Understanding Forex Positions

Question

I am new to forex trading and using an Oanda free practice account to play with it. However, I'm not understanding a few things.

1. When I buy or sell a currency pair, am I buying/selling a currency or am I buying a security to represent my trade?
2. When I open and close positions on Oanda, they appear to start with a loss instead of at zero. This is for short and long positions on pairs that I have and haven't traded in the past. Why is this?
3. Ultimately, I would like to be able to form a triangle and convert from currency A to currency B, then B to C, and C to A. However when I attempt to do this, the positions all stay open. How should I be executing trades so that I convert in this way, and return to my base currency with no positions open?

Answer 1

1) Imagine your have a USD denominated account (HOME currency USD) and you want to buy NZD/JPY. Without a broker you would use the HOME currency account as collateral to borrow money in the QUOTE currency (JPY), convert that money to NZD (known as the BASE currency) and put the amount in NZDs in a deposit (interest earning) account.

In this scenario you are Long NZD (because that is what you have), and you are short JPY (because you have to repay the loan at some time). During the time the position is open you may earn interest on the NZD, but pay interest on your JPY loan. Complicated, but in theory a broker will do all of this for you at the click of a button; I say in theory because in practice, unless you are a large trader, they will just take the other side of the trade as if they were a bookmaker.

If the value of NZD against JPY rises then your overall position will be profitable, if it falls then your position will be in loss.

All of which means the simple answer to your question is that, in theory, you are buying / selling currency.

2) The way brokers make their money is on the spread. The difference between the buying and selling price. The quote for NZD/JPY might be 73.80/73.82 which means that to open a position you pay 72.82, but if you were to immediately close you would only receive 73.80 - a 0.02 loss. Which is why when you open a position like this at the point it is opened it shows a negative value of -0.02.

3) I don't think any broker is going to offer a triangular trade like that, they only trade in pairs. I've heard of trading strategies that involve taking positions in 3 (or more) currencies simultaneously, but I would suggest they are very high risk and expensive as you will pay multiple spreads.

Answer 2

1) When you buy/sell a currency pair in the spot market, you will be holding the actual currency. For example, if one buys EUR/USD, one will own EUR and have paid with it in USD. If you have USD in the account to cover the purchase, your account will be debited the USD. If not, you will be borrowing USD from your bank and therefore incur financing costs.

2) Don't know Oanda works, but one of the reasons you are starting off at a loss is that when you trade, you were probably on one side of the bid-ask spread. When this position is marked-to-market (MTM), they will market either at the mid, or the side to unwind your position (more conservative). Therefore you will show a loss equivalent to the bid-ask spd (or half if marked at mid) * the size of your position.

Another possible reason for your loss could be the financing charge (see. pt. 1) associated with your purchase, including custody and transactions charges related to your trade and holdings.

3) If you trade the triangle in the spot markets, all of your positions should net down in your account. You may be trading forwards, in which case they will not net down due to forward points or financing differences in the currencies. Another reason for not netting down could be residual exposures. If the amount of the middle currency is not exact on all 3 legs, there will be some residual currency exposure that you would have to clean up to get to only currency A.