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FX trading may seem daunting, but let us simplify it for you as much as possible and explain why over USD5 trillion flows through the market daily.
In order to trade forex, you have to trade two individual currencies against each other (for example EUR/USD – the euro vs US dollar). In this pairing, EUR is known as the base currency, and USD as the quote currency.
You would speculate on whether the base currency will strengthen (appreciate) or weaken (depreciate) against the quote currency. If you think the base currency will appreciate, then you should go long (buy), and if you think the base currency will depreciate, you should go short (sell).
After choosing whether to go long or short, the currencies will fluctuate based on multiple factors until you decide to close the position. This will determine the profit or loss you make on the trade.
There’s a number of reasons why forex pairs move so much (this movement is known in the industry as volatility). Here’s a few volatility-causing factors you should be aware of when forex trading:
Large financial news events such as budgets and interest and unemployment rate announcements can significantly increase volatility in the markets. It can be more apprent in the local currencies where the announcement is being made.
The welfare of a country or nation can have a major impact on the performance of a currency. If a country is struggling economically, it’s extremely likely its associated currency will be too.
As horrible as they are, natural disasters can affect a currency’s wellbeing as well as people’s lives. Should an earthquake or tsunami occur, expect some sort of volatility to be generated in the currency associated with that region.
Now we know how to trade forex and what affects the markets, let’s look at a couple of example trades to see exactly how it works.
The current monetary policy is in favour of a strong dollar and we anticipate a bearish move on the AUD/USD.
We decide to go short 1 lot (100,000 units) of AUD/USD at a price of 0.73700. The margin required to open the position will be (using 400:1 leverage):
100,000 x 0.73700 / 400 = 184.25 USD
After some time the market moves in our direction, and is now trading at 0.73200.
We decide to take our profits and close the position.
The profit made on this position will be:
0.73700 - 0.73200 = 50 pips.
1 lot = 10 USD per pip.
Therefore, the total profit we made is 50 x 10 = 500 USD.
After a positive news update on UK employment, we anticipate a rise in the price of GBP/USD (also known as 'cable').
We decide to go long 2 lots of GBP/USD at 1.4030. The margin required to open the position will be (using 400:1 leverage):
200,000 x 1.4030 / 400 = 701.50 USD
Straight after we enter the position the market pushes against us and is now trading at 1.3985.
We decide to close the position at a loss. The amount we lost is: 1.4030 - 1.3985 = 45 pips.
2 lots = 20 USD per pip.
Therefore, the total loss for this trade is 45 x 20 = 900 USD.
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