Forex Trading: Spread Betting Currencies
The Forex markets or other names it is known by, such as; Currency, FX or the Foreign Exchange Markets have existed since one country or region started exchanging goods or services with each other. Once the goods were exchanged for the currency of the local economy, the merchant needed a way to convert it back into there local currency. Thus, the beginning of the Forex markets. Trading in forex currencies was once predominantly the domain of banks and institutions but spread betting has made it accessible.
Spread betting on foreign exchange has a number of advantages. Winnings from forex betting are tax-free in the UK, so you won’t be liable to capital gains tax and trading commission as you would if you dealt through a forex broker. Forex spread betting allows you to profit from falling as well as rising exchange rates, and you can limit potential losses by using automatic or manually-applied stops. In addition the high volatility of certain currency pairs suits this trading product. This doesn’t mean that forex trading is easy. In fact some say that with FX it is even more difficult to win as you are not only fighting big players like in other markets but you are also against Central Banks which can intervene at any time in a bid to manipulate their currency.
Forex Trading by CMC Markets
What is Foreign Exchange?
The foreign exchange market is the largest and most liquid financial market in the world and is used to determine the relative values of different global currencies.
Its main purpose is to facilitate international trade and investment by enabling one currency to be converted to another, with the US dollar, the euro, sterling and the Japanese yen being the most commonly exchanged.
Trading on forex involves speculating on the future price of one named currency against another by purchasing one currency and selling the other simultaneously. Currency pairs are therefore seen as a single unit.
There is no central marketplace for the exchange of currency. Instead, trading is carried out over-the-counter. Increases and decreases in foreign exchange are measured in percentage points, or pips.
Currency Trading Today
To claim that technology has changed forex trading would be a huge understatement. It was only about 15 years ago that forex trading was the sole domain of big players and institutions, where $100 million was the minimum to even be able to access the market. As financial barriers to entry lowered, technology also began to create a new force in the forex market: retail forex trading. While it started in the second half of the 1990’s, it was not until the early 2000s that sophisticated trading platforms were developed that made these markets accessible to a wider trading base, with the biggest breakthrough coming with the 2002 introduction of MetaQuote’s MetaTrader platform. As such, automated trading was brought to the retail sector. With the release of MetaTrader 4 in 2005, an increasing portion of the market moved to e-transactions requiring less need for dealers and human participation. This was the real birth of the retail market and the cutting edge of major changes in the forex market at the hands of technology.
Speculating on currency movement involves buying or selling one currency against another in the expectation that the exchange rate will change in your favour. Both currency trading and spread betting are leveraged high-risk products so in this context they share quite a few similarities.
Synopsis
The forex market is the largest in the world is open around the clock. It has no central exchange and is the most competitively priced. Recent data on turnover in traditional foreign exchange markets highlights an important feature in the evolution of the foreign exchange market. The average daily turnover had grown by an unprecedented 69% or $3.2 trillion between April 2004 and 2008 with about $110 billion of this making up the retail forex market, which indicates very high growth. Thus, in such cases, there is a tremendous opportunity to make significant profits provided you are diligent and don’t rush in, because when you have high volumes there is also extreme volatility which can go for you or against you. The key here is to manage risks. The value of a particular currency can and will go up and down throughout a day based on many factors.
Every currency traded in the financial markets is represented by a three letter code. For instance, sterling is usually quoted as GBP, while the USA dollar is displayed as USD. Keep in mind that currencies are always traded in pairs (for instance one might sell US dollars and buy Euros or vice versa). So for instance if you noted GBP/USD on your spread betting trading platform, the price next to it would represent the number of US dollars that could be bought with one pound. If you then went long GBP/USD, you would be hoping to profit from a rise in the pound. If you sold it, you would be backing the dollar to rise against the pound (the number would go down as less dollars would be needed to buy a pound).
Although in theory you can trade on any international currency pairing, the vast majority of currency trading is carried out on the following major pairings: EUR/USD, USD/JPY, GBP/USD, USD/CHF, AUD/USD, USD/CAD, NZD/USD, EUR/JPY, GBP/JPY and EUR/GBP. It is estimated trading on these 10 pairings accounts for 95% of all speculative global trading. It is worth noting that trading currencies is zero sum – if one currency moves up, the other must move down. In fact, currency pairs are a measure of the strength and competitiveness of one economic region against another. What’s more currency swings can be dramatic which means that you can make/lose money fast (a busy trading session can result in a 200+ point movement). Tell that to famous trader George Soros who made some $1 bn in days shorting the pound in 1992.
