Introduction to Forex Trading
The foreign exchange market is the world’s most actively traded market, with a turnover of over $3 trillion per day. The enormous volume of daily trades makes it the most liquid market available to trade, which means that under normal market conditions you can buy and sell currency as you please. Forex is traded by banks, institutions, and individual retail traders like yourself from all around the world. The Forex market is open 24 hours a day, 5 days a week.
Understanding the Basics:
Buy: Buying a currency pair at a certain price means you predict that price will go up. A “buy” in forex is equivalent to a “call” in binary. It is also referred to as a “long” position.
Sell: Selling a currency pair at a certain price means you predict that price will go down. A “sell” in the forex market is equivalent to a “put” in binary. It is also referred to as a “short” position.
Leverage: Leverage refers to the ratio of invested amount relative to the trade’s actual value. Forex brokers allow their clients to trade on borrowed capital so that traders do not need to invest large sums in order to make decent returns. The leverage you can obtain in the forex market is one of the highest available to investors. For example, let’s say you use 100:1 leverage. This means that for every 1$ that you invest from your account balance, the broker also invests 100$ for you. So if you invest 500$ from your account balance on a trade, you are controlling up to 50,000$ worth of capital (500$ X 100). It is important to note however that while profits are amplified, losses are also amplified and leverage can work against traders. It can be your best friend when used carefully, but your worst enemy if used recklessly. For instance, if a trader has $1,000 of margin in his account and he opens a $100,000 position, he leverages his account by 100 times, or 100:1. If he opens a $200,000 position with $1,000 of margin in his account, his leverage is 200 times, or 200:1. To calculate the leverage used, divide the total value of your open position by the total margin balance in your account. For example, if you have $10,000 of margin in your account and you open one standard lot of USD/JPY (100,000 units of the base currency) for $100,000, your leverage ratio is 10:1 ($100,000 / $10,000). If you open one standard lot of EUR/USD for $150,000 (100,000 x EURUSD 1.5000) your leverage ratio is 15:1 ($150,000 / $10,000).
Stop Loss: A stop loss is used to determine where a trader wishes to exit the trade if the market moves against them. This is a tool that protects your investment and realizes your profits. It allows you to set an exact amount that you’re willing to lose on a trade.
Take Profit: This can also be referred to as a limit order. Take profit is used so that once your trade reaches a certain level of profit, it will be closed and the profit will be secured. Take profit/limit orders are useful so that you don’t have to monitor the trade around the clock to achieve your desired profit.
How to Follow a Forex trade:
Consider the example below:
USD JPY buy @110.800
TP: 112.000, TP 2: 112.500
This signal is a buy signal on USD/JPY. This means that we predict price will go up. The strike rate is 110.800 and this is where you enter your trade. The first TP (take profit) is at 112.000, meaning that you will aim to secure your profits at this level which is 120 pips (1200 micropips) away from your entry point. Secure half of your profits at this time and adjust your stop loss accordingly.
There is second TP (take profit) at 112.500, meaning that I predict price may rise another 50 pips. You’re now out of half of the trade with a very nice profit and at the same time you are prepared to ride the market to TP # 2 for the remaining half of your position after adjusting your stop loss.
Where to place your stop loss:
I will usually tell you where to place your stop, but the idea is to try and place your stop at the most logical level possible. The easiest way to think about this is – it is the point where the signal would become invalid. For example: if you enter a long position on a breakout of a major resistance level after price retests that level now treating it as support, your stop loss should be just below the level that was broken. If the market does go there, it signals that a true breakout didn’t actually happen and the trade is invalid anyway. It is always best to enter your stop loss at the same time you enter your trade so that you don’t expose yourself to the market without a stop loss in place.
Types of orders:
Most brokers offer the following order types:
Market Orders – A market order is executed immediately when placed. It is priced using the current market price. A market order immediately becomes an open position and therefor is subject to fluctuations in the market. This means that if the rate should move against you, the value of your position decreases. This would be an unrealized loss. If you were to close the position at this point, you would realize the loss and your account balance would be updated to include the revised totals. Due to the nature of the forex market, the executed price may differ from the last price you saw on the trading platform. This is referred to as slippage. Slippage can work to your favor as well as to your disadvantage
Limit Orders – A limit order is an order to buy or sell a currency pair, but only when certain conditions included in the original trade instructions are fulfilled. Until these conditions are met, the order is considered a pending order and does not affect your account totals or margin calculation. The most common use of a pending order is to create an order that is executed automatically when price reaches a certain level. For example, if you believe that EUR/GBP is about to begin an upswing, you could enter a limit buy order at a price slightly above the market rate. If the rate does move upwards as you predicted and reaches your limit price, a buy order is executed with no further input on your part. A pending limit order has no impact on your account totals and can be cancelled at any time without consequence since the actual trade has not been executed. If the conditions of a limit order are met however, the pending order is executed and the trade becomes live.
