Trading Currencies on Margin

The key to FOREX popularity is margin. Without margin, the FOREX would be beyond the reach of the average investor. So, what exactly is margin and how does it work?

Margin accounts allow FOREX traders to control large amounts of currency with a relatively small deposit. Establishing a margin account with a FOREX broker enables you to borrow money from the broker to control currency lots which are usually worth $100,000. The amount of borrowing power your margin account gives you is the leverage. Leverage is usually expressed as a ratio – a leverage of 100:1 means you can control assets worth 100 times your deposit.

What this means in FOREX is that with a 1% margin account you can control standard lots of $100,000 with a $1,000 deposit. Trading on margin increases both profits and losses, and the potential exists for the trader to lose more than his original deposit. With proper safeguards, however, loss can be limited, and usually brokers will terminate a transaction that extends beyond the margin deposit.

Benefits

As we mentioned above, trading on margin gives you more buying power and the potential for more profits (and losses). How does this work, exactly? A 1% margin account allows you to control a currency lot of $100,000 for $1,000. When dealing with $100,000 small changes in the price of the currency can result in large profits or losses.

FOREX currencies are traded in much smaller units than cash. The American dollar, for example, is traded in units down to 4 decimal places. Instead of $1.32 FOREX quotes are seen as $1.3256. The smallest unit in FOREX currencies is called the pip, and when you have a $100,000 each pip of your total lot is worth $10 (when trading American dollars).

If the price of American dollars changes from 1.3256 to 1.3356, that’s a difference of 100 pips which represents a profit or loss of $1000. Without margin, if you had $1000 of currency, the price change from 1.3256 to 1.3356 represents a difference of $10. Significant to the tourist, perhaps, but not the investor.

So the benefit of margin is increased profit potential.

Risks

As there is increased profit potential, there is also increased loss potential. If you are not careful, your entire margin account could quickly be wiped out. If your margin account is 1% and the currency moves just one cent against you, you lose $1000.

FOREX trading, however, has several methods to limit loss. Stop loss orders automatically close your position if the value of the currency crosses a pre-determined point. Stop loss orders allow you to limit your losses to a specified amount while still allowing potential profit taking.

An often overlooked risk is the possibility that your broker may close your position if your potential losses approach the balance of your margin account. You may be riding out a down trend with the expectations of a market reversal, but unless you replenish your margin account you may find your position has been closed. If this happens, you lose all of your margin.

For example:

You sell EUR/USD at 1.2144 (sell 100,000 euros and buy 121,440 US dollars) with the expectation that the euro will fall in price. You have a 1% margin account which means the required margin is $1,214.40. You have $1250 in your margin account, so to enter this position your margin account is left with $35.60.

You have not specified a stop loss order, and after you enter this position the euro suddenly rallies, gaining 0.0263 for a price of 1.2407. 100,000 euros are now worth US$124,070 and your 1% margin requirements have risen to $1,240.70. Depending on the policy of your broker, your position may be automatically closed or the extra funds in your margin account may be used to make up the difference. In any case, if the euro continues to gain value and you wish to ride it out (bad idea) you will have to add more funds to your margin account or risk losing everything.

Another example:

You buy USD/CHF at 1.2623 with the expectation that the US dollar will gain against the Swiss franc. You buy a standard lot of 100,000 American dollars for 126,230 Swiss francs with a margin requirement of 1% or $1,000.

As expected, the US dollar rises to 1.2683 at which point you close your position. You sell 100,000 American dollars for 126,830 Swiss francs for a profit of 600 francs or US$473.08 (600 francs divided by the exchange rate of 1.2683).

FOREX Signals

One of the disadvantages of FOREX trading is the time investment needed to monitor the markets for advantageous entry and exit points. It’s possible to sit in front of a computer monitor for hours watching the markets.

Of course, you can use automated orders such as limits and stops. These allow you to walk away from your computer with the knowledge that your losses will be kept to a minimum, but by doing so, you may miss out on potential profits because your limit order kicks in too soon.

