All forex traders, and we do mean ALL traders, LOSE money on some trades.
Ninety percent of traders lose money, largely due to lack of planning, training, discipline, not having a trading edge and having poor money management rules.If you hate to lose or are a super perfectionist, you’ll also probably have a hard time adjusting to trading because all traders lose a trade at some point or another.
2. Trading forex is not for the unemployed, those on low incomes, are knee-deep in credit card debt or who can’t afford to pay their electricity bill or afford to eat.
You should have at least $10,000 of trading capital (in a mini account) that you can afford to lose.
Don’t expect to start an account with a few hundred dollars and expect to become a gazillionaire.The forex market is one of the most popular markets for speculation, due to its enormous size, liquidity, and the tendency for currencies to move in strong trends.
You would think traders all over the world would make a killing, but success has been limited to a very small percentage of traders.
The problem is that many traders come with the misguided hope of making a gazillion bucks, but in reality, they lack the discipline required for really learning the art of trading.
Most people usually lack the discipline to stick to a diet or to go to the gym three times a week.
If you can’t even do that, how do you think you’re going to succeed one of the most difficult, but financially rewarding, endeavors known to man (and woman)?
Short term trading IS NOT for amateurs, and it is rarely the path to “get rich quick”. You can’t make gigantic profits without taking gigantic risks.
A trading strategy that involves taking a massive degree of risk means suffering inconsistent trading performance and large losses.
A trader who does this probably doesn’t even have a trading strategy – unless you call gambling a trading strategy!
Forex Trading is NOT a Get-Rich-Quick Scheme
Forex trading is a SKILL that takes TIME to learn.
Skilled traders can and do make money in this field. However, like any other occupation or career, success doesn’t just happen overnight.Forex trading isn’t a piece of cake (as some people would like you to believe).
Think about it, if it was, everyone trading would already be millionaires.
The truth is that even expert traders with years of experience still encounter periodic losses.
Drill this in your head: there are NO shortcuts to forex trading.
It takes lots and lots of PRACTICE and EXPERIENCE to master.
There is no substitute for hard work, deliberate practice, and diligence.
Practice trading on a DEMO ACCOUNT until you find a method that you know inside and out, and can comfortably execute objectively. Basically, find the way that works for you!!!
You can open a demo account for FREE with most forex brokers. These “pretend” accounts have most of the capabilities of a “real” account.
But why is it free?It’s because the broker wants you to learn the ins and outs of their trading platform, and have a good time trading without risk, so you’ll fall in love with them and deposit real money.
The demo account allows you to learn about the mechanics of forex trading and test your trading skills and processes with ZERO risk.
Yes, that’s right, ZERO!
YOU SHOULD DEMO TRADE UNTIL YOU DEVELOP A SOLID, PROFITABLE SYSTEM BEFORE YOU EVEN THINK ABOUT PUTTING REAL MONEY ON THE LINE.
YOU SHOULD DEMO TRADE UNTIL YOU DEVELOP A SOLID, PROFITABLE SYSTEM BEFORE YOU EVEN THINK ABOUT PUTTING REAL MONEY ON THE LINE.
“Don’t Lose Your Money” Declaration
Now, place your hand on your heart and say…
“I will demo trade until I develop a solid, profitable system before I trade with real money.”
Now touch your head with your index finger and say…
“I am a smart and patient forex trader!”
Do NOT open a live trading account until you are CONSISTENTLY trading PROFITABLY on a demo account.If you can’t wait until you’re profitable on a demo account, then there’s very little chance you’ll be profitable live when real money and emotions are factored in.
You’re probably thinking, “Sooooo…what I hear you saying is…there’s still a chance then?”
If you’re that impatient, then at least try to demo trade for at least a MONTH.
You can hold off losing all your money for a month riiight?
If you can’t, just donate that money to your favorite charity or give it to your mama…show her you still care.
Even after reading this, you’re probably still NOT going to demo trade for at least a month since you’re stubborn like that.
But at least we tried. 😑
Concentrate on ONE major currency pair.
It gets far too complicated to keep tabs on more than one currency pair when you first start demo trading.Stick with ONE of the majors because they are the most liquid which usually means tighter spreads and less chance of slippage.
Plus, in the beginning, you need time to focus on improving your trading processes and creating good habits.
You’ll also need to experience different market environments and learn how to adjust your methods and strategies as market behavior changes.
You can be a winner at currency trading, but as with all other aspects of life, it will take hard work, dedication, a little luck, and a whole lot of patience and good judgment.
An order is an offer sent using your broker’s trading platform to open or close a transaction if the instructions specified by you are satisfied.
Basically, the term “order” refers to how you will enter or exit a trade.
Here we discuss the different types of orders that can be placed in the forex market.
Be sure that you know which types of orders your broker accepts.
Different brokers accept different types of forex orders.
There are some basic order types that all brokers provide and some others that sound weird.
Orders fall into two buckets:
Market order: an order instantly executed against a price that your broker has provided.
Pending order: an order to be executed at a later time at the price you specify.
Here’s a quick “map” of the different types of orders within each bucket.
