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How to begin Forex trading
Basic terms and notions of forex trading
What is forex?
Long story short, it’s the exchange of one currency for another. For example, if you live in the US and you visit a European country on your holidays, you will need to exchange your US dollars (USD) for euros (EUR). Usually, you can do that at the airport in an exchange booth. The reason is that in the EU they do not accept the American currency as a medium of exchange for goods and services. When you go to the counter of an exchange booth, you see a screen displaying different exchange rates for different currencies. Since you need to exchange your US dollars for euros, you will look at the EUR/USD pair. In other words, a transaction on Forex always involves the simultaneous purchasing and selling of two currencies.
So, the EUR/USD exchange rate actually shows how many US dollars are needed to buy 1 euro.
EUR/USD = 1.20
EUR = 1.20 USD
Bid and ask rate
There are the Bid rate for buying a currency and the Ask rate for selling it. The difference between the Bid and Ask prices is known as a spread. When you exchange USD for EUR, you actually buy the euros with your US dollars. In other words, you need to find the Ask rate for this pair on a quotation board. When you go back to the United States, you will need to exchange the remaining euros for the US dollars and therefore sell your EUR for USD. So, in an exchange booth at the airport you will need to look at the Bid price.
But how can you gain or lose money on Forex?
It's pretty simple. Suppose you come back from your holidays and sell the euros at your home airport. If the Bid price is higher than the Ask price at which you bought the euros, you will make profit. If it is lower, then you will lose money. To sum it up:
When you buy a currency pair, you use the Ask price and in order to close your transaction, you use the Bid price. You make profit if the Bid Price is higher than the Ask price. If you sell a currency pair, you open your transaction by using the Bid price and you close your transaction by using the Ask price. You gain money if the Ask price is higher than the Bid price. The difference between the Bid and Ask quotes is the spread and it is actually a profit of currency exchange.
What are leverage and margin and how do they work?
Leverage is another word for a loan. When you have leverage of 1:10, it means that a broker lends you 10 EUR for every 1 EUR of your own funds. Don’t worry though, it is not an actual loan that requires monthly repayments. It is just a possibility to multiply your profits or losses. The use of leverage increases the risk of losing money but it also enhances the chance of a higher return.
That’s enough theory. We know you like action so let's get down to practice.
Suppose you have a USD account with equity of 100 (also known as margin when you have no open positions) and a leverage of 1:10. You can open a trade of 1,000 on EUR/USD → 100 (margin) * 10 (leverage) = 1000 (maximum position). The other way around? Since you have the leverage of 1:10, you actually need 100 USD in order to open 1,000 deal on EUR/USD. The rest of the amount, 900 USD, will be given to you as a "loan" by a broker.
How did we come to this numbers?
Easy.
1000/10 = 100, which is also known as a margin. It is the minimum balance that is required to open a deal of 1,000 on EUR/USD. Since your account has 100 USD as an equity, you are free to open such a deal. Thus, the sum of 100 USD is taken from you while 900 USD are added by a broker so you could open your trade. Now be careful!
You have an equity of 100 USD and you have opened a position that requires 100 USD as your margin. This is known as Margin Call for EU brokers. Our regulators require us to give you a call (a notification) when your margin equals your equity. What does it mean?
It means that your position is getting close to an automatic Stop Out. What is this now?
A Stop Out level is a specific point defined by the regulation where your equity goes to 50% of your used margin. For example, if the mentioned-above trade of 1,000 EUR/USD loses 50 dollars (which is 50% of your 100 USD equity), a broker will need to close your position automatically. In this case you will lose 50 USD and 50 USD will remain in your account. A broker does that in order to protect you from losing all your money, so don’t get mad.
Logically, your next question is how you can avoid Stop Out. You need to limit your losses! For example, you can set Stop Loss orders in order to limit your losses (we will expand on different types of orders a bit later so keep reading).
Finally, you can close some positions (losing or winning ones) in order to free some margin.
Importantly, leverage can be used only on CFD products.
About CFDs
Are you wondering what CFDs are?
CFD stands for Contracts For Difference. They are usually OTC contracts (over-the-counter). In other words, it is a contract between you and your broker only. If you open a position in a CFD contract with your broker you need to close this position with your broker.
Some other characteristics are:
They are not deliverable, so you are not going to get actual euros to put them in your wallet when you trade EUR/USD or gold when you trade XAU/USD (XAU is a symbol for gold) or stocks from exchanges like NASDAQ, NYSE or FTSE.
Thus, these contracts do not imply that you can get the underlying assets. The only reason you trade them is to gain money from the price differences or maybe lose it. Don’t stress, we still have the obligation to give you all the profits of your gaining trades.
Sometimes, people trade not only to profit from price differences but also to own shares or gold. With CFDs you don’t own them, you are just making a prediction on the price direction.
