SO YOU ARE INTERESTED IN FOREX TRADING BUT YOU ARE A BEGINNER. WELL HERE IS A BEGINNERS GUIDE AS TO HOW YOU CAN GET STARTED TRADING FOREX!
The Forex market consists of buying or selling currencies. Placing a trade in the foreign exchange market is very simple: the process of a Forex trade is similar to those found in other markets, so if you have any experience in trading, say the stock market, then you should be able to pick this up with no problem.
The object of Forex trading is to exchange one currency for another with the expectation that the price will change.
As a trader you are expecting the currency you bought to increase in value as compared to the one you sold.
For example: You execute a market order for 10,000 units of GBP in exchange for USD, The market price of GBP is 1.2000, so this cost you $12,000.
1 month later you exchange your GBP back to USD at the current market price of 1.3000, is a gain of $1000.00
Here’s the math:
GBP =10,000 units @ 1.2000= $12,000 USD is the cost of 10k units of GBP; now you owe 10,000 GBP that cost $12,000.00 USD once GBP has increased exchanged rate of 1.3000 so now it’s time to sell your 10000 GBP back to USD for the increased exchange rate of 1.3000 this is a $1000.00 increase for 10,000 units. So just by simply buying GBP at a low rate and exchanging it back to USD at a higher rate you have profited $1,000.00.
An exchange rate is simply the ratio of one currency valued against another currency.
For example, the USD/JPY exchange rate indicates how many U.S. dollars can purchase one Japanese Yen, or how many Japanese Yen you would need to purchase one U.S. dollar.
Understanding Forex Quotes
For starters understand that currencies are always quoted in pairs, such as EUR/USD or USD/JPY. The reason they are quoted in pairs is because, in every foreign exchange transaction, you are concurrently buying one currency and selling another.
A Forex Quote is structured like this: EUR/USD= 1.2000
The first listed currency to the left of the slash is called the base currency (in this example, the Euro), and the second listed currency on the right of the slash is called the quote currency (in this example, the U.S. dollar).
When buying, the exchange rate tells you how much you have to pay in units of the quote currency to buy 1 unit of the base currency. In the example above, you have to pay 1.2000 U.S. dollars to buy 1 Euro.
When selling, the exchange rate tells you how many units of the quote currency you get for selling one unit of the base currency.
In the example above, you will receive 1.2000 U.S. dollars when you sell 1 Euro.
The base currency is the basis for the buy or the sell. If you buy GBP/USD this simply means that you are buying the base currency and simultaneously selling the quote currency. In simpler terms, you are buying GBP, and selling (or exchanging it for) USD.
• You would buy the pair if you believe the base currency will appreciate (increase in value) as it relates to the quote currency.
• You would sell the pair if you think the base currency will depreciate (decrease in value) as it relates to the quote currency.
Long or Short
Before considering a trading opportunity, you should determine whether you want to enter into a buy or sell trading position or in other words take a long or short trading position .
If you want to buy, meaning you wish to buy the base currency and sell the quote currency, you are expecting the base currency to increase in value and then you would sell it back at a higher price. Forex traders call this going long or taking a long position. The key point here is that long is the same as buy.
If you want to sell meaning you wish to sell the base currency and buy the quote currency, you are expecting the base currency to decrease in value and then you would buy it back at a lower price. Forex traders call this going short or taking a short position. The key point here is that short is the same as sell.
All Forex quotes are quoted with two prices: the bid and ask. For the most part, the bid is always lower than the ask price.
So, the bid is the price at which your broker is willing to buy the base currency in exchange for the quote currency. This means the bid is the best available price at which you will sell to the market.
The ask is the price at which your broker will sell the base currency in exchange for the quote currency. This means the ask price is the best available price at which you will buy from the market. The ask is also referred to as the offer price.
The difference between the bid and the ask price is what’s known as the SPREAD.
On the EUR/USD quote above, the bid price is 1.16741 and the ask price is 1.16756.
• If you want to sell EUR, you click “Sell” and you will sell euros at 1.16741.
• If you want to buy EUR, you click “Buy” and you will buy euros at 1.16756.
See the chart below for the break down on the ask, bid, and the spread.
