” found in the top right-hand corner of the Account Summary.



Why Trade Forex?
24 hour trading
One of the major advantages of trading Forex is the opportunity to trade 24 hours a day from Sunday evening (20:00 GMT) to Friday evening (22:00 GMT). This gives you a unique opportunity to react instantly to breaking news that is affecting the markets.
Superior liquidity
The Forex market is so liquid that there are always buyers and sellers to trade with. The liquidity of this market, especially that of the major currencies, helps ensure price stability and narrow spreads. The liquidity comes mainly from banks that provide liquidity to investors, companies, institutions and other currency market players.
No commissions
The fact that Forex is often traded without commissions makes it very attractive as an investment opportunity for investors who want to deal on a frequent basis.
Trading the “majors” is also cheaper than trading other cross because of the high level of liquidity. For more information on the trading conditions of Saxo Bank, go to the Account Summary on your SaxoTrader and open the section entitled “Trading Conditions” found in the top right-hand corner of the Account Summary.
100:1 Leverage
Leverage (gearing) enables you to hold a position worth up to 100 times more than your margin deposit. For example, a USD 10,000 deposit can command positions of up to USD 1,000,000 through leverage. You can leverage the first USD 25,000 of your investment up to 100 times and additional collateral up to 50 times.
Profit potential in falling markets
Since the market is constantly moving, there are always trading opportunities, whether a currency is strengthening or weakening in relation to another currency. When you trade currencies, they literally work against each other. If the EURUSD declines, for example, it is because the US dollar gets stronger against the euro and vice versa. So, if you think the EURUSD will decline (that is, that the euro will weaken versus the dollar), you would sell EUR now and then later you buy euro back at a lower price and take your profits. The opposite trading scenario would occur if the EURUSD appreciates.

Important Forex Trading Terms
Spread
The spread is the difference between the price that you can sell currency at (Bid) and the price you can buy currency at (Ask). The spread on majors is usually 3 pips under normal market conditions. For more information on the trading conditions at Saxo Bank, go to the Account Summary on your Client Station and open the section entitled “Trading Conditions” found in the top right-hand corner of the Account Summary.
Pips
A pip is the smallest unit by which a cross price quote changes. When trading Forex you will often hear that there is a 3-pip spread when you trade the majors. This spread is revealed when you compare the bid and the ask price, for example EURUSD is quoted at a bid price of 0.9875 and an ask price of 0.9878. The difference is USD 0.0003, which is equal to 3 “pips”.

On a contract or position, the value of a pip can easily be calculated. You know that the EURUSD is quoted with four decimals, so all you have to do is cancel out the four zeros on the amount you trade and you will have the value of one pip. Thus, on a EURUSD 100,000 contract, one pip is USD 10. On a USDJPY 100,000 contract, one pip is equal to 1000 yen, because USDJPY is quoted with only two decimals.

Trading Scenario – Trading Rising Prices
If you believe that the euro will strengthen against the dollar you'll want to buy euro now and sell it back later at a higher price.


• You buy euro We quote EURUSD at Bid 0.9875 and Ask 0.9878, which means that you can sell 1 euro for 0.9875 USD or buy 1 euro for 0.9878 USD.

In this example you buy euro 100,000, at the quote price of 0.9878 (ask price) per euro.

• The market moves in your favor Later the market turns in favour of the euro and the EURUSD is now quoted at Bid 0.9894 and Ask 0.9896.

• Now you sell your euro and get the profit You sell euro at a Bid price of 0.9894.


• The profit is calculated as follows Sell price-buy price x size of trade
(0.9894 minus 0.9878) multiplied by 100.000 = USD 140 Profit
(Note that the profit or loss is always expressed in the secondary currency)

Trading Scenario – Trading Falling Prices
If, on the other hand, you believe that the euro will weaken against the dollar, you'll want to sell EURUSD.


• You sell euro We quote EURUSD at a Bid price of 0.9875 and Ask price of 0.9880 and you decide to sell euro 100,000 at a Bid price of 0.9875.

• The market moves in your favour The euro weakens against the dollar and the EURUSD is now quoted at bid 0.9744 and ask 0.9749.

• Now you buy back your euro You buy EUR at an ask price of 0.9749.


• Your profit/loss is then Sell price-buy price x size of trade
(0.9875 minus 0.9749) multiplied by 100.000 = USD 1260 Profit
Remember that trading EUR 100,000 as we have done in our examples, does not mean that you have to put up euro 100,000 yourself. On a 2% margin means that you have to deposit 2.0% of euro 100,000, which is euro 2,000 on margin as a guarantee for the future performance of your position.

