Table of Contents
Chapter 1: What is Forex Trading
Chapter 2: History of Money and Origins of Forex Trading
Chapter 3: Forex Trading Terminology
Chapter 4: Important Aspects of Forex Trading
Chapter 5: Players in The Forex Market
Chapter 6: Factors that Affect the Forex Market
Chapter 7: Risks Involved With Trading Forex
Chapter 8: Why Trade in the Forex Market
Chapter 9: How Forex Trading Works
Chapter 10: How to be a Successful Forex Trader
Chapter 9: How Forex Trading Works
Now that you have an understanding of the way forex trades work and the risks inherent in them, you can start making small trades. The trade is carried out electronically and happens in real time. So, it is critical for you to plan out your strategy and analyze all your actions before you actually execute a trade.
For trading in forex currencies, you need a margin account with a broker. There are a lot of online brokers in the market and you will need to consider several factors before you select one of them:
- Spreads – Brokers make their profits from the difference between sale and purchase price, or the spread. Different brokers have different spreads. Finding the broker with the smallest difference between bid and ask price gives you the best possible gains. Online comparison tools are an invaluable help in comparing spreads of different brokers.
- Margin – The margin required by the broker, or the leverage that you will get, is also an important point to consider when selecting your broker. A high leverage is an opportunity for higher gains but also puts your investment at a higher risk. Assess your risk appetite and investment goals to find the combination that suits you best.
- Access and Reliability – You must be able to access your broker and the trading platform 24 hours a day so that you can trade whenever you want to. A breakdown in the trading platform can cut you off from the market at a crucial time leaving you with no means of closing an unfavorable position to curb losses or add to a winning position to magnify gains.
A reliable broker will have the system back online in the shortest possible time. Make sure you sign up with a broker with a 24 hour service so that you can bring such problems to his notice immediately. Many brokers take orders over telephone if the electronic system fails for some reason. Opt for a broker with such a back up trading channel so that you can trade uninterrupted.
- Trustworthiness – As forex trades are based largely on trust, it is critical for you to find a broker who can be trusted to fulfill his end of the deal. Arbitration is a lengthy and long winded process and can prove very costly if the verdict goes against you. So it is best to check the credentials of the broker before you sign up with him. Make sure he is a registered member of the CFTC and NFA.
- Research Tools – Many brokers also give customers access to research tools and online analyses. These resources are a great help in determining market trends. A broker who gives accurate and reliable tools like these is a great ally in forex trading.
Forex margin accounts come in many types. A mini account has a low minimum margin and offers high leverage. A standard account needs a higher minimum capital but lets you make bigger trades. Premium accounts are fancy accounts with many add-ons, but they need a larger amount of initial funds and let you determine the leverage you need for different transactions.
Choose from one of these accounts and make sure your broker tells you exactly what it will cost in terms of initial margin, maintenance and leverage to maintain the account.
To open an account, you will need some proof of identification along with a form that needs to be filled in. The broker will also give you a margin agreement for your forex account. This agreement contains the margin requirements which apply on the account, the leverage and other terms and conditions which are to be followed during trading. The leverage offered on your account may range from 50:1 to 200:1. Typically, brokers offer a 100:1 leverage meaning you need $1,000 to conduct a $100,000 trade.
You will also find certain provisions in the agreements which allow the broker to interfere in transactions that may end in huge losses. Remember that your forex trade will mostly use the money borrowed from the broker. He will, therefore, have some safety mechanisms in place to curtail his losses if your trading strategy fails.
Once you give your written consent in these forms, you can deposit the necessary funds into your account and begin trading.
Forex trading requires constant attention and regular tracking of the markets. The markets are active 24 hours a day and this makes it very difficult to manage your positions. This is where a standing order comes in handy. These are instructions given to your broker which will be executed by the trading software automatically when a predetermined condition is met. Check the kind of orders your broker accepts before you sign up with one.
For a beginner forex trader, it is enough to understand the three main order types – market order, limit order and stop loss order.
- Market Order – The market order is simply a ‘buy’ or ‘sell’ instruction given to the broker. A market order executed through the electronic trading platform lets you purchase or sell currency at the current market price. Remember that all forex trades happen in real time so what you see is what you get with respect to the price.
- Limit Order – A limit order sets the limits at which you want the broker to buy or sell a currency. This order makes it easy for you to keep your position on the currency pair in line with your investment strategy even when you are not actively trading. Simply set the target price for your buy or sell and intimate your broker about your limit order. The system will execute the deal when the target price is reached.
- Stop Loss Order – This order is, by far, the most important and most valuable of all the tools you have. A stop loss is the price at which a position is automatically closed to prevent further losses. A trader may set a stop loss at a price slightly below his purchase price in a long transaction. If the price drops instead of rising, his long position is closed automatically when the price touches the stop loss level.
A stop loss order lets you restrict your losses when the trade goes against you. You should set your stop loss level depending to your risk appetite and your capacity to absorb losses. Every forex investor sets a stop loss order when he enters a trade.
This order is in force unless you cancel it or you close the trade. A smart investor knows how to set stop loss correctly so that he allows enough time for the currency to regain ground while protecting himself from a situation where prices go into a nosedive.
Next Chapter: How to be a Successful Forex Trader