Forex Trading in Nigeria

Understanding the Forex Market and its Participants

The forex market is the largest financial market in the world. The forex market has an average daily turnover of more than $6 trillion. This also makes the forex trading market the most liquid market in the world. The size of the global forex market has only been increasing every year.

Similar to other financial markets, the exchange rate between different currencies depends on demand and supply, amongst other factors. The price of a currency moves upwards if there are more people buying the currency than those selling the currency. However, retail traders are responsible for a very small proportion of daily trading volume.

The forex market is an example of a decentralized market. This means that there is no central control over the market. The decentralized nature of the market makes it possible for traders and investors to deal directly with each other rather than rely on a central exchange.

The global forex trading market is open at all hours during weekdays. It is closed during the weekends. This 24/5 activity makes it convenient for traders from all around the world to trade with each other. A forex trader can choose his or her own hours of trading. The spreads generally get wider during the inactive hours but trading can still be done at any time of the day.

People from different time zones interact and make the market active for 24 hours a day. However, the forex market can be divided into four main time zones. These different time zones correspond with the Australian market, the United States market, the European market, and the Japanese market.

There are several participants that contribute to the forex market in different ways. Some of the most major players in the market include the banks (both central and commercial), worldwide governments, large multinational companies, retail investors and traders, investment management firms, brokers and dealers, money-transfer and money-exchange companies, and so on.

For example, as a retail trader, you can use a bank to convert your currency from NGN to USD. There can be different purposes for making the exchange including travel and business needs.

3 ways to trade forex

There are three main ways to trade in foreign exchange: spot, forward, and future.

Spot market

The spot market is also known as the ‘cash market,’ where currencies are bought and sold and delivered on the spot. The price of a currency in the spot market is determined by demand and supply. That means the more the demand for a currency higher the value of that currency.

However, it’s not that simple. Some countries intentionally keep the currency values low to make export cheaper or attract foreign investments. The currency value is calculated on many factors, such as interest rate, market sentiment, political change, and economic news.

The final deal between one party that sells an agreed-upon currency price and the other that buys that agreed-upon exchange rate is known as a ‘spot deal.’ Once you close the position, you receive the specified amount of that currency in cash. Although the spot deal is considered spontaneous, the cash settlement usually takes two days.

Forward market

A private agreement between the two parties to buy a currency at a future date and the pre-agreed price is a forward contract. Let’s take an example to understand how a forward contract works.

Assume that a UK car company wants to secure a contract for a future purchase of spare parts from X, which is located in the US. The UK company signs an agreement with the US company to buy the spare parts after six months.

Both agree for a future exchange rate of 1 GBP = 1.3700 USD, and at the time of the agreement, 1 GBP is equal to USD 1.3700. Now suppose, after six months, the value of one dollar drops to 1.3800. That means the importer will benefit by USD 0.01 per unit of the exchanged currency. Now reverse the situation, the price of one dollar increases to 1.36.

In this case, company X (exporter) will benefit from the forward contract to hedge their risk. The vital thing to note is that currency value can move in any direction, either up or down. Who benefits from a forward contract depends upon the value of one currency against the other after six months.

Future market

A future agreement is similar to a forward contract; the only difference is that latter is a standardized contract. The futures contract is a standard contract that specifies the quantity of a particular asset at a pre-determined price and delivery date.

For example, suppose Indian Oil signs a future contract to import 1 million barrels of oil with an oil producer based in Saudi Arabia. The oil producer promises to deliver the specified quantity in twelve months at a pre-agreed price of $75 per barrel.

So even when the price of one barrel falls to $70, the importer is obligated to pay the premium. The same is true when the price reaches $80; the oil producer will deliver the quantity despite the changes in the spot price.

How Are Currencies Traded and the Various Forex Instruments

Forex is traded in pairs. For example, a currency pair is NGN/USD. This currency pair allows you to buy or sell NGN in exchange for USD. There are numerous currency pairs operating in the global forex market.

However, forex traders should know that the USD is the most traded currency in the world. Most of the popular currency pairs in the world involve the USD. For example, EUR/USD is one of the most prominent currency pairs.

Currency pairs can be traded through a variety of financial instruments. A financial instrument denotes the type of contract through which you are making the trade. Different financial instruments include spot forex contracts, forward contracts, contracts for difference, and so on.

We have briefly covered each financial instrument here:

Spot forex contract – A spot forex contract is the most widely used instrument for forex trading. This is the traditional way in which forex trading is and was done. A spot forex contract allows currencies to be exchanged immediately and the delivery and settlement of the contract are done instantly.

