Financial Markets: Forex

One of the newest financial markets available to the individual retail trader is the foreign exchange market. While the foreign exchange market has been around for a long time, only recently have small retail traders been able to participate in it. The foreign exchange market also known as Forex or simply FX is the single largest market available today. Each day, there is approximately $5.1 trillion that exchanges hands in the FX markets. In comparison to the entire US stock market which trades an average of $100 billion in daily turnover, the FX market is not only the largest but is over 50 times the size of any other market. Because of this, liquidity is never in short supply in the FX market. Investors can rest assure that if the underlying price touches their predetermined values, it is almost certain that their orders will be filled. FX pairs are composed of two currencies represented by three letters and arranged in the pattern XXX/YYY. For example, the largest pair is EUR/USD which exchanges the Euro and the U.S. dollar. The first currency in the pair is referred to as the base currency, and the second is referred to as the quote currency. In this example, the value of the pair EUR/USD (Ex. 1.25000) tells us how many Dollars we can get for one Euro; in this case one Euro equals $1.25. There is a currency exchange rate for nearly every recognized currency in the world. FX pairs are split into three basic classifications: major pairs, minor pairs, and exotic pairs. Exactly which currency pair belongs to each category can be found with a simple Google search, but the largest portion of the daily $5.1 trillion comes from the major and minor pairs. The smallest increment that a currency pair can move is referred to as a “pip.” For the majority of currency pairs, a pip is represented by the fourth decimal place (0.0001). Most currency quotes will also quote a fifth decimal place which is referred to as a the micro-pip or pipette. Notable exceptions to this rule include any pair which has JPY(Japanese Yen) in its quote currency. USD/JPY for example is quoted as 111.500 where the second decimal place is the pip (0.01). Most retail traders use leverage in order to increase the potential profits they stand to make from any one trade. For an individual with a $10,000 account that offers 50:1 leverage, he or she can buy or sell up to $500,000 in notional currency. This process is know as trading on margin. Traders use “lot size” to specify how many units of notional currency they wish to own. A standard lot, written as 1.00 is equivalent to 100,000 units of quote currency. Thus to buy one standard lot of EUR/USD is to control $100,000. Additionally, traders can also use “mini lots” (written as 0.1 and equal to 10,000 units) and “micro lots” (written as 0.01 and equal to 1,000 units) to create very specific lots sizes such as 5.73 or 573,000 units. You may be saying $100,000 is a lot of money to have in a trading account, but leverage reduces this burden significantly. For example, a person whose account offers 100:1 leverage would only need $1000 in their account to control one standard lot of $100,000. Because of this, Forex allows traders with very minimal capital to start trading and potentially grow their accounts to larger values. 

CFTC Required Rule 4.41:

Hypothetical or simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been executed, the results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profit or losses similar to those shown.

Hypothetical Performance Disclaimer: 

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.