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Trader Development Internship Module 1 - Currency Market Basics
The Apiary Investment Fund manages money in the foreign currency market. There are many reasons for this: leverage, diversification, liquidity, market hours, etc. While it is not necessary to have an extensive knowledge of the forex market before you start to trade, there are a few essential points you must understand. For now, we’ll cover the basics and help you establish your foundation as a new currency trader! In order to give you a sense of direction over the next several months, we have developed 12 modules designed to guide a beginner to hopefully become money management ready. Though they were originally conceived as weekly checkpoints, you can always find them on the my.apiaryfund.com site under “Resources” in “Extras.” For now, let’s focus on understanding the following concepts: Why trade currencies? How does currency trading work? When to buy and sell What is a “PIP?” What is a “Lot?” How do you calculate profits?
Trader Timeline...
Where should you be right now?
It’s important to understand the basics in order to become a successful currencies trader. Fortunately, you’re off to a great start! Begin by watching the following recordings of previous discussions before moving through the rest of this module:
Forex Basics February 14, 2011 my.apiaryfund.com/node/424 Intermarket Analysis March 09, 2011 my.apiaryfund.com/node/454
In this introductory module, we discuss Currency Market Basics. It’s important to remember that the process of becoming consistently successful as a currencies trader is a journey, and not a destination. That being the case, starting your journey on the right path can help you enjoy the experience every step of the way! Let’s get started...
Why Trade Currencies? Why do individuals and institutions trade trade currencies? For the same reason that investors trade stocks and options, or commidities and futures - the changing relationship between buyers and sellers, or supply and demand creates differences in value. Where there is a difference in value, there is an opportunity to make a profit depending upon which trade strategy you’re using. Trade in the foreign exchange of currencies works the same way - each country or region in the world expereinces periods of growth and contraction, gain and loss every once in a while. The economy of one country might be in the midst of a decline, while at the same instant, another country might be increasing in economic power. Here’s a simplistic example: It might make sense to use a weakening currency to buy units of currency of a stronger economy. That way, as the weaker economy continues to decline, the relative value of the stronger economy increases the relative value of the currency you own your money in. Traders savvy enough to sell the weakening currency in order to purchase units of the strenghtening currency will see their holdings increase in value over time. Here’s the best part... Because of the Earth’s rotation, business is always transacting somewhere on the planet every moment of
every day. As a result, Bankers and governments world-wide maintain constant electronic communications as they facilitate and broker multi-national business deals and trade relationships. This constant electronic marketplace enables traders to take advantage of the ebb and flow of global commerce 24-hours a day, 5-days a week (Currencies markets close at 5:00 pm Eastern time on Fridays, and begin to re-open at 5:00pm Eastern time Sunday evenings). This unique round-the-clock availability makes global currencies an incredibly dynamic and lucrative opportunity for traders with the training and tools looking to take advantage of the constantly changing marketplace.
Here’s How it Works: Suppose that you think the Euro is about to increase in value. You rustle up $100,000 USD and exchange it for Euros. A day later, the value of the Euro riases by $0.01 USD - or one US penny. The new value of your Euro currency is $101,000. At this point, suppose you want to get rid of your Euros and book your profits. When you exchange them back for US Dollars, you make a profit of $1,000 US (the new $101,000 minus your original $100,000 invetment). Currencies are always quoted in pairs. In the previous example, you used two different currencies to complete the trade - you “bought” Euros with US Dollars. The reason currencies are quoted in a paired relationship is that in every foreign exchange transaction, you buy one currency in exchange for another. The first currency in the pair is called the “base currency.” The second is called the “quote currency.” In a currency transaction, the base currency is the ‘basis’ for purchases and sales. When you say you want to buy, you’re buying the base currency.
For example, if you want to buy Euro Dollars using US Dollars, then you would buy the EUR/USD currency pair. When you are ready to get rid of your Euro dollars and put the money back into US Dollars, then you sell the EUR/USD currency pair. You can see that every currency transaction must have two sides - a buy and a sell. When buying currencies, the exchange rate tells you how much you have to pay in units of the quote currency to buy one of the base currency. For example: EUR/USD = 1.1702 In this example, you have to pay 1.1702 U.S. dollars to buy 1 EURO. When selling, the opposite also holds true. If you were to sell 1 Euro, you would receive 1.1702 U.S. dollars.
