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Currencies

Posted By Robert On Wednesday, November 27th, 2013 With 0 Comments

Currency trading has exploded over the recent years with the advances in technology and the internet. In fact, with the recent exponential growth in global economies, currency trading is becoming increasing popular for traders old and new.

A foreign exchange rate is the amount of one unit of currency needed to sell (or buy) in order to buy (or sell) one unit of another currency.

It is important to fully understand that when trading currencies, are you buying or selling. As currencies are quoted in pairs, it is the ‘first’ currency that you are trading against the ‘second’ currency.

So if for example you are watching Euro / Dollar and you are ‘buying’ then you are expecting the Euro to strengthen and the Dollar to weaken.

On the other hand, if you are ‘selling’ then you expect the Euro to weaken and the Dollar to strengthen.

Remember the underlying currency is always the first named currency that is quoted in the pair and is always the one that you buy or sell against the other currency in the pair.

The ‘bet per’ is the last figure before the decimal place in the quote. For example, the British Pound/US Dollar Spread is 19401.5 / 19404.5 so a move from 19404.5 to 19405.5 is one point.

Some traders favour foreign exchange (forex) currency trading over equity and index trading because the foreign exchange markets are the largest and most liquid in the world. Which means there is less likelihood of any adverse event such as a “price gap”, and you can trade currencies pretty much 24/7 which may be useful if you need to trade out-of-hours while also holding down your “day job”.

Similar to commodities, currency trading is considered a higher risk vehicle and as currency trading can be volatile it may not be suitable for all traders. As with all markets, common sense and control of risk is very important. Most if not all of the spread betting companies allow you to trade currency pairs such as the GBP:EUR (British Pound vs. Euro) or USD:AUS (US Dollar vs. Australian Dollar).

Note: Our preferred method of trading method for FOREX is the via the use of technical analysis. Technical analysis is the study of past price and volume information to try and predict future movements in price. A FOREX trading strategy is a must and as this site grows we will be bringing you some of our favourite trading strategies for you to learn form and potentially trade yourself.

Dealing in foreign exchange currencies has been the preserve of high net individuals and institutions in the past, but spread betting has opened the market up – and the volatility of certain currency pairs makes them well suited for dealing this way. In fact, most providers have experienced a surge in currency trading over the past 7 years.

Example of a Currency trade:

With a spread betting account you also have the option to trade major indices, equities and commodities as well as FOREX.

Opening a position:

Today is March 1st and the spread betting provider is quoting GBP v USD Rolling Spot (also known as ‘Cable’) as:

GBP v USD SELL 20500.0 – 20503.0 BUY

In this currency pair, the British pound is the first named currency and therefore the underlying currency. You have 2 options:

OPTION 1: You believe the British pound will appreciate against the US Dollar (US Dollar will weaken against British Pound); you BUY British Pound/US Dollar.

OPTION 2: You believe the British pound will weaken against the US dollar (US dollar will strengthen against British pound); you SELL the British pound/US dollar.

You decide that the British pound will appreciate against the US dollar so you BUY at 20503.0 for £10 per point.

Closing a position:

Today is March 5th and after a few days of volatility you decide to get a quote on GBP v USD Rolling Spot. The provider’s quote is:

GBP v USD SELL 20630.0 – 20633.0 BUY

To close your position, you decide to sell £10 per point at 20630.0

Your profit is calculated as below:

Opening Level 20503.0
Closing Level 20630.0
Difference 127.0

You bet £10 per point, hence your profit is calculated as;

127 x £10 per point = £1270

Financing of rolling spot currencies

Overnight financing on rolling spot currencies is based on the industry standard method for calculating currency financing in the official FX market. This is referred to as ‘Spot Next’ financing.

Spot Next financing is the rate used to finance your product from the ‘Spot’ date to the following business date, hence the term ‘Spot Next’. The provider then uses these rates to determine what your financing rate is to hold your currency bet overnight.

Due to the convention of the underlying FX market, financing to cover a weekend period is actually transacted on a Wednesday evening. You will therefore pay or receive 3 days of financing to hold your position from a Wednesday to a Thursday. Spot Next financing rates also incorporate public holiday dates into the rates. Therefore Spot Next points will take into account 4 days worth of financing on a Wednesday evening if there is a public holiday the following Monday.

