If I told you there was a highly liquid market much larger than the New York Stock Exchange, where you have the potential to double your money in hours -- with limited risk -- your initial reaction might be utter disbelief, or at least a large dose of skepticism. Doubt no more, because it's true. Forex trading and Forex has exploded full force onto the trading scene, and it offers traders some unique characteristics not found elsewhere. Don't pre-judge this market; ignore it at your own risk. Many traders have expanded their trading to include Forex in addition to stocks and/or futures, and many of you have asked us for information and how to get involved. So here it is -- a quick overview of the Forex market.
What Is Forex and Forex trading?
Forex is an acronym for "foreign exchange," and involves trading pairs of currencies, i.e., buying one currency and selling the other in a single transaction. For example, USD/JPY is buy US dollar/sell Japanese yen. In this case, you expect the dollar to appreciate versus the yen, the yen to depreciate against the dollar, or both. The latter situation, of course, is ideal.
What Currencies Are Traded?
The foreign exchange market is gigantic: over $1.5 trillion in daily Forex trades, with national banks such as the Bank of Japan, money center banks such as Citicorp and large pension plans and hedge funds being the major players. It's mainly the larger currencies that are involved, together with the US dollar.
While there are several currency pairs that offer good opportunities, these four are the most widely traded: Euro/US dollar (EUR/USD), US dollar/Swiss franc (USD/CHF), US Dollar/Japanese yen (USD/JPY), British pound/US dollar (GBP/USD).
How Do You Calculate Price Movement?
Price movement for any foreign currency pair is calculated in "PIPs” (Price Interest Points) which are 1/10 of 1% of the contract size. For example, for a large account, a PIP is $10. For a mini account, one PIP will be $1.00. For example, on a mini account, let's take a quote of 1.2386 EUR/USD. If price moves to 1.2387, that's one PIP, or $1.00. 100 PIPs equals 1 basis point, or "BIP," so a move from 1.2386 to 1.2486 = one BIP, or $100. Not bad for $50 initial margin.
You Risk Is Limited -- Here's How
Unlike stocks or futures, stops on Forex are guaranteed to be filled, even on gaps, and your account cannot go below your initial margin deposit. You can never lose more than you put down, and you will never receive a maintenance call. To show how this works, let's look at the following trade-gone-wrong:
A short in the Swiss Franc at 1.2676 with a stop loss at 1.2710, risking a total of 35 pips. Then the unthinkable happens: a big gaping hole in the chart appears over the weekend. If something like this happened in the equity markets, your stop is meaningless and you would cover at the opening price Monday morning, locking in a huge loss. With FX, your stop is honored, yielding a more manageable 35-pip loss. Note that a stop must be in place to receive this protection!
The Spread
There is no commission on Forex trades, but the transaction does involve paying the spread. The spread is the difference between the BID and ASK, which is usually about 4-5 PIPs, but can vary with market volatility. Large banks are the primary Forex dealers, and they make money on this spread, much like a Nasdaq market maker. If you are going long, you'll take the offer from the dealer, and if you want to go short, you'll hit the dealer's bid..
Why Trade Forex?
There are plenty of good reasons to trade Forex, and if you have experience trading stocks or futures, you have a definite edge over the crowd. Let's take a look at why you should consider this market:
Huge Leverage
Incredibly, you get can 200:1 leverage on Forex pairs. In a mini account, $50 controls a $10,000 position! $500 controls a $100,000 position. This obviously means potentially huge profits. But what about the risk?
Limited Risk
With Forex, your stops are always honored, even on gaps. If you have a position on into the weekend and it gaps against you Sunday night, you will be filled at your stop price -- provided you have a stop in place. Plus, if your account should go to 0.00, your broker will automatically close out trading, so you can't possibly lose more than your margin deposit. If you've ever had a maintenance call from a broker, you'll appreciate this.
