Introduction To Forex Trading For Spread Betting

So you’re comfortable with stock markets rising and falling and making a few quid trading XYZ, but what about Cable, Loonie, Kiwi and the Yen? Trading currencies is a lot of fun once you get past the basics, so here we go.

The foreign exchange market, also known as forex, currency trading, spot forex and FX; can offer attractive opportunities to spread traders, even during turbulent market conditions. The currency markets are highly liquid with the global forex market being worth some $4 trillion-a-day. If you are interested in forex trading, you can actually trade forex through financial spread betting and currencies like the euro/pound have always been popular with traders. Most spread betting providers offer trading on a wide range of major and even exotic currency pairs. The added advantage is that with your same spread betting account you can trade a wide range of other financial markets that are often impacted by fluctuations in the forex market.

Major Fx Currencies

The major currencies and their designation in the foreign exchange market are:

The other currencies are referred to as Minor Currencies and they are usually traded against a Major Currency.

Major Fx Currency Pairs

There are many currencies around the world but only eight currencies (referred to as the majors) are actively traded and make up about 90% of all global trade transactions and therefore comes with excellent liquidity. The USA dollar (USD) is naturally the most traded. The other majors are the euro, British pound, Japanese yen and Swiss franc. The Canadian dollar, Australian dollar and New Zealand dollar are also included and these are sometimes known as the ‘commodity currencies’ since their price movements are very much correlated to international commodity prices. Major currency pairs have the USD on one side and most forex traders will be dealing in the Major Currency Pairs. For the USA dollar crosses you would do well to keep an eye on what is said by the Federal Reserve as this can trigger sizable movements and impact the principal currency pairs. You would also do well to follow economic releases including GBP data, employment, consumer and production figures as well as announcements like confidence and retail sales data. The main currency crosses are:

 

Minor Fx Currency Pairs

Minor Currency Pairs or Major Crosses are forex pairs that do not contain the USA Dollar such as the GBP/JPY. Currency pairs that have the Euro are commonly referred to as Euro crosses, for instance EUR/GBP.

Here are some examples of the Major Crosses:-

Euro Crosses

 

Yen Crosses

 

Pound Crosses

 

Aussie Crosses

 

Other Crosses

 

Exotic Currency Pairs

Lastly, there are the exotic currency pairs which are mainly pairs from emerging economies such as parts of Asia, the Pacific, the Middle East and Africa. Minors can experience large movements on modest volumes as there is much less liquidity when trading such currency pairs than the majors like EUR/USD or USD/JPY. As such these pairs can carry wide spreads since they aren’t particularly liquid and in general bid-offer spreads on emerging market pairs will always be wider than those on major currency pairs; in some exotics spreads can be as much as ten times that of the majors. For instance an exotic currency pair like the USD/ZAR may have easily double or triple the spread of the EUR/USD pair. Exotic forex pairs aren’t classified as major nor minor, but they still play an important part in the global economy. Traders would do well to use less leverage than usual and modest position sizes due to the higher volatility typically experienced by exotic pairs. Research for exotics will also require some extra effort.

Please Note: Trading exotic currency pairs is best left for experienced traders as these currencies are more prone to be subject to political and central bank intervention. Also, some exotics are pegged to the value of another currency or may fluctuate in a managed float. So, even if you think that a currency represents good value, it may still not move due to the underlying technicalities. As such, if you are just starting out stick to the majors and crosses first.

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If Carlsberg had been asked to come up with a market for spread betting it would have produced the forex (aka FX or currencies) market – massively liquid, tight dealing spreads, good for technical analysis and the major news events are announced publicly rather than nods and winks between well-paid City folk. Also you get more leverage, and for owls and insomniacs, it’s open 24 hours a day.

OK, that’s the spin, now a word of warning, there are some very big fish in these waters and we’re the minnows. It doesn’t matter whether the big fish are clever or not as they’ve got the size to determine which way the waters flow. They may have misinterpreted Big Ben Bernanke’s comments, or missed the revisions to US payroll data, but they’ll determine the market direction long enough to stop you out. So, who are these big fish?