Spot Next financing rates are calculated using the interest rates of the two currencies that you have traded. The general rule is that you will receive interest on the currency you are long and pay interest of the currency you are short. The amount you pay and receive on each of these is dependent upon the interest rate of each currency of the pair. It should be remembered that if you are long a currency bet, you are long the first named currency and short the second. If you are short a currency bet then you are short the first named currency and long the second. For example, if you have a position £10 short of GBP/USD then you are short GBP and long USD.

In summary the table below illustrates when you pay financing and when you receive funding:

Financing of Rolling Spot Positions

Example

Euro v Dollar Rolling Spot (EUR v USD)

Euro Zone Interest Rate = 3.75%
US Interest Rate = 5.25%

Tuesday 10th April
The provider is quoting:

EUR v USD SELL 14550 – 14552 BUY

1) You sell £10 Euro Dollar at 14550

You are selling Euros (thus paying Euro interest) and buying US dollars (thus receiving US dollar interest).

Since you are paying the lower rate of interest and receiving the higher rate of interest, you will effectively receive financing each night.

How much do you receive?

Spot Next points are 0.40 – 0.50
(If you are long, you pay financing rate of 0.50 if you are short you receive 0.40 in financing).

Tuesday financing: £10 (stake) x 0.40 = receive £4.00

Wednesday financing: £10 x 1.20 (0.40 x 3) = receive £12.00 (This
incorporates 3 days of financing to cover the weekend period).

Thursday financing: £10 x 0.40 = receive £4.00

2) You buy £10 Euro Dollar at 14552

Here you are buying Euros (hence receiving Euro interest) and selling US dollars (hence paying US dollar interest).

You are effectively receiving the lower rate of interest and paying the higher rate of interest therefore you will pay a net financing rate for rolling your bet each night.

Tuesday Financing: £10 x 0.50 = pay £5

Wednesday Financing: £10 x 1.50 (0.50 x 3) = pay £15

Thursday Financing: £10 x 0.5 = pay £5

Calculating Spot Next Points

The provider uses Spot Next prices from recognised financial institutions to calculate FX financing. The following is an example of how to calculate Spot Next points for British Pounds / US Dollar (Cable). We will make a number of assumptions:

Currency Rate: 19862.0
GBP Overnight Deposit Rate: 5.75%
USD Overnight Deposit Rate: 4.50%
British Pound deposit: £10,000

The Spot Next calculation rate is calculated as:

(($19862.0 + (($19862.0 x 4.5%)/360)(£10000 + ((£10000 x 5.75%)/365))) x 10000) – 19862.0

(19864.48 / 10,001.58) x 10000 = 19861.34 (forward rate)

19861.34 – 19862.0 = -0.66

Spot Next points reflect the funds the client would have gained/lost had the actual amounts of the two currencies traded been deposited overnight. Therefore, if 19,862 USD were invested overnight, it would be worth USD 19,864.48. If GBP 10,000 were invested overnight it would be worth GBP 10,001.58. The forward rate for tomorrow is then calculated by simply dividing USD 19864.48 by GBP 10,001.58 and multiplying by a factor which returns 19861.34. The Spot Next point is then calculated as the difference between tomorrows’ forward rate and today’s rate (19861.34 less 19862) to give -0.66.

If the forward rate was not calculated as such, then one party would be receiving an unfair advantage by deferring the exchange of currencies.

Spot Next prices have two prices, one used for long positions and one used for short positions. This is to reflect the difference in the deposit rate where money can be borrowed and lent. For instance, Spot Next points are 0.40 – 0.50 (see example 1) above; if you are long, you pay a financing rate of 0.50 if you are short you receive 0.40 in financing.

P.S. Be careful trading currencies. This what Robbie Burns; a veteran trader had to say: ‘Never ever get tempted into spread betting Forex. Nearly everyone loses over time. Yes, that will include you. The only ones to make money out of it are those selling you Forex “systems”. Oh, and the spread betting firms of course. You will be bombarded with ads for Forex winning strategies. Don’t fall for it.’

I am inclined to agree with Robbie about Forex trading, and in this guide my preference for spread betting equities will have been obvious, but I know that some other traders would likely disagree with both of us. In one sense I think that any financial instrument with a fluctuating price can be successfully (or not so successfully) spread bet and therefore the perceived problem may be with ‘forex systems’ rather than with forex markets.

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