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1 Copyright Alpha Markets Ltd. Page 1

2 Financial Industry - Module 1 Welcome to this unit on the Financial Industry. In this module we will be explaining the various aspects of the Financial Industry as well as where you fit in as an independent financial trader. Key Learning Outcomes: - To understand how the Financial Industry operates on a day to day basis as well as the key terminology used by financial traders. - To understand the key market participants who make up the Financial Industry, as well as how they can affect the change in value of a currency pair. - To know when it is possible to trade and how to take advantage of the key market sessions, which allows for the facility to trade 24 hours a day. - To understand how a currency pair is measured in value, as well as how you can begin to profit as a currency pair either rises or falls in value. Copyright Alpha Markets Ltd. Page 1

3 What is Financial Trading? Financial trading involves organisations, institutions and individuals trading certain financial markets in order to capitalise on market movement. The things that are traded are known as instruments and this includes; - Forex - The Stock Market - Indices - Commodities Indices: An index is the average weighted price of a group of large companies listed on a nations Stock Exchange. Some of the more common indices include; - FTSE DOW 30 - DAX 30 Commodities: A commodity is a raw material or product that can be bought or sold, for example Gold or Oil, and is traded by individuals in order to profit from their change in value. During the course we will be mainly focusing on the Forex market, however, many of the techniques and principles can be applied across various financial markets. Page 2 Copyright Alpha Markets Ltd.

4 What is Forex? The term Forex refers to the Foreign Exchange and is also commonly known as FX. The Foreign Exchange is essentially a market where global currencies are traded on a daily basis, including major currencies such as the Great British Pound, the Euro, the US Dollar and the Japanese Yen. Each day an estimated $3 trillion is traded on the Forex market, making it the single largest financial market in the world. The Forex market is larger than the New York Stock Exchange, the Tokyo Stock Exchange and the London Stock Exchange combined. This creates great liquidity or movement within the Forex market and therefore potential trading opportunities. This exchange, or buying and selling of global currencies known as Forex Trading, is done electronically via a network of thousands of computers worldwide. Copyright Alpha Markets Ltd. Page 3

5 The Forex market is ruled by the law of supply and demand. This means that as the demand for a currency increases, the value of that currency will also increase. In contrast, the greater the supply of a currency, the more it will then decrease in value. Greater demand - value increases Greater supply - value decreases How the Forex industry operates can be explained with the example of exchanging money when on holiday. If we were looking to exchange Great British Pounds into Euros, the amount we would receive would depend on the current exchange rate. For example, if the exchange rate was 1.2, and we were looking to exchange 100, we would receive 120 Euros. It is this continuous exchange of currencies on a global scale that drives the change in value of currencies and creates the Forex market as we know it. Page 4 Copyright Alpha Markets Ltd.

6 Forex History In the past only banks and large investment funds could trade the Forex market, as they had access to expensive specialist software and programmes enabling them to connect and trade with each other. However, due to the rapid growth of the internet and ease of access, many more people now trade the Foreign Exchange market. This consists of many independent, often home-based traders, who have the ability to trade through an online broker in order to capitalise on market movement. Key Market Participants There are different market participants who operate in the Forex market on a daily basis, each responsible for affecting the market in different ways. Copyright Alpha Markets Ltd. Page 5

7 Banks: Large investment and retail banks are responsible for the majority of volume in transactions found within the Forex market, due to the large amounts of currencies they exchange. The exchange of currencies between these banks is what drives the value of currencies either higher or lower and can be seen on a currency chart. Furthermore central banks, such as the Bank of England, are responsible for setting policies such as interest rates, which again can have a large impact on the Forex market. Hedge Funds: Hedge Funds are responsible for trading large amounts of money or capital in order to profit for investors and pension funds. Due to the large capital of these funds, the exchange of currencies in order to profit for investors has a direct impact on the value of a currency and the Forex market. Large Institutions: Large institutions are also key market participants in affecting the value of a currency. When importing or exporting goods or services between countries, institutions and companies will have to exchange currencies. This therefore impacts the movement found within the Forex market. Retail Traders: Retail traders are individuals who trade the Forex market, usually via a brokerage company. In doing so, they try to capitalise on movement or change in value in the currency market, as a result of the transactions of other market participants. Banks Hedge Funds Large Institutions Retail Traders Page 6 Copyright Alpha Markets Ltd.

8 Trading Hours The Forex market is open 24 hours a day from Sunday night until Friday night in the UK, with key market sessions continuously overlapping. London Session 08:00-16:00 (BST) Tokyo Session 00:00-08:00 (BST) New York Session 13:00-21:00 (BST) Sydney Session 22:00-06:00 (BST) Sydney Session: The Forex market opens around 10pm on Sunday evening in the UK when trading activity begins in cities such as Sydney. This session then closes around 6am British Standard Time (BST). Tokyo Session: The Asian session then continues when traders in other major cities such as Tokyo begin their trading activity around 12pm BST. This session then closes around 8am BST. London Session: The London session then begins at 8am BST and is one of the most popular and actively traded sessions, with large volumes of transactions taking place. This session then closes around 4pm BST. New York Open: The New York session then begins at 1pm BST as traders in cities such as New York begin their trading activity, increasing the volume within the Forex market. This session then closes around 9pm BST. These market sessions continuously overlap, meaning that traders can trade the Forex market 24 hours a day from Sunday night until Friday evening in the UK. The majority of the movement or volume in the Forex market occurs as the major sessions open with volume then decreasing towards the end of these key sessions. Copyright Alpha Markets Ltd. Page 7

9 Over the Counter The Forex market is known as an Over the Counter (OTC) market. This means that it is a decentralised market where key market participants are not located in one geographical location. What this essentially means is that there is no central exchange or single industry regulator. Individual countries are therefore responsible for regulating financial services companies. In the UK the Financial Conduct Authority is responsible for regulating financial service companies such as brokers. Independent traders are not required to be regulated or hold any special licences for trading their own capital. Currency Pairs When trading the Forex market the value of a currency is measured against another in what is known as a currency pair. There are many currencies that are available to trade, however, some of the more popular currencies include the Great British Pound, the Euro, the US Dollar and the Japanese Yen. Page 8 Copyright Alpha Markets Ltd.

