A Foray into Forex Trading
Foreign exchange trading—or forex trading—is the buying or selling of a currency to gain a profit based on the price movements of that currency. Currency trades happen in pairs—trading one currency for another—and are facilitated by a forex broker. Unlike the stock market, currency markets are open 24-hours a day during the week because there is always a global market opening up somewhere.
The Asian markets are the first to open, during Sunday night (by U.S. eastern standard time), followed by the European and then North and South American markets. This sequence continues all week until the end of business on Friday, when the U.S. market closes. To keep everything straight, traders often use GMT time.
Currencies are bought and sold in pairs, and how they are listed shows their relative relationship. For example, GBP/USD is the price of the U.S. dollar (USD) relative to the British pound (GBP). If the price for this pair is listed as 1.4000, that means it costs 1.40 USD to buy one GBP. The price is always how much of the second listed currency it costs to purchase one unit of the first listed currency.
You can also flip the relationship to learn how much it costs of the first currency to buy one unit of the second. To do this, flip the signs and divide 1 by the price. For our example, GBP/USD becomes USD/GBP, and divide 1 by 1.40 to get 0.71428. This means it takes 0.71428 GBPs to buy one USD, and the price of the pair USD/GBP is 0.71428.
The price associated with each currency pair, be it USD/CAD (U.S. dollar to the Canadian dollar) or JPY/NZD (Japanese yen to the New Zealand dollar), will constantly change. There are charts online that list all of the various currency abbreviations.
What makes currency transactions profitable are the changes in the prices of currency pairs. To know if a currency transaction will net a profit, you’ll need to understand position size and pip values.
Position Size and Pip Values
Currency pair movements are measured in increments called pips (price interest points). Most major currency pairs are measured at the fourth decimal place of the currency pair price. So, if the price is 1.0673, any price movement that effects the place where the number “3” sits is worth one pip. If the price changes to 1.0679, that is a six pip move.
Currency pairs may be quoted to fractional pips, called pipettes, located in the fifth decimal place. For example, if the price goes from 1.12315 to 1.12320, that represents a half pip (0.00005) move. Unfortunately, the decimal location for pip movement isn’t the same across all currencies. In currency pairs that involve the Japanese yen (JPY), for example, a pip is represented by the second decimal place and pipettes by the third.
Pips matter because pip movements, along with position size, determine traders’ profits and losses. Position size, also called trade size, is how many lots you take on a trade. Lots (broken into three categories of micro, mini, and standard) are amounts of currency entered into a currency exchange.
A micro lot contains 1,000 units of currency; a mini lot contains 10,000 units of currency; a standard lot contains 100,000 units. In one trade, it’s possible to use multiple lots, so a trader could sell six micro lots in one exchange.
Let’s jump into an example using lot size and pip value. If a trader bought/sold a micro lot (1,000 worth) of a EUR/USD pair, one pip of movement would result in a $0.10 gain or loss (lot size x pip placement, so 1,000 x .0001). This is the pip value of the trade. If a mini lot were used, buying/selling 10,0000 worth of the currency pair, the trade would result in a $1 gain or loss for each pip of movement. A 100,000 position means gaining or losing $10 per pip of movement.
Looking back at the example of the trader using six micro lots, a pip of movement will result in a $0.60 gain or loss.
Like with currency abbreviations, there are forex price charts to help traders keep the many movements and values straight.
Test Drive Before Diving In
The forex industry is not heavily regulated and provides high leverage, which, combined with its markets remaining open 24-hours a day during the week, makes it an attractive option for new traders starting out with limited capital.
Most brokers offer demo accounts to give new investors the opportunity to use an account and experiment with different platforms and services risk fee. With “simulated” money, you can practice placing trades and seeing the results of your decisions without risking any real-world money.
There are risks, broker and trading fees, and other basic information anyone interested in forex day trading should investigate before starting.