Buy Limit Buy Stop Sell Limit Sell Stop
A market order is an order to buy or sell at the best available price.For example, the bid price for EUR/USD is currently at 1.2140 and the ask price is at 1.2142.
If you wanted to buy EUR/USD at market, then it would be sold to you at the price of 1.2142.
You would click buy and your trading platform would instantly execute a buy order at that (hopefully) exact price.
If you ever shop on Amazon.com, it’s kinda like using their 1-Click ordering. You like the current price, you click once and it’s yours!
The only difference is you are buying or selling one currency against another currency instead of buying a Justin Bieber CD.
Please keep in mind that depending on market conditions, there may be a difference between the price you selected and the final price that is executed (or “filled”) on your trading platform.
When you place a market order, you do not have any control over what price your market order will actually be filled at.
A limit order is an order placed to either buy below the market or sell above the market at a certain price.
This is an order to buy or sell once the market reaches the “limit price”.
You place a “Buy Limit” order to buy at or below a specified price.
You place a “Sell Limit” order to sell at a specified price or better.
Once the market reaches the “limit price” the order is triggered and executed at the “limit price” (or better).
In the image above, the blue dot is the current price.
Notice how the green line is below the current price. If you place a BUY limit order here, in order for it to be triggered, the price would have to fall down here first.
As you can see, a limit order can only be executed when the price becomes more favorable to you.
Notice how the red line is above the current price. If you place a SELL limit order here, in order for it to be triggered, the price would have to rise up here first.
For example, EUR/USD is currently trading at 1.2050. You want to go short if the price reaches 1.2070.You can either sit in front of your monitor and wait for it to hit 1.2070 (at which point you would click a sell market order).
Or you can set a sell limit order at 1.2070 (then you could walk away from your computer to attend your ballroom dancing class).
If the price goes up to 1.2070, your trading platform will automatically execute a sell order at the best available price.
You use this type of entry order when you believe the price will reverse upon hitting the price you specified!
A limit order to BUY at a price below the current market price will be executed at a price equal to or less than the specified price.
A limit order to SELL at a price above the current market price will be executed at a price equal to or more than the specific price.
Stop Entry Order
A stop order “stops” an order from executing until price reaches a stop price.
You would use a stop order when you want to buy only after price rises to the stop price or sell only after the price falls to the stop price.
A stop entry order is an order placed to buy above the market or sell below the market at a certain price.
You place a “Buy Stop” order to buy at a price above the market price, and it is triggered when the market price touches or goes through the Buy Stop price.
You place a “Sell Stop” order to sell when a specified price is reached.
In the image above, the blue dot is the current price.
Notice how the green line is above the current price. If you place a BUY stop order here, in order for it to be triggered, the current price would have to continue to rise.
Notice how the red line is below the current price. If you place a SELL stop order here, in order for it to be triggered, the current price would have to continue to fall.
As you can see, a stop order can only be executed when the price becomes less favorable to you.
For example, GBP/USD is currently trading at 1.5050 and is heading upward. You believe that price will continue in this direction if it hits 1.5060.
You can do one of the following to play this belief:
Sit in front of your computer and buy at market when it hits 1.5060 OR
Set a stop entry order at 1.5060.
Stop Loss Order
An order to close out if the market price reaches a specified price, which may represent a loss or profit.
A stop loss order is a type of order linked to a trade for the purpose of preventing additional losses if the price goes against you.
If you are in a long position, it is a sell STOP order.
If you are in a short position, it is a buy STOP order.
REMEMBER THIS TYPE OF ORDER.
A stop loss order remains in effect until the position is liquidated or you cancel the stop loss order.
For example, you went long (buy) EUR/USD at 1.2230. To limit your maximum loss, you set a stop loss order at 1.2200.This means if you were dead wrong and EUR/USD drops to 1.2200 instead of moving up, your trading platform would automatically execute a sell order at 1.2200 the best available price and close out your position for a 30-pip loss (eww!).
Stop losses are extremely useful if you don’t want to sit in front of your monitor all day worried that you will lose all your money.
You can simply set a stop loss order on any open positions so you won’t miss your basket weaving class or elephant polo game.
Please note that a stop order is NOT guaranteed a specific execution price and in volatile and/or illiquid markets, may execute significantly away from its stop price. Stop orders may be triggered by a sharp move in price that might be temporary. If your stop order is triggered under these circumstances, your trade may exit at an undesirable price. If triggered during a sharp price decline, a SELL stop loss order is more likely to result in an execution well below the stop price. If triggered during a sharp price increase, a BUY stop loss order is more likely to result in an execution well above the stop price.
A stop loss order which is always attached to an open position and which automatically moves once profit becomes equal to or higher than a level you specify.
A trailing stop is a type of stop loss order attached to a trade that moves as the price fluctuates.
Let’s say that you’ve decided to short USD/JPY at 90.80, with a trailing stop of 20 pips.
This means that originally, your stop loss is at 91.00. If the price goes down and hits 90.60, your trailing stop would move down to 90.80 (or breakeven).
Just remember though, that your stop will STAY at this new price level. It will not widen if the market goes higher against you.
Going back to the example, with a trailing stop of 20 pips, if USD/JPY hits 90.40, then your stop would move to 90.60 (or lock in 20 pips profit).
