The global foreign currency exchange market, more commonly referred to as forex, is the most liquid, active and accessible financial trading platform in the world. With trading volumes estimated to be around one trillion dollars per day, and opportunities for individual traders to get started with just a couple of hundred dollars plus an internet connection, forex is ripe with profitable opportunities, but only for those who establish trading strategies and who can regularly commit to efficient money management.
Forex traders can profit from the minute-to-minute fluctuations of major international currencies. Cash is the only security traded in this market; the instruments are currency pairs, and they are 100 percent liquid at all times.
Understanding the Forex Market
Individual forex traders participate along with central banks, interbank players, institutional investors, investment banking firms, market makers, and retail brokerages. These are financial entities that typically deal with large amounts of currency; the typical size of a forex transaction, called a standard lot, is worth 100,000 units of the dominant currency in the pair, which is called the base currency. Millions of forex lots are traded around the clock; this requires individual traders to rely on leverage granted by retail brokerages.
The average forex trader is not able to place a standard lot order; instead they can place smaller lot orders worth 10,000, 1,000 or even 100 base currency units through margin provided by retail brokers. Forex traders profit from pips, which are fractional fluctuations in the value of currency pairs. When a margin position is taken on the forex market, the retail brokerage will subtract a few pips from the order for the leverage provided. This margin fee can be thought of as a brokerage commission that the trader must cover before he or she can start realizing profits.
Forex traders who lack clear money management and trading strategies are very susceptible to margin calls. The leverage provided by brokerages does not affect the value of a lot; it only affects the possible profit outcome for individual traders.
Forex Money Management and Strategic Trading
A forex trader who can afford to invest $100,000 can take a buy position on a standard lot of USD/EUR. Based on the USD/EUR value of 0.953697964 on January 11, 2016, this position would be worth $9,536.97. Since the trader is buying, she is speculating that her lot would be worth more in the future; she is not trading on margin, and thus she may choose to exit the position if the value drops to $9,000 or she may decide to take profits at $10,000.
The example above is of a very basic buy strategy with minimal money management. A trader who can only afford to invest on a micro USD/EUR lot worth $953.69 by tapping his or her margin account on a buy order may start the position around $951, which means that the market will have to turn in her favor just to make things even. This also means that she may lose more than she invested if she does not apply an exit strategy.
In both aforementioned examples, there should be a minimum of a stop loss, leverage and take profit parameters set on each position. A $100 EUR/USD buy order priced at $1.0549 on January 11 could be set at a leverage of 100 with a stop loss of $50 and taking profit as soon as $50 have been realized; this would be a more balanced trade.
Fundamental and Technical Analysis
The forex market can be very sensitive to geopolitical events and behavioral trading. To this effect, many forex traders utilize technical analysis because it suits their active trading patterns; however, technical indicators and signals should not be interpreted without at least some fundamental background.
Swing trading is very common in forex; it is a highly technical strategy that can be conducted over several days. A swing trade begins by spotting certain patterns and moving averages, but forex traders should understand why the indicators appeared in the first place. For example, the January 11 press conference given by U.S. President-elect Donald Trump was preceded by a stronger greenback against the Japanese yen and the Mexican peso; however, swing traders exploring new positions may have held back until after the conference due to volatility.