The Players In The Forex Market

By far the biggest group are the speculators, or sharks (historically known as the ‘white sock brigade’). Their aim is straightforward, to whack it up, down or both so long as they make money. They can trade on technicals, economics or rumours just so long as they bring the profits in.

Then there are the hedgers, split into those who hedge investments and those who hedge commercial risk. An example of investment hedging would be a fund manager who wants exposure to the US market but not the dollar, so having bought the currency to pay for his investments he then sells it for settlement at some future date. Corporations (proper companies like Shell or Tate & Lyle) use the forex market to hedge exposure to future overseas payments.

The national central banks, like the Bank of Japan and the Peoples Bank of China, are also occasional big players in the markets. Their actions range from covertly targeting particular levels to issuing a very public message by visibly dealing in the forex markets.

How Does The Market Work

As usual there’s a bit of jargon, but nothing too frightening. Firstly, currencies are loosely grouped into categories with names like ‘Majors’, ‘Minors’, ‘Exotics’ and ‘Scandies’. I won’t list them all, but the majors are the US Dollar (USD), Sterling (GBP), Euro (EUR), Japan (JPY), Swiss Franc, known as Swissie (CHF) and Australian, Canadian and New Zealand dollars (AUD, CAD, NZD) known as the Aussie, Loonie and Kiwi respectively. The other useful bit of jargon is that GBP/USD is referred to as ‘Cable’ as it was originally quoted by cable under the Atlantic.

Currencies differ from other investment markets in that you’re both buying and selling something at the same time. Currencies are quoted in pairs such as GBP/USD (Sterling/ Dollar) where the first quoted currency is known as the base currency and signifies the denomination of your trade. For example buying GBP/USD means that you are buying Sterling and at the same time selling US Dollars.

The way to make money from currency rate fluctuations is to go long on the market and speculate that one currency will continue to strengthen, or weaken against another currency. So a trader who believes that the UK pound would continue to strengthen would buy at the upper end of the bid-offer spread (or vice-versa i.e. sell at the lower end if he believed that the pound is prone for further weakening).

Prices are quoted in pips and most main currencies are quoted to four decimal places (Japan is only quoted to 2 decimal places as it’s a massive figure already). So, carrying the example through if you buy €1 a pip of GBP/USD at 1.6070 and it rises to 1.6085, that’s €15 in the account. Easy isn’t it?

Normally, spread betting works by staking a certain £x per ‘pip’ or basis point (some provider now even offer fractional pip pricing, i.e. five decimal places, which makes for even tighter, more accurate spreads). Let’s suppose you place a bet staking £1 per ‘pip’ and the currency pair you are trading moves from 1.3000 rising 5 ‘pips’ to 1.3005 you have made £5 (excluding transaction fees). A rise to 1.3300 nets you £300.

Currencies normally don’t move so much but they do tend to fluctuate a bit up and down on a day-to-day basis. This naturally attracts people who like to take positions on things but traders will normally borrow an amount in execess than their initial deposit amount so as to maximise profits. This has to be understood in the context that currency movements are usually miniscule constituting only a few basis points (one basis point is 0.01%) a day. As such if you have $100 in the market and you manage to get the market direction right then you might just make two or three cents a day. That’s very little and nothing to get excited about so speculators go out and deal in these markets with tens and hundreds of thousands at a time. Naturally, most traders don’t have tens or hundreds of thousands to day trade currencies so brokers permit traders leverage. So with a leverage ratio of 100:1 you put in your $100 upfront and you’re allowed to take positions in up to $10,000 of currency (i.e. brokers may charge only a 1% deposit). If prices move by 100 basis point (that’s 1%) you will have to put more money in your trading account or the provider will close your trade to protect themselves. If the market moves sharply against you, you might also face a margin call for the additional losses sustained not covered by your account balance.

The fees involved in financial spread betting depend on how long you keep position open. The buy rate is always higher than the sell rate so the provider makes a profit but there is also a financing fee for keeping the position open overnight. If the position is kept open for only a few days, the financing fee is likely to be quite small. For quarterly futures, the fee could amount to 8 to 10 pips for the majors.

