Basic characteristics of instruments

It is very easy to define a financial instrument. It is something you can buy or sell; some object that is worth something and that someone is willing to buy. These include company, foreign currency contracts, gas and oil contracts, bonds, futures contracts and the list goes on. It does not really matter which instrument is chosen to deal in, it is more important for the process to be comfortable and transparent. In most cases trading is all about paperwork or even mouse-click-work – it is, after all, the 21st century!

In this studybook we will mostly deal with currency trading although the major characteristics of financial instruments are mostly the same for all types of securities or contracts. Apart from all the significantly traded currencies, Forex4you also offers trading in shares of big corporations, oil, gas, corn or wheat contracts, and the ability to trade popular indexes like the S&P and NASDAQ.

• Rate or price. The cornerstone of any speculative trading. If there were no rates or they did not change there would be no sense in selling or buying something for speculative profit.
• Time of trading. Some instruments can be bought or sold 24-hours a day, others require our timetable to be adapted to them. For example, almost all currencies are available in the Forex market 24-hours a day from Monday to Friday but wheat contracts can only be traded during the daytime, that is, specific hours when the exchange where they are traded is open.
• Available purchase volume. How many units of an instrument can we buy? What is the minimum and maximum quantity? It is clear that we are limited by our capital but what are the market possibilities? For instance, the traditional volume on the Forex market is 100 000 currency units and the selling lot for oil is 500 barrels for a contract. Smaller units are not available because they are not economically viable. For example, farmers typically sell their milk in half-liter or liter quantities; one cannot usually buy smaller units (such as a quarter of a liter)

Now, let us describe in detail some basic terms used in the Forex market. Exchange rate is simply the price of a currency expressed in terms of another currency. When we say “The price of the currency is …” we usually mean one unit of a currency, something like one US dollar or 1 euro and so on. If the exchange rate of a pound sterling is 1.5 US dollars, for example, it means that any market participant can turn his pound into one and a half of US dollars or vice versa. There are stock prices (exchange prices, market-rate) defined at an exchange during a trading session, compared with the crawling peg system where rates are managed by Central Banks or governments and altered in small measured amounts.

An exchange rate can be free, which means it is set solely by market forces or it can be managed by the Central Bank or government of a country as in the crawling peg system. For example, the exchange rate of the Russian ruble is free. This also means it can be subject to volatility – today the ruble is higher; tomorrow much lower, but the Indian rupee, by contrast, is controlled by the Central Bank of India, and so there are no surprises or extreme changes in its exchange rate.

Exchange rates are defined in various ways:

• Direct quotation is when the exchange rate for a national currency is expressed by the currency of another country. For example EUR/USD is the direct quotation in the USA of their national currency and the currency of the European Union. It is worth mentioning that traditionally all direct quotations are expressed in US dollars as currency trading was born in the United States of America.
• Reverse quotation is the back-to-front version of a direct quotation. It is when a foreign currency is expressed by a national one. The difference between these two quotations is elementary; it just depends on the side you are watching from. EUR/USD is the direct quotation for the USA and at the same time it is the reverse quotation for euro-zone countries as their national currency is the euro. Therfore you can’t name the quotation as ‘direct’ or ‘reverse’ without naming the country you are in.
• Cross-rate it is the quotation which is not expressed by US dollars.

Let us now introduce to you some main Forex currencies:

• USD is the symbol for the US dollar, the American dollar also known as “buck” or “greenback”. It is the most common currency in the Forex market.
• GBP means Great British Pound; it is the symbol for the English pound, also known as ‘sterling’ . (UK is not the only EU country using its own currency; Sweden is a member of the EU which also still uses its own currency (Swedish Krone) and it is also the case with Denmark (Danish Krone).)
• CHF is the Swiss franc. In spite of the tiny size of the country this currency is very popular in the World. It is sometimes also called the “swissy”.
• EUR stands for the euro, it is the currency of the European Union and the second most common currency in the Forex market after the US dollar.
• JPY ia the symbol for the Japanese yen or simply the “yen” .
• CAD is the symbol for the Canadian dollar.
• AUD represents the Australian dollar. Also sometimes called the “aussie”.
• NZD goes for the New Zealand dollar, sometimes also called “kiwi”.

A currency pair is the recording of a quotation as a formula. Exchanges and banks display it in this way (for example):

EUR/USD = 1.2126

The part to the left of the slash is refered to as the base currency, whilst the one on the right of the slash is called the quotation currency. The amount is always quoted in the currency to the right of the slash, thus ‘quotation currency’. This means that to buy one euro we need to pay 1.2126 US dollars. It almost seems like we would have to split a coin or bill into pieces!

All Forex market operations are performed in the base currency! If we buy USD/GBP it means that we will get US dollars by paying for them in pounds. If we sell EUR/CAD, we sell euros to buy Canadian dollars.

A Point (or “pip”) it is the minimum unit of change in the price of a currency. All the numbers after the decimal point that you can see in the formula are points or “pips”.

In currency pairs with GBP, EUR, USD, CAD, CHF or AUD one point is equal to 0.0001 whilst in yen (JPY) pairs, for example, one point is 0.01.

So a change in the EUR/USD currency pair from 1.2126 to 1.2124 would be called a “two point change”. A change in the USD/JPY currency pair from 107.24 to 107.26 would be called a “two point change”.

A Base number is one hundred points. It is sometimes also called a “big figure” or simply “figure”. Therefore, the change in the EUR/USD quotation from 1.2163 to 1.2263 or the USD/JPY quotation from 107.24 to 108.24 is called a “one figure increase”.