How to Trade Forex

Base and Counter Currencies

With Forex, traders are always presented with a currency pair – for example, EUR/USD or USD/JPY. The currency on the left is called the ‘base’ currency and the one on the right is called the ‘counter’ currency, with the counter currency being compared to the base currency. For example, if the current EUR/USD reading was 1:1.35, it means that at this moment in time €1(the Euro being the base currency) is worth $1.35 (USD being the counter currency).

How Leverage Works

Leverage and Trading Forex

How Leverage Works

If you were trading in solid assets, actually owning the currency you were trading, you would be limited by the amount of money you had available to place. For example, if you had £50, you would only be able to trade £50 worth of currency.

Leverage enables you to trade without being limited by your actual funds; traders can take a much larger position in the markets than the money available to them would normally allow.

Different currency pairs may have different maximum leverage rates depending on risk; maximum leverage on pairs offered by ETX Capital ranges from 14:1 EUR/HUF (Euro/Hungarian Forint) all the way up to 200:1 for pairs including EUR/USD and GBP/USD (traders are reminded that leverage settings can change based on market conditions) . For example, if I had £50 and wanted to trade GBP/USD, with the maximum leverage offered I could take a position at two hundred times my £50, depending on the exchange rate when my trade was placed. In other words, leverage enables traders to punch significantly above their weight when it comes to the trade size.

Since traders are controlling such a large stake via such a small initial investment, positive and negative aspects of leverage are enhanced. If the trade goes according to plan the profits can be substantial, but if markets move in the opposite way to the trade, then losses can be just as considerable.

When trading it is prudent to keep in mind that increasing one's leverage increases one's risk.

Forex Trading: Going Long or Short

As with spread betting, there are only two options when it comes to currency pairs; buying or selling.

Going long means you’re buying the base currency – and by extension selling the counter currency. Going short means the opposite – you’re selling the base currency and as a consequence buying the counter currency.

going long

Going long

Let’s look at an example of going long, using EUR/USD as our currency pair;

Consider the following scenario; there is a considerable amount of market tension concerning upcoming US GDP figures, as well worry that an upcoming election will see gains for a party traditionally hostile to big business.

As a result, you decide that the Euro looks likely to strengthen against the dollar and so you go long on EUR/USD, which is currently trading at bid/ask rate of 1.6764/1.6770. You decide that you’re going to take full advantage of the leverage opportunities available to you; you ‘buy’ €10,000 at that rate of 1.6770, at a leverage scale of 200:1.

The following equation determines how much your initial deposit needs to be;

(Amount I want to buy times counter currency exchange rate/leverage scale)

So, (10,000 times 1.6770/200), which equals €83.85. This is the amount required in the initial deposit. Let’s say events play out as you expected, with the result being that the Euro does strengthen against the dollar. The bid/ask rate is now 1.6811/1.6817 and you decide to close out the trade at this point, ‘selling’ your €10,000 at a price of 1.6811

Having bought at 1.6770, I sold at 1.6811, which is a rise of 41 percentage points.

(Level I sold at – Level I bought at) times Amount I bought

So, (1.6811-1.6770) times 10,000 = $41

However, let’s say the markets went the other way to my trade and the dollar strengthened against the Euro. When the bid/ask rate hits 1.6720/1.6726 I decide to cut my losses and sell all €10,000. My losses would be worked out as follows;

(Level I bought at - Level I sold at) times Amount I bought

So, (1.6770-1.6720) times 10,000 = $50

Going Short

Going short

In another scenario, trade output in the US seems to be picking up, whilst the Eurozone has been hit by severe weather conditions over the past month. You suspect that the Dollar will strengthen against the Euro, and therefore decide to sell, or ‘short’ €10,000, at a price of 1.4989, with a leverage scale of 1:50.

So (10,000 times 1.4989/50) = €299.78

You made a good call, the Euro weakens against the dollar and at you ‘buy’ €10,000 in order to close your trade, at a price of 1.4902, a fall of 87 percentage points. Your profit would be worked out as follows;

(1.4989-1.4902) times 10,000 = $87

On the other hand, let’s instead say that the Euro actually ended up strengthening against the Dollar, meaning that you were on the losing side of the trade and you decide to buy and close out all €10,000 at a bid/ask price of 1.5114/1.5120. Your loss would be the following;

(1.5120 – 1.4989) times 10,000 = $131

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