Common Themes In The Forex Market

One of the key themes for some time has been the Carry Trade, which is covered in the link. Here’s a round up. In Japan, interest rates are always bugger-all, but in New Zealand, rates are usually pretty high. So the bright idea has been to borrow from Japan at lets say 0.1% and put it on deposit in New Zealand at 5% for example. This is known as the Carry Trade. You get an interest rate difference of nearly 5%. If enough people do this trade, the New Zealand Dollar, aka Kiwi, will go up and the Japanese Yen will go down. NZD/USD soars! Of course, in times of risk aversion, the Carry Trades are reversed and NZD/USD falls. It all about predicting times when the market feels bullish or not.

The Carry Trade can be done with a lot of currency crosses. Not all traders fancy the Kiwi, but lots of them fancy borrowing Yen and selling it into various currencies. The Aussie Dollar and South African Rand are two other high interest rate currencies.

Other key influences on the forex market include central banks, their interest rate decisions, currency intervention, currency pegs and the potential of a reserve currency. I’ve got you covered for these topics if you fancy some more reading.

It is worth noting that in periods where the economic climate worsens, investors seek refuge in safe-haven currencies like the USA dollar or Japanese yen while exiting equities. The reverse also holds true and when risk appetite returns, stocks rise while the dollar falls. Currencies are always traded in pairs and spread trading providers can quote as many as 50 major, minor and exotic currency pairs. Less margin is required for trading forex currencies as the market is quite liquid so it is normally easy to get a tradable price compared with other markets. For the more commonly traded currency pairings, such as Euro-Dollar or Pound-Dollar, spreads are very tight. Of course if you trade less liquid pairs such as USD/SEK (USD/Swedish Krona), the spreads are much wider.

Current Situation

Currency trading has increased in popularity in the last few months. More and more traders are looking for ways to profit from current movements as governments continue with their money-printing fiscal and monetary policies to stimulate their economies. What we are essentially experiencing are hidden currency wars as strong currencies make exports more expensive and as such having a weak currency can be financially advantageous. Interventions from governments to stimulate their economies has led to sizable movements in the USA dollar, Euro, Sterling and Yen in recent months. In present scenarios the ones who actually move to devalue their currencies are indebted currencies primarily led by the USA, Europe and Japan. On the other side of the equation we have the emerging countries like China, Brazil and Russia. These are debtors but also exporters of products and raw commodities and as such prefer a weak currency as it will permit them to reduce their debt piles.

To Conclude

Spread betting is a flexible and tax efficient way to trade the currency markets. But beware, there is no benefit on tax breaks if you don’t manage to make money in the first place. And if you end up losing money, you won’t be able to offset it against any gains, as you can do when trading shares for instance.

The main problem with forex trading is that there are a whole lot of variables to consider and the foreign exchange markets can be very volatile. However, the higher volatility isn’t necessary a bad thing; the forex markets are particularly interesting when the wider markets are flat since you are always trading two currencies against each other and there is always something going up. However, one also has to be careful of exotic pairs, for instance the CAD/SGD typically experiences low interest during the European trading session and the spreads may widen to as much as 10-12 points (compared with 1-3 points for an ordinary trade) making the pair too expensive to deal in.

Many traders get into forex trading because of the high leverage that is normally possible – most brokers offer 1:100 leverage, some even go as high as 1:400. Because of this, anyone with 500 quid could in theory open an account and trade with currencies worth 50,000 pounds. Although this would be quite dangerous of course yet forex trading appeals to the masses who don’t have a lot of money to start with. As a consequence, 90% of Forex traders fail due to overleverage/underfunded accounts.

It is worth noting that certain spread trading companies charge higher spreads than other brokers… while some offer guaranteed stops whereby the maximum you’ll stand to lose (should the market move against you) is guaranteed to be the amount you put as your stop-loss even if market opens much lower. But of course the most important features of a spread betting firm’s offering should be the actual trading software used to make trades- how fast and efficient it is to handle deals.

Many traders end up failing but there are still quite a number of people who make big amounts of money trading forex. But remember that most of the successful ones have travelled a rocky journey on their way to gaining the knowledge they need to be profitable.

>> UK Mortgages with European Interest Rates?

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