Further Reading
To see how you can trade the Forex market and benefit from our toolbox of information and live quotes, please proceed to the Forex Quick Start found under the Trading menu of SaxoTrader.










Glossary

• Appreciation
An increase in the value of a currency.

• Ask
The price requested by the trader. This usually indicates the lowest price a seller will accept.

• Base currency
The currency that the investor buys or sells (i.e. EUR in EURUSD).

• Bear
Someone who believes prices are heading down. A bear market is one in which there has been a sustained fall in prices and which does not look like it will recover quickly.

• Bid
The price offered by the trader. This usually indicates the highest price a purchaser will pay.

• Bid/Ask
The Bid rate is the rate at which you can sell. The Ask (or offer) rate is the rate at which you can buy.

• Bull
Someone who is optimistic about the market. A bull market is characterised by enthusiastic and sustained buying.

• cross
When trading with currencies, the investor buys one currency with another. These two currencies form the cross: for example, EURUSD.

• Cross rate
An exchange rate that is calculated from two other exchange rates.

• Depreciation/decline
A fall in the value of a currency.

• Exchange rate
What one currency is worth in terms of another, for example the Australian dollar might be worth 58 US cents or 70 yen.

Currencies traded freely on foreign-exchange markets have a spot rate (applying to trades settled “spot”, i.e., two working days hence) and a forward rate. Countries can determine their exchange rates in a variety of ways.
1. A floating exchange rate system where the currency finds its own level in the market.
2. A crawling or flexible peg system which is a combination of an officially fixed rate and frequent small adjustments which in theory work against a build-up of speculation about a revaluation or devaluation.
3. A fixed exchange-rate system where the value of the currency is set by the government and/or the central bank.

• EURUSD
Means that you trade EUR against dollars. If you buy euro you pay in dollars and if you sell euro you receive dollars.

• FX, Forex, Foreign Exchange
All names for the transaction of one currency for another, e.g. you buy GBP 100.00 with USD 150.25 or sell USD 150.25 for GBP 100.00.

• Interbank
Short-term (often overnight) borrowing and lending between banks, as distinct from a banks business with their corporate clients or other financial institutions.

• Interest rate differential
The yield spread between two otherwise comparable debt instruments denominated in different currencies.

• Leverage (gearing)
The investor only funds part of the amount traded.

• Long
To buy.

• Long position
A position that increases its value if market prices increase.

• Liquid (-ity)
The capacity to be converted easily and with minimum loss into cash. A liquid market is one in which there is enough activity to satisfy both buyers and sellers. Ultra-short-dated treasury notes are an example of a liquid investment.

• Margin
The deposit required when entering into a position as well as to hold an open position. Your margin status can be monitored in the Account Summary.

• NYSE
The New York Stock Exchange.

• Open position
A position in a currency that has not yet been offset. For example, if you have bought 100,000 USDJPY, you have an open position in USDJPY until you offset it by selling 100,000 USDJPY, thus “closing” the position.

• Over the counter
When trading takes place directly between two parties, rather than on an exchange. Over the counter trades can be customised whereas exchange-traded products are often standardised.

• Pips
A pip is the smallest unit by which a Forex cross price quote changes. So if EURUSD bid is now quoted at 0.9767 and it moves up 2 pips, it will be quoted at 0.9769.

• Position
Traders talk of “taking a position” which simply means buying or selling currency cross. “Position” can also refer to a trader's cash/securities/currencies balance, whether he or she is short of cash, has money to lend, is overbought or oversold in a currency, etc.

• Risk
Trying to control outcomes to a known or predictable range of gains or losses. Risk management involves several steps which begin with a sound understanding of one's business and the exposures or risks that have to be covered to protect the value of that business. Then an assessment should be made of the types of variables that can affect the business and how best to protect against unwelcome outcomes. Consideration must also be given to the preferred risk profile – whether one is risk – averse or fairly aggressive in approach. This also involves deciding which instruments to use to manage risk and whether a natural hedge exists that can be used. Once undertaken, a risk-management strategy should be continually assessed for effectiveness and cost.

• Secondary currency (variable currency or counter currency)
The currency that the investor trades the base currency against (i.e. USD in EURUSD).

• Short position
A position that benefits from a decline in market prices.

• Short
To sell.

• Speculative
Buying and selling in the hope of making a profit, rather than doing so for some fundamental business-related need.

• Spot
A Spot rate is the current market price of an asset.

• Spot market
The part of the market calling for spot settlement of transactions. The precise meaning of “spot” will depend on local custom for a commodity, security or currency. In the UK, US and Australian foreign-exchange markets, “spot” means delivery two working days hence.

