» Foreign Exchange Risk and Reward

International travel and spending is on the rise. According to the Office for National Statistics, the annual number of visits overseas by UK residents jumped nearly 20 percent from 2002 to 2007. Along with the increase in cross-border travel, the associated international spending by UK individuals has also increased – up to a staggering £9.8 billion in 2007. With the steady increase in international travel, chances are good that you are likely quite familiar with exchange rates. You may know how much money can be made or lost when changing from one currency to another.

Or perhaps you’ve had a go at trading shares and have become familiar with foreign exchange risk and reward through company mergers and acquisitions, as international businesses integrate to compete in a constantly evolving global economy. When a company purchases goods and services from foreign suppliers, it faces exchange rate risk. If you take a look at any publicly traded company’s annual report, you’ll likely find P&L lines for foreign exchange dealings.

No matter what your level of familiarity with exchange risk and reward is, there are now an abundance of speculative opportunities that cater to individuals wishing to get into the foreign exchange marketplace. This is why the practice of trading foreign currencies online has increased more than fourfold from 2002 to 2007 – up to an average daily volume of £1.65 billion. 

Spot forex, the abbreviation for foreign exchange, is the largest financial trading market in the world. It is based on the principle that as the supply and demand of a country’s currency fluctuates, the value of one currency relative to another can change dramatically. These changes in the relative value of a country’s currency provide speculative opportunities and advantages over trading individual shares or indices.

The currency speculation that used to happen only between large banks in the interbank market over the telephone can now be done by individuals from home, or while travelling, any time of the day or night. The use of technology has greatly opened up the spot forex market for average investors to access and trade. The pound, euro, yen, dollar and a variety of other currencies can now quickly and easily be traded from a personal computer or even a mobile phone.

Unlike traditional financial markets, speculators can respond to currency value fluctuations caused by economic, social and political events at the time they occur, day or night. This means that you can attempt to profit from the exchange rate differences by placing a trade whenever you want, 24 hours a day, 5.5 days a week.

Figure 1. Source: GFT’s DealBook® 360 trading software

By taking a look at the figure 1, we can see that in almost seven months, the pound fell in value against the U.S. dollar by .1639 pence. While that may not seem like very much of a decrease in value, if it is punted correctly, it could result in a handsome profit of £8,434 or more for the speculator. Of course, a move in the opposite direction could have resulted in a loss of equal or greater value.

How spot forex works

Spot forex trading involves speculating on exchange rates between two currencies. When you place a trade, you are simultaneously buying one currency and selling another, as forex is always traded pairs, such as GBP/USD or EUR/USD. When you buy one currency, you must give up something (another currency) in exchange, similar to how you would give up money to buy shares of a company in the stock exchange. Therefore, you would never refer to buying or selling any one currency by itself.

It is important to understand that the exchange rate between two currencies specifies how much one currency is worth in terms of the other. The first currency is the base currency, and the second currency is the pricing currency. A quoted exchange rate indicates the amount of pricing currency that can be exchanged for one unit of the base currency. For example, if GBP/USD is quoted as 1.9322, it means that one pound can be exchanged for 1.9322 U.S. dollars.

Because currency pairs can be bought or sold to seek a profit, it is helpful to think in terms of the first currency pair listed in the quote. For example, if you think the pound will increase in value, you’d buy the GBP/USD. If you think it will decrease in value, you’d want to sell the GBP/USD currency pair. Remember that in this example, your forecasted increase or decrease for the pound is in relation to the U.S. dollar. 

When trading with a spot forex broker or dealer, you will receive a quote that includes two numbers, such as GBP/USD 1.9322/1.9324. The first price is the price at which you can sell the pair, and the second price is that at which you can buy the pair. The difference between these two numbers is referred to as the “spread.”

Speculators can “gear” their trading capital to control 100,000 units of currency in the spot forex market, which is another reason why currency trading has grown in popularity. This is also referred to as leverage, and means that just a .0001 pound move in one direction can mean quickly realised P&L opportunities. Spot forex allows you to use a smaller amount of capital to control a larger market position than what is possible with other traditional financial markets.

Learn more about the basics of trading spot forex with GFT, a leading provider of spot forex, CFD and spread betting software and services. If you’d like to try trading for yourself, log on to www.gftuk.com for a free practice trading account.

CFDs, spot forex trading and spread betting carry a high degree of risk to your capital and it is possible to lose more than your initial investment as well as any variation margin that you may be required to deposit from time to time. You should only speculate with money that you can afford to lose. These products may not be suitable for all investors; therefore please ensure that you fully understand the risks involved and seek independent advice if necessary and prior to entering into such transactions.

GFT Global Markets UK Limited is authorised and regulated by the Financial Services Authority. GFT Global Markets UK Ltd. Subsidiary of Global Futures & Forex, Ltd.

CFDs · SPOT FOREX · SPREAD BETTING

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This entry was posted on Thursday, May 15th, 2008 at 22:21 and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.