What is a Forex deal?

The investor's goal in Forex trading is to profit from foreign currency

movements.

More than 95% of all Forex trading performed today is for speculative purposes

(e.g. to profit from currency movements). The rest belongs to hedging

(managing business exposures to various currencies) and other activities.

Forex trades (trading onboard internet platforms) are

non-delivery

trades:

currencies are not physically traded, but rather there are currency contracts

which are agreed upon and performed. Both parties to such contracts (the

trader and the trading platform) undertake to fulfill their obligations: one

side undertakes to sell the amount specified, and the other undertakes to buy

it. 

As mentioned, over 95% of the market activity is for speculative purposes,

so there is no intention on either side to actually perform the contract (the

physical delivery of the currencies). Thus, the contract ends by offsetting it

against an opposite position, resulting in the profit and loss of the parties

involved.

Components of a Forex deal

A Forex deal is a contract agreed upon between the trader and the market-

maker (i.e. the Trading Platform). The contract is comprised of the following

components:

The currency pairs (which currency to buy; which currency to sell)

The principal amount (or "face", or "nominal": the amount of currency

involved in the deal)

The rate (the agreed exchange rate between the two currencies).

Time frame is also a factor in some deals, but this chapter focuses on Day-

Trading (similar to “Spot” or “Current Time” trading), in which deals have a

lifespan of no more than a single full day.  Thus, time frame does not play

into the equation.  Note, however, that deals can be renewed (“rolled-over”)

to the next day for a limited period of time.

The Forex deal, in this context, is therefore an obligation to buy and sell a

specified amount of a particular pair of currencies at a pre-determined

exchange rate.

Forex trading is always done in currency pairs. For example, imagine that the

exchange rate of EUR/USD (euros to US dollars) on a certain day is 1.5000

(this number is also referred to as a “spot rate”, or just “rate”, for short). If

an investor had bought 1,000 euros on that date, he would have paid 1,500.00

US dollars. If one year later, the Forex rate was 1.5100, the value of the euro

has increased in relation to the US dollar. The investor could now sell the

1,03300 euros in order to receive 1,510.00 US dollars. The investor would then

have USD 10.00 more than when he started a year earlier.

However, to know if the investor made a good investment, one needs to compare

this investment option to alternative investments. At the very minimum, the return

on investment (ROI) should be compared to the return on a “risk-free” investment.

Long-term US government bonds are considered to be a risk-free investment since

there is virtually no chance of default - i.e. the US government is not likely to go

bankrupt, or be unable or unwilling to pay its debts.

Trade only when you expect the currency you are buying to increase in value

relative to the currency you are selling. If the currency you are buying does

increase in value, you must sell back that currency in order to lock in the

profit. An open trade (also called an “open position”) is one in which a trader

has bought or sold a particular currency pair, and has not yet sold or bought

back the equivalent amount to complete the deal.

It is estimated that around 95% of the FX market is speculative. In other

words, the person or institution that bought or sold the currency has no plan

to actually take delivery of the currency in the end; rather, they were solely

speculating on the movement of that particular currency.