• Spread
The difference between the bid and the ask rate.
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Forex trading examples
Example 1
An investor has a margin deposit with Saxo Bank of USD 100,000.
The investor expects the US dollar to rise against the Swiss franc and therefore decides to buy USD 2,000,000 - 2% of his maximum possible exposure at a 1% margin Forex gearing.
The Saxo Bank dealer quotes him 1.5515-20. The investor buys USD at 1.5520.
Day 1: Buy USD 2,000,000 vs. CHF 1.5520 = Sell CHF 3,104,000.
Four days later, the dollar has actually risen to CHF 1.5745 and the investor decides to take his profit.
Upon his request, the Saxo Bank dealer quotes him 1.5745-50. The investor sells at 1.5745.
Day 5: Sell USD 2,000,000 vs. CHF 1.5745 = Buy CHF 3,149,000.
As the dollar side of the transaction involves a credit and a debit of USD 2,000,000, the investor's USD account will show no change. The CHF account will show a debit of CHF 3,104,000 and a credit of CHF 3,149,000. Due to the simplicity of the example and the short time horizon of the trade, we have disregarded the interest rate swap that would marginally alter the profit calculation.
This results in a profit of CHF 45,000 = approx. USD 28,600 = 28.6% profit on the deposit of USD 100,000.
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Example 2:
The investor follows the cross rate between the EUR and the Japanese yen. He believes that this market is headed for a fall. As he is not quite confident of this trade, he uses less of the leverage available on his deposit. He chooses to ask the dealer for a quote in EUR 1,000,000. This requires a margin of EUR 1,000,000 x 5% = EUR 10,000 = approx. USD 52,500 (EUR /USD 1.05).
The dealer quotes 112.05-10. The investor sells EUR at 112.05.
Day 1: Sell EUR 1,000,000 vs. JPY 112.05 = Buy JPY 112,050,000.
He protects his position with a stop-loss order to buy back the EUR at 112.60. Two days later, this stop is triggered as the EUR o strengthens short term in spite of the investor's expectations.
Day 3: Buy EUR 1,000,000 vs. JPY 112.60 = Sell JPY 112,600,000.
The EUR side involves a credit and a debit of EUR 1,000,000. Therefore, the EUR account shows no change. The JPY account is credited JPY 112.05m and debited JPY 112.6m for a loss of JPY 0.55m. Due to the simplicity of the example and the short time horizon of the trade, we have disregarded the interest rate swap that would marginally alter the loss calculation.
This results in a loss of JPY 0.55m = approx. USD 5,300 (USD/JPY 105) = 5.3% loss on the original deposit of USD 100,000.
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Example 3
The investor believes the Canadian dollar will strengthen against the US dollar. It is a long term view, so he takes a small position to allow for wider swings in the rate:
He asks Saxo Bank for a quote in USD 1,000,000 against the Canadian dollar. The dealer quotes 1.5390-95 and the investor sells USD at 1.5390. Selling USD is the equivalent of buying the Canadian dollar.
Day 1: Sell USD 1,000,000 vs. CAD 1.5390. He swaps the position out for two months receiving a forward rate of CAD 1.5357 = Buy CAD 1,535,700 for Day 61 due to the interest rate differential.
After a month, the desired move has occurred. The investor buys back the US dollars at 1.4880. He has to swap the position forward for a month to match the original sale. The forward rate is agreed at 1.4865.
Day 31: Buy USD 1,000,000 vs. CAD 1.4865 = Sell CAD 1,486,500 for Day 61.
Day 61: The two trades are settled and the trades go off the books. The profit secured on Day 31 can be used for margin purposes before Day 61.
The USD account receives a credit and debit of USD 1,000,000 and shows no change on the account. The CAD account is credited CAD 1,535,700 and debited CAD 1,486,500 for a profit of CAD 49,200 = approx. USD 33,100 = profit of 33.1% on the original deposit of USD 100,000.

Working with statistics
Trade Balance
The trade balance is a measure of the difference between imports and exports of tangible goods and services. The level of the trade balance and changes in exports and imports are widely followed by foreign exchange markets.
The trade balance is a major indicator of foreign exchange trends. Seen in isolation, measures of imports and exports are important indicators of overall economic activity in the economy.
It is often of interest to examine the trend growth rates for exports and imports separately. Trends in export activities reflect the competitive position of the country in question, but also the strength of economic activity abroad. Trends in import activity reflect the strength of domestic economic activity.

