Continuing on with my Forex 101 series I thought I would go to the very nuts and bolts of it all and walk you through the basics of FX trading and hopefully along the way to help you understand better what can be at times a very confusing, scary and possible disastrous world for the retail trader.
Forex trading – Basic overview:
Forex trading at its most basic is kind of like flipping a coin, theoretically you have a 50% chance of winning, only in FX your betting on whether a currency goes up or down. If you buy let’s say the EURUSD your beating that the EUR gains strength and goes up against the USD but we all know it’s not that simple and there are a lot of factors involved in making an educated, profitable trade. We won’t go into detail about that in this article as it’s for the complete beginner.
What is forex?
Wikipedia describes forex as the following. The foreign exchange market (forex, FX, or currency market) is a global decentralized market for the trading of currencies. The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.
The foreign exchange market works through financial institutions, and it operates on several levels. Behind the scenes banks turn to a smaller number of financial firms known as “dealers,” who are actively involved in large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the “interbank market”, although a few insurance companies and other kinds of financial firms are involved. Trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars.
What is a PIP?
This is a great place to start as it is the most basic of functions in FX. A PIP or “Percentage In Point” is the measurement of how the market moves. You may hear on the news that the “Aussie Dollar” had a strong day moving 200 “PIP’s” against the US Dollar, meaning if it had a starting position of 0.92180 it would have moved to 0.92380.
PIP’s are calculated and move in units of 1 so depending on the size of your position (how many lots) would determine how much each pip is worth per tick. Let’s say you placed a mini lot or a $10k position the market value for each tick or PIP would be worth $1. So even with a small trade a movement of 200 pips would equal a $200 gain.
What is a “LOT”?
A lot is the standard trading term referring to the amount or volume of currency you are either buying or selling.
There are 3 types of “LOT” or position sizes;
- Micro lot, which is worth $1,000
- Mini lot, which is worth $10,000
- Standard lot, which is worth $100,000
Having these different sizes helps traders place different sized trades in a speedy manner. You can of cause place any type of trade you need depending on the position required i.e. a large position would be 50.00 standard lots or $5,000,000 and a small trade would be 0.03 or $30,000.
What is leverage?
Normally the average investor is too small to enter the forex market place which is dominated by what’s called tier 1 banks i.e. your Deutsche Bank, UBS and JP Morgan’s etc. but with leverage someone with a modest investment of $1000 using leverage of 100:1 now has buying power of $100,000. Leverage is one of the most important facets of trading FX and by utilizing companies such as Tradeview you can be a part of the largest market in the world with daily volumes on over $5 trillion.
Leverage needs to be properly understood because it can work against you as well. Many Forex brokers entice customers by offering massive leverage like 1000:1 this sort of leverage seems great at first because the amount of money needed to buy and hold a position is smaller with the same profitability should your trade move in your favor but like a double edged sword can just quickly move against you.
Example: If you place a one mini lot ($10,000), each pip would be worth around $1. If you gain 5 pips, everything is great, you used $50 and made a 10% return. If you lose 5 pips, you have a 10% loss just as fast.
Think of margin as a down payment to hold the trade you just placed that is larger in value, like you would if buying a new car or house. As mentioned before currency pairs are traded in either standard, mini or micro so if a trader buys 1 standard lot ($100,000) of the base currency while selling the same about of the counter currency.
Example: When the ask price for EUR/USD is 1.2500, 100,000 Euros are bought while 125,000 Dollars are sold. For a standard contract (1 Lot) in which the USD is the counter currency 1 pip will equal $10 ($1 for a mini lot). For all other pairs exact pip values are slightly different and range from $8 to $10.
One thing I tell all of my clients who are new to forex is to download a demo and test every aspect of what we just covered until you are totally confident you understand what you are doing, then and only then should you think of investing real money.
Feel free to download Tradeview’s free demo platform HERE.
Vice President of sales