An important thing to consider about forex spread betting is that depending on your perspective, do you buy or sell the forex pair you’re interested in? For example, when looking at the GBP/USD (this widely traded forex pair is also known as ‘cable’), if you believe that the GBP will gain against the USA dollar, then you will buy GBP/USD (and vice-versa i.e. sell if you believe that the USA dollar will gain against the sterling). The first currency (in this example GBP) is known as the base currency and this is the currency that you think will strengthen or weaken against the other currency (known as the ‘quote’ currency).
So what’s the difference between normal currency trading and spread betting on currencies? One of the main differences is tax since if you deal through a forex broker you are liable to both capital gains tax (CGT) and commissions. The same would hold true for other currency derivatives such as contracts for difference, futures, options and covered warrants. Spread betting is unique in this sense in that gains are tax-free and the exchange rates are usually far better than any bank is ever going to offer you.
Spread betting allows you to profit from changes in forex pairs by utilising margin: your spread betting provider is lending you the bulk of the value of your spreadbet position by only requiring you to deposit a small portion of it; your margin. This is useful for forex trading, since many forex pairs only change incrementally against each other on a daily basis. Take the GBP/USD currency pair for instance. The Pound might rise against the Dollar over a one-month period from say 1.588 to 1.622, this is only a 34 point change. If you were to take a £4 per point spread betting position (with no margin), this would only result in a profit of about £136. However, spread trading providers quote fractional changes to the forex rate, one decimal point further to the right. In practice this means that you might see the GBP/USD price fluctuating between 1.5432 and 1.5571 in a single day. This equals a daily trading range of 139 points, and extending this over a month you could very well well see a move of 350 points or more, up or down.
So as we have seen currencies are typically quoted in 1000’s units i.e. 1 unit = 1 Point. So if you see the Euro/ US Dollar (€/$) quoted at say 1.1707 – 1.1711 then this is effectively 11,707 – 11,711. Another example would be Euro/GBP 0.7086 – 0.7089 equates to 7,086 – 7,089. The first price is the Bid Price and the second quoted price the Offer Price. The bid price for a counter currency is always lower than the ask price. This is because the bid price, which makes up how much will be received in the counter or quote currency when selling one unit of the base currency, is always lower than the ask price, which represents how much must be paid in the counter or quote currency when buying one unit of the base currency. Please do check with your spreadbetting company exactly how their Currencies prices are quoted.
Once you have determined this the next thing to understand is exactly what these quotes actually mean – they can be very confusing. Here are some simply guidelines to ‘de-mystify’ the situation.
- The second quoted currency is always the amount of that currency you need to buy one unit of the first, for example:
€/$ = 1.1815 – you need $1.1815 to buy €1
£/$ = 1.6364 – you need $1.6364 to buy £1
£/€ = 1.3881 – you need €1.3881 to buy £1
$/yen = 119.4 – you need 119.4 yen to buy $1
€/£ = 0.7204 – you need 72.04p to buy €1
- When the quoted price is rising then the first quoted currency is strengthening against the second quoted currency – when falling it is weakening against the second. Or, when the quoted currency is falling then the second quoted currency is strengthening against the first and, when rising, weakening.
e.g. When the €/$ is 1.1815 then you need $1181.50 to buy something priced at €1000.
If the € strengthened against the $ to 1.24 then you would need $1240 to buy something priced at €1000.
If the € weakened to against the $ to 1.17 then you would need $1170 to buy something priced at €1000.
In practice it is the first currency in the pair which you need to consider. So when spreadbetting currencies, Buy or go Long the quoted currency if you anticipate that currency strengthening and, obviously, Sell or go Short the quoted currency if you anticipate weakness.
- Some spreadbetting companies actually offer Currency trades in various currency units so for example you can have £, $ or € based bet which means that you can either bet the £ vs. € or the € vs. £. In this example if you anticipated the € strengthening against the £ you would Buy the €/£ but Sell the £/€.
