Learn Forex Trading
Forex is the trading of money - always with a pair of currencies.
Currency Pairs
Every forex trade involves selling one currency and buying another. This is because currency prices can only change relative to another currency. As such, forex products are expressed as a pair of currencies.
Currency pairs are normally denoted in the format:
(base currency) / (counter currency)
eg EUR/USD
In a typical 'Buy' order, the base currency (the numerator) is the currency the trader believes will go up, while the counter currency (the denominator) is the currency the trader believes will go down.
Using the EUR/USD as an example, and assuming the conversion is 1 Euro to $1.28 US Dollars, a trader is essentially selling the Dollar at $1.28 and buying 1 Euro. This is done in the hope the Euro will continue to grow vis-vis the Dollar.
Exchanges
Unlike stocks and bonds, their is no one central exchange for Forex trading. Instead, various banking centers around the world facilitate trading 24 hrs a day on market open days. The largest trading centers are in New York, London, Singapore, Hong Kong and Tokyo.
In 2007 the CME and Reuters joined forces to launch FxMarketSpace. The long term goal of FxMarketSpace is to become the central market for forex transactions.
Contract Size
Stock investors are used to the concept of buying shares of stock.
Forex, which is really a subset of the futures industry, works in a very different manner. Forex is traded via contracts between buyers and sellers in the market. Contracts are sold at predetermined sizes - called lots. In Forex, a lot is typically 100,000 of the base currency (the numerator in the trade symbol).
100,000 - Hoy Cow!
Yes, that is a substantial amount to trade. However, even small traders can participate through the use of margin and leverage. Rather than paying the full 100,000, forex traders buy on margin. Think of margin and leverage like buying a house. The amount paid in margin is equivalent to the equity held in a house. The leverage is the equivalent of the total value of the house.
Brokerages usually maintain 2 sets of margins - initial and maintenance. The initial margin is the amount paid to enter a trade. After the position is opened, if the trade becomes a loser, the brokerage will require that a minimum amount of equity is maintained. Usually, the maintenance margin is below initial margin. Note maintenance margin is NOT a factor for day traders. It only kicks in if the position is held over night.
When entering an overnight trade, you must keep an account balance that allows you to cover maintenance margin.
The eight most frequently traded currencies (USD, EUR, JPY, GBP, CHF, CAD, NZD and AUD) are called the major currencies. All other currencies are referred to as minor currencies.
Pips
A pip is the last decimal place in a quoted price. For instance, if the EUR/JPY moves from 108.15 to 108.16 it has moved 1 pip.
Each currency pair will have a different pip value (for instance, the USD/JPY is quoted to the hundredths as 1.30).
To obtain the value of a pip for a currency pair, their are 2 formulas. In the case where the USD is quoted first, divide the pip value by the exchange rate and multiply by lot size
(pip value = (pip / exchange rate) * lot size)
USD/JPY (.01 / 119.80) x 100,000 USD = $8.34 per pip
In the case where the USD is quoted 2nd, determine the value of the pip in the foreign currency, and then apply the exchange rate.
Using the EUR/USD example from above,
(0.001 / 1.308) x 100,000 EUR = 7.64525994 EUR
7.64525994 EUR x 1.308 = $10
Example of Margins in Trades
Lets put all of these concepts into an example trade, emphasizing margin and account values.
- Joe trader opens an account with a brokerage, depositing an initial $10,000.
- Joe then buys a 1 lot of EUR/USD. The opening margin is $1,500, so $1,500 is taken from the account and set aside as equity.
- That day, Joe's trade turns bad. He loses $300, which is deducted from the equity. But Joe feels confident his trade will turnaround, so he keeps his position overnight. Joe has $1,200 in equity, but the maintenance margin is $1,350. As a result, a further $150 is taken from Joe's account to bring equity up to the maintenance level.
- The next day, Joe's trade turns to the upside, and he makes $225. Since his equity is now above maintenance levels, margin is not an issue.
Trading Platform - The Forex Account Screen
As with a futures account, forex trading software will have 3 key numbers: balance, equity, and margin available.
Balance is the total value of the account (including open positions).
Equity is the amount held to cover open trades.
Margin available is the amount that can be used to enter new trades or cover maintenance.
Using the previous trade as an example, the account screens will looks as follows:
Joe Enters Trade
Balance: $10,000
Margin Available: $8,500
Equity: $1,500
Joe loses $300 on trade
Balance: $9,700
Margin Available: $8,350 ($8500 - $150 maintenance)
Equity: $1,350 ($1500 open - $300 loss + $150 maintenance)
Joe gains $225
Balance: $9,925
Margin Available: $8,575 ($225 profit)
Equity: $1,350 (unchanged, account at minimum)
There is a substantial risk of loss in forex trading.
You should only trade with risk capital that you can afford to lose without impacting your lifestyle or retirement plans.
The views expressed on this site represent the current good faith views of the authors at the time of publication. Please be advised that these views are subject to change at any time and without notice.