EUR (Base Currency) 1.16756 (ASK)
USD (Counter Currency)
The number in RED is the pip the difference between the ask and the bid is the spread which equals 1: (5-4=1)
How Do You Know When to Buy or Sell a Currency Pair?
So looking at a trade fundamentally, meaning using fundamental analysis to help us decide whether to buy or sell a specific currency pair.
In the EUR/USD example, the euro is the base currency and this means it is the currency that will receive the action; the buy or the sell.
If you believe that the U.S. economy will continue to weaken, which is bad for the U.S. dollar, you would execute a BUY EUR/USD order.
By doing so, you have bought EUROS in the expectation that they will rise versus the U.S. DOLLAR.
If you believe that the U.S. economy is strong, and the euro will weaken as it relates to the U.S. dollar, you would execute a SELL EUR/USD order.
By doing so, you have sold euros in the expectation that they will fall as it relates to the US dollar.
In this example, the U.S. dollar is the base currency and thus the “basis” for the buy/sell.
If you think that the Canadian government is going to weaken the Canadian dollar in order to help its exports industry, you would execute a BUY USD/CAD order.
By doing so you have bought U.S dollars in the expectation that they will increase in value against the Canadian Dollar.
If you believe that Canadian investors are pulling money out of U.S. financial markets and converting all their U.S. dollars back to the Canadian Dollar, and this will hurt the U.S. dollar, you would execute a SELL USD/CAD order.
By doing so you have sold U.S dollars in the expectation that they will decrease in value against the Canadian Dollar.
In this example, the Aussie Dollar is the base currency and again is the basis for the buy or the sell.
If you think the Australian economy will continue to do better than the U.S. in terms of economic growth, you would execute a BUY AUD/USD order.
By doing so you have bought the Aussie Dollar expecting it to rise versus the U.S. dollar.
If you believe the Australian economy is slowing while the United States’ economy remains strong then, you would execute a SELL AUD/USD order.
By doing so you have sold the Aussie Dollar expecting it to depreciate against the U.S. dollar.
In this example, the U.S. dollar is the base currency and once more is the basis for the buy or the sell.
If you think the Swiss franc is overvalued, you would execute a BUY USD/CHF order.
By doing so you have bought U.S. dollars expecting that they will appreciate versus the Swiss Franc.
If you believe that the U.S. real estate market weakness will hurt future economic growth, which will weaken the dollar, you would execute a SELL USD/CHF order.
By doing so you have sold U.S. dollars expecting that they will depreciate against the Swiss franc.
In Forex currencies are sold in lots. You can trade a micro lot which is 1,000 units, a mini lot which is 10,000 units, or a standard lot which is 100,000 units.
Your broker and the type of account you have determines the amount you are able to trade.
“But I don’t have enough money to buy 10,000 euros! Can I still trade?”
Naturally new traders may be put off by that information thinking “I don’t have enough money to buy 1,000 Euros let alone 100,000.”
This is where Forex shines, you can absolutely purchase a lot with margin trading!
Margin trading is simply means trading with borrowed capital.
This is how you’re able to open $1,250 or $50,000 positions with as little as $25 or $1,000. You can conduct fairly large transactions, very quickly and inexpensively, with a small amount of initial capital.
Here’s an example how:
• You are interested in purchasing GBP.
• You open mini lot (10,000 units) GBP/USD at a 2% margin when the price hit 1.60000 you buy 10,000 units of GBP/USD which is worth 16,000.00 (10,000 units of GBP *1.6000).
If the margin requirement was 2%, then US$320 would be set aside in your account to open up the trade (US$60,000 * 2%). You now control 10,000 pounds with just US$320.00.
When your trade hits your take profit. Your position closes at 1.60500. You earn about $500.
When your trades close, the deposit that you originally made is returned to you and your profits or losses is calculated.
This profit or loss is then credited to your capital.
What’s even better is that, with the expansion of retail Forex trading platforms, there are brokers that allow traders to have custom lots.
For positions open at your broker’s “cut-off time” (usually 5:00 pm EST), there is a daily rollover interest rate that a trader either pays or earns, depending on your established margin and position in the market.
If you do not want to earn or pay interest on your positions, make sure that all your positions are closed before 5:00 pm EST, the established end of the market day.