Your trade will remain open as long as the price does not move against you by 20 pips.
Once the market price hits your trailing stop price, a market order to close your position at the best available price will be sent and your position will be closed.
Limit Orders versus Stop Orders
New traders often confuse limit orders with stop orders because both specify a price.
Both types of orders allow traders to tell their brokers at what price they’re willing to trade in the future.
The difference lies in the purpose of the specified price.
A stop order activates an order when the market price reaches or passes a specified stop price.
For example, EUR/USD is trading at 1.1000, you have a stop entry order to buy at 1.1010. Once the price reaches 1.1010, your order will be executed. But it doesn’t necessarily mean that your buy order was filled at 1.1010. If the market was moving fast, you might’ve been filled at 1.1011.
Basically, your order can get filled at the stop price, worse than the stop price, or even better than the stop price. It all depends on how much price is fluctuating when the market price reaches the stop price.
Think of a stop price simply as a threshold for your order to execute. At what exact price that your order will be filled at depends on market conditions.
A limit order can only be executed at a price equal to or better than a specified limit price.
For example, EUR/USD is trading at 1.1000, you have a limit entry order to buy at 1.1009. Your order will not be filled unless you can get filled at 1.1009 or better.
Think of a limit price as a price guarantee. By setting a limit order, you are guaranteed that your order only gets executed at your limit price (or better).
The catch is that the market price may never reach your limit price so your order never executes.
In the previous example, EUR/USD may only fall down to 1.1009 before skyrocketing. So even though you wanted to go long EUR/USD, your order was never executed since you were trying to enter a long position at a cheaper price. You watch EUR/USD rise without you. 😭
This is the tradeoff when using a limit order instead of a market order.
Weird Forex Orders
“Can I order a grande extra hot soy with extra foam, extra hot split quad shot with a half squirt of sugar-free white chocolate and a half squirt of sugar-free cinnamon, a half packet of Splenda and put that in a Venti cup and fill up the “room” with extra whipped cream with caramel and chocolate sauce drizzled on top?”
Oops, wrong weird order.
Good ‘Till Cancelled (GTC)
A GTC order remains active in the market until you decide to cancel it. Your broker will not cancel the order at any time. Therefore, it is your responsibility to remember that you have the order scheduled.
Good for the Day (GFD)
A GFD order remains active in the market until the end of the trading day.
Because foreign exchange is a 24-hour market, this usually means 5:00 pm EST since that’s the time U.S. markets close, but we’d recommend you double-check with your broker.
GFC and GTC are known as “time in force” orders.
The “time in force” or TIF for an order defines the length of time over which an order will continue working before it is canceled. Think of it as a special instruction used when placing a trade to indicate how long an order will remain active before it is executed or expires.
An OCO order is a combination of two entry and/or stop loss orders.Two orders are placed above and below the current price. When one of the orders is executed the other order is canceled.
An OCO order allows you to place two orders at the same time. But only one of the two will be executed.
Let’s say the price of EUR/USD is 1.2040. You want to either buy at 1.2095 over the resistance level in anticipation of a breakout or initiate a selling position if the price falls below 1.1985.
The understanding is that if 1.2095 is reached, your buy order will be triggered and the 1.1985 sell order will be automatically canceled.
An OTO is the opposite of the OCO, as it only puts on orders when the parent order is triggered.
You set an OTO order when you want to set profit taking and stop loss levels ahead of time, even before you get in a trade.
For example, USD/CHF is currently trading at 1.2000. You believe that once it hits 1.2100, it will reverse and head downwards but only up to 1.1900.
The problem is that you will be gone for an entire week because you have to join a basket weaving competition at the top of Mt. Fuji where there is no internet.
In order to catch the move while you are away, you set a sell limit at 1.2000 and at the same time, place a related buy limit at 1.1900, and just in case, place a stop-loss at 1.2100.
As an OTO, both the buy limit and the stop-loss orders will only be placed if your initial sell order at 1.2000 gets triggered.
An OTO and OTC order are known as conditional orders. A conditional order is an order that includes one or more specified criteria.
As in any new skill that you learn, you need to learn the lingo… especially if you wish to win your love’s heart.
You, the newbie, must know certain terms like the back of your hand before making your first trade.Some of these terms you’ve already learned, but it never hurts to do a little review.
Major and Minor Currencies
The eight most frequently traded currencies (USD, EUR, JPY, GBP, CHF, CAD, NZD, and AUD) are called the major currencies or the “majors.” These are the most liquid and the most sexy.
All other currencies are referred to as minor currencies.
The base currency is the first currency in any currency pair. The currency quote shows how much the base currency is worth as measured against the second currency.
For example, if the USD/CHF rate equals 1.6350, then one USD is worth CHF 1.6350.In the forex market, the U.S. dollar is normally considered the “base” currency for quotes, meaning that quotes are expressed as a unit of 1 USD per the other currency quoted in the pair.
The primary exceptions to this rule are the British pound, the euro, and the Australian and New Zealand dollar.
The quote currency is the second currency in any currency pair. This is frequently called the pip currency and any unrealized profit or loss is expressed in this currency.
A pip is the smallest unit of price for any currency.
