Forex Glossary Archives - Forex Education

Trading Limits in the Currency Markets

Forex trading limits in the currency markets

Forex daily trading limit is the maximum amount, either up either down, that exchange-traded security (currency pair) is allowed to fluctuate in one trading session.

The price of a security like a stock or currency that is traded will change daily depending on a number of factors like political, economic news, demand, the supply of the currency and other factors. In some cases, large dealers and traders may attempt to manipulate the price of the security to maximize their profit. Hence to curb the manipulation in the foreign exchange (forex) or other securities market and make it less volatile, limits are set by the exchange or the regulatory body. Usually, for forex, the forex trading limits are specified by the central bank for the particular currency.

After the daily trading limit is reached for the specified currency, further trading will not increase or decrease the exchange rate beyond the limit which is specified. However, it may be possible to continue trading at the exchange rate limit which has been reached. The market which has reached the trading limit is called a locked market. Alternately the market status is limit up or limit down if the upper or lower price/exchange rate limit has been reached respectively. When trading resumes, the next day, the new limits will be set, based on the previous close.

Central bank

The exchange rate for a particular currency affects the economy of the country, the exports, and imports for the country. Hence the central bank of the country is usually responsible for deciding the limits to control the volatility of the currency of the country in the forex market. In the United States, the Federal Reserve is the central bank of the country. The central bank has currency reserves, and it will ensure that the forex rate for its currency remains within the desired limit by selling or buying currencies, by altering the composition of the currency reserve.

Though these efforts of the central bank will make the currency less volatile, and reduce the manipulation of the forex rate, it could lead to overvaluation or undervaluation of the currency. Also, the limits imposed on daily trading can adversely affect the valuation of the asset, the currency. There are usually fundamental factors that affect the value of the currency, like the demand for the currency for paying for imports like crude oil. However, if limits are imposed on the forex rate by the central bank, the currency may not reach its real value, and it may become a mispriced asset.

Reasons for imposing limits

Limits reduce the impact of extreme volatility on the exchange rate for a currency. Often certain political and economic events or news can lead to panic selling or purchasing of a particular currency, resulting in a large increase or decrease in the forex rate. The exchange rate is important for the economy, since a large number of business transactions, especially the value of imports and exports, will vary depending on the currency forex rate. Hence the central bank of the country will usually try to ensure that the increase or decrease in forex rates remains within reasonable limits. This will also ensure that large companies do not manipulate the rates to maximize their profit

Disadvantages of trading limits

Some market analysts, experts and traders are of the opinion that there should be no limits on the forex rates for currencies. They believe that the market participants should determine the forex rate, price of the currency, in a free market. They also claim that these restrictions may be misused by some of the market participants to manipulate the market and make a profit. The ease of manipulating the market depends to a great extent on the trading mechanism used by the exchange, and simpler mechanisms are easier to manipulate.

Conclusion

The daily limits imposed on securities trading are important for those trading in currency and other securities. Forex traders should be aware of the limits for forex rates so that they can make the right decision and reduce the risk of forex trading. These limits help to reduce the volatility in the forex markets which have lower liquidity, and where there is more leverage. In the forex market, the central bank of the country will usually set the limit for the variations in the exchange rate for the currency of the country, since the exchange rate can affect the economy of the entire country.

Bid and Ask Price Meaning in Forex

by Fxigor

Bid and ask meaning in forex

There are different types of securities that can be traded in a financial marketplace. In the case of the forex market, the currencies of different countries and the forex rates are the securities that are traded in the market. In financial markets, especially the forex market, most buyers and sellers like businesses and investors will not interact with each other directly. Instead, the trades in securities like forex will be routed through intermediaries like traders and dealers who will purchase and sell the security on behalf of their client.

Since the traders and dealers are taking a risk in purchasing and selling the forex, there is likely to be a difference in the value of prices at which the security will be purchased and sold. Typically a forex trader will offer a lower price for a currency if he is purchasing it and sell it at a higher price to the currency buyers to compensate for the risk he is taking when investing his money in the currency at a particular time. Hence those who are dealing in forex should be aware of the bid and ask meaning in forex since these terms are used frequently by those selling and buying forex.

Bid price

The bid price in forex is the maximum exchange rate which a forex trader is willing to pay for the currency pair. The forex buyer will always be interested in paying the lowest price for the currency he wishes to purchase and will specify the lowest bid price. This bid price will be considered by forex traders, who wish to sell the specified currency. However, the currency will only be purchased when the currency buyer is able to find a seller who is willing to match his bid price. If the buyer is unable to find a seller, matching his bid price, he may have to increase it.