When to Buy or Sell: You buy the pair when you believe the base currency will appreciate (increase) in value relative to the quote currency. You sell the pair when you think the base currency will depreciate (decrease) in value relative to the quote currency. Because you’re always dealing in pairs, values are relative. If a currency looks like it is strengthening when compared will all other currencies, it is gaining relative value in the entire global market. If the currency looks like it is strengthening on one chart, but not others, it may be that the other currency on the first chart is just weakening. You should be aware that in today’s electronic market, no physical currency delivery is ever really changing hands. It’s all done on computer. As currency traders, we look at charts displaying the changing values over time and place orders to buy or sell over the internet. You won’t regularly need to call anyone or go anywhere.
What is a ‘PIP?’ When the exchange rate of a currency pair goes up or down, the amount that it goes up or down is usually described in ‘PIPs.’ ‘PIP’ is an acronym that stands for “Price Interest Point” or “Percentage In Point” depending on who you ask. More important than understanding the acronym is understanding what it means to traders. A PIP traditionally represents the smallest price change of an exchange rate. For example, when trading the EUR/USD, the smallest price change is 0.0001. A move from say, 1.3941 to 1.3942 is a one-PIP move - likewise, a move from 1.3941 to 1.3991 represents a 50-PIP move. Most currency exchange rates are traditionally quoted up to 4 decimal points, though pairs including the Japanese Yen often have the third decimal place as the pip. More recently, many banks and dealers have started adding another decimal place to their quotes. You will hear this referred to as a “point.” So, as you might imagine, there are 10 points in a pip. Traders still talk in terms of pips most often, though.
What is a “Lot?” When you choose to buy or sell a currency pair, you have to decide the amount of wish to buy or sell. The amount you buy or sell is usually expressed in ‘lots.’ The standard lot size is 100,000 units of the base currency. For the USD/CAD pair, one lot is $100,000, two lots are $200,000 and so on. When you buy one lot of the USD/CAD, it means that you are buying $100,000 US dollars in exchange for enough Canadian dollars to equal $100,000 according to the exchange rate. In other words, if the exchange rate for USD/CAD is 1.1000, then buying one lot of USD/CAD means that you will acquire $100,000 US dollars in exchange for $110,000
(i.e. 100,000 X 1.100) Canadian dollars. Of course, the opposite is true when you sell. If you sell one lot of USD/CAD at the exchange rate of 1.1000, then you exchange $100,000 US dollars for $110,000 Canadian dollars in return.
How do you Calculate Profits? Fortunately, the Apiary Investment Fund’s trading software calculates your profits for you. Even so, it’s important to understand how that profit is calculated. For Example: Suppose we buy one lot (100,000) at 1.3902. A few hours later, the exchange rate moves to 1.3950 (up 48 pips). You decide to close your trade and take your profit. Since you initially bought to enter the trade, you simply need to sell in order to close your trade. You press the button to close the trade and... congratulations! You just made 48 PIPs profit! Your actual profit in dollars is calculated in the following manner: Exchange rate difference (0.0048) x Your position size ($100,000) = $480.00 Something you’ll need to account for, too, is the “spread.” There is a difference between the amount you can buy and sell a currency for. For regular accounts on major currency pairs, this is often around 2 pips. That’s where the bank or dealer makes their money. So if you made 48 pips, but there is currently a 2 pip spread, you will have only profited on 46 pips, or $460.00.
...Bring it All Together
Hopefully, you’ve found this quick beginning information helpful. Regardless of whether you’re new to currency trading, or you bring years of experience to the program, we’re excited to be working together to forge a mutually beneficial partnership. We look forward to your continued success!
Key Concept: The “Spread” Example: Bid = 1.3950 Ask = 1.3952 Spread = 2 pips The difference between the “Bid” and the “Ask” prices is known as the “Spread.” It’s sometimes helpful to think of the ‘Bid’ and ‘Ask’ prices in terms of “Wholesale” and “Retail.” When you want to sell a position, the most you can get for it is wholesale, but you’ll always have to pay retail to buy it. The difference between the Buy and the Sell goes to the Market Maker (aka. bank or dealer)
Module 1 Review Check off the concepts you now understand:
Why trade currencies? How does currency trading work? When to buy and sell What is a “PIP?” What is a “Lot?” How do you calculate profits? If you’re having trouble with some of these concepts, visit my.apiaryfund.com to watch recordings of previous “Forex Basics” or “Forex Formula” discussions. You may also want to view terms in the Glossary or ask other Apiary Fund members to explain a concept to you in the forum. Additionally, you can email us at info@apiaryfund.com or call 1-888-702-2340.