Nearly all currency pairs consist of five significant digits and most pairs have the decimal point immediately after the first digit, that is, EUR/USD equals 1.2538.
In this instance, a single pip equals the smallest change in the fourth decimal place – that is, 0.0001. Therefore, if the quote currency in any pair is USD, then one pip always equals 1/100 of a cent.
Notable exceptions are pairs that include the Japanese yen where a pip equals 0.01.
One-tenth of a pip. Some brokers quote fractional pips, or pipettes, for added precision in quoting rates.
For example, if EUR/USD moved from 1.32156 to 1.32158, it moved 2 pipettes.
The bid is the price at which the market is prepared to buy a specific currency pair in the forex market. At this price, the trader can sell the base currency. It is shown on the left side of the quotation.
For example, in the quote GBP/USD 1.8812/15, the bid price is 1.8812. This means you sell one British pound for 1.8812 U.S. dollars.
The ask/offer is the price at which the market is prepared to sell a specific currency pair in the forex market. At this price, you can buy the base currency. It is shown on the right side of the quotation.
For example, in the quote EUR/USD 1.2812/15, the ask price is 1.2815. This means you can buy one euro for 1.2815 U.S. dollars. The ask price is also known as the offer price.
The spread is the difference between the bid and ask price.The “big figure quote” is the dealer expression referring to the first few digits of an exchange rate. These digits are often omitted in dealer quotes.
For example, the USD/JPY rate might be 118.30/118.34, but would be quoted verbally without the first three digits as “30/34.”
In this example, USD/JPY has a 4-pip spread.
Exchange rates in the forex market are expressed using the following format:
Base currency / Quote currency = Bid / Ask
The critical characteristic of the bid/ask spread is that it is also the transaction cost for a round-turn trade.
Round-turn means a buy (or sell) trade and an offsetting sell (or buy) trade of the same size in the same currency pair.
For example, in the case of the EUR/USD rate of 1.2812/15, the transaction cost is three pips.
The formula for calculating the transaction cost is:
Transaction cost (spread) = Ask Price – Bid Price
A cross-currency is any currency pair in which neither currency is the U.S. dollar. These pairs exhibit erratic price behavior since the trader has, in effect, initiated two USD trades.
For example, initiating a long (buy) EUR/GBP is equivalent to buying a EUR/USD currency pair and selling GBP/USD. Cross-currency pairs frequently carry a higher transaction cost.
When you open a new margin account with a forex broker, you must deposit a minimum amount with that broker.This minimum varies from broker to broker and can be as low as $100 to as high as $100,000.
Each time you execute a new trade, a certain percentage of the account balance in the margin account will be set aside as the initial margin requirement for the new trade.
The amount is based upon the underlying currency pair, its current price, and the number of units (or lots) traded. The lot size always refers to the base currency.
For example, let’s say you open a mini account that provides a 200:1 leverage or 0.5% margin. Mini accounts trade mini lots. Let’s say one mini lot equals $10,000.
If you were to open one mini-lot, instead of having to provide the full $10,000, you would only need $50 ($10,000 x 0.5% = $50).
Leverage is the ratio of the amount capital used in a transaction to the required security deposit ( the “margin“).
It is the ability to control large dollar amounts of a financial instrument with a relatively small amount of capital.
Leverage varies dramatically with different brokers, ranging from 2:1 to 500:1.
Now that you’ve impressed your dates with your forex lingo, how about showing them the different types of trade orders?
Forex is commonly traded in specific amounts called lots, orbasically the number of currency units you will buy or sell.
A “lot” is a unit measuring a transaction amount.
When you place orders on your trading platform, orders are placed in sizes quoted in lots.
It’s like an egg carton (or egg box in British English). When you buy eggs, you usually buy a carton (or box). One carton includes 12 eggs.
The standard size for a lot is 100,000 units of currency, and now, there are also mini,micro, and nano lot sizes that are 10,000, 1,000, and 100 units.
NUMBER OF UNITS
Some brokers show quantity in “lots”, while other brokers show the actual currency units.As you may already know, the change in a currency value relative to another is measured in “pips,” which is a very, very small percentage of a unit of currency’s value.
To take advantage of this minute change in value, you need to trade large amounts of a particular currency in order to see any significant profit or loss.
Let’s assume we will be using a 100,000 unit (standard) lot size. We will now recalculate some examples to see how it affects the pip value.
USD/JPY at an exchange rate of 119.80: (.01 / 119.80) x 100,000 = $8.34 per pip
USD/CHF at an exchange rate of 1.4555: (.0001 / 1.4555) x 100,000 = $6.87 per pip
In cases where the U.S. dollar is not quoted first, the formula is slightly different.
EUR/USD at an exchange rate of 1.1930: (.0001 / 1.1930) X 100,000 = 8.38 x 1.1930 = $9.99734 rounded up will be $10 per pip
GBP/USD at an exchange rate of 1.8040: (.0001 / 1.8040) x 100,000 = 5.54 x 1.8040 = 9.99416 rounded up will be $10 per pip.
Here are examples of pip values for EUR/USD and USD/JPY, depending on lot size.