Ask price

Ask price is the lowest price that the forex dealer or trader is willing to sell the currency for. Often the forex dealer is acting on behalf of a business that is selling a particular currency which it has received as payment for a product or service sold. The dealer will usually look at the bid price of the currency to set the asking price. A deal will be finalized when the forex dealer finds a trader willing to pay the asking price. Though the dealer would want to maximize his profit, setting the asking price high as possible, he will find it difficult to find a buyer for currency, if the price is much higher than the market rate.

Here are below bid, ask price , spread example:

Understanding the bid, ask price

The bid and the ask price are important for those who wish to deal in forex since they provide an indication of the rates at which a transaction is likely to get finalized. The forex trader who wishes to purchase currency will find that he is paying a price which is higher than the current selling price of the currency since there are transaction costs involved for every trade. The information about the bid and ask prices provided by the various forex traders and dealers are used by the forex buyer or seller to choose the trader or dealer who is offering the best possible price.

The asking price, the bid price is an indication of the transaction cost which a person will incur if they purchase a currency and sell it immediately. The bid and ask price will also depend on the economy of the country, financial stability. In some countries, the inflation rates are high, and the currency value, is decreasing rapidly. In these cases, forex traders will find it difficult to find buyers for the currency of the country. Hence if they are investing in this currency, they will usually keep the asking price higher.

Spread

The difference between the bid and the asking price for a particular currency pair is called the forex spread or bid-ask spread. It is an indication of the market liquidity, how easy or difficult it is for a seller to find a buyer who is willing to pay the price he requires. When there is a lot of liquidity in the market, the spread will be low, and when there is less liquidity in the market, the spread will be higher. Typically when forex markets are open, the spread for major currency pairs like the USD/Euro will below. On weekends, major forex dealers are closed, reducing the liquidity in the market and the spread will also be higher.

How Currency Futures Work ?

by Fxigor

Forex futures contracts

The foreign exchange (forex) rates for currencies are always changing depending on a number of factors, so a business trader may wish to ensure that currency is available at a specified rate in the future. Currency futures contracts are a type of forex futures contract for exchanging a particular currency to another at an exchange rate which is fixed on a specified future date. These future contracts are also called forex futures contracts or abbreviated as FX futures. Since the contract value for the future depends on the exchange rate for the currencies, futures contracts are considered to be financial derivatives.

Currency forwards are similar to forex futures in many ways. However, unlike the forwards which are customized, the contracts for futures are standardized. These futures contracts are also traded on centralized exchanges. These currency futures may be used for speculative purposes or for hedging. Since speculators holding the futures can leverage their position, and the futures contracts are extremely liquid, the speculators will prefer to use currency futures instead of currency forwards. Typically one of the currencies in the futures contract is the US dollar.

Understanding currency futures

The forex futures or currency futures are standardized contracts for specified amounts, which can be purchased or sold at the exchanges. These futures are either physically delivered or cash-settled. For the physical delivery of the future, at the date of expiry, the currencies of the amount indicated in the contract must be exchanged. The cash settlement of the futures is done daily based on market prices. Since the prices of the currencies change daily, the difference is settled paying cash till the date of expiration of the contract. The contract can be closed at any date. Forex-futures contracts have multiple components.

Foreign currency futures contract componenets

Underlying asset – this is the exchange rate which has been specified for the currencies

Expiration date – for futures that are physically delivered, it is the date when the currencies are to be exchanged. In the case of cash-settled futures, it is the last date when it will be settled.

Size – the size of a futures contract is standardized. For example, the currency contract for euros is typically standardized at 125,000 euros

Margin requirement – A margin is initially required to enter a futures contract and is called the initial margin. A maintenance margin is also usually specified. If the initial margin reduces below the maintenance margin, a margin call will take place. The trader or investor should deposit money to ensure that the margin is above the maintenance margin specified. Margins can be implemented since currency futures can be traded through clearinghouses and centralized exchanges. These margins reduce the counterparty risk when compared to currency forwards. Typically the initial margin and maintenance margin are four and two percent respectively.

How are currency futures used

Forex futures may be used for speculation or hedging like other futures. The FX futures may be purchased by a business that knows that it will require foreign currency in the future, yet does not wish to purchase the foreign currency immediately. This purchase will help the business in hedging against the volatility if any, in the currency exchange rate. On the expiration date, when the business has to purchase the currency, it will be guaranteed the exchange rate specified in the contract for the FX futures. Similarly, if the business knows that they will receive a large amount in foreign currency for payment, they may use futures for hedging.

Example – How can currency futures be used to hedge the risk ?

