To many people, it all seems like a tangled bowl of spaghetti; how can one currency trading chart reads that the index for the US dollar is 1.68, the Euro is 1.90, and the Canadian dollar is .73? Understanding the exchange rates for foreign currency trading isn't difficult but it can be a little confusing. By understanding the language of the Forex markets it is easier to understand these rates and untangle the spaghetti.
Basic Foreign Currency Trading Rates
The exchange rates for foreign currency trading are really born out of a simple formula. That formula reads like this: Y-to-X exchange rate = 1 / X-to-Y exchange rate. Because of this inversion, comparing US dollars to Euros is a different number than comparing Euros to US dollars. For example, one Euro is worth 1.34 US dollars but 1 US dollar is worth .75 Euros. Since a Forex trade is bi-directional, so are the ratios.
If it still doesn't seem to make sense, think of foreign currency trading the same way you would if you were converting from metric to English measurement and visa versa. One mile is equal to 1.6 kilometers , yet 1 kilometer is only equal to 0.6 miles .
How to Read Foreign Currency Trading Charts
Forex markets use charts that have a basic structure for foreign currency trading; the first column is the country code, which is a three letter code that designates the currency. For example, the United States dollar is represented by USD, while the Canadian dollar has a code of CAD. The second column in a foreign currency trading chart is the name of the country and its currency. The remaining columns each reflects comparisons between the base currency desired and other currencies. This type of foreign currency trading chart allows for fundamental analysis of the rates for a particular currency against the other currencies of the world.
Sample Foreign Currency Trading Chart
Sometimes using a visual can help make an explanation clearer; note the sample chart below:
Code Country Units/USD USD/Unit Units/CAD CAD/Unit
ARP Argentina (Peso) 2.9450 0.3396 2.1561 0.4638
AUD Australia (Dollar) 1.5205 0.6577 1.1132 0.8983
BSD Bahamas (Dollar) 1.0000 1.0000 0.7321 1.3659
BRL Brazil (Real) 2.9149 0.3431 2.1340 0.4686
CAD Canada (Dollar) 1.3659 0.7321 1.0000 1.0000
This example helps to show the workings of the chart and the relationship between the various currencies. For instance, looking at the row for the Canadian dollar, the foreign currency trading chart shows that the US dollar is worth about 1.37 Canadian dollars, one CAD is worth about .73 USD, and just for assurance 1 CAD is equal to 1 CAD. (That seemed like an investment basic, but aren't you glad it worked out right?)
Looking for Arbitrage in Foreign Currency Trading
Arbitrage is the investment strategy of trading multiple currencies with the intention of profiting from any differences in the exchange rates. For example, we will trade USD, CAD and ARP. We will sell 5 USD and in return get 6.8295 CAD. After this we will sell our 6.8295 and get 14.725 Argentinean pesos. Finally when we sell our pesos and buy US dollars we get 5.00 again. While this example did not yield an arbitrage for us, it is easy to see how it works. If your investment timing is right and you catch volatility between the various pairs, arbitrage has the potential to be very profitable
Conclusion
Foreign currency trading can have its confusing moments, tangled up like a bowl of spaghetti. Once you learn Forex trading, concepts like foreign currency trading charts crystal clear!
Tuesday, April 29, 2008
Foreign Exchange Swaps
One of the beauties of Forex trading lies in the ability to trade using leverage, which is often as high as 1,000 times your capital. In other words, you can effectively borrow up to 1,000 times your capital in order to trade. But borrowing money to trade is no different to borrowing money for any other purpose and you will be charged interest.
However, because every transaction involves both buying and selling currency, interest payments payable on money borrowed to fund a transaction can be offset by interest earned on the currency held. If this seems a little confusing we'll look at an example in a moment, but first it is worth just taking a moment to examine the subject of interest rates in general to see the wider picture as it affects the Forex market.
Interest rates are established by central banks and are used to regulate a currency in order to meet a country's monetary policy. Interest rates directly affect the cost of a currency with high interest rates making it expensive to buy a currency and low interest rates making a currency more affordable.
As a tool of monetary policy the government of a country facing high inflation, with the price of goods and services rising rapidly, might choose to raise interest rates. This would have the effect of raising the cost of currency so that borrowing becomes more expensive and both demand and consumption fall. Following the normal laws of supply and demand, as demand falls, so the rate at which prices rise will also fall and inflation will come down.
By the same token, a country facing recession might well choose to lower interest rates in an effort to stimulate the economy into growth. As the cost of the currency falls, so too will the cost of borrowing and investors, companies and individuals will be encouraged to borrow and thus spend more, so increasing demand and stimulating supply to meet that demand.
Interest rates established by central banks determine the rate at which commercial banks can borrow from the government and thus the rate at which they will lend to their customers, including Forex traders.
So just how do interest rates impact individual Forex trades?
Suppose a trader buys GBP/USD at 1.9430. In this case he is borrowing US Dollars to buy UK Pounds and is thus paying interest on the US Dollars he has borrowed and is earning interest on the UK Pounds which he holds.
If the Bank of England has set a higher rate of interest for the UK Pound than the Federal Reserve has set for the US Dollar then the trader has the opportunity to earn more in interest on the UK Pounds that he is holding than on the US Dollars he had borrowed.
However, unless interest rates are particularly high on one currency and the differential between the two interest rates is significant, any net gain or loss is likely to be small. It should also be borne in mind that interest rates are set at an annual rate and that most currency trades are conducted over short, or extremely short, timeframes. This again will reduce any interest gained or paid considerably.
However, because every transaction involves both buying and selling currency, interest payments payable on money borrowed to fund a transaction can be offset by interest earned on the currency held. If this seems a little confusing we'll look at an example in a moment, but first it is worth just taking a moment to examine the subject of interest rates in general to see the wider picture as it affects the Forex market.
Interest rates are established by central banks and are used to regulate a currency in order to meet a country's monetary policy. Interest rates directly affect the cost of a currency with high interest rates making it expensive to buy a currency and low interest rates making a currency more affordable.
As a tool of monetary policy the government of a country facing high inflation, with the price of goods and services rising rapidly, might choose to raise interest rates. This would have the effect of raising the cost of currency so that borrowing becomes more expensive and both demand and consumption fall. Following the normal laws of supply and demand, as demand falls, so the rate at which prices rise will also fall and inflation will come down.
By the same token, a country facing recession might well choose to lower interest rates in an effort to stimulate the economy into growth. As the cost of the currency falls, so too will the cost of borrowing and investors, companies and individuals will be encouraged to borrow and thus spend more, so increasing demand and stimulating supply to meet that demand.
Interest rates established by central banks determine the rate at which commercial banks can borrow from the government and thus the rate at which they will lend to their customers, including Forex traders.
So just how do interest rates impact individual Forex trades?
Suppose a trader buys GBP/USD at 1.9430. In this case he is borrowing US Dollars to buy UK Pounds and is thus paying interest on the US Dollars he has borrowed and is earning interest on the UK Pounds which he holds.
If the Bank of England has set a higher rate of interest for the UK Pound than the Federal Reserve has set for the US Dollar then the trader has the opportunity to earn more in interest on the UK Pounds that he is holding than on the US Dollars he had borrowed.
However, unless interest rates are particularly high on one currency and the differential between the two interest rates is significant, any net gain or loss is likely to be small. It should also be borne in mind that interest rates are set at an annual rate and that most currency trades are conducted over short, or extremely short, timeframes. This again will reduce any interest gained or paid considerably.
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