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  1. #1
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    Financial Market Basics

    Hello everybody,

    This topic is meant to begin principle discussions on terms and concepts of Trading.

    It is advisable for a beginner to spend time on the fundamentals of trading as it is of uttermost importance in practical Trading world.

    Any comment on this matter is appreciated from experienced guys to fully convey the matter, as I'm not a rocket science master of the market.

    Thanks a lot
    Goodluck
    Last edited by stream1981; 05-08-2014 at 10:05 AM.

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  3. #2
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    Currency Pairs and their symbols

    Symbols of currency pairs are abbreviations which International Standard Organization (ISO) has specified for currencies, indices and major commodities. These symbols usually come in 3 letters. Generally in currency abbreviation, first two letters represent its country of origin and the third letter of the symbol shows the first letter of the name of that currency.

    United States Dollar - USD

    European Union Euro - EUR

    Japanese Yen - JPY

    Pound Sterling - GBP

    Swiss Franc - CHF

    Australian Dollar - AUD

    Canadian Dollar - CAD

    Prices always come as pairs, like GBP/USD or USD/JPY. The reason quotes is given as pairs is because in every trade in the exchange market (Forex) you buy a currency versus selling another one concurrently and vice versa. An example of British Pound versus U.S Dollar exchange rate is as follows:

    GBP/USD=1.7500

    The first currency (here for British pound) is known as the underlying currency and the second currency (here for U.S Dollar) is known as the opposite currency.
    When buying, the exchange rate tells you how much opposite currency you are supposed to pay to buy a unit of the underlying currency. In the aforementioned example you have to pay 1.7500 U.S Dollar to buy 1 British pound.
    When selling, the exchange rate tells you that how much opposite currency you would be paid for selling the underlying currency. According to the above example, you will be paid 1 U.S Dollar by selling 1.7500 Pound.

    The underlying currency is the “Base” of selling and buying.
    If you are buying EUR/USD, in fact it’s like when you are buying the underlying currency and selling the opposite currency simultaneously.
    If you think of rising the underlying currency versus the opposite currency, you will buy the currency pair, and when you think of falling the underlying currency versus the opposite currency, you surely will sell the currency pair.

    The concept of Long/Short

    First things first, you ought to determine which side you are going to be, the Buyer or the Seller.
    If you are going to be a buyer (which in fact means buying the underlying currency versus selling the opposite currency), you expect the underlying currency to rise, and then you will sell the high. Between traders this is called “Short Position”. Just try to remember this way for sure: Short = Sell.
    If you are going to be a seller (which in fact means selling the underlying currency versus buying the opposite currency), you expect the underlying currency to rise, and then you will sell the high. Between traders this is called “Long Position”. Just try to remember this way for sure: Long = Buy.

    To be continued......

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  5. #3
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    Understanding the Concept of “pip”

    The least incremental change in the price of a currency is called a “pip” or Percentage In Points. Generally, for most of the currency pairs the pip is the fourth decimal.
    Example, if EUR/USD reaches from 1.3382 to 1.3384, we say it rose by 2 pips. Let’s take another example, if GBP/USD moves down from 1.8855 to 1.8757, we would conclude it has dropped 98 pips. For pairs consisting of Japanese Yenas the quote currency,the pip is the second decimal. For example if GBP/JPY moves up from 188.88 to 188.99, then we say it has grown 11 pips.

    As every currency has its own price (quote), it is required to calculate the pip of every currency pair. In pairs the U.S. Dollar is the base currency, the calculation is as follows:
    Let’s suppose USD/JPY quote is 119.80 (note that this currency pair is offered in 2 decimal points, others usually are quoted in 4.)
    0.01 divided into 119.80 gives us the pip value.

    0.0000834 = 119.80 / 0.01


    It seems a long number, but the Lot size will be explained.

    The next example:

    USD/CAD = 1.4890

    The pip value = 0.0001 / the exchange rate

    0.0001 / 1.4890 = 0.00006715

    In the next example the U.S. Dollar is quote currency and we have to add one more step in the calculation to get its pip value

    1.2200 = EUR/USD

    0.0001 / 1.2200 = 0.00008196

    But we are willing to have U.S. Dollar. So, the following calculation will be done.