24-Hour Trading
If you just can't get enough trading out of your system during regular NYSE trading hours, you'll love the fact the Forex trades 24 hours a day, from the beginning of the Japanese session Sunday evening about 8 PM EST to the end of the US session on Friday at 4:00 or 5:00 PM EST. European bourses open at 3:00 AM EST, and the US session opens at 9:30 AM EST. The slowest periods are between 4:00 PM EST and 8:00 PM EST, between the end of the US session and the beginning of the Asian markets.
No Commissions/Low transaction costs
There's no question but that stock commissions have come down a lot, but with Forex, there is no commission -- your fee is the dealer spread. The spreads are small, usually about 4-5 PIPs. On a mini account, that's $4-$5.
Excellent Liquidity
This is an extremely active market, with $1.5 trillion traded daily in interbank market. Recently it has become wildly popular with traders around the world.
Tremendous Upside Potential -- And Fast
Because of the incredibly high leverage, you have the potential to double your investment quite rapidly -- in hours even. I'll show you a trade shortly to make this point.
Responds Well To Standard Technical Analysis
The Forex market consists of traders like you, all around the world. There is no specialist or market maker to influence and manipulate price, so Forex responds very well to technical analysis. In particular, you'll frequently see reversals at Fibonacci levels -- even more so than with stocks. If you know technical analysis, you have an advantage.
Low Capital Requirements
Many brokers will let you open an account with $2000, and you can even open a mini Forex account for a few hundred dollars. This obviously is substantially less than the $25,000 requirement for daytraders. Mini Forex trades can be put on for as little as $50.
Strong Trends
There's nothing more maddening than a choppy market, but Forex trends very well. If you are able to jump on a trend at the right time, you are more likely to have a longer, more pleasant ride.
No Bull Or Bear Markets
With stocks, 70% of the move is due to the market, so if the market isn't moving, it's harder to find good stocks to trade. Not so with Forex, as the many combinations available mean there is always some currency pair moving.
No Restrictions On Selling Short
Shorting stocks has always been a little tricky, with the uptick rule and now that bullets are gone, life just got tougher. In the Forex market, there are no restrictions on selling short. It's just as easy to short in Forex as it is with the QQQs or E-minis.
A Real Trade
The following is an example of an ongoing, foreign exchange trade put on by one of our own, Todd Gordon. Todd was stalking a long trade in the EUR/USD midday on Monday, Dec. 29, 2003. After the EUR poked its head above the pivotal 1.2500 USD per EUR level, Todd was looking to buy a pullback into support illustrated by the following 4 classic technical studies.
1) 20-period EMA support (blue moving average)
2) 38% Fibonacci Retracement
3) Trendline support (black trendline)
4) Classic Bull flag pattern
Todd initiated a long position in the EUR/USD at 1.2486 with a 25-PIP stop of 1.2461 just on the other side of the 50% retracement level. After the push to new highs, Todd sold one half of the position at 1.2530 for a 44 PIP gain. His stop went to breakeven on the remaining half and as of press time, he was still in the trade with a 61 PIP gain and a stop loss at 1.2525. Again, the beauty in the FX markets is that his stop at 1.2525 is guaranteed, including any gaps that happen over the weekend.
If You Already Trade Stocks Or Futures, You Have An Advantage
As I mentioned earlier, if you're trading stocks or futures now and have a good grasp of technical analysis, especially Fibonacci, you have a leg up on the competition, in my opinion. If you're the type who looks into fundamentals, you'll be exposed to some differences in Forex. In the stock market, you trade stocks and analyze price action and the economic outlook of companies. In the Forex market, you trade currency pairs and analyze price action and the economic outlook of countries.
Brokers
As a trader, you already know how important it is to do business with a good brokerage firm, and it's no different with Forex. Refco, for example, is a large, solid, reputable firm, and there are others. Some things you may want look for are 24-tech support, and reasonable spreads.
I hope you try some Forex trading. It's fast, convenient, and has many advantages over stock/futures trading. We've added CME floor trader Yra Harris to provide you with ongoing commentary in the Forex markets. Plus, if you'd like learn more about how to trade the Forex markets, here's a great course to check out.
Brice Wightman
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