For most people, the Forex market can be very daunting. They think that it is a market that is dominated by major banking and finance corporations and that they have little chance of making money safely as an individual trader. While it is true that over 97% of the Forex market is traded by banks, hedgefunds and finance corporations, individual traders can take part in this $2 trillion/day market, and even make a very good living at it. Unfortunately, there are hundreds of people around the world who spend lots of money on ebooks that promise to show them an easy way to make millions trading Forex doing very little work. The end result is usually these people end up losing not only the $50-$100 on the ebook, they also lose a lot more money on the Forex market. The usual reason is because they do not spend the time learning the basics on how Forex is traded, and also ignore the most important “law” of Forex trading, which is: “you WILL make losing trades”.
This article will hopefully give you some insight into how Forex is actually traded, how profits are made, and more importantly, how losses are made and how to minimise them. This article will assume that you already know which currencies are the most commonly traded, which is the US dollar, the Japanese Yen, the Euro, the British Pound, the Swiss Franc and the Australian Dollar
Currencies are always traded in pairs, which means there is a simultaneous buying of one currency in the pair with a selling of the other in the pair. For example, if you see a quotation for USD/AUD as 1.3342, this means that $1 can be exchanged for $1.3342 Australian (there’s a reason for 4 decimal points, which I’ll get to later). If the value of this pair goes up to 1.3343 (after you have bought a “contract” to sell $100 000 US to buy $133 420 Australian dollars), it means that the US dollar can now buy 1/100th of a cent more with each dollar. “So what?” I hear you say? It means that if you are trying to exchange $100 US dollars, you will get a whole cent more. Big woop! If you exchanged $100 000 US, you would then get an extra $10 etc. Still nothing to really get excited about. The tiny increment of 0.0001 is called a “pip”; therefore for each pip, you make $10. Keep this in mind for later.
Most people don’t have $100 000 US to throw around to trade, but what if I showed you how you can be loaned $100 000 and all you have to put down is $1000? Read on…
The whole key to Forex trading is leverage. If you wish to trade Forex, a Forex broker will place trades for you, and for every $100 000 you wish to trade, you only need to put down $1000 of your own money. That means your level of leverage is 100:1 where you can control something 100 times larger than your own money. Then if you took the above example, you have made $10 on your $1000, which means a 1% profit. Not too bad for a days’ work actually. The best part of the Forex market is that it can be extremely volatile and a pair may move 50-60 pips in an hour. If you got $10 for each pip and you made 50 pips, that’s a profit of $500. If you only needed to put down $1000 of your own money, that’s a whopping 50% profit! Wouldn’t it be great to make a series of trades where you make 50% on each trade? This is where people get sucked in to thinking trading Forex is easy. This is because they fail to realise that there is the opposite side to the trading. If you have chosen your pair wrongly, each pip will cost you $10. So if you choose the wrong direction of the trade and you lose 50 pips, it has cost you $500 and that’s a 50% LOSS on your original $1000. Again, this type of market action can and does happen quite regularly. Can you handle losing 50% of your money in the space of less than an hour? How many trades losing 50% can you withstand? If the pair loses 100 pips, which isn’t hard to do in Forex trading sessions, you will have lost ALL of your money. Your broker will then call you up and tell you to put more money in your account, or they have to sell everything to get their money (not yours!) back. It has happened to thousands of want to-be Gordon Geckos around the world.
At the end of the day, when you enter a trade, your broker has loaned you $100 000 and all they required from you was $1000. If you start making losses, they will want their $100 000 back regardless, so all losses will be taken out of your account!
When trading Forex, it is actually quite simple how to make money. If you have the right charts (easily found online) and looked at any upcoming events (such as a country possibly devaluing their currency) and made a calculated decision, your chances are actually quite good that you will make a profit. However, even if you think all things point to the market moving in a certain direction, the market can (and does) move in the opposite direction. If you start making a loss, the best advice is to get out FAST because in Forex trading, small losses become very large losses very quickly! Remember, the “Law” of Forex trading is you WILL make losing trades. How a trader handles a losing trade (rather than a winning trade) is what separates the great traders from the want to-bees.