Risk Disclosure

"Forex trading can involve the risk of loss beyond your initial deposit. It is not suitable for all investors and you should make sure you understand the risks involved; seeking independent advice if necessary"

Binary Options

Sunday, November 11, 2007

Learn to Trade Forex

The foreign exchange market exists wherever one countries currency is exchanged for that of another country. The currency market is by far the largest market in the world, in terms of cash value traded. Transactions take place between large banks, central banks, multinational corporations, investment houses, governments and currency speculators.

It is estimated that 70 to 80% of currency trading is speculative. Speculators do not take possession of the currency instead they are only interested in profiting from the movement of that currency. The investor’s goal in Forex trading is to profit from foreign currency movements. Forex trading or currency trading is always done in currency pairs like the Euro USD pair or the USD Japanese Yen.

The most liquid currencies along with their symbols are shown below:

Symbol Country CurrencyNickname
USD USADollarBuck
GBP BritianPoundCable
CHF SwitzerlandFrancSwissy
NZDNew ZeakandDollarKiwi

Forex currency symbols are always three letters, the first two letters identify the name of the country and the third letter identifies the name of that country’s currency. The first listed currency is known as the base currency while the second of the pair is called the quote currency.

When you buy a currency pair the exchange rate tells you how much of the quote currency you need to buy 1 unit of the base currency. When selling the exchange rate tells you how many units of the quote currency you will receive for 1 unit of the base currency.

If for example you bought EUR/USD (Eur Base) (USD quote) this Morning the exchange rate (or rate) was 1.4175. 1000 euros would have purchased 1417.50 $. By this afternoon the price went up to 1.4279 and had you sold your euros at that price you would have received 1427.90 $ a net gain of $10.40 for the day.

If we decided that the Euro would weaken against the $ we would sell the pair the the transaction would look like this. Rate 1.4175 = 1417.50 $ The Euro price goes down to 1.4075 and we buy back our dollars at the cheaper rate. Selling price 1.4175 - buying price 1.4075 = a 10 $ profit on the trade.

Now that hardly seems worth the effort. So how do speculators make money trading. A better understanding of how the market works will help you make sense of the riddle. There are a number of elements to this riddle. The first is how the value of a currency is actually calculated relative to another currency, then, Leverage, spread, lots, pips margin and Price.

Currencies are mostly traded on the 4th decimal point which is the most common or lowest denominator in currency pricing, commonly referred to as a “pip” meaning “Price interest point” If we look at our example above EUR/USD was bought at 1.4175 then sold at 1.4279 we see that the pip difference was 104 pips. 1.4279-1.4175 Ok great so now I have exchanged my $ 10.40 profit for 104 pips somehow I don’t feel any richer.

Just imagine your bank lends you $10,000 to buy currencies and all he asks in return is that you give him $1,000 as a good faith deposit, which he will hold for you but not necessarily keep. Well this is how leveraged Forex trading works. Leverage is a double edged sword though that can make you filthy rich or stone broke.

In currency trading your broker, market maker or trading platform is like the generous banker. He will offer you leverage from 100:1 to 400:1 The higher the leverage the larger the profit potential but also the larger the potential for loss.

Again lets take our EUR/USD trade above to see how this effects us. Our 1417.50 $ we used to purchase 1000 Euros at a leverage of 100:1 would equal 141,750$ or 100,000 Euros. We then sold at 1.4279 X 100:1 or 142,790 $ So how much did we make on the trade. 104 pips x100:1 equals 1040$.

Wow! more than 100% profit on our margin, where can I sign up? You have probably heard the saying “if it sounds too good to be true then it is too good to be true” What if the price had come down 104 Pips? Yes you would have lost 100% of your margin. Not such a good deal now is it! Not so fast, what happened to my 1000 $ deposit?

