Understanding the basics of Forex!

By BankBazaar | August 20, 2013

Commonly referred to as FX in short, the forex market is by far the largest in the world with over trade worth $ 4 Trillion on an average day. Simply stated this implies exchange of currencies of foreign countries with the purpose of trading. In India there are three aspects of Forex starting with the RBI which is the overall regulator, the bank to bank or inter bank trading and bank to customer or merchant rate transaction trading of foreign exchange. An interesting fact about Forex is that it cannot be dome at the individual level and all transactions have to be dome through a bank only. With these facts as premises this article will discuss some of the basic elements of Forex trading.

  • All communication in Forex trading is done from the bank point of view. If a customer wants to buy a certain amount of USDs, then instead of referring to it as the customer wants to buy, it is always said as the bank wants to sell.
  • The two market rates referred to in Forex are the Bid and Ask. Bid is the rate at which the foreign exchange is bought and Ask is the selling rate of the same.
  • Conventionally the market if Forex buys at a lower rate of the exchange and sells at a higher rate. Assuming that 1USD =55.50 INR this implies that the bid is Rs. 55.50 and the Ask maybe a higher figure like Rs. 56.00
  • Quotes in Forex are two types – Direct and Indirect. The direct quite is the pricing of a certain number of units of currency of home country as against one unit of the foreign currency. For example Rs. 55.50 for 1$. In the UK this can be 0.19 Sterling Pounds =1$ since the home currency there is pound sterling. In an indirect quote the opposite happens. In this case the quote is for number of units of foreign currency against one unit of home currency. For example Rs. 1 =1/56th of $.
  • Conventionally the direct quote is referred to as American and the indirect quote is referred to as European across the globe.
  • Spread in Forex is the difference between the Bid and Ask value of currency at that time. For example if the Bid is 1$ =Rs 55 and the Ask is 1$ =Rs 60 then the spread at that time is Rs. 5. As an indicator of the market a lower spread indicates a stable market as compared to a higher spread.
  • Cross rate in Forex refers to indirect relationship between two currencies. For example if quotes are 1USD =Rs 55 and 1 Euro =Rs 80 then this is a cross rate between USD and Euro.
  • In Forex the exchange rate can be based on Spot market or Future market. Spot market implies that the settlement will be made on the second working day after the transaction. Future market implies that the rates will be fixed for a future date. Thus if a bank fixes a particular exchange rate for a day in near future but the prices change, the bank will still have to buy at those rates and face the losses. The same is applicable for individual bidders in the Forex markets.
  • The appreciation and depreciation formulas referred to in the Forex simply mean the change in value of a particular currency against another one over a period of time typically calculated for a year. For example if USD/INR ratio has moved from 45 to 54 in a year then the depreciation for INR is calculated and the appreciation of USD is calculated. For direct quotes (Forward Rate – Spot rate)/Spot rate x 12 Months gives appreciation or depreciation rates for that year. But in case of indirect quotes the formula used is (Spot Rate – Forward Rate)/ Forward rate x 12 months is used to calculate appreciation or depreciation.
  • Swap Points in Forex refers to the difference between Forward rate and the prevailing Spot Rate.

These are some of the more often used terms in Forex which are useful in getting the preliminary idea about this sphere of trading. Forex trading is an arena worth exploring for people who have the inclination and interest in gaining maximum from their investments. However Forex trading has its own share of risks which must be understood prior to investing. With a little study and research the Forex trading can be mastered by any one with basic knowledge of finances and markets.

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