If you don’t have the time to watch your computer monitor and still wish to achieve as much profit as possible, consider signing up for a FOREX signal service. These services monitor and analyze the market for you and send their findings directly to your computer desktop, email, or SMS on your cell phone or pager.

Companies that offer FOREX signals do so on a paid basis, so you have to sign up and pay a monthly or yearly fee. Some brokers may offer this service as an extra which integrates into their trading software. You can receive signals as a popup on your screen or by any of the other methods described above.

There are usually a limited number of currency pairs that are available for FOREX signals. Most services offer signals on EUR/USD, USD/JPY, GBP/USD, USD/CHF, but specialized services may offer other currency pairs.

FOREX signals are primarily based on technical analysis of market conditions. Most companies use a combination of indicators to identify main trends and entry and exit points. The results are sent to subscribers who have the option of acting on them or passing. Some services will even execute the trade for you.

Using a variety of technical studies, various types of signals can be derived from currency charts. The SMA (Simple Moving Average) indicates buy signals when currency prices rise above the average line. Sell signals occur when the price falls below the moving average line.

MACD (Moving Average Convergence Divergence) studies have a signal line that is used to generate a buy signal (above the line) or a sell signal (below the line).

Volume indicators are used to determine market interest. High volume (especially near the bottom of the market) can indicate the start of a new trend while low volume indicates investor uncertainty.

Bollinger Bands indicate potential changes in the market. Sharp price changes tend to occur when the bands tighten while prices that touch one band tend to go all the way to the other band.

Other indicators like volatility and momentum can be used to reinforce signals provided by other sources. Taken together they form a relatively reliable source of information about how the market is behaving.

Are signals a sure thing? Of course not, otherwise we would all be millionaires. Signals can give you good advice about which currencies to trade, but no signal service will guarantee their information is 100% accurate. Reputable services will show you their track record, however, and let you see for yourself how they have done in the past.

FOREX signals cost anywhere from $50 to $200 a month. It’s up to the individual trader to decide if the cost is worth it. Don’t think that signals can take the place of trader education – they are advice, and if you don’t have the knowledge to analyze the advice, you should go back to the books before using a signal service.

?Five No Nonsense Strategies in Forex Trading

When considering forex trading as a profit making venture, it is important to work out winning strategies beforehand if at all possible. Making decisions regarding your forex trading and developing a strategy can be seen as your foundation. With your strategy you will optimize your risk with respect to the expected reward, or put the odds in your favor. Trading strategies should be disciplined and limit risk, while placing you at the most favorable advantage in the market. One strategy is the simple moving away average, which is based on a technical study over twelve periods, with each period fifteen minutes in length. This is a good example of a trading decision that is arrived at through strategy.

A simple algorithm is used in this strategy. When currency price crosses above the twelfth period, simply move away it is a signal to stop and reverse. In this way a long position will be liquidated and a short position will be established, both using market orders. This system will keep trades always in the market, with either a short position or a long position after the first signal.

Another strategy is of support and resistance levels. This is another technical analysis strategy and derives support and resistance. The idea is that the market tends to trade above support levels and trade below resistance levels. If either a support or a resistance level is broken, then the market will follow through is the direction given. These levels can be determined by analysis of the chart and assessment of where the chart has encountered unbroken support or resistance in times past.

Anther strategy that many see as exotic is called the balloon strategy. A balloon option is an option that balloons, or increases in size when triggers are reached. For example, if an investor believes that the dollar will gain strength against the Euro in the near future and is currently trading at 100, the investor will see 110 as being strong resistance, but the investor also believes it will be broken. So, rather than buying straight dollars at 100 for the next six months the investor will purchase at “at the money” balloon call with a 110 trigger and multiple of two. The investor will then own a 100 call in USD110mm. But if the dollar and Euro ever trade at or above 110, the 110 call will double to USD 20mm.

The double bottom is another strategy worth looking at. The double bottom is significant to the short term trader as double bottoms indicate a possible major change in sentiment and trend. The pattern is used on all times frames, and many powerful intraday and long term bull markets are conceived from this setup. Double bottoms reflect strong support levels. When prices fail to break support in the down trending markets on more than one occasion we see powerful changes of trend. These reversal signals are meaningful. The most common entry point where a trader will open on a double bottom trade is on a move through the high of the two troughs. This high will represent secondary resistance, and when penetrated confirms a price reversal. The stops are placed around the lows of he patters because a move below lows negates the pattern premise.