Spread Betting on Forex
Forex spread betting involves betting on the relative movement of one currency against another and is one of the most popular forms of spread betting, given the size of market and hours it trades.
Most providers will quote a wide range of currency pairings, including major pairs like Sterling and the US dollar (GBPUSD) and minor pairs such as the Canadian dollar and the Swiss franc (CADCHF).
Spreadbetting Major currencies is good. You can also spread bet on Minor currencies and Exotics. Beware that for the exotics different systems might be in place; they could be fixed to the value of another currency like the dollar or be a managed float so they can only move up to a certain point.
Currencies are then usually referred to as ‘spot’, this has nothing to do with what you might see on pubescent faces!
It is more related to the underlying ‘spot’ market.
Let’s start with the spots;
Major spot fx pairs are;
Euro/Pound (EUR/GBP)
Pound/Dollar (GBP/USD)
Pound/Euro (GBP/EUR)
EUR/Dollar (EUR/USD)
Euro/Yen (EUR/JPY)
Dollar/Swiss (USD/CHF)
What you might notice is that you have Euro/Pound and Pound/Euro. Don’t get confused. All it means is the first currency is quoted first. In my view, I always find it easy to think with the Pound first, whether that is POUND/USD or POUND/EURO.
How do the firms calculate what their quotes for FX will be? They take a sample of different rates offered by banks and then average them out. You always have to keep in mind that the spreadbetting firms derive their prices from the underlying. In the case of currencies or Forex the quote you see on the screen is derived from an average of currency pair quotes provided by banks.
At any given time, each pair has a buy price and a sell price, and the spread is the difference between these.
If you think the first named currency in a quoted pair is likely to strengthen against the second, then you buy. If you think the first named currency will weaken, then you sell.
The amount you profit will depend on how much you bet per point of movement and how far above or below the spread the currency has moved.
Almost anything can affect the foreign exchange markets, from changes in a country’s output and interest rate environment to large multinational mergers and political instability.
To successfully bet on currency movements it is therefore important to keep a close eye on developments in the financial markets, as well as major political and economic news stories.
Updates such as interest rate movements and the publication of fiscal data are often released on scheduled dates, so spread betters can prepare for possible forex fluctuations by keeping abreast of these announcements.
A good place to start with the major spot FX pairs is the cable trade this is GBP/USD. It’s a very popular market, and for UK citizens it is a currency they know about.
Things you might consider when placing spread bets on the pound are;
- Is the pound getting weaker or stronger?
- What is the sentiment like?
- What are the technicals saying?
Then you jump in. I generally find that FX trades well technically, by this, the technical analysis charts come in very useful.
What’s the point of trying to second the people in the know? You haven’t got the money or resources.
Forex Spread Betting
A spreadbetting account allows traders to buy and sell foreign exchange contracts either intraday or over a longer term period, so you can hold positions for just a few minutes to weeks or even years.
Minimum stakes amongst the providers typically range from 50p or £1 a point and the spreads just 2 ticks on the main spot rates and 10 to 12 on the equivalent forward contracts. Margin requirements are about 1 to 2% of the total exposure (or typically 40 to 100 times the stake). The tick size is usually 0.0001 so if a pound is worth $1.6345 the quote would be 16345. Providers say foreign exchange betting tends to revolve around four currencies: sterling, the dollar, the euro and the yen.
Spot FX or Rolling Bets
For shorter-term positions it can be better to use a spot currency bet. These follow spot foreign exchange trading in the interbank markets and close at 8pm UK time and settle at the prevailing spot rate, although it is possible to rollover them over into the next day at a small additional cost. Rolling bets are usually suitable for short-term trades of up to 3 weeks or less.
Forward FX
Forward FX bets are suitable for taking longer-term positions of up to 6 months. In the underlying markets, a forward currency is an agreement of a rate today at which currencies will be exchanged on an agreed date in the future. The Forward FX bets are very similar, except rather than exchanging currencies, bets are simply expired based on the spot rate at 8pm London time on the expiry date of the contract. With a quarterly forex spread bet you don’t incur the daily financing charge (unlike the daily rolling) although the spread will be a little wider. At any point in time the forward rate will reflect the current spot rate and the effect of the interest rate differential between the two countries over the remaining time to expiry. For example interest rates in the USA are currently lower than those in the United Kingdom so the GBP/USD forward rate will be a little less than the prevailing spot rate to make up for the loss of yield through holding the money in dollars.
