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So what is Forex trading, you may ask? Forex is an exchange where you can buy and sell currencies. For example, you can buy British pounds (by converting them to dollars you have), then after the pound-to-dollar ratio goes up, you sell pounds and buy dollars again. At the end of this transaction, you will have more dollars than you had at the beginning.
The forex market has much higher liquidity than the stock market because much more money is exchanged. Forex is spread between banks all over the planet and as a result, it means 24-hour trading.
Unlike stocks, Forex transactions are carried out with high leverage, usually 100. This means that by investing $1000 you can control $100,000 and increase potential profits accordingly. Some brokers also offer so-called mini-Forex, where the minimum deposit size is equal to $100. It makes it possible for individuals to easily enter this market.
Name convention. The name of a “symbol” in Forex consists of two parts – one for the first currency and one for the second currency. For example, the symbol usdjpy stands for US dollar (USD) – Japanese yen (jpy).
As with stocks, you can apply technical analysis tools to Forex charts. Trader indices can be optimized for Forex “symbols” and allow you to find a winning strategy.
Example Forex transaction
Suppose you have a $25,000 trading account and you trade with a 1% margin requirement. The current quote for EUR/USD is 1.3225/28 and you place a market order to buy 1 lot of 100,000 euros at 1.3228, waiting for the euro to rise against the dollar. At the same time, you place a stop-loss order at 1.3178, 50 pips below your order price, and a limit order at 1.3378, 150 pips above your order price, representing a maximum of 2% of your account equity if the trade goes against you. For this trade, you risk 50 pips to gain 150 pips, giving you a risk/reward ratio of 1 part risk to 3 parts reward. This means you only need to be right a third of the time to stay profitable.
The face value of this trade is $132,280 (100,000 * 1.3228). Your required margin deposit is 1% of the total, which equals $132.80 ($132,280 * 0.01).
As you expected, the euro strengthened against the dollar, and your limit order reached 1.3378. The position is closed. Your total profit for this trade is $1500 and each pip is worth $10.
