A look at forex trading basics

Forex trading introduction

Any decent forex guide should start with a few basic facts. First of all the forex markets are massive, over US$3 trillion is traded in the currency markets every day primarily by investment banks, international corporations, investment companies and hedge funds. Because of the size of the market and the thousands of different participants, currency prices move around a lot which provides a great opportunity for private traders to take their share of the profits.

What's more you don't need to have a huge pile of cash to get started. These days, due to the internet it is much easier to get forex education and start trading with as little as US$200 (using a mini account). However beginners will find a lot of conflicting advice on everything from which platform to use, the best broker and the best course to follow.

A Working Example of a Trade

Since exchange rates change by such a small percentage, a term called the pip is used to describe changes in rates or profits. For example, if the GBP/CHF (British Pound versus Swiss Franc) goes from 1.7000 to 1.7001, it has increased by 1 pip, and an increase to 1.7100 would be 100 pips because for this pair one pip is 0.0001. However, for a rate like 95.00 for the USD/JPY, the pip represents 0.01, so 95.01 would be a 1-pip gain while 96.00 would be a 100-pip gain. This just describes the rate differences. To calculate your dollar gains, you need to factor in the lot size

Forex brokers make their profits, not by charging a commission on each trade, but by creating a small difference between the Bid (Sell) and Ask (Buy) prices. This is called the Spread and it is measured in pips. A typical spread might be between 1 and 10 pips. So if you bought and then sold right away, you would actually lose money by the amount of the spread. For example, buying EUR/USD at 1.5000 (the Ask) and selling at 1.4995 (the Bid) would be a loss of 5 pips.

Using Leverage

Since currency rates change by such small amounts at a time, most forex brokers offer a large amount of leverage, such as 200 to 1. That means you only use $1 of your actual cash for every $200 of a forex pair that you purchase. For example, if you buy 10K of EUR/USD at 200:1 leverage, that would only require $50 of cash because 10,000 divided by 200 is 50. The purpose of the leverage is to amplify your profits but keep in mind it can just as easily amplify your losses. Many, many traders have lost all of their trading money because of leverage, so be careful!