The Currency Trading Market is the largest and most liquid market in the world with trading volumes reaching $4 trillion per day ( BIS). Currency Trading is an over-the-counter market, where currency trades are conducted directly without the use of a clearing house or central exchange. The huge increase in Currency trading, is due to the introduction of retail trading platforms like MetaTrader which have made it easier and cost efficient for retail Currency traders to trade online.
Currency trading has lately become the most popular market for speculators. The liquidity and the tendency for strong trends in currency pairs formulate a very exciting currency trading environment. It would seem that these characteristics facilitate currency traders to have extraordinary trading success. Nonetheless, currency trading success has been limited for most currency traders. Here is why.
Most currency traders open accounts with unrealistic expectations while they lack both the discipline and the know-how required for successful trading. Currency trading is not a recreational sport and is not the course for fast wealth. Currency trading appears to be much more glamorous than traditional markets like equities, futures, etc. but the rules of finance apply to all currency trading instruments. Research demonstrates that currency traders lack discipline and are continually suffering from inconsistent currency trading performance and large capital losses. Currency trading is not easy and even experienced currency traders frequently sustain trading losses. New currency traders must realize that currency trading takes time to become a skill and there is no fast route towards this goal.
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The most alluring aspect of currency trading is leverage. Leverage seems very attractive to those who are expecting to turn undersized account capitalization into a fortune in a very short time frame. Keep in mind that leverage is a double-edged sword. A currency trader can easily trade one lot (€100,000 of any currency) with a minimum margin deposit of €2,000 by simply using a leverage of 1:50.
For many currency traders this implies that with a €10,000 account capitalization they should easily be able to trade 5 lots. This is sadly a common misconception amongst inexperienced currency traders. One lot is a €100,000 and should be treated as a €100,000 investment and not as €2,000 put up as margin. Many currency traders study technical analysis and learn to analyze the charts correctly while placing sensible trades, yet they have a tendency to over-leverage and thus end up forced to stop-loss a position.
If a currency trader has an account capitalization of €10,000 and he places a trade for 1 lot, he is in effect, leveraging himself 10 to 1, which is a considerable leverage. Professional currency traders are not authorized to leverage this high and this is because currency trading should be done incrementally in order to tolerate several losing trades without experiencing huge monetary losses. Most common currencies traded in the currency market
In the most part global retail currency trading is taking place within the seven most liquid currency pairs which are the four majors:
- EUR/USD (euro/dollar)
- USD/JPY (dollar/Japanese yen)
- GBP/USD (British pound/dollar)
- USD/CHF (dollar/Swiss franc)
Plus the three commodity pairs:
- AUD/USD (Australian dollar/dollar)
- USD/CAD (dollar/Canadian dollar)
- NZD/USD (New Zealand dollar/dollar)
These currency pairs, along with a mixture of other combinations such as EUR-JPY, GBP-JPY and EUR-GBP), account for more than 95% of all speculative currency trading. There is a much larger number of currency trading instruments but only 18 pairs and crosses are actively traded. In effect, Currency trading is way too concentrated than the stock market.
Currency Trading Expressions
Since currency pair prices constantly fluctuate up or down these currency movements are measured in “PIP's”. A Pip is generally the fourth decimal place in an exchange rate. For example, if EURUSD is currently trading at 1.2980 and then the exchange rate changes to 1.2990, the pair rose by 10 Pips. If EUR/USD depreciated from 1.2922 to 1.2921, then the pair dropped by 1 Pip which is 0.0001 of a unit.
A Long position means you buy, a Short position indicates selling, an Open position refers to creating a new trade and a Close position means to close an open position. However, there are currency pairs like USDJPY (98.45) where the Pip is the second decimal place.
A Lot represents 100,000 units of the base currency. If, for instance, a client is Long 5 Lots EURUSD it means that he/she has purchased 500,000 EUR in exchange for USD. The Spread is the difference between the price you can buy a currency pair, “the Ask price”, and the price at which you can sell a currency pair, “the Bid price”. The Ask price is always higher than the Bid but Spreads are minimal for the most actively traded pairs like EUR/USD, GBP/USD, USD/JPY, usually 3-5 Pips.
Fundamental and Technical Currency Trading Factors
There are arrays of factors that determine how much a currency is worth. These include actual monetary flows (imports, exports) caused by changes in GDP, inflation, unemployment, interest rates, budget and trade deficits or surpluses. All these macroeconomic conditions affect the value of a currency because they regulate the demand and supply of the particular currency. If, for example, you have high inflation the demand for the particular currency will drop as its purchasing power is eroded.
Leverage
- The main reason why many people are attracted to FOREX is the liquidity of the market which allows more significant leverage than other financial instruments.
- Currency movements are measured in PIPS and could be the 2nd or 4th decimal place depending on the pair.
- These movements are just fractions of a cent e.g. if GBP/USD moves 100 PIPS that is just a $0.01 move.
- For this reason the leverage is applied in order to magnify these minute changes and translate them into decent profits.
- When dealing with amounts such as $100,000 small changes can result in significant profit or loss.
- Therefore leverage is subject to your trading style and money management preferences.
- However leverage has the potential to enlarge your profits or losses equally. The greater the leverage the higher the risk you obtain.
- 100 PIP loss chart with USD being the counter currency.
| |
| Conditions |
Trader A
|
Trader B
|
| Trading Capital |
$10,000
|
$10,000
|
| Real Leverage Used |
100 times
|
20 times
|
| Total Value of Transaction |
$1,000,000
|
$200,000
|
| In the case of a 100-PIP Loss |
- $10,000
|
- $2,000
|
| % Loss of Trading Capital |
100%
|
20%
|
| % of Trading Capital Remaining |
0%
|
80%
|
| |
- With a small leverage you can afford to give your trade breathing space.
- A high leverage can quickly wipe-out your account if it goes against you.
- Leverage is flexible and customizable. Trading profitably is not about making millions by the end of the month or year. Be patient and methodical.
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