10 When trading the Forex market you may come across the term Major. A Major refers to a currency pair that includes the US Dollar. The Majors tend to be the most liquid and widely traded pairs in the Forex market. Many independent traders tend to concentrate on these pairs, as they can often produce the more tradeable opportunities. Currency Pairs & PIPs When trading the Forex market a currency pair is typically quoted to four decimal places. For example: GBP / USD In this example the Great British Pound is known as the Base currency and the US Dollar would be the quote currency. What this essentially means is that 1 is worth $1.6 in this example. If the value of the Great British Pound increased against the US Dollar then the exchange rate would rise. This change in value of a currency pair is measured in PIPs, which stands for Percentage in Points. Using the same example: GBP / USD (Increase of 5 PIPs) GBP / USD (Increase of 10 PIPs) In contrast, if the Great British Pound decreased in value against the US Dollar then the exchange rate would fall. Using the same example: GBP / USD (Decrease of 5 PIPs) GBP / USD (Decrease of 10 PIPs) Copyright Alpha Markets Ltd. Page 9

11 In some cases a currency pair may be quoted to five decimal places. This fifth digit is known as a Pippette which is essentially a fraction of a PIP. Using our previous example: GBP / USD (The fifth digit 0 is a pipette) GBP / USD (Increase of 5 pipettes) There is an exception with the Japanese Yen currency pairs, which are typically quoted to two decimal places. For example: EUR / JPY (One Euro is worth Japanese Yen) EUR / JPY (Increase of 10 PIPs) EUR / JPY (The fifth digit 0 is a pipette) EUR / JPY (Increase of 5 pipettes) Profit from a Rising or Falling market When trading the Forex market, traders can profit from either a rising or falling market, by taking either a long or short position. If a trader believes a currency pair will rise in value, they would take a long position. Therefore they would be looking to profit as a currency pair increases in value. If a trader believes a currency pair will fall in value, they would take a short position. Therefore they would be looking to profit as a currency pair decreases in value. Page 10 Copyright Alpha Markets Ltd.

12 When placing a trade through an online broker, traders will enter what is known as a stake amount or trade size in their order ticket. The value of this stake amount will represent the value of one PIP. Sell: By selecting the sell button, a trader would be anticipating the GBP / USD to decrease in value. GBP / USD > (Decrease in 10 PIPs) So if the GBP / USD decreased in value by 10 PIPs, as shown in this example, a trader would make a profit of 100 (Stake Amount x no. of PIPs). GBP / USD > (Increase in 10 PIPs) However if the GBP / USD increased in value by 10 PIPs, as shown in this example, a trader would make a loss of 100 (Stake Amount x no. of PIPs). Buy: By selecting the buy button, a trader would be anticipating the GBP / USD to increase in value. GBP / USD > (Increase in 10 PIPs) So if the GBP / USD increased in value by 10 PIPs, as shown in this example, a trader would make a profit of 100 (Stake Amount x no. of PIPs). GBP / USD > (Decrease in 10 PIPs) However if the GBP / USD decreased in value by 10 PIPs, as shown in this example, a trader would make a loss of 100 (Stake Amount x no. of PIPs). Copyright Alpha Markets Ltd. Page 11

13 It is worth noting that financial traders can use methods to reduce the amount of risk or loss that they can incur per trade, by using features such as Stop Losses. A Stop Loss effectively enables a trader to limit the amount of risk when trading to a predefined level. This risk amount can often represent a percentage of your trading account. Therefore traders can predefine the percentage of their account that they are looking to risk on a trade, to as little as 1%. We will be explaining this concept in more detail within the Money Management section. The Spread Many independent traders will place their trades through an online broker who provides specific software and trading accounts in order to execute trades in the Forex market. When placing a trade through a broker, there will be a difference between the buying price and the selling price on a currency pair. The difference between these two numbers is known as the spread. As we can see there is a 3 PIP difference between the buying price and selling price called the spread. The spread can vary depending on the currency pair that you may look to be trading. Typically the more common currency pairs and actively traded pairs have smaller spreads than others. We will be explaining the relevance of the spread in more detail in the Platforms & Accounts section. Page 12 Copyright Alpha Markets Ltd.

14 Financial Industry - Summary - The Forex market is a global market in which various currencies are traded on a daily basis, with an estimated daily turnover in excess of $3 trillion. - There are various key market participants in the Forex market such as banks, large institutions, hedge funds and retail traders, many of whom are responsible for driving the movement in price or value of a currency. - The Forex market is open 24 hours a day from Sunday evening until Friday night BST. This is due to the key market sessions continuously overlapping creating a constant market place. - Currencies are measured and traded against each other in what s known as a currency pair. Some of the more popular currencies include the Great British Pound, the Euro, the US Dollar and the Japanese Yen. - The value of a currency pair is measured in PIPs, which stands for percentage in points. Financial traders can make a profit on a change in PIPs in both a rising or falling market. Copyright Alpha Markets Ltd. Page 13