For example, the trader sells futures contracts on the euro (EURUSD projection down) to hedge its projected receipt because If the euro depreciates against the US dollar, the company’s projected receipt is protected.

Speculators also use currency futures to make a profit. If the speculators expect the exchange rate for a particular currency to increase, he may purchase a contract for FX futures, hoping for a profit. The speculators can afford these contracts, since the initial margin, is usually very small compared to the contract size. The speculators can leverage their position, to increase their exposure to changes in the exchange rate.

The currency futures can also be used while comparing interest rates in different countries. If there is no parity in the interest rates, the trader may implement arbitrage, using borrowed funds, and a futures contract to make a profit. Investors who are interested in hedging will prefer to use currency forwards since these can be easily customized when compare to the standardized futures contracts. In contrast, currency futures are preferred by speculators since they allow leverage and have high liquidity.

What Does Spread Mean in Forex?

by Fxigor

Calculating the forex spread for a currency deal

The foreign exchange (abbreviated as forex) market is the largest financial market and there are a large number of companies, traders and dealers who are buying and selling different currencies. Usually, the buyer and seller of forex will not deal directly with each other, they will use the services of a trader or dealer to purchase or sell the currencies they require. The trader who is purchasing the currency will specify the maximum amount he will pay which is the bid price. Similarly, the dealer who is selling the currency will also indicate the lowest price for which the currency will be sold.

Forex Spread definition

The forex spread also called the bid-ask spread is the difference between the bid and the ask prices for a specified currency pair. The forex traders and dealers are aware that different companies and organizations worldwide are valuing the currencies of each country differently based on demand and supply. Hence using the information which they have, they are selling and purchasing currencies. The forex trades exploit the fact that the information in the market is asymmetrical, all traders and dealers do not have access to the same information, and this will affect the trading decisions they take

Forex spread Formula

The Forex spread is usually calculated as a percentage and the formula for the forex spread cost calculator is given below

Spread % = ((Ask price – Bid price)/Ask price) X 100

where for the specific deal

Ask price is the lowest price for which currency units will be sold by the dealer

The bid price is the highest price for which the trader will purchase currency units for the deal.

Spread in currency trading

Theoretically, the price at which a trade should take place is the midpoint of the forex spread. This midpoint is calculated by adding the bid and ask price for the deal and getting the average, by dividing the sum obtained by two. Since the currency prices are changing rapidly, the trader and dealer are taking some risk selling and buying currencies, and the spread compensates the traders, dealers for the risk they take.

Factors affecting forex spread for deals

The forex spreads are affected by a large number of factors, which vary depending on the currency pair being considered. Some of these factors are discussed below.

Trading volumes

Usually, when trading volumes are higher, it indicates that there is more liquidity in the market. This also usually implies that the bid-ask spread will be lower. When the forex spread decreases, the difference in the valuations of the dealer, the buyer of the specific currency will also decrease. Hence forex dealers will find it easier to find a buyer whose bid price is similar to their ask price and finalize the trade. Similarly for liquid markets, currency buyers find it easier to find dealers, accepting their offer to purchase the currency at the specified price. Usually, forex spreads will be higher when trading volumes are lower, since dealers, buyers will find it more difficult to find a trade partner for the currency at the price they specify

Political and economic risks

In countries where the economy and the political climate is not stable, the currency is usually associated with greater risk, since its value can fluctuate frequently. In these countries, the inflation rate is typically higher and the approach towards the monetary policy is not very disciplined. Hence for the currencies of these countries, the forex spread will be higher. Due to economic conditions, the dealers will consider the currency of these countries as a risky investment and will sell the currency at a higher price to compensate for the risk. Similarly, the buyers will also want to purchase the currency at a discounted price, to compensate them for the risk which they are taking. So the bid-ask spread will increase in these economies, reducing the forex trade volumes.

Volatile currency

The exchange rate for the currency of a country depends to a large extent on having a central bank which is stable, and discipline in the monetary policy. If the central bank is not stable, and undisciplined, the exchange rate for the currency will change more often. Hence to compensate for the risk which they are taking, the dealers will increase the ask price for the currency, and this will also make the forex spread for the currency higher.

What is Arbitrage Trading in Forex ?

by Fxigor

Arbitrage trading in forex

Arbitrage trading is widely used for making a profit in different sectors, so it is crucial to understand the definition of arbitrage.

Arbitrage is a trading method where the trader will try to make a profit after noticing the differences in the prices of identical, related, or similar financial instruments available from different brokers, organizations, and companies. Various organizations are selling and purchasing financial assets like currencies to varying prices due to differences in costs, profit margins, demand, supply, and other reasons.