Interest rollover charges are part of Forex trading because every currency trade involves borrowing one currency to buy another.
Interest is PAID on the currency that is borrowed.
Interest is EARNED on the one that is bought.
If you are buying a currency with a higher interest rate than the one you are borrowing, then the net interest rate differential will be positive and you will earn funds as a result.
Likewise, if the interest rate differential is negative then you will have to pay.
It’s worth noting that many retail brokers do adjust their rollover rates based on different factors.
Do your due diligence and check with your broker for more information on rollover rates and crediting/debiting procedures.
What is a Pip in Forex?
Forex traders trade what is known as pips (and sometimes pipette). Which is the unit of measurement to express the change in value between two currencies.
Understanding what a pip is, is very important for Forex traders. As it is required knowledge for all traders.
You shouldn’t even enter a trade until you have a good understanding with pip values and calculating profit and loss.
If EUR/USD moves from 1.2050 to 1.2051, that .0001 USD rise in value is 1 PIP.
A pip is usually the last decimal place of a quotation.
Most pairs go out to 4 decimal places, but there are some exceptions for instance the Japanese Yen pairs which only goes out to two decimal places.
What is a Pipette?
There are brokers that quote currency pairs beyond the standard “4 and 2” decimal places, out to the “5th and 3rd” decimal places.
These brokers are quoting FRACTIONAL PIPS, or what is known as “pipettes.”
For instance, if GBP/USD moves from 1.10542 to 1.10543, that .00001 USD move higher is 1 PIPETTE.
What is a Lot in Forex?
In the past, spot Forex was only traded in specific amounts called lots, which is basically the number of currency units you will buy or sell.
The standard size for a lot is 100,000 units of currency, but there are also mini, micro, and nano lot sizes that are 10,000, 1,000, and 100 units respectively.
You already know, the change in currency value relative to another is measured in pips (a very, very small percentage of a unit of currency’s value).
To take advantage of this minute change in value, you need to trade large amounts of a currency so that you can see a significant profit (or loss).
What is leverage?
You are probably wondering how a small investor can trade a large amount of money.
Your broker acts as a bank that basically fronts you $100,000 to buy currencies.
All the bank asks from you is that you give it $1,000 deposit, which it will hold for you but not necessarily keep.
This is how Forex trading using leverage works.
The amount of leverage you use depends on your broker and your comfort level.
Typically the broker will require a trade deposit, also known as account margin or initial margin. Once you have deposited your capital you will be able to trade. Your broker will specify how much is required per position traded.
For example, if the allowed leverage is 100:1 (or 1% of position required), and you wanted to trade a position worth $100,000, but you only have $5,000 in your account.
Your broker would set aside $1,000 as down payment, or the “margin,” and let you “borrow” the rest.
Of course, any losses or gains will be deducted or added to the remaining cash balance in your account.
The minimum margin for each lot will vary from broker to broker.
In the example above, the broker required a one percent margin. This means that for every $100,000 traded, the broker wants $1,000 as a deposit on the position.
For example let’s buy U.S. dollars and sell Canadian Dollar.
1. The rate you are quoted is 1.3525 / 1.3530. Because you are buying U.S. dollars you will be working on the “ASK” price of 1.3530, the rate at which traders are prepared to sell.
2. So you buy 1 standard lot (100,000 units) at 1.3530.
3. A few hours later, the price moves to 1.3550 and you decide to close your trade.
4. The new quote for USD/CAD is 1.3550 / 1.34555. Since you initially bought the CAD to open the trade, to close the trade, you now must sell the CAD in order to close the trade so you must take the “BID” price of 1.3550. The price which other traders are prepared to buy at.
5. The difference between 1.3530 and 1.3550 is .0020 or 20 pips.
6. Using our formula from before, we now have (.0001/1.3550) x 100,000 = $7.38 per pip x 20 pips = $144.60
When you enter or exit a trade, you have to also take in account the spread in the bid/ask quote.
When you buy a currency: you will use the offer or ASK price.
When you sell: you will use the BID price.
