involvement with forex
Wednesday, May 30, 2007
Go to a dinner party and mention your involvement with forex? and you’re likely to get a few baffled looks. Most people don’t have a clue what forex is or how it works. Worst of all, neither do most beginning forex? traders. Understanding what makes these markets tick is a good step towards a successful trading record.
Q: What are pairs and pips?
A: Each currency exists in the marketplace not on its own, but as a “cross” between itself and another currency. This is practical, since when you travel to Europe you want to exchange your money for Euros. If you have US Dollars, you will be exchanging money at the rate set by EURUSD. EURUSD is a “pair”. It also happens to be the most popular pair.
Most currencies are paired with EUR and USD, and to other currencies to a lesser extent. The “four majors” are EURUSD (Euro/Dollar), USDJPY (Dollar/Yen), GBPUSD (Pound/Dollar), and USDCHF (Dollar/Franc). The bid-ask spread is usually lowest for the four majors, since their volume is the highest. With high volume the dealer is usually assured of having ample liquidity to meet your trading needs, so they charge you less through the spread.
For more obscure, less traded pairs, the spread will be more, since dealers assume more risk in completing those transactions. The spread itself is made up of pips. A pip is simply an incremental unit in forex. In stocks, you call them ticks or points. That makes sense because usually all stocks are quoted in the same currency. In forex, each currency may have a different incremental unit. For example, a quote in EURUSD might be 1.3240, versus a quote in USDJPY at 107.87. What is the incremental unit? There is no common unit, so one was created, and it was named a pip. A pip is always worth $10 if the pair ends in USD. If not, you will need to refer to a pip calculator to get the value, since these per pip values can vary, even within the same currency.
Q: How do you trade forex?
A: There are two major methods for trading forex: fundamental and technical. Fundamental analysis relies upon a broad and near-expert understanding of multi-national macroeconomic statistics and events. Fundamental traders believe that the value of a pair is determined by the underlying health of the two nations involved in the pair. A high value for GBPUSD, for example, would suggest a better economic outlook in Britain vis-à-vis the United States. Global events like news, catastrophes, politics or economic shocks all play a role in determining price. Technical analysis is based on the mathematical analysis of price, and of many variables which all derive from price. Technical traders believe that technical indicators include fundamental analysis and also provide repeatable, tradable patterns. Technical traders use charts to determine support and resistance, draw trend lines, or analyze measures like moving averages, etc. Whichever camp you belong to determines your trading approach. A fundamental trader may take the Warren Buffet approach and buy-and-hold a pair, expecting long term returns. A technical trader may play long term as well, but usually day trades. Some fundamental traders trade on news, which may just be certain days of the month.
Q: What is leverage?
A: Since dealers have ultimate control over accounts and trades, they are willing to loan money to the trader. That’s called margin – basically a loan from the dealer to the trader, but based on the trader’s equity. Normally if the trader wants to trade EURUSD he would need $100K, but not if the dealer offers margin. Margin is another word for leverage, with a little difference in concept. Some dealers will allow you to trade a full standard contract with just $500 in margin available. That means the user has to have at least $500 (or really $500 + spread) in their account to trade. If at any time their account balance equals or drops below their margin requirement, the dealer will liquidate all of their positions. That’s called a Margin Call. So if you traded 5 contracts with $4,000 in your account, you would be using $2500 in margin. If the trade went against you $1500, you would be taken out. When you traded the one contract with $500 in margin, you controlled $100,000. That’s leverage. It’s 200:1 in this case (leverage = $100,000 divided by $ per contract as a % of total equity). In this example, you would only be employing 200:1 leverage if your account equity was $500. Most dealers have scaling margin which allows smaller accounts to use something like 200:1 and bigger accounts to use 50:1, or 10:1. If you had $20K in your account and played 40 contracts, that would be 200:1 leverage. $100K with 10 contracts is 10:1. Leverage is one of the biggest reasons people trade forex?, but it’s also one of the biggest reasons people lose money. Be careful to manage your leverage position when trading, especially when starting out.
Labels: Forex Tips
posted by inlink5 @ 4:07 PM,