Typically, a nation that runs a substantial trade balance deficit has a weak currency due to the continued commercial selling of the currency. This can, however, be offset by financial investment flows for extended periods of time.
Gross Domestic Product
The Gross Domestic Product (GDP) is the broadest measure of aggregate economic activity available. Reported quarterly, GDP growth is widely followed as the primary indicator of the strength of economic activity.
GDP represents the total value of a country's production during the period and consists of the purchases of domestically produced goods and services by individuals, businesses, foreigners and the government.
As GDP reports are often subject to substantial quarter-to-quarter volatility and revisions, it is preferable to follow the indicator on a year-to-year basis. It can be valuable to follow the trend rate of growth in each of the major categories of GDP to determine the strengths and weaknesses in the economy.
A high GDP figure is often associated with the expectations of higher interest rates, which is frequently positive, at least in the short term, for the currency involved, unless expectations of increased inflation pressure is concurrently undermining confidence in the currency.
Consumer Price Index
The Consumer Price Index (CPI) is a measure of the average level of prices of a fixed basket of goods and services purchased by consumers. The monthly reported changes in CPI are widely followed as an inflation indicator.
The CPI is a primary inflation indicator because consumer spending accounts for nearly two-thirds of economic activity. Often, the CPI is followed but excludes the price of food and energy as these items are generally much more volatile than the rest of the CPI and can obscure the more important underlying trend.
Rising consumer price inflation is normally associated with the expectation of higher short term interest rates and may therefore be supportive for a currency in the short term. Nevertheless, a longer term inflation problem will eventually undermine confidence in the currency and weakness will follow.
Producer Price Index
The Producer Price Index (PPI) is a measure of the average level of prices of a fixed basket of goods received in primary markets by producers. The monthly PPI reports are widely followed as an indication of commodity inflation.
The PPI is considered important because it accounts for price changes throughout the manufacturing sector.
The PPI is often followed but excludes the food and energy components as these items are normally much more volatile than the rest of the PPI and can therefore obscure the more important underlying trend.
Studying the PPI allows consideration of inflationary pressures that may be accumulating or receding, but have not yet filtered through to the finished goods prices.
A rising PPI is normally expected to lead to higher consumer price inflation and thereby to potentially higher short-term interest rates. Higher rates will often have a short term positive impact on a currency, although significant inflationary pressure will often lead to an undermining of the confidence in the currency involved.
Payroll Employment
Payroll employment is a measure of the number of people being paid as employees by non-farm business establishments and units of government. Monthly changes in payroll employment reflect the net number of new jobs created or lost during the month and changes are widely followed as an important indicator of economic activity.

Payroll employment is one of the primary monthly indicators of aggregate economic activity because it encompasses every major sector of the economy. It is also useful to examine trends in job creation in several industry categories because the aggregate data can mask significant deviations in underlying industry trends.
Large increases in payroll employment are seen as signs of strong economic activity that could eventually lead to higher interest rates that are supportive of the currency at least in the short term. If, however, inflationary pressures are seen as building, this may undermine the longer term confidence in the currency.
Durable Goods Orders
Durable Goods Orders are a measure of the new orders placed with domestic manufacturers for immediate and future delivery of factory hard goods. Monthly percent changes reflect the rate of change of such orders.
Levels of, and changes in, durable goods order are widely followed as an indicator of factory sector momentum.

Durable Goods Orders are a major indicator of manufacturing sector trends because most industrial production is done to order. Often, the indicator is followed but excludes Defence and Transportation orders because these are generally much more volatile than the rest of the orders and can obscure the more important underlying trend.
Durable Goods Orders are measured in nominal terms and therefore include the effects of inflation. Therefore the Durable Goods Orders should be compared to the trend growth rate in PPI to arrive at the real, inflation-adjusted Durable Goods Orders.
Rising Durable Goods Orders are normally associated with stronger economic activity and can therefore lead to higher short-term interest rates that are often supportive to a currency at least in the short term.
Retail Sales
Retail Sales are a measure of the total receipts of retail stores. Monthly percentage changes reflect the rate of change of such sales and are widely followed as an indicator of consumer spending.
Retails Sales are a major indicator of consumer spending because they account for nearly one-half of total consumer spending and approximately one-third of aggregate economic activity.
Often, Retail Sales are followed less auto sales because these are generally much more volatile than the rest of the Retail Sales and can therefore obscure the more important underlying trend.
Retail Sales are measured in nominal terms and therefore include the effects of inflation. Rising Retail Sales are often associated with a strong economy and therefore an expectation of higher short-term interest rates that are often supportive to a currency at least in the short term.
Housing Starts
Housing Starts are a measure of the number of residential units on which construction is begun each month and the level of housing starts is widely followed as an indicator of residential construction activity.
The indicator is followed to assess the commitment of builders to new construction activity. High construction activity is usually associated with increased economic activity and confidence, and is therefore considered a harbinger of higher short-term interest rates that can be supportive of the involved currency at least in the short term.