How Forex Works? (Session 6)

Basic Forex working mechanism
Forex which stands for foreign currency exchange.

It is about changing your currency (say Singapore Dollars SGD) to another currency (say Malaysian Ringgit MYR).

Why change? Because you need to buy Malaysian goods and services.

Like wise when you have excess MYR and you are coming back to Singapore, you may want to exchange them back. Why change back? Because MYR cannot be use to buy Singapore goods and services.

Can you observed the term "buy" for both occassions?

I am trying to remove the misconception and the fear people have when they "sell" stocks and shares

In forex, you always need a pair and you are always buying one, which means you are selling the other.

The RATES determine how much you can get MYR for each SGD and likewise how much SGD you can get for each MYR.

Bid and Ask Price

The difference between the bid and ask price is call the spread.

When you go to the money changer with a SGD100 and ask to exchange for MYR, the uncle will say to you 2.20. That is with SGD100 you can get MYR220.

One minute later, after you get your MYR220, you go back to the same money changer and say sorry and ask for SGD100 back, he will refuse you. Instead, he will say that using MYR to get back SGD is using a different rate at, say MYR230. That is he will need MYR230 to give you SGD100. Oops, that means with MYR220, you can only get SGD95.65. The uncle will earn SGD4.35 and profit from your silliness!

MYR220 is termed the bid price and MYR230 is termed as the ask price. In forex, it will be shown as SGD/MYR = 220/230

The difference in bid and ask price is call the spread.

Confuse about bid and ask? You always buy low sell high.

So how do you make money?

Now instead of changing back you MYR220 to SGD, you hold. Say after a week, the rates is now at SGD/MYR = 200/210

You went back to the money changer and say I want my SGD and this time the uncle will give you MYR210 for SDG100, and because you have MYR220, you get back more SGD! So this time you profited SGD4.76

The converse is true, when you started off with MYR100 and the rates is at SGD/MYR = 220/230, which you will get SGD43.48 (using 230 to calculate because you are buying SGD).

After one week, the rates now become SGD/MYR = 240/250. You change back to MYR and you will get MYR104.35, profit MYR4.35

Stop for a while and read again to understand the above principle.

I hope you can see that it always take a pair of currency and you are always buying one while selling the other. As such there is always a buying.

To put it simply, using a graph or a chart to help you.

From the chart, you can see a up trend. This means SGD/MYR is going up.

If you think that the trend will contiune, you do a buy (or using the term "long") SGD/MYR, which in actual, buying SGD (the first pair) and selling MYR.

If the graph shows the reverse as shown

To profit, you sell SGD/MYR (or the term "short"), which in fact you are buying MYR (the second pair) and seling SGD.

So up -> buy and down ->sell. In both way you can profit.

Of course you must first make sure you cover the spread. You cannot buy and sell immediately or you will lose money.

When you do a buy (using ask price), you must wait until the bid price (sell price) go pass your ask price, then you have break even.

When you do a sell (using bid price), you must wait until the ask price (buy price) go pass you bid price, then you have break even.

Confuse - start a demo account and practice. You must get this principle correct and you must internalize it, so much so that in the heat of a battle, you know when is buy and when is sell and when you have break even.

In the next sessions I will talk more about spread.