Forex or FX financial terms are abbreviated from “Foreign Exchange”. Forex Trading takes place in “Forex Market” where multinational currency pairs are being bought and sold. Forex market is the most developed yet the highest liquid financial market. All of the international currency prices are being set in this huge market. According to the information taken from Wikipedia, the daily transaction turnover of foreign exchange market is US$3.98 trillion as of April 2010 and continuously growing.
In the Forex market, you can exchange the countries’ currencies (buying/selling). Euro (€), USD ($), Great Britain Pound (£), Swiss Franc (CHF) and Japanese Yen (JPY) pair combinations cumulatively make the 70% of transactions volume of this market.
Most Frequently Traded Currency Pairs of Forex
- USD: United States Dollar
- EUR: Euro
- JPY: Japanese Yen
- GBP: Great Britain Pound
- CHF: Swiss Franc
- CAD: Canadian Dollar
- AUD: Australian Dollar
- YTL: Turkish Lira
What is the meaning of “Leverage” in Forex?
1 LOT equals to USD ($) 10,000. But you have deposited a total amount of USD ($) 100. How could it be?
In the traditional trading market, if you want to trade with USD ($) 10,000, you have to deposit USD ($) 10,000.
But in the Forex market, the situation is totally different. Thanks to “Leverage” mechanism that you can deposit much less amount than you aim to trade.
“Leverage Factor” or “Leverage Ratio” gives us the ability of trading with a multiplier. This means that the money you deposit is only for “Guarantee” on a one-to-one basis. All of the trades are being made via the leverage mechanism. But do not forget that the leverage both involves higher profit opportunities and loss threats with the same weight.
For Example: If you have selected 100:1 as a leverage ratio, your deposited money will be multiplied by 100 in the foreign exchange market. This means that you will be trading with x100 amount. And you will naturally realize the profit or loss of your transactions by the result of leverage effect. So one of the most important things to care about in forex trading is preferring the most suitable leverage ratio according to your trading experience.
A Sample Forex Trade Transaction:
- You as a forex (fx) trader have opened an account for USD ($) 1,000.
- You have bought 1 LOT of EUR/USD (€/$) parity with a buying price of 1.2000.
- This transaction means that: You have BOUGHT 1*10,000=10,000 EUR (€) and SOLD a reciprocal amount of USD ($).
- “Leverage Ratio” of your account is 100:1 and “Margin Ratio” is 1 %.
- So, 10,000/100=100 EUR (€) amount is blocked as a “Guarantee” in your account.
Then the market raised from EUR/USD (€/$) 1.2000;
- You have SOLD our 1 LOT EUR/USD (€/$) at 1.2010 which has a buying cost of 1.2000.
- You have earned 10 PIPS for each LOT. You have bought and got 1 LOT so our profit is 10 PIPS in total which makes 10 USD ($) profit.
- Your account balance increased to USD ($) 1,010 and your profit percentage for this transaction become 1%.
Reversely, the market falls from EUR/USD (€/$) 1.2000;
- You have SOLD our 1 LOT EUR/USD (€/$) at 1.1990 which has a buying cost of 1.2000.
- You have lost 10 PIPS for each LOT. You have bought and got 1 LOT so our loss is 10 PIPS in total which makes 10 USD ($) loss.
- Your account balance decreased to USD ($) 990 and your loss percentage for this transaction become 1%.