Your 1000$ deposit was held by your broker as collateral against any losses. If your trade was closed out in profit as above then your 1000 $ is returned to you along with your profit. If however your trade was closed out at a loss then the amount you lost would be deducted from your 1000 $ and the balance returned to you. This deposit we call “Margin” If your losses exceed the amount of your capital then your trade will be closed out with a “Margin call“

Can I wind up owing my broker money? Highly unlikely as your broker will close out all your trades before it gets to that point. The spread is the cost of doing the trade. Your generous broker who offers the huge leverage is not a benevolent society, he is in the business for the money he can make out of it. In Forex we have a bid ask spread. Bid = selling price Ask buying price. The spread can be anything from 2 pips to 10 pips or more depending on the currency.


Lets look at our EUR/USD example again Bid 1.4175. The average spread on the EUR/USD pair these days seems to be 2 pips. Therefore the ask price would be 1.4177 based on our trade 2 pips X 100:1 leverage would equal 20$. When we buy a currency pair we buy at the ask price and when we sell a currency pair we sell at the bid price.

Our actual profit on that trade would have been 20 $ less because we pay the spread when we enter the trade on a buy. When we sell a currency pair we we sell at the bid price and close the trade on the ask price. The spread is only paid when we close the trade at the ask price. When we buy a currency pair your broker is deducting his spread when we enter the market. When we sell a currency pair your broker is deducting his spread when we exit the trade.

When we trade in the forex market we use lots to purchase a currency contract. Lots generally have different values.
Standard lots = 100 000 $ at 100:1 leverage means 1000 $ per lot Margin and 10$ per pip profit or loss.
Mini lots = 10 000 $ at 100:1 leverage = 100 $ per lot Margin and 1$ per pip profit or loss.

Micro mini lots = 1000 $ at 100:1 leverage = 10$ per lot margin and 10c per pip profit or loss.
1 lot is the smallest amount we can buy or sell at a time. Depending on how much capital you have to trade with will determine the type of account you will open Standard account, Mini account or Micro Mini account.

As you have now discovered, currency trading values are measured in pips, which is the smallest increment of that currency. The amount of leverage and the type of account you open will determine the value of each pip.
As we calculate on the 4th decimal place of most currencies we would calculate the value of a pip as follows. Std account pip value calculation.

CurrencyDecimalsRateStd.Acc.Pip Value

The calculation of a standard lot size $100,000 is as follows USD/JPY at an exchange rate of 120.50(.01 / 120.50) x $100,000 = $8.30 per pip In cases where the US Dollar is not quoted first, the formula is slightly different. EUR/USD at an exchange rate of 1.3528(.0001 / 1.3528) X EUR 100,000 = EUR 7.39 x 1.13528 = $10.00 per pip.

Now look at the calculation for mini lots USD/JPY at an exchange rate of 120.50(.01 / 120.50) x $10,000 = $0.83 per pip
Mini lot pip value calculation

CurrencyDecimalsRateMini.Acc.Pip Value

Remember where the US Dollar is not quoted first, the formula is slightly different.EUR/USD at an exchange rate of 1.3528(.0001 / 1.328) X EUR 10,000 = EUR .7392 x 1.3528 = $1.00 per pipis at the particular time. As the market moves, so will the pip value depending on what currency you are currently trading.You won’t have to calculate this every time you trade, your trading software will automatically do it for you.

What Tools are needed Start Trading Forex?A computer with a high-speed Internet connection and the basic trading information available on this site are all you need to begin as a novice trader.

What Does It Cost to Trade Forex? An online currency trading (“micro account”) may be opened with a few hundred bucks. Micro accounts and mini accounts are both good ways to test the water without drowning. Free “Demo” Accounts, "News," "Charts," and "Analysis" are available from many brokers. Most online Forex brokers offer ‘demo’ accounts to practice trading, along with breaking Forex news and charting services. All free! These are extremely valuable tools for novice traders who would like to hone their trading skills with ‘play’ money before opening a live trading account and risking real money.To open a free demo account click HERE

“Mini” and “Micro” Trading: You would think that getting started as a currency trader would cost a ton of money. The fact is, compared to trading stocks, options or futures, it does'nt. Online Forex brokers offer “mini” and “micro” trading accounts, minimum margin deposit of $250 or less. It does make Forex far more accessible to the average person who does'nt have tons of start-up capital

Reccommended Reading

No comments: