img

ForEx Trading Explained Simply

Share:

First time I saw Fx abbreviation I immediately thought of Brian Brown and F/X, movie popular when I was young. Your first association with term Fx would probably be FX TV Shows Network featuring vastly popular “American Horror Story” and “Louie”.

While both associations are correct, Fx abbreviation is mostly used in two cases:

  • For “effects”, as in “movie special effects”
  • Fx meaning “ForEx”, short for “Foreign Exchange Market”

Fx abbreviation for ForEx is the one I will be using through this site. As said before, I will not be bothering you with origin of money or currency exchange history as there are many good resources for these around the web. I will be jumping straight for the meat of Fx trading and getting through the Fx trading basics as fast as possible. With this out of the way lets see what ForEx trading really is.

What Is Fx Trading All About?

simple forex explanation

Simply put, on ForEx market traders exchange one currency for another and speculate about currency pair’s exchange rate going one way or another. If you are right in your speculation you will earn profit, otherwise you will lose money.

For example, you have done your Fx Technical Analysis, you have checked the economic news calendar. Based on these you think that exchange rate for EUR/USD currency pair will rise in the next period. In this case you open long position and if you were right and exchange rate for EUR/USD currency pair rises, you will earn certain amount of money.

Fx Currency Pair Explained

In EUR/USD currency pair EUR is Base Currency and USD is Quote Currency. Exchange rate simply shows how many Quote Currency units you can buy with one unit of Base Currency.

Spread in Fx Market

Every Currency Rate has two rates, lower, called Buy Price or Bid price, and higher, called currency pair Sell or Ask Price. Difference between these two is called The Spread.

pip and spread in forex simply explained picture

For example, in our EUR/USD currency pair (also called simply Euro), Buy price is 1.1414 and Sell or Ask Price is 1.1415. In this currency pair case the spread is 1 PIP.

What is Pip in Fx Trading?

Pip is short for “price interest point” and it is used to show us change in currency pair exchange rate. It is fourth
decimal digit of the exchange rate (except with Japanese Yen currency pairs, where pip is second decimal digit).

pip calculated forex explained picture

Your profit and loss in Fx trading will be shown and calculated in Pips.

How Much is 1 Pip in Fx Trading?

If you had successful trade and you ended up winning 50 pips, how much money would have you made?

This will depend on the volume you have chosen when you entered the market. The volume is expressed in lots. Every time when you are about to open the position and enter the Fx currency market you will have to choose the volume (size and number of lots) of your Fx Market Order.

How to Choose Volume in Fx Market

Although there is Standard Size Lot of $100K, you can decide to use bigger lot size ($1 million) or smaller lot size ($10K). Which lot size should you use?

This depends on couple of things:

  • How much you expect exchange rate to move in pips
  • Amount of money you are willing to risk
  • How much profit you want to make

Simply, if you enter the market with volume of 1 Standard Lot, or $100.000, and put your take profit at some point, it will show, for example, profit of $100.

If you entered the market with bigger volume, or $1 million, your take profit would be showing $1000 profit.

Bottom line, you will decide on volume depending on how many pips you are expecting to win.

In our EUR/USD example, again, you have done your Technical and Fundamental Analysis, and based on these you expect the currency exchange rate for EUR/USD to rise for 70 Pips. Being the smart and conservative trader you are, you decide to put your take profit at 60 Pips. Now you have to decide on volume to enter the market long.

  • If you decide to enter the market with $10K volume your profit per Pip (with spread we used above) would have been $1. Your overall profit from this trade would be $60.
  • If you decide to enter the market with Standard Lot, or $100K volume, your profit per Pip would have been $10. Your overall profit from this trade would be $600.

What you are probably asking yourself now is how do you enter the market with $100K when you have only $1000 in your Fx account balance? This is where Leverage comes in play.

Leverage in Fx Trading

Every Fx Broker will offer you their own leverage levels. You saw in previous example that with $10K invested you will win about $1 per pip. Without leverage it would take very long to make money with balance smaller than $100K. This is why Fx brokers are offering leverage, giving you control over lot bigger amount of money than your initial deposit.

forex explained simply

Simply put, if you have $1000 ForEx account balance, with leverage 1:100 you are in control not of $1000 but $100.000. You calculate your profits and your losses from trading with $100.000.

Word of caution: Leverage will give you high profits, but be careful, you calculate your losses with leverage too.

This puts you side to side with banks, concerns and other big boys playing on the market. As this market is so huge and it can not be manipulated in any way it is all up to you and your dedication to make it in ForEx trading.

When offering you leverage Fx brokers had also to protect themselves.

Margin and Free Margin in ForEx Trading

With Leverage Fx brokers also introduce Margin.

Margin is being calculated as amount in position you have open divided by leverage.

For example, let’s say your Leverage is 1:100 and you have $100K open position. In this case your Margin will be 1000. If  you open one more standard $100K position your margin will be increased for another 1000.

Every Fx broker will offer you certain amount of Free Margin you can use. Free Margin in Fx trading is calculated as Equity minus used margin.

Equity in ForEx is calculated as your balance plus/minus your realized profits and losses.

Fx brokers will calculate your margin level in percents and when it reaches 100% they will not let you open any more
positions.

ForEx Stop Out Level

Stop Out Level In Fx trading is the point at which your broker will start closing your open positions with a loss in order to protect them self. It is usually around 30%. When Margin Level reaches 30% your broker will stop you out. How to protect yourself from Stop Out when trading ForEx? Simply, by doing proper Risk Management and lot of practice.

Now with all this explained you should know what is ForEx trading and how it works. It is not complicated as it might seem at first sight. You just need to focus and practice. As with every article on the website, you can download Forex trading basics explained simply in PDF. Print these PDFs and refer back to them whenever you need.

 

Share:
It is main inner container footer text
error: