The Basics of Currency Trading

The Basics of Currency Trading
The Chicago Mercantile Exchange is an international marketplace enabling institutions and businesses to manage their financial risks and allocate their assets. On its trading floors, buyers and sellers meet to trade futures contracts through the process of open outcry. The "Merc's" diverse product line consists of futures within four general categories: Foreign currencies, interest rates, stock indexes and agricultural (including live stock).The International Monetary Market division is the marketplace for currency trading in the Canadian Dollar, Swiss Franc, Japanese Yen, British Pound, Brazilian Real, Deutsche Mark, Mexican Peso and Euro Dollar. The exchange opens at 8:20 a.m. Eastern Standard Time (5:20 a.m., Pacific Standard Time) and closes at 3:00 p.m. Eastern Standard Time (12:00 noon, Pacific Standard Time).Currency ContractsCurrency, like other commodities, are traded in futures contracts. Simply, these are contracts to deliver a fixed amount of a particular currency, in a given month in the future, at a price agreed upon and paid for today. Consequently, you are really buying and selling a contract (written agreement) rather than the physical currency. You can think of the contract as a written document that says, "I promise to deliver, to the owner of this contract, 125,000 Japanese Yen on June 16th, 2002".Currencies are quoted in pairs, such as EUR/USD or USD/JPY. The first listed currency is known as the base currency, while the second is called the counter or quote currency. The base currency is the "basis" for the buy or the sell. For example, if you BUY EUR/USD you have bought euros (simultaneously sold dollars). You would do so in expectation that the euro will appreciate (go up) relative to the US dollar.Buying/SellingFirst, the trader should determine whether they want to buy or sell. If they want to enter a short order -- whereby they will profit if the exchange rate falls -- they simply need to click on the SELL rate. The opposite holds true for traders who enter buy orders: they can simply click on the BUY rate, and thus will profit if the exchange rate goes up.Just like in all markets, there are two prices for every currency pair. The difference between these two prices is the spread, or the cost of the trade.MarginThe margin deposit is not a down payment on a purchase of equity, as many perceive margins to be in the stock markets. Rather, the margin is a performance bond, or good faith deposit, to ensure against trading losses. The margin requirement allows traders to hold a position much larger than the account value.In the event that funds in the account fall below margin requirements, the forex broker will close some or all open positions. This prevents clients' accounts from falling into a negative balance, even in a highly volatile, fast moving market.Example of How Margin WorksSince the trader opened 1 lot of the EUR/USD, his margin requirement or Used Margin is $1000. Usable Margin is the funds available to open new positions or sustain trading losses. If the equity (the value of his account) falls below his Used Margin due to trading losses, his position will automatically be closed. As a result, the trader can never lose more than he/she deposits.RolloverFor positions open at 5pm EST, there is a daily rollover interest rate that a trader either pays or earns, depending on your established margin and position in the market. If you do not want to earn or pay interest on your positions, simply make sure it is closed at 5pm EST, the established end of the market day. Since every currency trade involves borrowing one currency to buy another, interest rollover charges are an inherent part of forex trading.Interest is paid on the currency that is borrowed, and earned on the one that is purchased. If a client is buying a currency with a higher interest rate than the one he/she is borrowing, the net differential will be positive -- and the client will earn funds as a result. Please note that clients must be on 2% margin in order to earn funds.