Learn the basic principles of Forex
Know how currencies are traded in Forex. The foreign exchange market is a global platform for exchanging currencies and currency-covered financial instruments (these are contracts for buying and selling foreign exchange at a later date). Participants are everyone from the largest banks and financial institutions to individual investors. Currencies are traded directly with other currencies in the market. This means that currencies are valued against other currencies, such as euros against US dollars or the Japanese yen against the British pound. By actively looking for differences in value and expected price increases or decreases, participants can make profits by trading currencies that are sometimes quite large.
Understand currency rates. In Forex, prices are given in relation to other currencies. This is because there is no measure of the value of one currency to another. But the US dollar is used as the base currency to determine the value of other currencies.
• For example, the value of the euro (EUR) is given as USD / EUR.
• Currency rates are listed with four decimal places.
• Once you know how to do it, currency rates are easy to understand. For example, the yen against the US dollar is shown as 0.0087 JPY / USD. Understand that because “You have to pay $ 0.0087 to buy a Japanese yen.”
Learn what arbitrage is. In short, arbitrage is the exploitation of price differences in the markets. Traders can buy a financial instrument in one market with the hope of selling it for a profit in another. Within Forex, arbitrage is used to turn these differences between currency rates into profit. These differences do not only exist between two currencies, so the trader must use the “triangle arbitrage”, which consists of three different trades, in order to benefit from the exchange rate differences.
For example, imagine that you realize that the following exchange rates: 20.00 USD / MXN, 0.2000 MXN / BRL, and 0.1500 BRL / USD (between the US dollar, the Mexican peso, and the Brazilian real) are. You are wondering if there is an arbitrage opportunity here, so you start with a theoretical value of $ 10,000. With your $ 10,000, you could buy 200,000 pesos (10,000 * 20.00 USD / MXN). With your 200,000 pesos, you could buy 80,000 reals (200,000 * 0.2000 MXN / BRL). Finally, with the 80,000 reals, you could buy $ 12,000 US dollars (80,000 * 0.1500 BRL / USD). If you do these three trades, you will have made a profit of $ 2,000 ($ 12,000 – $ 10,000).
But the reality is that you make very little profits in arbitrage deals, if at all, because profits and price differences are adjusted almost instantly. Lightning fast trading systems and high investments are used to overcome these hurdles.
Trades in forex are traded in lots. A standard lot consists of 100,000 units of a currency, a mini lot consists of 10,000 units and a micro lot corresponds to 1,000 units.
Understand leveraged deals. Traders, even the very good ones, can often only score a few points on arbitrage differences or trading profits. In order to compensate for these low percentage returns, traders have to work with large sums of money. To top up the money they have at their disposal, traders often use leverage that is basically money borrowed. Compared to other types of securities, trades made in Forex can be incredibly large amounts of leverage, with typical trading systems that allow for a 100: 1 profit margin.
This 100: 1 requirement means that you actually only deposit 1 / 100th of what you want to invest in the currency. This security deposit is known as margin and protects you from future losses from currency trading.
Trades that use leverage increase both potential gains and losses, so be careful when making these types of trades.