Personal Investment > Forex

Forex

Foreign exchange, also known as FOREX, is traded round-the-clock by financial institutions, commercial users and individual investors around the world. The top foreign exchange trading centres are London, New York, Tokyo, Singapore and Hong Kong.

How does FOREX work?

In spot foreign exchange trading, you can buy or sell a currency priced in terms of another currency in the interbank spot foreign exchange market through Phillip Futures.

For example, when you buy US$/¥, you are actually buying US$ priced in terms of Yen. Therefore, when you buy US$/¥ at a rate of 115, it means that you are buying US$1 priced at ¥115. If your market view is correct and you sell it at ¥116, you would make a profit of ¥1. When buying a FOREX contract, the contract or position can be closed-out or liquidated later by an opposite offsetting sell transaction.

In actual trading, however, investors buy or sell in minimum multiples of US$100,000 for most currencies, except British Pound, Australian Dollar and New Zealand Dollar which would be 100,000 in BP, A$ and NZ$ respectively. As a trading example, if an investor who develops a view that on the basis of economic fundamentals and/or technical analysis that the US dollar is going to appreciate against the Yen, he can decide to buy US$100,000 at the prevailing price of ¥115 and then sell if the price rises to ¥120.

The result, if his view was correct, would be a profit of ¥500,000 (120 - 115 = 5 x US$100,000).

Margin Trading in FOREX
To buy or sell US$100,000, however, you do not need to deposit the full amount but only a margin of usually 2-5% of the amount traded. However, investors should be prepared with more than just the minimum margin deposit to weather price fluctuation.

For investors who use foreign exchange contracts for trading, there is also no need to do physical delivery of the currencies. Instead, the foreign currency contract or position would be automatically rolled-over or carried forward indefinitely until the investor decides to liquidate the position.

SWAP Points
In addition to foreign exchange rate which determines the profit and loss of a trade, another factor to note is that there are also interest rates applicable when buying or selling foreign exchange.

The buyer or holder of the currency which bears a comparatively higher interest rate will receive interest rate differential between the two currencies daily while the holder of the opposite currency which bears a lower interest rate will be debited the daily interest rate differential.

This interest differential is referred to or calculated as swap points which would be used to discount or add a premium to the buying or selling prices to reflect the daily interest earned or paid.

For example, the buyer of US$ at a price ¥135 would have his price discounted to reflect the interest differential earned (when US$ interest rate is higher then Yen interest rate).

So when his US$ position is rolled forward at the "spot" delivery date which is two days later, the buying price of ¥135 would be adjusted to, say, ¥134.99 if the interest swap points was 1 point.

To find out more information on Forex, please visit our Futures site.