So what is is Forex trading you may ask? Forex is the exchange you can buy
and sell currencies. For example, you might buy British pounds (by
exchanging them to the dollars you had), then, after pounds / dollar ratio
goes up, you sell pounds and buy dollars again. At the end of this
operation you are going to have more dollars, then you had at the
beginning.
The Forex market has much higher liquidity, then the stock market, as much
more money is being exchanged. Forex is spread between banks all over the
planet and as a result it means 24 hour trading.
Unlike stocks, Forex trades are performed with high leverage, usually it
is 100. It means that by investing $1000 you can control $100,000, and
increase potential profits accordingly. Some brokers provide also so
called mini-Forex, where the size of minimum deposit equals $100. It makes
possible for individuals to enter this market easily.
The name convention. In Forex, the name of a "symbol" is composed of two
parts - one for first currency, and another for the second currency. For
example, the symbol usdjpy stands for US dollars (usd) to Japanese yen
(jpy).
As with stocks, you can apply tools of the technical analysis to Forex
charts. Trader's indexes can be optimized for Forex "symbols", allowing
you to find winning strategy.
Example Forex transaction
Assume you have a trading account of $25,000 and you are trading 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, expecting
the euro to rise against the dollar. At the same time you place a
stop-loss order at 1.3178 representing a maximum loss of 2% of your
account equity if the trade goes against you, 50 pips below your order
price, and a limit order at 1.3378, 150 pips above your order price. For
this trade, you are risking 50 pips to gain 150 pips, giving you a
risk/reward ratio of 1 part risk to 3 parts reward. This means that you
only need to be right one third of the time to remain profitable.
The notional value of this trade is $132,280 (100,000 * 1.3228). Your
required margin deposit is 1% of the total, which is equal to $1322.80
($132,280 * 0.01).
As you expected, the Euro strengthens against the dollar and your limit
order is reached at 1.3378. The position is closed. Your total profit for
this trade is $1500, each pip being worth $10.
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