For example, let’s say the spot rate of GBP/USD is 19910/19922. Someone who thought that sterling would continue to strengthen against the dollar over the next three months could buy a forward FX bet on the sterling/dollar rate at 19922 for $2 a point. This bet would be the equivalent of buying £20,000/selling $39,844 in the foreign exchange market and would require an initial margin deposit of just $600. Should sterling appreciate against the dollar and the quote move to 19980/19992, the position could be closed at 19980 for a profit of 58 points or $116.
Trading Example
The spread amounts to the difference between the Bid and the Ask prices of a currency pair. The Ask is the price you pay to buy and the Bid is the price at which you sell a currency pair. For example, if the quote between EUR/USD at a given moment is 1.35013/1.35020, then the spread is 0.7 pip (1.35020 – 1.35013). Naturally low spreads are a must when trading currencies and while some providers offer variable spreads, other brokers offer fixed ones.
Let’s take an example. You think that the US Dollar will appreciate against the Japanese Yen and place a spread bet on the USDJPY currency pair. The quote for USDJPY (US Dollar vs Japanese Yen) is 77.20 / 77.22 and you decide to buy £10 per point at 77.22. Having bought US Dollars you have immediately sold Japanese Yen. For every point that USDJPY goes above 77.22 you will make £10 and for every point that USDJPY moves below 77.22 you will lose £10.
Profit and Loss Calculation
The US Dollar has appreciated against the Japanese Yen and is now being quoted 78.05 / 78.07 and you decide to exit your initial Buy position (77.22) by selling £10 per point at 78.05.
You have made £830 (78.05 -77.22 = 83 points x £10 per point = £830).
Currency Spread Betting Examples
First Example
Most currency pairs are quoted quoted per 0.0001 with a few on a per 0.01 basis. Thus, if you bought GBP/USD at 1.6210 for £1 per point, to stand to extract a gain of £1 you would have to sell it at 1.6211. Let’s look at an example for USD/JPY which is currently trading at 92.34 in the spot forex market. Spread betting providers quote a spread on a given currency pair. The spread betting provider’s quote might be 92.33-92.35. 92.33 represents the price at which you could sell USD/JPY if you believed the USA dollar was going to gain against the Yen. You think that with rising uncertainty in the global markets the USA dollar is set to recover some ground over the coming months, thus you buy USD/JPY at 92.35. You now need to decide on the stake to use and let’s assume you want to trade at £5 per point so you buy £5 per point of USD/JPY at 92.35. Before you can place this spread bet you will need to deposit some funds in your account and since the minimum deposit for a trade on USD/JPY is 40 multiples of your stake (this multiple varies from provider to provider, we are talking about Capital Spreads in this instance), so in this case you would need to deposit at least £200 to open the trade.
Assuming you are correct in your prediction and over the next two months the USA dollar does indeed gain against the Yen to a new level of 94.65. The provider’s quote is now 94.64-94.66. To realise your profit you need to close your spreadbet, so to do this you do the opposite trade to what you did when opening the spread bet, in this case selling at £5 per point. Your gain amounts to the number of points difference between the closing and opening prices (94.64 – 92.35 = 229), multipled by your stake (£5), so £1,145. (229 x £5)
Second Example
At the time of writing Capital Spreads is quoting a spread on the pound against the euro of €1.1542-€1.1545. You could ‘buy’ at the upper end – if you believe the pound will strengthen – or ‘sell’ at the lower end if you think it will weaken. This means that the euro was worth 115p with the minimum stake of a £1 a point translating into an effective exposure of £11,545. Initial margin for this position can be as low as 40 times the stake.
Suppose you bought at €1.1545, on a £1 a point movement bet, and the pound strengthened until the spread being quoted was €1.1815-€1.1818. You could then close your position by selling at €1.1815. This would give you an £270 profit (€1.1815 minus €1.1545 equals 270 points which is multiplied by your £1 a point stake). However, of course if the market has moved against you, you would lose an equal amount.
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