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.


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On these pages, we offer you a brief introduction to the FX 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 internet trading system, SaxoTrader.




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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.



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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.

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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 realtime acount overview are built into SaxoTrader, while further account information can be produced in accordance with your specific requirements.

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.



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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.


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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.


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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.

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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.

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.



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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.


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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.


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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.

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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.

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.



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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.


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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.


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This results in a profit of CHF 45,000 = approx. USD 28,600 = 28.6% profit on the deposit of USD 100,000.


Example 2:

The investor follows the cross rate between the EUR o 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 o at 112.60. Two days later, this stop is triggered as the EUR o strengthens short term in spite of the investor's expectations.

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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.
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 investors 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.

Base Currency and Variable Currency

Base Currency and Variable Currency

When you trade, you will always trade a combination of two currencies. For example, you will buy US dollars and sell Euro. Or buy Euro and sell Japanese yen, or any other combination of dozens of widely traded currencies. But there is always a long (bought) and a short (sold) side to a trade, which means that you are speculating on the prospect of one of the currencies strengthening in relation to the other.

The trade currency is normally, but not always, the currency with the highest value. When trading US dollars against German marks, the normal way to trade is buying or selling a fixed amount of US dollars, i.e. USD 1,000,000. When closing the position, the opposite trade is done, again USD 1,000,000. The profit or loss will be apparent in the change of the amount of Euro credited and debited for the two transactions. In other words, your profit or loss will be denominated in Euro, which is known as the price currency. As part of our service, Saxo Bank will automatically exchange your profits and losses into your base currency if you require this.

This way of trading is different to the futures markets, for example, where the marks, francs and yen are the fixed trade currency, resulting in a US dollar denominated profit or loss. You can, however, also choose to trade in this reciprocal manner in foreign exchange markets but it is not the norm.

Dealing Spread, but No Commissions

When trading foreign exchange, you are quoted a dealing spread offering you a buying and a selling level for your trade. Once you accept the offered price and receive confirmation from our dealers, the trade is done. There is no need to call an exchange floor. There are no other time-consuming delays. This is possible due to live streaming prices, which are also a great advantage in times of fast-moving markets: You can see where the market is trading and you know whether your orders are filled or not.

The dealing spread is typically 3-5 points in normal market conditions, e.g. USD/EUR 1.7780-85. This means that you can sell US dollars against the Euro at 1.7780 and buy at 1.7785. There are no further costs, commissions or exchange fees.

This ensures that you can get in and out of your trades at very low slippage and many traders are therefore active intra-day traders, given that a typical day in USD/EUR presents price swings of 150-200 points.

Spot and forward trading

When you trade foreign exchange you are normally quoted a spot price. This means that if you take no further steps, your trade will be settled after two business days. Due to the fact that the EU investment directive does not presently cover spot foreign exchange trading we will, however, require you to swap your trade forward at least another two business days. This ensures that your trades are undertaken subject to supervision by regulatory authorities for your own protection and security. If you are a commercial customer, you may need to convert the currencies for international payments. If you are an investor, you will normally want to swap your trade forward to a later date. This can be undertaken on a daily basis or for a longer period at a time. Often investors will swap their trades forward anywhere from a week or two up to several months depending on the time frame of the investment.

Although a forward trade is for a future date, the position can be closed out at any time - the closing part of the position is then swapped forward to the same future value date.



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Interest Rate Differentials

Different currencies pay different interest rates. This is one of the main driving forces behind foreign exchange trends. It is inherently attractive to be a buyer of a currency that pays a high interest rate while being short a currency that has a low interest rate.

Although such interest rate differentials may not appear very large, they are of great significance in a highly leveraged position. For example, the interest rate differential between the US dollar and the Japanese yen has been approximately 5% for several years. In a position that can be supported by a 5% margin deposit, this results in a 100% profit on capital per annum when you buy the US dollar. Of course, an even more important factor normally is the relative value of the currencies, which changed 15% from low to high during 2005 - disregarding the interest rate differential. From a pure interest rate differential viewpoint, you have an advantage of 100% per annum in your favour by being long US dollar, and an initial disadvantage of the same size by being short.
Please refer to our page Forex Rates & Conditions for current Spreads, Margins and Conditions!


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Such a situation clearly benefits the high interest rate currency and as result, the US dollar was in a strong bull market all through 2005. But it is by no means a certainty that the currency with the higher interest rate will be strongest. If the reason for the high interest rate is runaway inflation, this may undermine confidence in the currency even more than the benefits perceived from the high interest rate.









Stop-loss discipline

As you can see from the description above, there are significant opportunities and risks in foreign exchange markets. Aggressive traders might experience profit/loss swings of 20-30% daily. This calls for strict stop-loss policies in positions that are moving against you.



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Fortunately, there are no daily limits on foreign exchange trading and no restrictions on trading hours other than the weekend. This means that there will nearly always be an opportunity to react to moves in the main currency markets and a low risk of getting caught without the opportunity of getting out. Of course, the market can move very fast and a stop-loss order is by no means a guarantee of getting out at the desired level.