Typically Arbitrage usually involves purchasing the asset from the organization selling at a low price, and almost immediately selling the asset to the organization purchasing at a high price for a profit.

The trader is taking advantage of the differences in the prices quoted by the financial organizations. Since the asset is sold almost immediately after it has been purchased, arbitrage is considered low risk for the trader. Yet there is some risk involved in this type of trading if the prices are fluctuating rapidly or the market liquidity levels are low. Many Forex traders would like to find out what is arbitrage trading in Forex, so a detailed explanation is provided below.

Understanding arbitrage trading

It is possible to make a profit with arbitrage trading because the financial markets are not perfect and efficient. The price of any asset in the financial market depends on the demand and supply of the asset. Hence any change in the supply or demand can result in a decrease or increase in the price of the asset. The arbitrage traders try to make a profit from the temporary glitches in the financial asset values in the markets. The traders will try to be the first to spot the differences in the asset prices, which may occur if there is any mismatch in the demand or supply levels in the exchanges dealing with these assets.

Once the trader notices the difference, he could quickly make a profit, without taking much risk. Traders may use a trading system that is automated as part of their strategy for arbitrage trading. These automated systems incorporate algorithms, which detect the price discrepancies immediately and alert the trader. Hence the trader can exploit the price differences to make a quick profit. After some time, other traders will also notice the difference, and the prices of the asset in the market will get adjusted accordingly.

Types of arbitrage – forex arbitrage opportunities

Forex arbitrage can be classified into three main categories

Two currency arbitrage involves making a profit from the differences in the prices quoted for the currency pairs; It does not consider the differences in the prices of the currencies in the pair which is considered.

Triangular arbitrage utilizes the differences in the prices of three different types of currencies. The asset in one currency is converted into two other currencies before it is converted back into the original currency to make a profit.

Covered-interest arbitrage involves making a profit from the differences in the interest rates in two countries. The trader will use a forward contract for hedging and reduce the risk caused by fluctuations in the exchange rate.

Two-currency arbitrage

Two-currency arbitrage is the most popular form of forex arbitrage. The trader will trade the same currency pair with different forex brokers to make a profit from the differences in prices of the currency pairs. The EUR/USD currency pair is the most widely traded. The selling price and buying price of the different banks may be different. If the selling price for one bank A is lower than the buying price of another bank B, the trader can purchase Euro from bank A paying dollars and sell the Euro to Bank B for a dollar profit. However, the trader should act fast since other traders will also notice the difference in prices.

When many traders try to make a profit from the same difference in bank rates for a currency pair, due to the increase in demand, Bank A will increase its price, and Bank B will decrease in price due to increase in supply, till both the banks offer similar prices.

Triangular arbitrage

Banks are quoting different prices for currency pairs based on supply and demand. So in triangular arbitrage, the trader is exchanging the currency pairs in three banks, hoping to make a profit using the difference in the prices. Exchanging the currencies in the same bank will not result in a profit since banks have an efficient system for pricing currencies and do not allow the traders to make any profit using arbitrage. Usually, the commonly traded currency pairs are the USD/EUR, EUR/GBP and GBP/USD, and the trader should monitor the exchange rates offered by different banks. The trader should also consider the transaction costs which the banks will charge for currency conversion, which may reduce the profit.

Covered-interest arbitrage

In Covered interest arbitrage, the trader exploits the differences in the interest rate of two currencies to make a profit. The trade will also use a forward contract so that they can control the risk they are exposed to. The forward contract allows the trader to purchase currency at the market rate at present, and also fix the exchange rate at a future date. A detailed explanation of the strategy for interest arbitrage for EUR/USD is as follows:

– Determine how much higher the Eurozone interest rates are compared to the US interest rates

– Using the available amount of US dollars, the dollars are converted into euro at the spot price, and the euros are invested at a higher rate in euro-zone. The trader should also arrange for a forward contract that specifies the exchange rate for EUR/USD to protect the investor against any fluctuation in the exchange rate during the duration of the investment.

– The trader will receive an interest in euros

– the euros can be converted back into US dollars at the guaranteed exchange rate, ensuring that the trader makes a profit.

How to make money from currency arbitrage ?
This is very hard because these day’s brokers have the same prices across all currency pairs. Even the small differences in prices, because spreads, it is almost impossible to make a profit from currency arbitrage.

Conclusion

Arbitrage in forex trading involves exploiting the forex market inefficiencies to make a profit without taking much risk. Only high equity accounts with proper technology can do this.

Main Forex Info

Main navigation:

Forex social network