Big currency fluctuations mean forex traders are making money right now. Should you join their ranks?
A growing number of online forex platforms makes it easy to start trading currencies but what do you need to know before you start?
Forex has some definite advantages over trading shares, for example, starting with the fact markets are open 24-hours a day. You can put on and take off positions at any time of the day or night. This gives you time available to trade on your own time, outside of your 9-5 job, for example.
Trading costs are low. Most forex brokers don’t charge commission. They make their money out of the bid/spread offer (explained below) but those spreads can be quite small as more brokers are competing for business.
You don’t need much money to open an account with some brokers. eToro, for example, allows you to open an account and start trading with as little as $50.
There are multiple ways to get into forex trading including the traditional spot market, but you can also consider CFDs and ETFs
Finally, you can make money from taking long or short positions whereas there are restrictions to how you can short sell on share markets.
Of course, there are disadvantages you need to consider. The lack of a centralised exchange like the ASX makes some investors wary of forex trading as there is not central regulatory mechanism. It is complex with many factors from unemployment to the price of crude oil impacting on the value of different currencies at different times. It requires time to build up your skills and knowledge as a trader.
What is it?
Foreign exchange (forex) involves trading currencies to make a profit or loss from fluctuations in their exchange value.
For example, you’re selling Aussie beef to the UK and you’re paid in GBP, but you need AUD to pay your workers, the government and live in Australia. To do that you would need someone who wants to buy your GBP by selling you AUD.
Normally your bank does this for you, but if you imagine not using a bank, you have thousands of individuals and companies trading currencies via computer networks. This makes the forex market a 24-hour over-the-counter market, there is no central marketplace to exchange currencies, like the ASX for shares.
However the daily fluctuations in exchange values are generally very small, moving less than one cent per day. While this makes foreign exchange one of the least volatile markets available it is also difficult to make a decent profit with small amounts of cash.
So speculators use huge leverage to increase the value of potential movements. The leverage a broker provides varies, some will have different accounts with varying maximum leverage ratios.
The leverage available for some accounts can be as high as 1:500, which means you can trade with $500,000 of the broker’s money by providing $1000 of your own.
While this can provide you with enormous profits it can also substantially increase your losses. Thus it is important to remember to only trade as much as you are prepared to lose.
How to read a trade
A currency is quoted in relation to another currency. e.g AUD/USD = 1.00760 which means $1 AUD will buy $1.00760 USD. The currency on the left is called the base currency and the right is called the quoted or counter currency.
Brokers will offer a bid price (buy) and ask price (sell) for currency pairs. When buying a currency pair the ask price is the quoted currency and is the amount needed to buy one unit of the base currency. This is taking a long position or ‘going long’.
The bid price is used when selling a currency pair and reflects how much of the quoted currency will be obtained for selling 1 unit of the base currency. This is taking a short position or ‘going short’.
The difference between the buy and sell price is called the spread and is how brokers make their profit regardless of movements in exchange value. For example, a brokerage will show the AUD/USD pair as AUD/USD = 1.0071/80 which shows the bid price at 1.0071 and ask price 1.0080, a spread of 9 points (or pips).
So if you were to buy the base currency (AUD) you would need 1.0080 USD. If you were to sell the base currency you would receive 1.0071 USD. This means for you to just break even you need the exchange value of the currencies to move 9 points in your direction.
Most brokers will offer variable spreads, meaning they will change the size of the spread at their discretion but base it on the movements of the exchange value at the time.
This is also how brokers market their firm: by offering smaller minimum spreads you have a greater chance of making a profit with small movements in exchange value.
The other important attribute to consider when looking at different brokers is the minimum margin requirement. The margin is the amount you need to deposit to open a position. The broker keeps this as security.
If the market moves against your position and you have less than this margin in your account or can’t deposit additional funds, the broker may attempt to sell your position at lower value to minimise the loss and bill you for the additional funds.
Brokers generally offer a 0.5% margin requirement, which can be a substantial amount when trading with large quantities.
For example: If you buy $100,000 AUD (by selling $100,800 USD) and the margin requirement is 0.5% you need a minimum of $500 to open that position ($100,000 x 0.5% = $500). If the market then moved against you, the value of the AUD dropped 10 points to 1.0070, you would need to deposit an additional $500 to keep that trade open.
How to get started
The best place to start is with a practice account. Most forex trading platforms allow you to set up a practice account before you actually make any live trades.
It’s never been easier for small investors to start trading forex and CFDs. All you need to do is open an account with one of a growing number of online trading platforms and off you go.
More and more traders are using social networks such as facebook and twitter to connect with like-minded investors, share information and learn from their successes and failures. You can follow successful traders online and learn from their successes and failures.
- By Orion Mitchell
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