Futures forex contract – This is a more complicated forex contract. A futures forex contract allows you to deliver and settle your trade at a later date. The prices are agreed upon beforehand. A futures forex contract allows you to take advantage of future price movements in the present.

Currency swaps – A currency swap allows traders to exchange their loan denominated in one currency for a loan denominated in another currency. This is why its called a “swap”. A swap allows you to repay the principal amount and interest amount in a different currency.

Currency Forward – A forward contract allows you to exchange one currency for another at a future date, however, the exchange rate is determined at the present. This allows for future exchanges while negating the effect of price movements in the forex market. This type of contract is most often used for international trades.

Options forex contracts – An option contract provides the buyer with the right, but not the obligation, to exchange currency at a later date at a predetermined exchange right. The buyer does not have to exchange the currency on the future date, but they can. For this right, the seller is paid a premium at the time of making the contract.

Non-deliverable forward (NDF) – A non-deliverable forward allows a buyer and a seller to settle a currency exchange without actually exchanging any currency. This is why the term “non-deliverable” is used. A Non-deliverable forward is the same as a forward contract, with the exception that the actual currency is never exchanged.

CFDs – A CFD, also known as a contract-for-difference, allows forex traders to trade currency. Under this type of contract, only the price difference between the opening of the contract and the closing of the contract needs to be paid.

What is Online Forex Trading and How Does it Work?

Online forex trading allows retail traders (also known as individual traders) to trade currencies and profit from price movements in the currency market. Online forex trading is gaining in popularity around the world since it provides traders with access to a highly liquid and volatile market.

Forex traders can trade online by taking advantage of the high leverage provided by global online forex brokers. Online forex trading can be done through a variety of financial instruments (as detailed above) but the most commonly used instrument is CFD. CFDs allow traders to only pay the difference in price and the actual currency does not need to be exchanged.

The barrier to entry in online forex trading is very low. You only need to make a small minimum deposit into an online brokerage account in order to get started. You can trade using margins, which means that your deposited amount only needs to cover the difference between the trades. Further, online brokers offer high leverage which means that profits (and loss) can be very high.

Online trading is done through trading platforms like MetaTrader 4. These trading platforms offer an easy way to keep track of price movements of different currencies and to execute trades. Online forex brokers offer a trading platform for free to their users.

There are several online forex brokers in the world these days. Over the last decade, the popularity of online forex trading has grown exponentially due to the services provided by these brokers.

For example, a Nigerian trader just needs to open an account with a reputable forex broker such as HotForex or FXTM. To open an account, they need to complete certain KYC formalities and provide a deposit amount. Once the account is registered, the trader can download the trading platform and start trading.

Pips: A pip is the smallest movement that the price of a currency can make. Pip is generally the fourth decimal movement of price in currency pairs. For USD-related currency pairs, the value of a pip is $0.0001. The spread that you will be charged for trading a currency pair is denoted in pips.

Leverage: Leverage is the ratio between the amount of money that you need to invest and the amount of exposure that you can gain in a trade. For example, the leverage offered by a forex broker can be 1:500.

A 1:500 leverage means that you need to provide $1 in order to trade $500 worth of currency. The higher the leverage, the larger the trade that you can make with a given amount of money.

Leverage increases the potential profit you can make through your trades since you only need a fraction of the money to be able to enter a sizeable trade. However, this also increases the amount of risk that you face with your trades. `

Bid Price: The bid price is the highest price that a purchaser is willing to pay for a security. In forex, the bid price refers to the amount of base currency needed to purchase the quote currency.

Ask Price: The ask price is the lowest amount that a seller is willing to pay to sell a security. In forex, the ask price refers to the amount of quote currency that you will need to sell in order to get one unit of base currency.

Spread: The spread is essentially a fee levied by a forex broker. It is denoted as the difference between the bid price and the ask price. The difference between the two is the fee that the broker is charging in order to provide brokerage services.

The spread is usually variable in nature. This means that the spread fluctuates in accordance with the liquidity and the timing of the trade.

The spread for trading each currency pair will be different. Usually, major currency pairs have tighter spreads than minor currency pairs. This means that trading major currency pairs is more affordable than trading other types of currency pairs.

For example, this below screenshot shows the spread for EUR/USD at XM. Their spread with Micro Account is 1.9 pips on their MetaTrader platform.

Lot sizes: Lot size is the amount of currency that you will be trading. There are three different main lot sizes in the forex market.

The three sizes are Standard, Mini, and Micro.

