Forex Trading Basics
Last Update: June 15th, 2020
Key Forex trading terms
Let’s get familiar with the basics:We always trade Forex in pairs with each currency’s value being compared to another:The Base currency – the first currency (on the left)The Quote currency – the second currency (on the right)
By selling the base currency, we are buying the quote currency. When we buy a pair, we actually buy the base by selling the quote. In our example – buying 1 GBP In exchange for selling 1.4135 USD. When we sell a pair, we are doing the opposite.
When you see a currency pair quoted you’ll see two different prices listed:
The Ask price is the price the broker is asking me to pay to buy the base currency.
The Bid price is the price (in the quote currency) which Forex brokers will pay me if I want to sell the base currency.
The Exchange rate is the ratio between the values of the two currencies. Let’s look at another quote as an example:
Base Currency = EUR
Counter = USD
Bid price = 1.3272
Ask price = 1.3276
When selling Euros, 1 Euro = 1.3272 USD
When buying Euros, 1 Euro = 1.3276 USD
Spread = 1.3276 – 1.3272 = 0.0004
If we buy a pair it means that we sell the Quote currency in order to buy the Base currency. We do it when we believe that the value of the base currency will increase (relative to the Quote currency). If we sell a pair it means that we believe that the value of the Base currency will fall (relative to the Quote currency).
What you also need to know
Lot – the standard level of deposit per single trade. There are 3 main sizes:
Standard lots = 100,000 currency units
In a mini account a single pip is worth approximately $1
In a standard account a single pip is worth approximately $10
Long Position – A Buy action (expecting the currency to go up)
Short Position – A Sell action (expecting the currency to go down)
Let’s see an example on EUR/USD:
You purchase 10,000 euros at an EUR/USD exchange rate of 1.2880(BUY position on EUR/USD)
3 Days later, you exchange your 10,000 euros back into us dollars at the rate of 1.4880 (SELL position on EUR/USD)
You exit the trade with a $2,000 profit(EUR/USD increased 2,000 pips in 3 days! In our example, 1 pip is worth 1 us dollar)
Stop Loss orders: These are extremely important and useful orders! We advise all of you to get used to adding a “stop loss” to each and every position you open. It prevents any additional losses beyond a particular price level. In fact, it is an automated selling order which will be executed once the price reaches a particular level. When the market goes against you, a Stop Loss can be crucial for shielding you from heavy losses. Stop Loss is available on every trading platform. To activate it, give a stop loss order to your broker.
Where to put your stop loss:
When buying (going for long positions)– place your stop loss sell order beneath the actual support level of the present trend.
When selling (going for short positions) – place your stop loss buy order above the actual resistance level of the present trend.
Avoid these common mistakes:
Don’t place your stop loss too close to the present market price of the pair. Allow price movements, don’t suffocate the currency.
Don’t place your stop loss on the exact support/resistance levels
Give the price a chance to come back to the positive zone
Don’t change your stop loss orders in the middle of your trade. Stick to your trading plan and don’t let your emotions take control of your trading!
Take Profit orders: These are automated exit orders, determined in advanced by the trader. If the price reaches this level the position will close automatically, and the trader will collect their earnings. The purpose of this is to ensure a certain level of profit (even if there is a chance to earn more).The big advantage of using Stop Loss and Take Profit orders is that by doing so, you can avoid sitting in front of your computer all day, watching your trades! With these orders in place you know that if the price hits one of these 2 target levels, the position will close automatically.
More Forex lingos to remember
Volatility – the Forex market can be very volatile. The greater the volatility, the greater the risk factor in trading. But the greater the potential opportunity also! When markets are volatile traders need to be careful of painful losses, while looking out for powerful new trends. The less stable a country is, the higher the volatility of its currency will be.
Pip – the smallest price movement taking place. The fourth decimal. For example, if the EUR moved from 1.4431 to 1.4432, it moved up 1 pip. Profits and losses are calculated either by the value of money involved or by the amount of pips, depending on how you would rather look at your positions.
Forex language is the language of pips!
Spread – The difference between the Bid Price (Sell) and the Ask Price (Buy).
Margin – The amount of capital we will have to deposit as a ratio of the amount of money we wish to trade with.For example, assume we deposit 10 dollars at 5% margin, it means we trade with $200 ($10 is 5% of $200). This is similar to depositing an amount of capital with your broker and then receiving a loan in return (but without having to pay interest).
Leverage your money
The level of credit you get on your currency investment from your broker. In other words, the ratio between the size of your deposit and the amount of money you trade with. Leverage supersizes the impact of your trades, multiplying the potential for earnings or losses. If your trade goes as planned, you win big time. However, if the market goes against you, you can lose it all.
X10 leverage means that in exchange for $1,000 deposit you will be able to trade with $10,000 (Don’t worry, you can’t really lose $10,000 on this trade, only the capital you deposit). Back to our example, a 10% uptrend will double your capital, while 10% downtrend will erase it.
Let’s assume we’re going long on EUR/GBP (we buy EUR/GBP). The ratio between the two currencies is 1:1. After a couple of hours the ratio jumped to 1.1 in favor of the euro. In these couple of hours we earned 10% of our total investment. If we invested 1,000 euros, how much are we profitable right now? You guessed right! 100 euros.
But wait a minute, now let’s assume that we entered a trade with those 1,000 euros but with a leverage of x10. So in fact, we entered this trade with 10,000 euros. In this case, the 10% that the price went up is worth 10% profits on the trading capital, which is now 10,000 euros. 10% is worth 1,000 euros. In 2 hours. Well, thanks to x10 leverage we are right now 100% profitable on our real money – the 1,000 euros we used for this position. Hallelujah!
Leverage gives us the possibility to deposit small amounts like $100, $200 or $1,000 for example, and trade with massive capital like $50,000 or $100,000 dollars, by risking only the capital we actually invested!
High usage of leverage, like x50 for example can produce gigantic profits if we have luck on our side, but high leverage also enlarges the risk of losing all our money. This kind of risk taking strategy is good only for people with strong hearts! We advise you to start out trading with very low leverage, like x2 or x5.Leverage is a big draw for the Forex market – no bank in the world will allow you to invest $1,000 and collect a 20% return after just 2 months. Only the Forex market offers such opportunities.
There are several different trading styles, representing different Forex trading strategies:
Scalping – This is a very short term style usually undertaken during the busiest hours of the day. In scalping time frames are very short and positions are held from just a few seconds to a couple of hours. The idea is to win a high number of positions, but a low number of pips on each position.
Day Trading – This is also a short term trading strategy. Usually the trader will enter trades during the early hours of the day’s activity and will close them after few hours, at the end of the daily session.
Swing trading – This is a longer-term trading strategy, good for traders who wish to observe the market and wait for market trends which will bring opportunities along.
Position Trading – This long term trading strategy can last a few months, or even up to a year. It’s good for traders who think of themselves as investors and who wish to trade by using fundamental analysis and the analysis of market forces.