    EUR * Dollar exchange rate

    Therefore:

    1.2200 * 0.00008196 = 0.00009999
    And when it is rounded up it shows 0.0001.
    It is important to note that all these calculations are done by your broker. But it is good to know how these calculations work. In the next section, we will show you how to use these numbers.

    To be continued......

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  7. #4
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    Getting familiar with the conception of “Spread”

    There will be two price quotes for each currency pair called “Bid” and “Ask”.

    The “Bid” price, is the price the market traders (investors) offer you to buy (You are going to sell at). This means that you will be going to buy in this settled (consensus) price.

    The “ask” price, is the price the market traders (investors) offer you to sell (You are going to buy at). This means that you will be going to sell in this settled (consensus) price.

    The bid price is always lower than ask price. The difference between “Ask” and “Bid”price is called “spread”.

    Let’s take a look at an example of the case:


    In GBP/USD, the bid price is equal to 1.7445 and the ask price is equal to 1.7449. If you are willing to sell GBP, just click on the “Sell” button and you will be able to sell at the exchange rate of 1.7445 British Pound. But if you are willing to buy GBP, you have to buy it for the exchange rate of 1.7449.
    Due to the large number of buyers and sellers within the market that are connected through internet and their ability to modify/change their offers, this price or spread difference can vary several times a second.

    To be Continued...
    Last edited by stream1981; 05-16-2014 at 02:17 PM.

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  9. #5
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    Understanding the concept of “Lot”

    The currency pairs or the instruments are traded across the Forex market in Lots.

    Standard size for a lot is equal to $100,000. There are“mini” Lots also, which are equal to $10,000. As you have already learnt before, the currencies are measured by pips, which are the smallest incremental piece/unit of the currency. In order to benefit from this massive gains, you ought to take bigger volume trades.

    When it’s rounded up, the resulted pip value will be $10 per pip for a standard Lot.
    Calculations for the pair which is not having U.S. Dollar on any side.
    Suppose, we are going to calculate the pip value for EUR/GBP currency pair, in addition to the aforementioned steps, to convert it to Dollars, the resulting number should be multiplied with the price of GBP/USD.

    EUR/GBP = 0.8209

    Point Value of EUR/GBP (per pound) = $100,000 * (0.0001/0.8209)*0.8209 = 10 pounds

    (GBP/USD Quoted price at the moment of conversion) * 10 = 1.6718 * 10 = $16.718

    The exchange rate for USD/CHF is 1.4550/1.4555. As you have bought and now you are willing to close out your trade, you have to sell it to do so. Then, you will sell at 1.4550, because the other traders offer their bid price to buy yours at that price.

    The difference between 1.4530 and 1.4550 is equal to 20 pips.

    Using the formula we already have, we realized that we have earned $6.87 as profit based on the following calculation, (1.4550/0.0001) * 100,000 = $6.87for one pip, which for 20 pips will be equal to 20 * $6.87 = $137.40.

    Remember that when you enter a trade or close it, you must consider the buy spread or the sell spread. You sell one currency less that its real price in the market and you buy it more that its real price in the market. So, in fact you pay the spread upon entering the trade to buy and you pay the spread upon entering the trade to sell.

    1 Lot = $100,000

    The size of the trades is calculated multiples of 100,000 units, for example;

    0.1 Lot = 10,000

    0.01 Lot = 1000

    Suppose our Lot size is $100,000, we are going to perform some execution to show how much the size effects on the pip value.

    Example:

    USD/JPY = 119.90

    Pip value = $100,000 * (0.01/119.90) = $8.34

    In cases Dollar is not the underlying currency (the left side currency), the calculations are a little different;

    EUR/USD = 1.1930

    Pip value = $100,000 * (0.0001/1.1930) = $9.99734

    To be continued...

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  11. #6
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    How to calculate Profit/Loss of an individual trade?

    Now that you’ve learned how to calculate the pip value (P.V), let’s find out the way of calculating profit/loss of yours.

    E.g. when you want to buy U.S Dollar against Swiss Franc.

    The exchange rate we are going to settle the contract is 1.4530/1.4525 for USD/CHF. To buy you should trade at the exchange rate of 1.4530, because other traders offer based on their ask prices.

    So, you buy 1 Lot of $100,000 at the exchange rate of 1.4530.