A Standard lot is equivalent to 100,000 units of the base currency.

A Mini lot is equivalent to 10,000 units of the base currency.

A Micro lot is equivalent to 1,000 units of the base currency.

Different brokers offer different types of lot sizes, however, the terminology for the three main types of lots has largely remained the same.

Market Trading Terms

Some terminologies are based on market activities and traders must acknowledge these to understand price movements in the forex market.

1. Bull Market

Bullish trend or bullish market is a commonly used term in financial markets to denote appreciation in the price of the asset. For example, a continuous rise in prices of a commodity or stock for a prolonged period will be called a bullish trend.

In a forex pair, a bullish trend can be due to appreciation as well as the depreciation of one currency with respect to other. For example, a bullish trend in EUR/USD currency pair represents an appreciation of EUR and/or depreciation of USD.

2. Bear Market

A bearish trend or bearish market is exactly the opposite of a bullish trend. Continuous depreciation in the price of an asset is commonly denoted as a bearish trend.

In the forex market, appreciation of quote currency and/or depreciation of base currency can be called a bearish trend on a currency pair.

3. GDP

GDP or Gross Domestic Product is the total value of all the goods and services produced in a country in a particular time period. It is a popular indicator that represents the overall health of a nation’s economy.

Growth in GDP can be compared with other nations to predict the increase or decrease in the price of a currency pair. For example, in a hypothetical currency pair ABC/XYZ, the GDP of the country with ABC currency increases more than the GDP of XYZ nation. This means ABC is growing faster than XYZ and the price of ABC in terms of XYZ is very likely to increase.

4. Inflation

Inflation means a rise in prices in a nation over a time period. There are multiple factors in an economy that can increase or reduce inflation. Each country has different inflation rates at a particular time interval.

Inflation rates of two currencies involved in a currency pair can be compared to predict the price movement of a currency pair. The country with a higher rate of inflation will lose its value against the one that has a lower inflation rate.

5. Interest Rates

The interest rate of a country that is also known as the repo rate is the basic rate at which the central bank will provide loans in a particular nation to commercial banks. Interest rates also depict the rate at which investors can earn through fixed deposits in the country.

Interest rates are decided by the central bank or the monetary authority of a nation. Interest rates can be comprehended to predict the price movements in a currency pair.

Let us understand the complete process and working methodology of forex market with the help of an example.

Online forex trading is done through trading platform which is a software that can be downloaded on electronic devices. The trading platform connects the traders to brokers, liquidity providers, and other forex traders.

Traders place buy or sell orders through trading platforms on their preferred trading instruments. The exposure and profit/loss depends on the volume traded and leverage involved.

A leverage of 1:10 will allow you to open a position worth $100 exposure with $10 in your trading account.

In this example, we will take the leverage of 1:10 on EUR/USD currency pair. The supposed market price for EUR/USD is 1.2100/1.2102. This means that the bid price is 1.2100 (the price that the dealer is willing to pay) and the ask price is 1.2102 (the price at which the dealer is willing to buy) and the spread is 2 pips (difference between the bid and ask price at 4th decimal).

First, we will place a buy order for 1 standard lot (100,000 units of the base currency). To place a buy order of 1 standard lot on EUR/USD, the following will be the calculation of the required account balance.

$1.2102 * 100,000 * 1/10 = $12,102
(ask price) * (units of base currency) * (leverage ratio) = (minimum account balance required to open the given position)

Now suppose the price of EUR/USD went up by 100 pips and reaches 1.2200/1.2202. By closing the buy position at this price, the following will be the profit.

(1.2200 * 100,000 * 1/10) – $12,102 = $12,200 – $12,102 = $98
(bid price * units of base currency * leverage ratio) – (exposure) = Profit/Loss

Now let us understand the same scenario with a short position on EUR/USD with 1 standard lot at the current market price of 1.2100/1.2102. Following will be the exposure amount in a short position.

$1.2100 * 100,000 * 1/10 = $12,100
(bid price) * (units of base currency) * (leverage ratio) = (minimum account balance required to open the given position)

Now suppose the price of EUR/USD went down by 150 pips and reaches 1.1950/1.1952. By closing the position at this position, the following will be the profit.

$12,100 – $(1.1952 * 100,000 * 1/10) = $12,100 – $11,952 = $148
exposure – (ask price * units of base currency * leverage ratio) = profit

It must be noted the exposure amount ($12,102 in the long position example and $12,100 in the short position example) will be at risk of capital markets. If the leverage is high, the profit/loss amount will move more with the change in the pip value of the underlying asset.