PIP VALUE PER:
1 USD = 80 JPY
Your broker may have a different convention for calculating pip values relative to lot size but whatever way they do it, they’ll be able to tell you what the pip value is for the currency you are trading at that particular time.
In other words, they do all the math calculations for you!
As the market moves, so will the pip value depending on what currency you are currently trading.
What the heck is leverage?
You are probably wondering how a small investor like yourself can trade such large amounts of money.
Think of your broker as a bank who basically fronts you $100,000 to buy currencies.
All the bank asks from you is that you give it $1,000 as a good faith deposit, which it will hold for you but not necessarily keep.
Sounds too good to be true? This is how forex trading using leverage works.
The amount of leverage you use will depend on your broker and what you feel comfortable with.
Typically the broker will require a deposit, also known as “margin“.
Once you have deposited your money, you will then be able to trade. The broker will also specify how much margin is required per position (lot) traded.For example, if the allowed leverage is 100:1 (or 1% of position required), and you wanted to trade a position worth $100,000, but you only have $5,000 in your account.
No problem as your broker would set aside $1,000 as a deposit and let you “borrow” the rest.
Of course, any losses or gains will be deducted or added to the remaining cash balance in your account.
The minimum security (margin) for each lot will vary from broker to broker.
In the example above, the broker required a 1% margin. This means that for every $100,000 traded, the broker wants $1,000 as a deposit on the position.
Let’s say you want to buy 1 standard lot (100,000) of USD/JPY. If your account is allowed 100:1 leverage, you will have to put up $1,000 as margin.
The $1,000 is NOT a fee, it’s a deposit.
You get it back when you close your trade.
The reason the broker requires the deposit is that while the trade is open, there’s the risk that you could lose money on the position!
Assuming that this USD/JPY trade is the only position you have open in your account, you would have to maintain your account’s equity (absolute value of your trading account) of at least $1,000 at all times in order to be allowed to keep the trade open.
If USD/JPY plummets and your trading losses cause your account equity to fall below $1,000, the broker’s system would automatically close out your trade to prevent further losses.
This is a safety mechanism to prevent your account balance from going negative.
Understanding how margin trading works is so important that we have dedicated a whole section to it later in the School.
It is a must-read if you don’t want to blow up your account!
Moving on for now…
How the heck do I calculate profit and loss?
So now that you know how to calculate pip value and leverage, let’s look at how you calculate your profit or loss.
Let’s buy U.S. dollars and sell Swiss francs.
The rate you are quoted is 1.4525 / 1.4530. Because you are buying U.S. dollars you will be working on the “ASK” price of 1.4530, the rate at which traders are prepared to sell.
So you buy 1 standard lot (100,000 units) at 1.4530.
A few hours later, the price moves to 1.4550 and you decide to close your trade.
The new quote for USD/CHF is 1.4550 / 1.4555. Since you initially bought to open the trade, to close the trade, you now must sell in order to close the trade so you must take the “BID” price of 1.4550. The price that traders are prepared to buy at.
The difference between 1.4530 and 1.4550 is .0020 or 20 pips.
Using our formula from before, we now have (.0001/1.4550) x 100,000 = $6.87 per pip x 20 pips = $137.40
Remember, when you enter or exit a trade, you are subject to the spread in the bid/ask quote.
When you buy a currency, you will use the offer or ASK price.
When you sell, you will use the BID price.
Next up, we’ll give you a roundup of the freshest forex lingos you’ve learned!
Here is where we’re going to do a little math. Just a little bit.
You’ve probably heard of the terms “pips,” “points“, “pipettes,” and “lots” thrown around, and now we’re going to explain what they are and show you how their values are calculated.
Take your time with this information, as it is required knowledge for all forex traders.Don’t even think about trading until you are comfortable with pip values and calculating profit and loss.
What the heck is a Pip?
The unit of measurement to express the change in value between two currencies is called a “pip.”
If EUR/USD moves from 1.1050 to 1.1051, that .0001 USD rise in value is ONE PIP.
A pip is usually the last decimal place of a price quote.
Most pairs go out to 4 decimal places, but there are some exceptions like Japanese yen pairs (they go out to two decimal places).
For example, for EUR/USD, it is 0.0001, and for USD/JPY, it is 0.01.
What is a Pipette?
There are forex brokers that quote currency pairs beyond the standard “4 and 2” decimal places to “5 and 3” decimal places.
They are quoting FRACTIONAL PIPS, also called “points” or “pipettes.”
If the concept of a “pip” isn’t already confusing enough for the new forex trader, let’s try to make you even more confused and point out that a “point” or “pipette” or “fractional pip” is equal to a “tenth of a pip“.
For instance, if GBP/USD moves from 1.30542 to 1.30543, that .00001 USD move higher is ONE PIPETTE.
Here’s how fractional pips look like on a trading platform:
On trading platforms, the digit representing a tenth of a pip usually appears to the right of the two larger digits.
How to Calculate the Value of a Pip
As each currency has its own relative value, it’s necessary to calculate the value of a pip for that particular currency pair.
In the following example, we will use a quote with 4 decimal places.
