Forex Trading Basics for the Intermediate Trader
The contents of this page, as mentioned, assumes that you have some knowledge of forex and currency trading: what it is, how it works and some of the terminology used, but that you do not yet actually trade forex and you're here to learn how to trade forex for profits.
How to Profitably Trade Forex
How did you learn how to speak English? Stand upright? Kiss?
The best lessons in life are ones that you learn through experience.
A huge amount of time is spent in classrooms doing exercises mentally, or on paper. That's all well and good, but its no substitute for experience. Book-smarts are something you learn, but experience is something you earn. You feel it, first hand. It shapes you.
Everyone learns everything by practicing. The more realism you have in your practice, the more you learn. Even people who are naturally gifted or academically brilliant only find out if they can really hack-it when they're doing it for real.
In this section we'll encourage you to put your forex training into practice. Buying and selling forex; practice techniques for 'reading' the market; and when you mess-up, as rookies do, it will be a valuable lesson because it will be a painful one. Not too painful! You won't lose large amounts of money. But you'll be doing it live, so the experience will be real.
Introduction to brokerage account
You cannot trade forex unless you have an F/X account at a brokerage. Most forex trading guides would suggest that you start your forex trading career by signing-up for a brokerage account and then trading using a demo account. We think there is a better way. Here's why:
If all you do is buy and sell forex in a dummy account, you will get a very limited experience. This is for one simple reason: people act very differently, when they are trading on paper, and trading for real.
This is not just something that happens in forex. It happens in buying and selling shares; commodities, etc. It even happens in online Poker. People behave very differently when they are using 'play chips' than they do when they are using real money.
Using a dummy account can lead you to developing bad habits – when it's not real money people take bigger risks, with bigger sums. That's not a set of habits you want to get into!
When you switch from using 'dummy' money to the real thing there is a readjustment phase. Suddenly you're not as confident. You make more conservative deals. You close positions quicker if they're not going your way. You start acting like the indecisive kid in the candy store we met in the newbie page.
There is a better way to gain the experience that you need. It's not quite in-at-the-deep-end, but it is real; it is live.
Studies have shown that the quantity of real money does not influence the behavior of new traders: I.e. Even if the amount of 'real' money involved in making trades is very small, people still behave differently to the way they behave if the money is just dummy money.
We believe that is the best way to learn. You start gaining forex trading experience immediately. Real experience. You can start your life as a trader with a $50 deposit, but just to be sure that you have some breathing room we suggest that you actually start with a $250 margin deposit.
The first time you start trading you will probably feel a mix of emotions from nervousness to excitement. This is normal. Trading forex is exciting. Once you've registered your account and opened your first position, you are a forex trader.
We have also chosen these forex brokers because they have a lot of resources useful to new spot traders. How to's; a big glossary; chart information; forex calendar, etc. there is an awful lot of very useful information on their website.
Stop before you start!
Before you make your first trade we must tell you about your safety net. It's called a Stop Loss. A stop loss automatically closes a position if your trade is losing money. In fact “ejector seat” is probably more accurate than “safety net.”
Stop Loss examples
If the USD/ JPY rate was 125.00 and you chose to buy Yen, you should put in a STOP LOSS at 124.70 - about 30 “pips” lower than the starting rate you bought at. Now if the market goes against you and the Yen falls, your position will automatically close when the rate reaches 124.70. This will Stop you from Losing more money.
If the EUR/ USD rate was 1.3000 and you chose to sell Euro, you should put in a STOP LOSS at 1.3030 - about 30 “pips” higher than the starting rate you sold at. Now if the market goes against you and the Euro rises, your position will automatically close when the rate reaches 1.3030. This will Stop you from Losing more money.
Your first trade
You've opened a forex trading account. What trade should you make? Open these positions
Buy $1,250 worth of Yen
Sell $1,250 worth of Euro
Don't forget to include your Stop Loss ejector seat! (Every time you trade).
Keep those positions open for a day and watch what happens by checking the rates every few hours.
The above is no strategy. There is no secret to it; there is no formula. You may make money, you may lose money. In fact we kinda hope you lose! Not because we have anything against you. It's to kick-start your experience as a forex trader.
