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PART - III

Leverage

Leverage is the use of borrowed capital to multiply returns. The forex market is characterized by high leverages, and traders often use these leverages to boost their positions.

Example: A trader might put up just $1,000 of their own capital and borrow $9,000 from their broker to bet against the EUR in a trade against the JPY. Since they have used very little of their own capital, the trader stands to make significant profits if the trade goes in the correct direction. The flipside to a high-leverage environment is that downside risks are enhanced and can result in significant losses. In the example above, the trader’s losses will multiply if the trade goes in the opposite direction.

Lot size: Currencies are traded in standard sizes known as lots. There are four common lot sizes: standard, mini, micro, and nano. Standard lot sizes consist of 100,000 units of the currency. Mini lot sizes consist of 10,000 units, and micro lot sizes consist of 1,000 units of the currency. Some brokers also offer nano lot sizes of currencies, worth 100 units of the currency, to traders. The choice of a lot size has a significant effect on the overall trade’s profits or losses. The bigger the lot size, the higher the profits (or losses), and vice versa.

Margin: Margin is the money set aside in an account for a currency trade. Margin money helps assure the broker that the trader will remain solvent and be able to meet monetary obligations, even if the trade does not go their way. The amount of margin depends on the trader and customer balance over a period of time. Margin is used in tandem with leverage (defined above) for trades in forex markets.

Pip: A pip is a “percentage in point” or “price interest point.” It is the minimum price move, equal to four decimal points, made in currency markets. One pip is equal to 0.0001. One hundred pips are equal to 1 cent, and 10,000 pips are equal to $1. The pip value can change depending on the standard lot size offered by a broker. In a standard lot of $100,000, each pip will have a value of $10. Because currency markets use significant leverage for trades, small price moves—defined in pips—can have an outsized effect on the trade.

Spread: A spread is the difference between the bid (sell) price and ask (buy) price for a currency. Forex traders do not charge commissions; they make money through spreads. The size of the spread is influenced by many factors. Some of them are the size of your trade, demand for the currency, and its volatility.

Sniping and hunting: Sniping and hunting is the purchase and sale of currencies near predetermined points to maximize profits. Brokers indulge in this practice, and the only way to catch them is to network with fellow traders and observe for patterns of such activity.

Basic Forex Trading Strategies

The most basic forms of forex trades are a long trade and a short trade. In a long trade, the trader is betting that the currency price will increase in the future and they can profit from it. A short trade consists of a bet that the currency pair’s price will decrease in the future. Traders can also use trading strategies based on technical analysis, such as breakout and moving average, to fine-tune their approach to trading.

Depending on the duration and numbers for trading, trading strategies can be categorized into four further types:

A scalp trade consists of positions held for seconds or minutes at most, and the profit amounts are restricted in terms of the number of pips. Such trades are supposed to be cumulative, meaning that small profits made in each individual trade add up to a tidy amount at the end of a day or time period. They rely on the predictability of price swings and cannot handle much volatility. Therefore, traders tend to restrict such trades to the most liquid pairs and at the busiest times of trading during the day.

Day trades are short-term trades in which positions are held and liquidated in the same day. The duration of a day trade can be hours or minutes. Day traders require technical analysis skills and knowledge of important technical indicators to maximize their profit gains. Just like scalp trades, day trades rely on incremental gains throughout the day for trading.

In a swing trade, the trader holds the position for a period longer than a day; i.e., they may hold the position for days or weeks. Swing trades can be useful during major announcements by governments or times of economic tumult. Since they have a longer time horizon, swing trades do not require constant monitoring of the markets throughout the day. In addition to technical analysis, swing traders should be able to gauge economic and political developments and their impact on currency movement.

In a position trade, the trader holds the currency for a long period of time, lasting for as long as months or even years. This type of trade requires more fundamental analysis skills because it provides a reasoned basis for the trade.

Charts Used in Forex Trading

Three types of charts are used in forex trading. They are:

Line Charts

Line charts are used to identify big-picture trends for a currency. They are the most basic and common type of chart used by forex traders. They display the closing trading price for the currency for the time periods specified by the user. The trend lines identified in a line chart can be used to devise trading strategies. For example, you can use the information contained in a trend line to identify breakouts or a change in trend for rising or declining prices.

While it can be useful, a line chart is generally used as a starting point for further trading analysis.

Bar Charts

Much like other instances in which they are used, bar charts are used to represent specific time periods for trading. They provide more price information than line charts. Each bar chart represents one day of trading and contains the opening price, highest price, lowest price, and closing price (OHLC) for a trade. A dash on the left is the day’s opening price, and a similar dash on the right represents the closing price. Colors are sometimes used to indicate price movement, with green or white used for periods of rising prices and red or black for a period during which prices declined.

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