For the purpose of better explaining the calculations, exchange rates will be expressed as a ratio (i.e., EUR/USD at 1.2500 will be written as “1 EUR / 1.2500 USD”)
Example #1: USD/CAD = 1.0200
To be read as 1 USD to 1.0200 CAD (or 1 USD/1.0200 CAD)
(The value change in counter currency) times the exchange rate ratio = pip value (in terms of the base currency)
[.0001 CAD] x [1 USD/1.0200 CAD]
Or simply as:
[(.0001 CAD) / (1.0200 CAD)] x 1 USD = 0.00009804 USD per unit tradedUsing this example, if we traded 10,000 units of USD/CAD, then a one pip change to the exchange rate would be approximately a 0.98 USD change in the position value (10,000 units x 0.00009804 USD/unit).
We say “approximately” because as the exchange rate changes, so does the value of each pip move.
Example #2: GBP/JPY = 123.00
Here’s another example using a currency pair with the Japanese Yen as the counter currency.
Notice that this currency pair only goes to two decimal places to measure a 1 pip change in value (most of the other currencies have four decimal places). In this case, a one pip move would be .01 JPY.
(The value change in counter currency) times the exchange rate ratio = pip value (in terms of the base currency)
So, when trading 10,000 units of GBP/JPY, each pip change in value is worth approximately 0.813 GBP.
How to Find the Pip Value in Your Trading Account’s Currency
The final question to ask when figuring out the pip value of your position is, “What is the pip value in terms of my trading account’s currency?”After all, it is a global market and not everyone has their account denominated in the same currency.
This means that the pip value will have to be translated to whatever currency our account may be traded in.
This calculation is probably the easiest of all; simply multiply/divide the “found pip value” by the exchange rate of your account currency and the currency in question.
If the “found pip value” currency is the same currency as the base currency in the exchange rate quote:
Using the GBP/JPY example above, let’s convert the found pip value of .813 GBP to the pip value in USD by using GBP/USD at 1.5590 as our exchange rate ratio.
If the currency you are converting to is the counter currency of the exchange rate, all you have to do is divide the “found pip value” by the corresponding exchange rate ratio:
.813 GBP per pip / (1 GBP/1.5590 USD)
[(.813 GBP) / (1 GBP)] x (1.5590 USD) = 1.2674 USD per pip move
So, for every .01 pip move in GBP/JPY, the value of a 10,000 unit position changes by approximately 1.27 USD.
If the currency you are converting to is the base currency of the conversion exchange rate ratio, then multiply the “found pip value” by the conversion exchange rate ratio.
Using our USD/CAD example above, we want to find the pip value of .98 USD in New Zealand Dollars. We’ll use .7900 as our conversion exchange rate ratio:
0.98 USD per pip X (1 NZD/.7900 USD)
[(0.98 USD) / (.7900 USD)] x (1 NZD) = 1.2405 NZD per pip move
For every .0001 pip move in USD/CAD from the example above, your 10,000 unit position changes in value by approximately 1.24 NZD.Even though you’re now a math genius–at least with pip values–you’re probably rolling your eyes back and thinking, “Do I really need to work all this out?”
Well, the answer is a big fat NO. Nearly all forex brokers will work all this out for you automatically, but it’s always good for you to know how they work it out.
If your broker doesn’t happen to do this, don’t worry! You can use our Pip Value Calculator! Aren’t we awesome?!
In the next lesson, we will discuss how these seemingly insignificant amounts can add up
Forex trading involves trying to predict which currency will rise or fall versus another currency.
How do you know when to buy or sell a currency pair?
In the following examples, we are going to use a little fundamental analysis to help us decide whether to buy or sell a specific currency pair.
The supply and demand for a currency changes due to various economic factors, which drives currency exchange rates up and down.
Each currency belongs to a country (or region). So forex fundamental analysis focuses on the overall state of the country’s economy, such as productivity, employment, manufacturing, international trade, and interest ratezzzzzzzz.
If you always fell asleep during your economics class or just flat out skipped economics class, don’t worry!
We will cover fundamental analysis in a later lesson.
But right now, try to pretend you know what’s going on…
In this example, the euro is the base currency and thus the “basis” for the buy/sell.If you believe that the U.S. economy will continue to weaken, which is bad for the U.S. dollar, you would execute a BUY EUR/USD order.
By doing so, you have bought euros in the expectation that it will rise versus the U.S. dollar.
If you believe that the U.S. economy is strong and the euro will weaken against the U.S. dollar, you would execute a SELL EUR/USD order.
By doing so, you have sold euros in the expectation that it will fall versus the US dollar.
In this example, the U.S. dollar is the base currency and thus the “basis” for the buy/sell.
If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order.By doing so you have bought U.S dollars in the expectation that it will rise versus the Japanese yen.
If you believe that Japanese investors are pulling money out of U.S. financial markets and converting all their U.S. dollars back to yen, and this will hurt the U.S. dollar, you would execute a SELL USD/JPY order.
By doing so you have sold U.S dollars in the expectation that it will depreciate against the Japanese yen.
In this example, the pound is the base currency and thus the “basis” for the buy/sell.If you think the British economy will continue to do better than the U.S. in terms of economic growth, you would execute a BUY GBP/USD order.
By doing so you have bought pounds in the expectation that it will rise versus the U.S. dollar.