Take Profit Orders – A take profit order automatically closes an open trade when the price reaches the specified level. Take profit orders are used to lock-in profits when you are unavailable to monitor your open positions. For example, if you are entered into a long position on USD/JPY at 109.58 and you want to take your profit when the rate reaches 110.00, you can set this rate as your take-profit level. If the bid price touches 110.00, the open position is closed by the system and your profit is secured. Your trade is closed at the current market rate. In a fast moving or volatile market, there may be a small gap between this rate and the rate you set for your take-profit.
Stop Loss Orders – Similar to a take profit, a stop loss order is a defensive mechanism you can use to help protect against further losses. A stop-loss automatically closes an open position when price moves against you and reaches the level you specify. You might hear the term “stopped out” when a stop loss closes an open position. Using the same example as above; if you were entered into a long position on USD/JPY at 109.58, you could set a stop-loss at 107.00. This way, if the bid price falls to this level, the trade is automatically closed which reduces your losses. It is important to understand that stop-loss orders can only restrict losses, they cannot prevent losses. Same as with take profit orders, your trade is closed at the current market rate so there may be a small gap between this rate and the rate you set for your stop-loss during a fast moving market. It is highly recommended to include stop-loss instructions for your open positions as a form of money management.
Trailing Stop Orders – Similar to a stop-loss, a trailing stop can be used to restrict losses and avoid margin closeouts. A trailing stop resembles a stop-loss in that it automatically closes the trade after a specified distance if the market moves in the wrong direction. The main feature of a trailing stop is that as long as the market price moves in a favourable direction, the level which you have your trailing stop set at automatically follows the market price at the specified distance. This allows your trade to gain profits while reducing the amount of loss you put yourself at risk for. For example, if you entered a long position the trigger price will keep moving up if the market price moves up, but stays the same if the market price moves down. If you entered a short position, the trigger price will keep moving down if the market price moves down, but stays the same if the market price moves up.
Determining lot size:
In Forex, you can trade 4 different kinds of lot sizes. Standard lots equate to 100,000$ worth of currency traded, Mini lots equate to 10,000$ worth of currency traded. Micro lots are equivalent to 1000$ worth of currency and Nano lots are the smallest lot size you can trade with only 100$ worth of currency. See the table below:
|Lot||Number of Units|
Determining risk per trade:
The 1% rule is recommended so that traders can reduce losses to 1% of their account if the market moves against them. After figuring out what risk percentage is best for you, multiply your entire account balance by the amount of risk you wish to place on that trade. This will give you the total amount of money needed for that trade. So if you’re using 1% risk in a 5000$ account, you would place 50$ of your own money into the trade (5000 X 0.01).
Determining pip value:
Pip cost is how much you will gain or lose per pip. As your lot size increases, so does your pip size. To determine your pip cost, simply divide your risk (dollar value) by the number of pips you are risking to your stop order. So for a 5000$ account, you shouldn’t be trading more than 50$ per trade (1% of 5k). Using a 10 pip stop, this equals a pip cost of 5$ per pip (50$ / 10 pips).
An easy way to understand spread is to think of it as the cost of trading, or the fee the broker charges you to trade. For example: If the EUR/USD is at a value of 1.3000, the broker will not sell the EUR/USD to you at 1.3000. Brokers will quote a slightly higher price of something like 1.3001 if you’re looking to buy or a slightly lower price such as 1.2999 if you’re looking to sell. There is a 2 pip difference between 1.2999 and 1.3001 in the example above and this difference is called the spread. The spread is essentially the difference between the Bid (buy) and Ask (sell) price and the brokers make money off of this difference.
Risk to reward ratio
This simply refers to how much you will risk for each trade compared to how much you might lose if it goes against you. I always try and stick to a risk/reward ratio of 1:2. This means that your potential reward is two times bigger than your risk. So if you risk $20, then this is the amount of money you are prepared to lose. If the trade doesn’t work, you know exactly how much money you will lose. If you are looking to gain $40, then this is the reward you are seeking to achieve. The risk to reward ratio is 1:2, because you are risking $20 to gain $40. I recommend 1:2 as a healthy risk/reward ratio for both beginner and experienced forex traders while professional traders can use 1:3.
**If you have any questions regarding Forex tips, strategies or education, please email me at firstname.lastname@example.org and I’ll be happy to assist. **