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How to Trade Forex

Currencies: Base and Counter

Forex trading is different from many other forms of trading due to the fact that it is traded in pairs: one currency is bought whilst the other is sold. This is because a currency’s value is determined by its comparison to another.

Forex trades are typically quoted in pairs, for example, EUR/USD (Euro vs. US Dollar), or USD/JPY (US Dollar vs. Japanese Yen). The first value in the pair is the base currency, and the second is the counter currency. The value of a currency pair indicates the sum of counter currency needed to buy one monetary unit of the base currency. For example, if a trader bought the currency pair USD/EUR = 0.6500, they would receive €0.65 Euros for every $1 that they sold.

Leverage and Trading Forex

Leverage and Trading Forex

Leverage and Trading Forex

Many investors are attracted to Forex trading (it is one of the most commonly traded form of financial products), because of the high rate ofleverage often available; the leverage rates for Forex products can be amongst the highest available to financial traders. Leverage gives traders the ability to initiate trades with only a small amount of the capital usually needed to enter large trades. This means that the size of your trade is restricted to a far lesser degree by the capital in your bank account.

Leverage is generally expressed as a ratio. For example, a 50:1 leverage ratio means that for every €1 in your account, you can place a trade worth €50. With a 50:1 ratio, a trader would only need to deposit 2% of the trade to initiate a position/ (1/50 = 0.02 = 2%). So, to trade €100,000 of currency, a deposit of only €2,000 would be required. This differs from trading solid assets, where a trader is limited by his account capital. For example, if a trader has €2,000 in his trading account, they would only be able to trade €2,000 worth of currency.

Different leverage ratios are offered for different currency pairs. The leverage ratios of currency pairs that ETX Capital offers currently range from 14:1 EUR/HUF (Euro/Hungarian Forint) to 200:1 for pairs such as EUR/USD and GBP/USD. Leverage of up to 400:1 is also available for certain FX pairs on the MT4 platform; traders should keep in mind that leverage settings are changeable based on market conditions and that increasing leverage increases risk.

However, traders need to be aware of both the benefits and disadvantages of leveraged trading. Leverage can lead to large payouts, but alternatively may lead to losses larger than the amount deposited if the market suddenly moves against you. Starting out by using a small amount of leverage can help to minimise the risk of your trade – since increasing the leverage scale increases your risk. It can take the benefit of experience to know when to use leverage and to what extent, so be sure that you take the time to practice – perhaps by starting with a demo account.

Forex Trading: Going Long or Short

As currencies are traded in pairs, when initiating a Forex trade a trader is said to be “going long” on one currency and “going short” on the other. For example, if you choose to buy EUR/USD, you would be exchanging your US Dollars for Euros. You would be “long” on Euros and "short" on US Dollars.

Put slightly differently, if you bought a laptop for €600, you would be "short" €600 and "long" one television. This same principle applies to trading the Forex market.

going long

Going long

Let us say that after conducting some research, a trader believes that the US Dollar is likely to strengthen in comparison to the Euro. This motivates the trader to go long on USD/EUR, and he buys US Dollars in exchange for Euros. The currency pair is currently trading at a rate of 1.0963/1.0964. The trader selects the maximum leverage scale of this currency pair, 200:1, and purchases $10,000 at the rate of 1.0964.

To calculate your initial trading deposit:
Amount of the currency you would like buy X counter currency exchange rate / leverage scale

$10,000 x 1.0964/200 = $54.82 So in this case, $54.82 is needed to enter the trade.

After a short period, the market moves in accordance with the trader’s prediction, and the US Dollar strengthens against the Euro. The bid/ask rate becomes 1.1000/1.1014, and the trader decides to close their position here. They sell their $10,000 at the rate of 1.1000.

The trader bought at 1.0964 and sold at 1.1000, an increase of 36 percentage points (pips).

To calculate profit:
Profit = (price sold at - price purchased at) X sum of currency purchased

(1.1000-1.0964) x $10,000 = $36.
The trader has made a profit of $36.

In another scenario, the markets move in the opposite direction to this trader’s position and the Euro is seen to strengthen relative to the Dollar. The trader subsequently decides to sell their $10,000 when the bid/ask rate reaches 1.0925/1.0926.

To calculate loss:
Profit = (price bought at - price sold at) X amount of currency purchased

(1.0964-1.0925) x $10,000 = $39
In this scenario, the trader has made a loss of $39.

Going Short

Going short

In a different example, let’s say that Sterling/Dollar is currently trading at a rate of 1.4989/1.4092. A trader anticipates that the Dollar will strengthen in comparison to the Pound, and decides to sell $10,000 at 1.4989, with a leverage scale of 1:50.

Deposit needed = 10,000 x 1.4989/50 = $299.78

Some time after the initiation of the trade, GBP does indeed weaken against USD. The trader then decides to close the trade and buys $10,000 at 1.4902, a decrease in 87 pips.

To calculate profit:
Profit = (price sold at - price purchased at) X sum of currency purchased

Profit gained: (1.4989-1.4902) x 10,000 = $87

In another scenario, Sterling strengthens against the Dollar, against the trader’s initial speculation. The bid/ask price moves to 1.5114/1.5120. The trader decides to buy at this point, and closes the trade at $10,000. The outcome of this trade would be a loss of $131 for the trader [(1.5120 – 1.4989) x 10,000 = $131].

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