Forex Market Financial World

The forex market is the largest financial market in the world, trading in excess
of USD4 trillion in a single day. Although hundreds of currencies change
hands every day, most of the trading centers on seven major currency pairs.
The currency pair that handles the highest volume of trade is the EUR/USD.
A forex quote is always displayed in pairs. Examples include
EUR/USD, USD/JPY, and AUD/CHF. The currency on the left is called the
base currency while the currency on the right is called the counter cur-
rency. Almost all currency pairs are quoted to four decimal places, except
when the Japanese yen appears in the counter currency. In such cases, the
forex quote is displayed in two decimal places.
A pip is the smallest price movement in a currency pair. If the EUR/USD
moves up from 1.3435 to 1.3436, this movement is called 1 pip. Similarly, if
the same quote moves down from 1.3435 to 1.3434, the movement is also
called 1 pip. Whenever the U.S. dollar appears as a counter currency, 1 pip
earns the trader USD10 for one standard lot.
Some forex brokers go one step further and quote prices to fi
ve deci-
mal places. For such brokers, the EUR/USD quote could be seen as 1.34358.
It is important for us to take note that the fi
fth decimal place is not called
a pip but a pipette. Quotes that have the Japanese yen as the counter cur-
rency are displayed in three decimal places instead of two in these cases.
Brokers provide retail traders with leverage to trade the forex market.
Without leverage, a trader would need to pay out USD100,000 to trade one
standard lot of currencies. With a 100:1 leverage, a trader would need to put
up only 1/100th of the entire amount, or USD1,000. This amount is called
margin. Margin basically allows a trader to purchase a contract without the
need to provide the full value of the contract.
The higher the leverage employed, the smaller the margin required to
trade one standard lot. Some brokers even offer leverage up to 500:1. This
means traders need only USD200 to control USD100,000 worth of currencies.
Leverage is a double-edged sword. Although it helps to magnify a trad-
er ’s gains, it can also amplify a trader ’s losses. Hence, it is imperative that
traders fully understand the pros and cons of leverage before deciding the
appropriate amount of leverage to employ.