|
Currency Trading: Understanding The Basics Of Currency Trading
By: Raul Lopez
Investors and traders around the world are looking to the Forex market as a new
speculation opportunity. But, how are transactions conducted in the Forex
market? Or, what are the basics of Forex Trading? Before adventuring in the
Forex market we need to make sure we understand the basics, otherwise we will
find ourselves lost where we less expected. This is what this article is aimed
to, to understand the basics of currency trading.
What is traded in the Forex market?
The instrument traded by Forex traders and investors are currency pairs. A
currency pair is the exchange rate of one currency over another. The most traded
currency pairs are:
EUR/USD: Euro
GBP/USD: Pound
USD/CAD: Canadian dollar
USD/JPY: Yen
USD/CHF: Swiss franc
AUD/USD: Aussie
These currency pairs generate up to 85% of the overall volume generated in the
Forex market.
So, for instance, if a trader goes long or buys the Euro, she or he is
simultaneously buying the EUR and selling the USD. If the same trader goes short
or sells the Aussie, she or he is simultaneously selling the AUD and buying the
USD.
The first currency of each currency pair is referred as the base currency, while
second currency is referred as the counter or quote currency.
Each currency pair is expressed in units of the counter currency needed to get
one unit of the base currency.
If the price or quote of the EUR/USD is 1.2545, it means that 1.2545 US dollars
are needed to get one EUR.
Bid/Ask Spread
All currency pairs are commonly quoted with a bid and ask price. The bid (always
lower than the ask) is the price your broker is willing to buy at, thus the
trader should sell at this price. The ask is the price your broker is willing to
sell at, thus the trader should buy at this price.
EUR/USD 1.2545/48 or 1.2545/8
The bid price is 1.2545
The ask price is 1.2548
A Pip
A pip is the minimum incremental move a currency pair can make. A pip stands for
price interest point. A move in the EUR/USD from 1.2545 to 1.2560 equals 15
pips. And a move in the USD/JPY from 112.05 to 113.10 equals 105 pips.
Margin Trading (leverage)
In contrast with other financial markets where you require the full deposit of
the amount traded, in the Forex market you require only a margin deposit. The
rest will be granted by your broker.
The leverage provided by some brokers goes up to 400:1. This means that you
require only 1/400 or .25% in balance to open a position (plus the floating
gains/losses.) Most brokers offer 100:1, where every trader requires 1% in
balance to open a position.
The standard lot size in the Forex market is $100,000 USD.
For instance, a trader wants to get long one lot in EUR/USD and he or she is
using 100:1 leverage.
To open such position, he or she requires 1% in balance or $1,000 USD.
Of course it is not advisable to open a position with such limited funds in our
trading balance. If the trade goes against our trader, the position is to be
closed by the broker. This takes us to our next important term.
Margin Call
A margin call occurs when the balance of the trading account falls below the
maintenance margin (capital required to open one position, 1% when the leverage
used is 100:1, 2% when leverage used is 50:1, and so on.) At this moment, the
broker sells off (or buys back in the case of short positions) all your trades,
leaving the trader “theoretically” with the maintenance margin.
Most of the time margin calls occur when money management is not properly
applied.
How are the mechanics of a Forex trade?
The trader, after an extensive analysis, decides there is a higher probability
of the British pound to go up. He or she decides to go long risking 30 pips and
having a target (reward) of 60 pips. If the market goes against our trader
he/she will lose 30 pips, on the other hand, if the market goes in the intended
way, he or she will gain 60 pips. The actual quote for the pound is 1.8524/27, 4
pips spread. Our trader gets long at 1.8530 (ask). By the time the market gets
to either our target (called take profit order) or our risk point (called stop
loss level) we will have to sell it at the bid price (the price our broker is
willing to buy our position back.) In order to make 40 pips, our take profit
level should be placed at 1.8590 (bid price.) If our target gets hit, the market
ran 64 pips (60 pips plus the 4 pip spread.) If our stop loss level is hit, the
market ran 30 pips against us.
It’s very important to understand every aspect of trading. Start first from the
very basic concepts, then move on to more complex issues such as Forex trading
systems, trading psychology, trade and risk management, and so on. And make sure
you master every single aspect before adventuring in a live trading account.
About the Author:
Raul Lopez is a full time Forex trader and founder of http://www.straightforex.com
a high quality Forex training company.
|