    Few hours later the price reaches 1.4550 and you decide to liquidate (close out) your position (trade).

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  13. #7
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    As you have bought USD/CHF pair, you need to sell it to get your trade closed.The current exchange rate for USD/CHF is 1.4550/1.4555. So you sell it at 1.4550 to liquidate the position. The difference between buy price 1.4530 and sell price 1.4550 is 20 pips.
    Applying the formula we used before, we get (1.4550/0.0001) * 10,000 = $6.87 as profitper pip, which for 20 pips, is equal to $6.87 * 20 pip = $137.40.
    Remember that, you need to consider the spread of buy price (Ask) and sell price (Bid) when entering or closing a trade. Added spreads mean, you sell a currency lower than its real price in the market and buy it higher than its real price across the market. So, in fact when you try to buy a currency, you would pay the spread once you have opened the position and you would pay it again when you close the position by selling it.

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  15. #8
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    Understanding the concept of Leverage

    Let me give you an example to understand the concept of leverage. It’s like a bank has lent you $100,000 for investment, in return of a $1000 deposit that you need to maintain all the time. Leverage trading works on this concept.

    Also it depends on how much leverage you are willing to work and how much leverage a broker is offering.
    Typically, brokers ask for a minimum amount that must be deposited in an account as account margin or initial margin. With this margin amount, you will be able to trade when you open the account with your brokerage.

    E.g. using 1/100 leverage, you will be allowed to trade as much as $100,000, while you deposit just $1,000 in your account. Therefore, if you have $5000 in your account, you will be able trade up to $500,000.
    The account margin or margin is different from broker to broker. For example in the aforementioned case, the broker account margin is 1%. Which means this broker will be reserving $1.000 for every $100,000 traded.

    Margin can be mentioned in ratio or percentage (e.g. 1:100 or 1%).

    1:1=100% margin for the actual value of an open position

    1:50=2% margin for the actual value of an open position

    1:100=1% margin for the actual value of an open position

    1:200=0.5% margin for the actual value of an open position

    For example:
    Based on your analysis, the market moves up and Pound strengthens against U.S Dollar.
    You have an account of $1,000 and you Buy 1 Lot GBP/USD at the price of 1.5000 using 1% margin (1:100 leverage) and you wait for the exchange rate to climb. This means that you have entered to a $100,000 trade of British Pound using a $1,000 account.
    The margin that would be locked within your account is equal to:

    Locked in Margin = the value of the trade / leverage

    (The value of the trade = the price * traded Lot size)

    Locked in Margin = (1.5000 * $100,000) / 100 = $150

    So margin for entering this trade is $150.

    Your estimation turns out to be correct and you close out your trade at 1.5050. In this trade you will be making 50 pips or almost $500 of profit.

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  17. #9
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    Your Operation GBP USD The money in your account
    To buy GBP/USD while the exchange rate is 1.5000 +100,000 -100,000 $ 1,000
    To Sell GBP/USD while the exchange rate reached to 1.5050 -100,000 +150,500 $1,500


    When you close out your trade, the blockedmargin will be deposited back to your account alongwith your profit/loss on that trade.

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  19. #10
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    What is the meaning of “Margin Call”?

    As informed earlier, the decided margin amount has to be maintained in the account every time; and whenever your account with your broker gets lower than the intended margin, your broker will be allowed to close out all or some of your positions. This is the way to prevent your account margin going negative even in a severely volatile and fast moving market.

    Example:


    Suppose you opened a $10,000 account with your Forex broker and then you take a position of 1 Lot with $1,000 required margin. Remember that available margin is the money required to open new positions or closing out losing trades. So, the available margin or free margin of your account is $10,000 before opening the trade and thereafter, it would be $9,000. If your total loss is more than $9,000, you will get margin call.
    If your losses become greater than your free (available) margin, you have to provide the deficit (shortage) or your broker will close out your trade preventing himself from your risk exposure. As a result you never lose more money than your equity balance.
    If you are willing towork with these types of accounts, get the exact information about how your brokerdeals withmargins.
    The figure for margin level within Meta Trader 4 window determines when the account will get a margin call.
    For example, with PCM Brokers, for micro accounts your trades will be automatically closed out if margin level gets below to 50%.


    The formula to calculate margin level:
    Margin Level = Margin / Equity

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