What is important is that you experience your first trades. Once your own money is on-the-line the reasons and wherefores become so much more important. Did the dollar rise? Did it fall? What happened in the financial news that day? What events were on the forex calender? Were there any big political moves or announcements? Was it all quiet on the news-front?
When you have some experience with forex and you have made enough trades to feel comfortable learning more about forex strategies, we will introduce you to some of the better ones that help make big gains for traders in our Forex Trading Strategies section. For the moment though it is important to find your bearings: learn how to buy and sell, see bid and ask in action. See how the international news effects your profits and losses.
If you are brand new to the rest of the concepts on this page, be warned, it gets fairly deep fairly quick. Again, its the kind of thing that's obvious within a week of becoming an active forex trader, so take your time and try to understand each paragraph before you move on to the next.
Margins and losses
We explained margins briefly on the newbie page. As we said, you give the broker a “margin deposit” of $250. So what happens when you make a profit or a loss?
If you make a profit, everybody's happy!
You will make a profit on the above trades (in simple terms) if the Yen rises and the Euro falls.
Imagine that the yen rises by 2.5% and the Euro falls by 2.5% (these would be huge moves for one day, by the way). You would basically make a profit of $31.25 from each trade, for a total of $62.50 on paper. That's how much actual money you would profit by if you “closed” the positions and completed your trades. Lets assume that you do close out those positions.
The balance of your account would be:
$250 deposit + $62.50 = $312.50
Since your margin cover (cash) balance is now $312.50, you can now make trades of over $15,000 because you have the necessary funds in your account in the form of cash.
If you make a loss ....?
If there is a small change in the rates that go against you and you make a small loss (on paper) you may chose to keep the positions open in the hope that they come back 'round. You may close the position and realize that loss (i.e. make it real, not just on paper).
If you lose $10 in total on the 2 trades, that would reduce your cash balance to $240. This would in turn reduce the total amount you could use on margin.
Feel the pain
If you make a loss, have a good look at the market factors. What the hell happened? Why did you make that loss? Even though we suggested these trades (they could have been any trades) you made them. They are yours. Own the loss. Taking on board the real experience of making a loss and seeing why this happened will help make you a good investor. We hope you do make a loss on your first trade. It is a fitting baptism for any forex trader.
But what if things really went against you?
What if the market goes against you and you have a small margin deposit of only $125 and you did not have a Stop Loss? What if the yen falls by 2.5% and the Euro climbs by 2.5% (again these would be huge moves for one day!). You would be making a loss of $62.50 on paper.
Crucially that loss is equal to half your margin deposit, which was $125.
This would trigger what is know as a “margin call.” You would get a call, or an e-mail telling you that you need to add funds to your account in order to cover your margin.
I.e. If you closed-out your positions you would have a cash balance of $125 deposit - $62.50 loss
You would have $62.50 left. Once your usable margin has been reduced to zero, a margin call may ensue. The amount of available margin or used margin depends on which leverage level you apply on your account.
The broker does not want anyone to lose too much money, so they ask you to 'cover' the difference by putting more cash into your account, even if you wish to keep your position open.
It is highly unlikely that you would make a loss equal to or greater than half your margin deposit on your fist trades, but it may happen at some time.
If you do get margin call you need to know what it is and how to keep your positions open.
Your next trades
We're not going to give you a full set of “here: make these trades.” Each trade has to be made on a series of factors. Factors that need analysis. We can't just print them on a static page like this one and hope that they would work each time.
Suffice it to say that you have to make trades based on market conditions, and how you read those conditions. Simple things like an interest rate rise in a country generally means their spot rate rises too and if you can predict that before it happens, you can make money trading forex.
It is time for you to earn your stripes through trial and error (and success too, of course).
If you're familiar with trading or played with demo accounts and you just need some strategies to get going, we have our favorite inexpensive resources on our forex trading systems and strategies page. We believe these are great forex resources to learn from and they can help build your forex trading foundation.
In the more advanced pages we mention several proven techniques and we have links to how-to guides. Trading in forex is an exciting world.