If you believe the British economy is slowing while the American economy remains strong like Chuck Norris, you would execute a SELL GBP/USD order.
By doing so you have sold pounds in the expectation that it will depreciate against the U.S. dollar.
How to trade forex with USD/CHF
In this example, the U.S. dollar is the base currency and thus the “basis” for the buy/sell.
If you think the Swiss franc is overvalued, you would execute a BUY USD/CHF order.
By doing so you have bought U.S. dollars in the expectation that it will appreciate versus the Swiss Franc.
If you believe that the U.S. housing market weakness will hurt future economic growth, which will weaken the dollar, you would execute a SELL USD/CHF order.
By doing so, you have sold U.S. dollars in the expectation that it will depreciate against the Swiss franc.
Trading in “Lots”
When you go to the grocery store and want to buy an egg, you can’t just buy a single egg, they come in dozens or “lots” of 12.
In forex, it would be just as foolish to buy or sell 1 euro, so they usually come in “lots” of 1,000 units of currency (micro lot), 10,000 units (mini lot), or 100,000 units (standard lot) depending on your broker and the type of account you have (more on “lots” later).
“But I don’t have enough money to buy 10,000 euros! Can I still trade?”
You can! By using leverage.
When you trade with leverage, you wouldn’t need to pay the 10,000 euros upfront. Instead, you’d put down a small “deposit”, known as margin.
Leverage is the ratio of the transaction size (“position size”) to the actual cash (“trading capital”) used for margin.
For example, 50:1 leverage, also known as a 2% margin requirement, means $2,000 of margin is required to open a position size worth $100,000.Margin trading lets you open large position sizes using only a fraction of the capital you’d normally need.
This is how you’re able to open $1,250 or $50,000 positions with as little as $25 or $1,000.
You can conduct relatively large transactions with a small amount of initial capital.
Let us explain.
We will be discussing margin in more detail later, but hopefully, you’re able to get the basic idea of how it works.
Listen carefully because this is very important!
You believe that signals in the market are indicating that the British pound will go up against the U.S. dollar.
You open one standard lot (100,000 units GBP/USD), buying with the British pound with a 2% margin requirement.
You wait for the exchange rate to climb.
When you buy one lot (100,000 units) of GBP/USD at a price of 1.50000, you are buying 100,000 pounds, which is worth $150,000 (100,000 units of GBP * 1.50000).
Since the margin requirement was 2%, then US$3,000 would be set aside in your account to open up the trade ($150,000 * 2%).
You now control 100,000 pounds with just $3,000.
Your predictions come true and you decide to sell. You close the position at 1.50500. You earn about $500.
You buy 100,000 pounds at the exchange rate of 1.5000
You take a power nap for 20 minutes and the GBP/USD exchange rate rises to 1.5050 and you sell.
You have earned a profit of $500.
When you decide to close a position, the deposit (“margin”) that you originally made is returned to you and a calculation of your profits or losses is done.
This profit or loss is then credited to your account.
Let’s review the GBP/USD trade example above.
GBP/USD went up by a mere half a pence! Not even one pence. It was half a pence!
But you made $500! 😲
While taking a power nap!
How? Because you weren’t trading just £1.
If your position size was £1, yes, you would’ve made only half a pence.
But…your position size was £100,000 (or $150,000) when you opened the trade.
What’s neat is that you didn’t have to put up that entire amount.
All that was required to open the trade was $3,000 in margin.
$500 profit from $3,000 in capital is a 16.67% return! 😲😲
In twenty minutes!
That’s the power of leveraged trading!
A small margin deposit can lead to large losses as well as gains.
It also means that a relatively small movement can lead to a proportionately much larger movement in the size of any loss or profit which can work against you as well as for you.
You could’ve easily LOST $500 in twenty minutes as well.
You wouldn’t have woken up from a nightmare. You would’ve woken up into a nightmare!
High leverage sounds awesome, but it can be deadly.
For example, you open a forex trading account with a small deposit of $1,000. Your broker offers 100:1 leverage so you open a $100,000 EUR/USD position.
A move of just 100 pips will bring your account to $0! A 100-pip move is equivalent to €1! You blew your account with a price move of a single euro. Congrats. 👏
When trading on margin, it’s important to be aware that your risk is based on the full value of your position size. You can quickly blow your account if you don’t understand how margin works. We want you to AVOID this. Due to this danger, we dedicate an entire section on how margin trading works, called Margin Trading 101.
For positions open at your broker’s “cut-off time” (usually 5:00 pm ET), there is a daily “rollover fee“, also known as a “swap fee” that a trader either pays or earns, depending on the positions you have open.If you do not want to earn or pay interest on your positions, simply make sure they are all closed before 5:00 pm ET, the established end of the market day.
Since every currency trade involves borrowing one currency to buy another, interest rollover charges are part of forex trading.
Interest is PAID on the currency that is borrowed.
Interest is EARNED on the one that is bought.
If you are buying a currency with a higher interest rate than the one you are borrowing, then the net interest rate differential will be positive (i.e. USD/JPY) and you will earn interest as a result.
Conversely, if the interest rate differential is negative then you will have to pay.