The Major and Minor Currencies
The eight most frequently traded currencies are: USD, EUR, JPY, GBP, CHF, CAD, NZD, and AUD and are known as the major currencies or just the majors. The majors are the most liquid so they are most appealing to traders.
All other currencies are referred to as minor currencies and exotics.
The Base Currency
The base currency is the first currency in any currency pair. The currency quote shows how much the base currency is worth against the second currency.
For example, if the USD/CAD rate equals 1.2350, then one USD is worth CAD 1.2350.
In the Forex market, the U.S. dollar is normally considered the base currency for quotes, this means that quotes are stated as a unit of 1 USD per the other currency quoted in the pair.
The primary exceptions to this rule are the British pound, the euro, and the Australian and New Zealand dollar.
The quote currency is the second currency in the currency pair. This can be referred to as the pip currency and any unrealized profit or loss is expressed in this currency.
A pip is the smallest unit of price for any currency.
Nearly all currency pairs consist of five significant digits and most pairs have the decimal point immediately after the first digit, that is, EUR/USD equals 1.4321.
In this instance, a single pip equals the smallest change in the fourth decimal place – that is, 0.0001. Therefore, if the quote currency in any pair is USD, then one pip always equal 1/100 of a cent.
Notable exceptions are pairs that include the Japanese yen where a pip equals 0.01.
One-tenth of a pip. Some brokers quote fractional pips, or pipettes, for added accuracy in quoting rates.
For example, if EUR/USD moved from 1.32134 to 1.32136, it moved 2 pipettes.
The bid is the price at which the market is prepared to buy a specific currency pair in the Forex market. At this price, the trader can sell the base currency. It is shown on the left side of the quotation.
For example, in the quote EUR/USD 1.8812/15, the bid price is 1.8812. This means you sell one EURO for 1.8812 U.S. dollars.
The ask/offer is the price at which the market is prepared to sell a currency pair in the market. At this price, you can buy the base currency. The ask is shown on the right side of the quotation.
For example, in the quote EUR/USD 1.2812/15, the ask price is 1.2815. This means you can buy one euro for 1.2815 U.S. dollars. The ask price is also known as the offer price.
The spread is the difference between the bid and ask price.
Exchange rates in the Forex market are expressed in the following manner:
Base currency / Quote currency = Bid / Ask
The formula for calculating the transaction cost is:
Transaction cost (spread) = Ask Price – Bid Price
Cross Currency (Minors)
A cross currency is any pair in which neither currency is the U.S. dollar. These pairs have erratic price behavior since the trader has, in essence, initiated two USD trades.
For example, initiating a long (buy) EUR/JPY is equivalent to buying a EUR/USD currency pair and selling USD/JPY. Cross currency pairs frequently carry a higher transaction cost.
When you open a new margin account with a Forex broker, you must deposit a minimum amount with that broker.
This minimum varies from broker to broker and can be as low as $25to as high as $100,000.
Each time you execute a new trade, a percentage of the account balance in the margin account will be set aside as the initial margin for the next trade.
The amount is based upon the underlying currency pair, its current price, and the number of units or lots traded.
The lot size always refers to the base currency.
For example, if you open a mini account which provides a 200:1 leverage or 0.5% margin. Mini accounts trade mini lots. 1 mini lot equals $10,000.
If you were to open 1 mini-lot, instead of having to provide the full $10,000, you would only need $50 ($10,000 x 0.5% = $50).
Leverage is the ratio of the amount capital used in a transaction to the required capital margin.
It is the ability to control large dollar amounts of a security with a small amount of capital.
Leveraging varies dramatically with different brokers, ranging from 2:1 to 500:1.
Types of Forex Orders
The term “order” refers to how you will enter or exit a trade.
Check with your broker to know which types of orders your they accept.
Different brokers accept different types of Forex orders.
A market order is an order to buy or sell at the best available price.
For example, the bid price for EUR/USD is currently at 1.5120 and the ask price is at 1.5122.
If you wanted to buy EUR/USD at market, then it would be sold to you at the ask price of 1.5122.
Limit Entry Order
A limit entry is an order placed to either buy below the market or sell above the market at a certain price.
For example, EUR/USD is currently trading at 1.2050. You take a short position if the price reaches 1.2070.
You can wait for it to hit 1.2070 so that you can manually enter a sell market order.