But the main risk is really an event over the weekend, where all markets are closed. This happens from time to time as many important political events, such as G7 meetings, are normally scheduled for weekends.

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For speculative trading, we always recommend the placement of protective stop-lossorders. With Saxo Bank Internet Trading you can easily place and change such orders while watching market development graphically on your computer screen.

Forex Trading Basics

Forex Trading Basics

The global foreign exchange market is the biggest market in the world. The 3.2 trillion USD daily turnover dwarfs the combined turnover of all the world's stock and bond markets.

There are many reasons for the popularity of foreign exchange trading, but among the most important are the leverage available, the high liquidity 24 hours a day and the very low dealing costs associated with trading.



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Of course many commercial organisations participate purely due to the currency exposures created by their import and export activities, but the main part of the turnover is accounted for by financial institutions. Investing in foreign exchange remains predominantly the domain of the big professional players in the market - funds, banks and brokers. Nevertheless, any investor with the necessary knowledge of the market's functions can benefit from the advantages stated above.

In the following, we would like to introduce you to some of the basic concepts of foreign exchange trading. If you would like any further information, we suggest that you sign up for a FREE Membership on this website, where you will be able to exchange views with other FX traders and get answers to any questions you might have.


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Margin Trading


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Foreign exchange is normally traded on margin. A relatively small deposit can control much larger positions in the market. For trading the main currencies, SaxoBank requires a 1% margin deposit. This means that in order to trade one million dollars, you need to place just USD 10,000 by way of security.








In other words, you will have obtained a gearing of up to 100 times. This means that a change of, say 2%, in the underlying value of your trade will result in a 200% profit or loss on your deposit. See below for specific examples. As you can see, this calls for a very disciplined approach to trading as both profit opportunities and potential risks are very large indeed. Please refer to our page Forex Rates & Conditions for current Spreads, Margins and Conditions!

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History

History
Brief history of Forex trading

Initially, the value of goods was expressed in terms of other goods, i.e. an economy based on barter between individual market participants.

The obvious limitations of such a system encouraged establishing more generally accepted means of exchange at a fairly early stage in

history, to set a common benchmark of value. In different economies, everything from teeth to feathers to pretty stones has served this







purpose, but soon metals, in particular gold and silver, established themselves as an accepted means of payment as well as a reliable storage

of value.






Originally, coins were simply minted from the preferred metal, but in stable political regimes the introduction of a paper form of governmental

IOUs (I owe you) gained acceptance during the Middle Ages. Such IOUs, often introduced more successfully through force than persuasion

were the basis of modern currencies.




Before the First World War, most central banks supported their currencies with convertibility to gold. Although paper money could always be

exchanged for gold, in reality this did not occur often, fostering the sometimes disastrous notion that there was not necessarily a need for full

cover in the central reserves of the government.




At times, the ballooning supply of paper money without gold cover led to devastating inflation and resulting political instability. To protect

local national interests, foreign exchange controls were increasingly introduced to prevent market forces from punishing monetary

irresponsibility.

In the latter stages of the Second World War, the Bretton Woods agreement was reached on the initiative of the USA in July 1944. The

Bretton Woods Conference rejected John Maynard Keynes suggestion for a new world reserve currency in favour of a system built on the

US dollar. Other international institutions such as the IMF, the World Bank and GATT (General Agreement on Tariffs and Trade) were created

in the same period as the emerging victors of WW2 searched for a way to avoid the destabilising monetary crises which led to the war. The

Bretton Woods agreement resulted in a system of fixed exchange rates that partly reinstated the gold standard, fixing the US dollar at

USD35/oz and fixing the other main currencies to the dollar - and was intended to be permanent.

The Bretton Woods system came under increasing pressure as national economies moved in different directions during the sixties. A number

of realignments kept the system alive for a long time, but eventually Bretton Woods collapsed in the early seventies following president

Nixon's suspension of the gold convertibility in August 1971. The dollar was no longer suitable as the sole international currency at a time

when it was under severe pressure from increasing US budget and trade deficits.

The following decades have seen foreign exchange trading develop into the largest global market by far. Restrictions on capital flows have

been removed in most countries, leaving the market forces free to adjust foreign exchange rates according to their perceived values.

But the idea of fixed exchange rates has by no means died. The EEC (European Economic Community) introduced a new system of fixed

exchange rates in 1979, the European Monetary System. This attempt to fix exchange rates met with near extinction in 1992-93, when pent-up

economic pressures forced devaluations of a number of weak European currencies. Nevertheless, the quest for currency stability has

continued in Europe with the renewed attempt to not only fix currencies but actually replace many of them with the Euro in 2001.

The lack of sustainability in fixed foreign exchange rates gained new relevance with the events in South East Asia in the latter part of 1997,

where currency after currency was devalued against the US dollar, leaving other fixed exchange rates, in particular in South America, looking

very vulnerable.

But while commercial companies have had to face a much more volatile currency environment in recent years, investors and financial

institutions have found a new playground. The size of foreign exchange markets now dwarfs any other investment market by a large factor. It

is estimated that more than USD1,200 billion is traded every day, far more than the world's stock and bond markets combined.