The world of currency trading, also known as forex trading, operates on its own set of market conventions and terminologies that may seem daunting to newcomers. However, with a little understanding, you'll find that most currency trade conventions are quite straightforward.
One of the primary mental hurdles for new forex traders, especially those familiar with other markets, is grasping the concept that each currency trade involves a simultaneous purchase and sale. Unlike in the stock market, where buying 100 shares of a company means you own those shares and hope to see their price increase, in forex, buying one currency means you are simultaneously selling another. This is why currencies come in pairs, with names that combine the two currencies being traded against each other.
The U.S. dollar (USD) is the central currency against which other currencies are traded. The USD's dominance in the forex market is due to several factors, such as the U.S. economy being the largest in the world, the USD being the primary international reserve currency, and its widespread use in global transactions.
Major currency pairs involve the USD on one side of the deal, and they are denoted using International Standardization Organization (ISO) codes for each currency. For instance, EUR/USD represents the euro against the USD. Other major currency pairs include USD/JPY, GBP/USD, and USD/CHF, among others.
Additionally, there are cross-currency pairs, also known as "crosses," which do not include the USD. These pairs involve trading one major currency against another. Crosses can be effective for targeting trades to specific currencies based on news or events. Examples of crosses include EUR/JPY, GBP/JPY, and AUD/CAD.
To calculate profits and losses (P&L) in forex trading, traders use pips, which represent the smallest price increment in currency pairs. Most currency pairs are quoted with four digits after the decimal point, except for JPY pairs, which have two digits. Pips help traders determine the movement of currency prices and the resulting P&L.
Realized P&L occurs when you close out a trade position or a portion of it, while unrealized P&L reflects the profit or loss on open positions based on the current market value. Online forex trading platforms automatically calculate P&L, but it's essential for traders to understand how it works to manage risk effectively.
Understanding rollovers is also crucial in forex trading. Rollovers are transactions where open positions are carried over to the next value date. Rollover rates are based on the interest rate differential between the two currencies in the pair. Larger interest rate differentials result in more significant rollover impacts. Traders can use rollover rates to factor in interest gains or expenses when holding positions overnight.
Overall, grasping currency pairs, calculating P&L, and understanding rollovers are essential aspects of successful forex trading. With practice and knowledge, traders can navigate the forex market with confidence and make informed trading decisions.