Or you can set a sell limit order at 1.2070 and let the platform automatically execute a trade for you at the best available price.
You use this type of entry order when you believe price will reverse upon hitting the price you specified!
Stop Entry Order
A stop entry order is an order placed to buy above the market or sell below the market at a certain price.
For example, GBP/USD is currently trading at 1.7050 and is trending upward. You are expecting the price to continue in this direction to hit 1.7060.
You can again:
1. Sit in front of your computer and buy at market when it hits 1.7060 OR
2. Set a stop entry order at 1.7060.
You use stop entry orders when you feel that price will move in one direction!
Stop Loss Order
A stop loss order is a type of order linked to a trade to prevent additional losses if the price goes against you.
If you are in a long position, it is a sell STOP order.
If you are in a short position, it is a buy STOP order.
REMEMBER THIS TYPE OF ORDER.
A stop loss order remains in effect until the position is liquidated or you cancel the stop loss order.
A trailing stop is a type of stop loss order attached to a trade that moves as price fluctuates.
Let’s say that you’ve decided to short USD/CAD at 1.0080, with a trailing stop of 20 pips.
This means that originally, your stop loss is at 1.0070. If the price goes down and hits 1.0060, your trailing stop would move down to 1.0080 (or breakeven).
Just remember though, that your stop will STAY at this new price level. It will not widen if market goes higher against you.
Going back to the example, with a trailing stop of 20 pips, if USD/CAD hits 1.0040, then your stop would move to 1.0060 (or lock in 20 pips profit).
Your trade will remain open as long as price does not move against you by 20 pips.
Once the market price hits your trailing stop price, a market order to close your position at the best available price will be sent and your position will be closed.
- The basic Forex order types are: market, limit entry, stop-entry, stop loss, and trailing stop.
- Unless you have experience trading, don’t get to complicated and create a trading plan with a lot 0f Forex orders crammed in the market at all times.
- Stick with the basics initally.
- Make sure you fully understand and are comfortable with your broker’s platform specially the order entry system before executing a trade.
- Also, always check with your broker for specific order information and see if any swap fees will be applied if a position is held longer than one day.
- Major key: Keeping your ordering rules simple is the very best strategy.
- Trade a demo account, until you have an extremely high comfort level with the trading platform you are using and its order entry system, you have to get to know your platform before live investing. “Mistakes” trades are more common than you think!
Demo Trade Your Way to Success
You can open a demo account for FREE with most Forex brokers. These “pretend” accounts have almost all of the capabilities of a “real” account.
But why is it free?
If you’re familiar with stocks then paper trading would be what demo accounts in Forex are like. It’s because the broker wants you to learn how to use their trading platform, and to see if this platform is a good fit for you. Try more than one platform. Have a good time trading (without risk), Fall in love with the market.
The demo account allows you to learn about the mechanics of Forex trading and test your trading skills and processes without risking your capital.
YOU SHOULD DEMO TRADE UNTIL YOU WORK OUT YOUR PLAN DETAILS AND THEN CONSIDER PUTTING REAL MONEY ON THE LINE.
SAY AN AFFIRMATION RIGHT HERE:
“I will demo trade until I follow my trading rules profitable system before I trade with real money.”
Now touch your head with your index finger and say…
“I am a smart and patient Forex trader I take only the setups that are in line with my trading plan!”
- Do NOT open a live trading account until you are CONSISTENTLY trading PROFITABLY on a demo account.
- If you can’t wait until you’re profitable on a demo account, then there’s no chance you’ll be profitable live when real money and emotions are factored in even more.
- At least demo trade until you are comfortable trading this could be weeks, months, or even years.
- I recommend you concentrate on ONE major or minor currency pair just as I have been taught to.
- It gets too complicated to keep tabs on more than one currency pair when you first start trading.
- You may find it more favorable to stick with ONE of the majors because they are the most liquid which usually means tighter spreads and less chance of slippage, but the minor currency pairs are pretty liquid as well.
- In the beginning focus on improving your trading strategy and becoming a disciplined trader.
- It is wise to experience different market conditions and learn how to adjust your methods and strategies as market behavior changes before experiencing these issues with real money.