Another good potential strategy is the ichimoku chart. These charts are following indicators, which identify support and resistance levels and create trading signals in a way that is similar to moving averages. A big difference however between the two is that the Ichimoku chart lines shift forward in time, creating wider support and resistance zones and decreasing the risk of trading false breakouts. They are calculated using information on trend existence, direction, support and resistance.

The four main lines are:

Turning Line = (Highest High + Lowest Low) / 2, for the past nine days

Standard Line = (Highest High + Lowest Low) / 2, for the past twenty-six days

Leading Span 1 = (Standard Line + Turning Line) / 2, plotted twenty-six days ahead of today

Leading Span 2 = (Highest High + Lowest Low) / 2, for the past fifty days, plotted twenty-six days ahead of today’s date.

Whichever strategy you choose to use, devote as much study as possible to increase your chances of gain and profit.

?Money Management Basics for Forex Traders

Money management in the foreign exchange currency market requires educating yourself in a variety of financial areas. First, a definition of the foreign exchange currency or forex market is called for. The forex market is simply the exchange of the currency of one country for the currency of another. The relative values of various currencies in the world change on a regular basis. Factors such as the stability of the economy of a country, the gross national product, the gross domestic product, inflation, interest rates, and such obvious factors as domestic security and foreign relations come into play. For instance, if a country has an unstable government, is expecting a military takeover, or is about to become involved in a war, then the country’s currency may go down in relative value compared to the currency of other countries.

There are five major forex exchange markets in the world, New York, London, Frankfurt, Paris, Tokyo and Zurich. Forex trading occurs around the clock in various markets, Asian, European, and American. With different time zones, when Asian trading stops, European trading opens, and conversely when European trading stops, American trading opens, and when American trading stops, then it is time for Asian trading to begin again.

Most of the trading in the world occurs in the forex markets; smaller markets for trade in individual countries. Simply put forex trading is the simultaneous buying of one currency and selling of another. Over $1.4 trillion dollars, US of forex trading occurs daily and sometimes fortunes are made or lost in this market. The billionaire George Soros has made most of his money in forex trading. Successfully managing your money in forex trading requires an understanding of the bid/ask spread.

Simply put the bid ask spread is the difference between the price at which something is offered for sale and the price that it is actually purchased for. For instance, if the ask price is 100 dollars, and the bid is 102 dollars then the difference is two dollars, the spread. Many forex traders trade on margin. Trading on margin is buying and selling assets that are worth more than the money in your account. Since currency exchange rates on any given day are usually less than two percent, forex trading is done with a small margin. To use an example, with a one percent margin a trader can trade up to $250,000 even if he only has $5,000 in his account. This means the trade has leverage of 50 to one. This amount of leverage allows a trader to make good profits very quickly. Of course, with the chance of high profits also comes high risk.

People who do forex trading do so because they are attracted by 24 hour trading days, by strong liquidity ??” unlike stocks, buying and selling is almost instantaneous ??” and the fact that forex trading usually occurs without paying commissions.

Like many other speculative investments, a key part of money management for the forex trader is only using money that can be put at risk. It is wise to set aside a portion of your net worth and make that the only money you use in forex trading. While the chances of good profits are there, if you should have a problem and get wiped out, you’ll only have a limited amount of money placed at risk. Also remember that the market is n constant motion. There are always trading opportunities. If a currency is becoming stronger or weaker in relation to other currencies there is always a chance for profit. For instance, if you believe that the Euro is gong to become weak compared to the US dollar then selling Euros is a good bet. If you believe that the dollar is going to become weaker than the yen, or the pound sterling, then selling dollars is wise. Staying current on the news and current events in the countries whose currency you hold is a smart move. Many people reach points where they can predict currency changes based on political or economic news in a given country. Remember though that forex trading is speculation, so be careful when managing your funds and only invest what you can afford to risk.