CFD stands for Contracts For Difference. They are usually OTC contracts (over-the-counter). In other words, it is a contract between you and your broker only. If you open a position in a CFD contract with your broker you need to close this position with your broker.
Some other characteristics are:
They are not deliverable, so you are not going to get actual euros to put them in your wallet when you trade EUR/USD or gold when you trade XAU/USD (XAU is a symbol for gold) or stocks from exchanges like NASDAQ, NYSE or FTSE.
Thus, these contracts do not imply that you can get the underlying assets. The only reason you trade them is to gain money from the price differences or maybe lose it. Don’t stress, we still have the obligation to give you all the profits of your gaining trades.
Sometimes, people trade not only to profit from price differences but also to own shares or gold. With CFDs you don’t own them, you are just making a prediction on the price direction.
Now that we know all the basics let’s see how you can gain or lose money from your 1,000 trade on EUR/USD.
Let’s recap
Let’s recap
Account currency:
US dollars
Leverage:
1:10
Equity:
100 USD
Trading instrument:
EUR/USD
Trade volume:
1,000
Opening Price (aka Ask since it’s a Buy deal):
1.10500
Closing Price (aka Bid):
1.11000
Before you move on, ask yourself: Have you gained or lost this deal?
If you are not sure, go back and read everything again. Repetition is the mother of learning.
So, you have made a profit.
You have bought the pair and the closing price is higher than the opening price.
But how much have you gained?
Here is the calculation: ((Closing Price - Opening Price) * Trade Volume) * Exchange Rate to your Account currency)((1.11000 - 1.10500)*1000)*1 since your account is USD and the Quote currency is also USD)
If you make the calculation, you will find out you can limit your losses to 5 USD.
If you were selling EUR/USD, you would have lost 5 USD.
If you were using leverage 1:30 instead of 1:10 with the same margin of 100USD, the trade volume in your formula would be 3,000 instead of 1,000. In that case you would have gained 15 USD if you were buying the EUR/USD pair.
If you get it all right, let’s move on. If something is not clear for you, reread the information until you feel ready.
MT4 and order type platform
Let’s explain the order types now and how to use them.
In the MT4 platform, there are 8 order types that you can use to limit your losses, secure your profits, and open or close a position.
There are two main categories of order types:
Market/Instant Execution orders
Pending Orders
The Market/Instant execution type includes two sub-types of orders:
Buy Market/Instant Execution order
It means you want to open a position immediately at the current price and you expect the price to move upwards.
Sell Market/Instant Execution order
It means you want to open a position immediately at the current price and you expect the price to move downwards.
The Pending Orders are divided into 6 order types:
Buy Limit
It is a buy order placed below the current price and you believe it’s a turning point of the price.
Here is an example:
The current price on EUR/USD is 1.10500 and you believe that the price will stop going downwards at 1.10000 and will start to increase. In this example you need to set a Buy Limit order which will open your buy deal when the price of EUR/USD goes to 1.10000.
Sell Limit
It has the same logic as Buy Limit but in this case the price is expected to be moving upwards and you think you have found a turning point for the price to go downwards. So, you need to set the Sell limit order above the current price when you expect the price to go downwards when your pending order is executed.
Here is an example:
The current price on EUR/USD is 1.10000 and you believe that the price will stop going upwards at 1.10500 and will start to decrease. In this example you need to set the Sell Limit order which will open your sell deal when the price of EUR/USD goes to 1.10500.
Buy Stop
This order type is actually the opposite of Buy Limit. If the level at which you want your BUY order to be triggered is above the current price, you need to set this type of order. Usually, you do this when you expect the price to rise higher.
Here is an example:
The current price on EUR/USD is 1.10000 and you believe that upon reaching 1.10500, the price will keep going upwards. In this example you need to set the Buy Stop order which will open your buy deal when the price of EUR/USD goes to 1.10500
Sell Stop
If the level at which you want your SELL order to be triggered is below the current price, you need to set this type of order. Again, you do this when you expect the price to fall lower.
Here is an example:
The current price on EUR/USD is 1.10500 and you believe that upon reaching 1.10000, the price will keep going downwards. In this example you need to set the Sell Stop order which will open your sell deal when the price of EUR/USD goes to 1.10000.
The described-above order types are used to open a deal.
The remaining two pending orders are used to close a deal.
Stop Loss
After you have opened a position you can set a Stop Loss level in your MT4 for every deal.
This is used to limit your losses when the market moves against you. So, if you have a BUY deal on EUR/USD and the current price is 1.10500, you can set your Stop Loss level at 1.10000 in order to make sure that you will not lose more than 5 USD.
Take Profit
After you have opened a position, you can set a Take Profit level in your MT4 for every deal.
So, if you have a BUY deal on EUR/USD, the current price is 1.10500 and you expect the price to go up to 1.11000, you can set Take Profit at 1.11000 and the deal will be closed automatically when the price reaches this level.
You can set Take Profit and Stop Loss orders simultaneously.