For more information on how a rollover works, check out our Forexpedia page on rollover.
Note that many retail forex brokers do adjust their rollover rates based on different factors (e.g., account leverage, interbank lending rates).
Please check with your broker for more information on their specific rollover rates and crediting/debiting procedures.
Here is a table to help you figure out the interest rate differentials of the major currencies.
Benchmark Interest Rates
Later on, we’ll teach you all about how you can use interest rate differentials to your advantage.
Placing a trade in the foreign exchange market is simple. The mechanics of a trade are very similar to those found in other financial markets (like the stock market), so if you have any experience in trading, you should be able to pick it up pretty quickly.
And if you don’t, you’ll still be able to pick it up….as long as you finish School of Pipsology, our forex trading course!
The objective of forex trading is to exchange one currency for another in the expectation that the price will change.
More specifically, that the currency you bought will increase in value compared to the one you sold.
Here’s an example:
You purchase 10,000 euros at the EUR/USD exchange rate of 1.1800
Two weeks later, you exchange your 10,000 euros back into U.S. dollar at the exchange rate of 1.2500
You earn a profit of $700
*EUR 10,000 x 1.18 = US $11,800 ** EUR 10,000 x 1.25 = US $12,500
An exchange rate is simply the ratio of one currency valued against another currency.
For example, the USD/CHF exchange rate indicates how many U.S. dollars can purchase one Swiss franc, or how many Swiss francs you need to buy one U.S. dollar.
How to Read a Forex Quote
Currencies are always quoted in pairs, such as GBP/USD or USD/JPY.
The reason they are quoted in pairs is that, in every foreign exchange transaction, you are simultaneously buying one currency and selling another.
How do you know which currency you are buying and which you are selling?
Excellent question! This is where the concepts of base and quote currencies come in…
Base and Quote Currency
Whenever you have an open position in forex trading, you are exchanging one currency for another.
Currencies are quoted in relation to other currencies.
Here is an example of a foreign exchange rate for the British pound versus the U.S. dollar:
The first listed currency to the left of the slash (“/”) is known as the base currency (in this example, the British pound).
The base currency is the reference element for the exchange rate of the currency pair. It always has a value of one.
The second listed currency on the right is called the counter or quote currency (in this example, the U.S. dollar).When buying, the exchange rate tells you how much you have to pay in units of the quote currency to buy ONE unit of the base currency.
In the example above, you have to pay1.21228 U.S. dollars to buy 1 British pound.
When selling, the exchange rate tells you how many units of the quote currency you get for selling ONE unit of the base currency.
In the example above, you will receive1.21228 U.S. dollars when you sell 1 British pound.
The base currency represents how much of the quote currency is needed for you to get one unit of the base currency
If you buy EUR/USD this simply means that you are buying the base currency and simultaneously selling the quote currency.
In caveman talk, “buy EUR, sell USD.”
You would buy the pair if you believe the base currency will appreciate (gain value) relative to the quote currency.
You would sell the pair if you think the base currency will depreciate (lose value) relative to the quote currency.
With so many currency pairs to trade, how do forex brokers know which currency to list as the base currency and the quote currency?
Fortunately, the way that currency pairs are quoted in the forex market is standardized.
You may have noticed that currencies quoted as a currency pair are usually separated with a slash (“/”) character.
Just know that this is a matter of preference and the slash may be omitted or replaced by a period, a dash, or nothing at all.
For example, some traders may type “EUR/USD” as “EUR-USD” or just “EURUSD”. They all mean the same thang.
“Long” and “Short”
First, you should determine whether you want to buy or sell.
If you want to buy (which actually means buy the base currency and sell the quote currency), you want the base currency to rise in value and then you would sell it back at a higher price.
In trader talk, this is called “going long” or taking a “long position.” Just remember: long = buy.
If you want to sell (which actually means sell the base currency and buy the quote currency), you want the base currency to fall in value and then you would buy it back at a lower price.
This is called “going short” or taking a “short position”.
Just remember: short = sell.
“I’m long AND short.”
Flat or Square
If you have no open position, then you are said to be “flat” or “square”.
Closing a position is also called “squaring up“.
The Bid, Ask and Spread
All forex quotes are quoted with two prices: the bid and ask.
In general, the bid is lower than the ask price.
What is “Bid”?
The bid is the price at which your broker is willing to buy the base currency in exchange for the quote currency.
This means the bid is the best available price at which you (the trader) can sell to the market.
If you want to sell something, the broker will buy it from you at the bid price.
What is “Ask”?
The ask is the price at which your broker will sell the base currency in exchange for the quote currency.
This means the ask price is the best available price at which you can buy from the market.
Another word for ask is the offer price.
If you want to buy something, the broker will sell (or offer) it to you at the ask price.
What is “Spread”?
The difference between the bid and the ask price is known as the SPREAD.
On the EUR/USD quote above, the bid price is 1.34568 and the ask price is 1.34588. Look at how this broker makes it so easy for you to trade away your money.
If you want to sell EUR, you click “Sell” and you will sell euros at 1.34568.
If you want to buy EUR, you click “Buy” and you will buy euros at 1.34588.
Here’s an illustration that puts together everything we’ve covered in this lesson: