BACKGROUND

The Foreign Exchange market, also referred to as the “Forex” or “FX” market, is the largest financial market in the world, and according to industry sources has a daily average turnover of well over US$1 trillion -- 30 times larger than the combined volume of all U.S. equity markets.

QUOTING CONVENTIONS

As with all financial products, FX quotes include a ‘bid’ and ‘offer’. The ‘bid’ is the price at which a dealer is willing to buy (and clients can sell) the base currency for the counter currency. The ‘ask’ is the price at which dealers will sell (and clients can buy) the base currency for the counter currency.

The US dollar is the centerpiece of the Forex market and is normally considered the ‘base’ currency for quotes. In the “Majors”, this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The exceptions to USD-based quoting include the Euro, British pound (also called Sterling), and Australian dollar. These currencies are quoted as dollars per foreign currency as opposed to foreign currencies per dollar.

To illustrate a typical FX trade, consider the following example.

The current bid/ask price for USD/CHF is 1.1822/1.1827, meaning you can buy $1 US for 1.1827 Swiss Francs.

Suppose you decide that the US Dollar (USD) is undervalued against the Swiss Franc (CHF). To execute this strategy, you would buy Dollars (simultaneously selling Francs), and then wait for the exchange rate to rise.

So you make the trade: purchasing US$100,000 and selling 118,270 Francs. (Remember, at 2% margin, your initial margin deposit would be $2,000.)

As you expected, USD/CHF rises to 1.2035/40. You can now sell $1 US for 1.2035 Francs or buy $1 US for 1.2040 Francs. Since you bought Dollars and sold Francs in your previous trade, you must now sell Dollars for Francs to realize any profit. If you sell US$100,000 at the current USD/CHF rate of 1.2035, you will receive 120,350 CHF.

Since you originally sold (paid) 118,270 CHF, your profit is 2080 CHF. To calculate Dollar-based P&L, simply divide 2080 by the current USD/CHF rate of 1.2040.

Total profit = US $1727.57

FACTORS EFFECTING THE MARKET

Currency prices are affected by a variety of economic and political conditions, most importantly interest rates, inflation and political stability. Moreover, governments sometimes participate in the Forex market to influence the value of their currencies, either by flooding the market with their domestic currency in an attempt to lower the price, or conversely buying in order to raise the price. This is known as Central Bank intervention. Any of these factors, as well as large market orders, can cause volatility in currency prices. However, the size and volume of the Forex market makes it impossible for any one entity to "drive" the market for any length of time.

FUNDAMENTAL vs TECHNICAL ANALYSIS

Currency traders make decisions using both technical factors and economic fundamentals. Technical traders use charts, trend lines, support and resistance levels, and numerous patterns and mathematical analyses to identify trading opportunities. Fundamentalists predict price movements by interpreting a wide variety of economic information, including news, government-issued indicators and reports, and even rumour.

The most dramatic price movements however, occur when unexpected events happen. The event can range from a Central Bank raising domestic interest rates to the outcome of a political election or even an act of war. Nonetheless, more often it is the expectations surrounding an event that drives the market rather than the event itself.