The Spot FX market or “Forex” used to be limited to banks and long term investors, plus those who had masses of capital money. Trading would take place via a guy shouting what what going on on the trading floors or a “voice broker” which has gradually been replaced by automated computerised systems.
It is now actually possible for the retail investor or “home office based trader” to trade real time with the banks through the environment of a broker using computerised trading platforms which may have live desk traders placing trades either in the brokers books (95% of traders lose money so it’s in their interests not to trade for real), or for real – for the winners.
A forex trading strategy must usually comprise of two main components – technical analysis and fundamental analysis. The technical side is looking at the charts and using mathematics to reflect the movement of the market and the fundamental side requires knowing about important market-influencing economic news and announcements.
So let’s talk about fundamental analysis in your forex trading strategy. Every day, figures are released which are designed to reflect certain economic circumstances of a country. Some of these announcements for example “Non-Farm Payrolls” will almost certainly have an unpredictable affect on the market depending on previous data and implications of the figures released. A hard, fast rule for beginners trading (and veterans) is to stay out of the market during important announcements. You can find out where to get these by taking one of our courses.
Technical analysis will involve the use of indicators on charts to bring out areas of support and resistance areas where the price may either “get stuck” or “stop and reverse” in the opposite direction. One of the most popular (and accurate) methods of calculating support and resistance levels is the use of “Fibonacci”. The sequence of numbers discovered by Fibonacci 750 years ago is a proportion found in nature (for example pineapply rind or sunflower seeds) and is commonly learned in high school math. Did you ever get a question “What is the next number in this sequence….1,1,2,3,5,8,13,21,X?” That is the fibonacci sequence.
When we put the fibonacci numbers against each other we get a percentage ratio which can be plotted on out chart (you don’t need to be a math whiz – most forex charting software does this for you). This will bring out key areas of potential support and resistance for each move on your charts. Using Fibonacci in combination with indicators showing momentum or strength of the current market can give you a strategy to be profitable on a consistent basis because a mathematical rule in forex is “what has happened before will happen again – history repeats itself”.
Profit is made in forex trading much like in traditional business – in fact call to mind a haberdashery! You make a profit by buying at a lower price and selling at a higher price. The difference in forex is that it is also just as common sometimes to be able to sell at a higher price and then buy at a lower price. The profit can be made in both direction.
The process is simple. A trade is placed (either a buy or sell or the base currency) which automatically (sells or buys) the opposite currency in the pair. The price will change live every fraction of a second and for example if you bought the GBP/USD you have bought the pound and sold the US dollar. You want the value of the pound to rise and then you will sell your pounds (in other words “close your position”) and make a profit on the difference in value. This can be done in seconds, minutes or hours.
The broker takes his cut and you’re left with a little less than the actual “distance” the price has moved.
Due to brokers allowing you a leverage of up to 200:1 on your capital, you can control a lot more money than you actually have. Since you are buying one currency and selling the other, not all of your capital is at stake really. Only the proportion which will be lost or gained considering the change in value of the currency pair you are trading together.
For example, you have a forex trading strategy that tells you to buy the Euro against the dollar. The exchange rate is 1.2866 which means 1 EUR = 1.2866 USD
Due to your broker having a “spread” you are offered to buy at 1.2868 or to sell at 1.2864 (in other words the price must change by 2 [analogous] pips or points (significant figures or 4th decimal place) in order to break even. This is usually equivalent to paying a commission and you will not pay a commission depending on your broker.
Your forex trading strategy or system is accurate and you have timed the trade well and continue to watch the exchange rate rise 22 points over the next 15-20 minutes.
You see that the price is now 1.2888 and close your position.
You have made 20 points profit. This was a successful trade.
What do the 20 points mean though in terms of your portfolio?
Good question. With a 100:1 leverage, you have required at least $1000 to place your money in your account will have risen by $200 bcause each “pip or point” has been worth $10 to you. (I have deducted a 2 pip brokers spread or $20).
So, with a capital of about $2000 (you need a $1000 deposit to trade and some surplus equity in case the price goes in the opposite direction to what you wanted at first) you can traded 1 lot at 100:1 for each pip to be worth $10 profit. Since the market moves rapidly – sometimes 30 pips or more in a few minutes during very volatile times, you can make money fast placing accurate trades. The risk associated is that you can also lose money fast. We therefore need risk management plan to complete our forx trading strategy. This at it’s most basic level means placing a “stop loss” to have your trade closed automatically if you misplace a trade. You can also have a “take profit” level or a “trailing stop” which you can move to break even or more as your trade becomes more profitable. That way, you have a guaranteed profit even if you “let the trade run”.