►Forex

2. Trading Fundamentals

The following Forex FAQ section contains fundamentals about trading on foreign exchange markets.

2.1. What is Margin?

Margin is a performance bond, or good faith deposit, to ensure against trading losses. The margin requirement allows you to hold a position much larger than your actual account value. Most forex brokers' online trading platforms perform automatic pre-trade checks for margin availability, and will only execute the trade if you have sufficient margin funds in your account. These systems also calculate the funds needed for current positions and displays this information to you in real time. In the event that funds in your account fall below margin requirements, some or all of your open positions will be closed. This prevents your account from ever falling below the available equity even in a highly volatile, fast moving market.

2.2. What does it mean have a "long" or "short" position?

A long position is simply one in which a trader buys a currency at one price and aims to sell it later at a higher price. In this scenario, the investor benefits from a rising market. A short position is one in which the trader sells a currency in anticipation that it will depreciate. In this scenario, the investor benefits from a declining market. However, it is important to remember that every forex position requires an investor to go long in one currency and short the other.

2.3. What is the difference between an "intraday" and "overnight position"?

Intraday positions are all positions opened and closed before 17:00 Eastern Time (the end of the international trading day). Overnight positions are positions that are held through 17:00 Eastern Time.

2.4. How are currency prices determined?

Currency prices are affected by a variety of economic and political conditions, but probably the most important are interest rates, inflation and political stability. Sometimes governments actually participate in the forex market to influence the value of their currencies, either by flooding the market with their domestic currency in an attempt to lower the price, or conversely buying in order to raise the price. This is known as Central Bank intervention. Any of these factors, as well as large market orders, can cause high volatility in currency prices. However, the size and volume of the forex market makes it impossible for any one entity to "drive" the market for any length of time.

2.5. How does the Margin Call work?

If the equity balance in your account falls below the margin requirement, a margin call will be generated. In the event that an account exceeds its maximum allowable leverage, some or all open positions will be liquidated immediately.

3. Strategies and Techniques

The following Forex FAQ section contains information on different forex strategies and techniques.

3.1. How do I manage risk?

The limit order and the stop loss order are the most common risk management tools in forex trading. A limit order places restriction on the maximum price to be paid or the minimum price to be received. A stop loss order ensures a particular position is automatically liquidated at a predetermined price in order to limit potential losses should the market move against an investor's position. The liquidity of the forex market ensures that limit order and stop loss orders can be easily executed.

3.2. What kind of trading strategy should I use?

Currency traders make decisions using both technical factors and economic fundamentals. Technical traders use charts, trend lines, support and resistance levels, and numerous patterns and mathematical analyses to identify trading opportunities, whereas fundamentalists predict price movements by interpreting a wide variety of economic information, including news, government-issued indicators and reports, and even rumors. The most dramatic price movements, however, occur when unexpected events happen. The event can range from a Central Bank raising domestic interest rates to the outcome of a political election or even an act of war. Nonetheless, more often it is the expectation of an event that drives the market rather than the event itself.

3.3. How long are positions maintained?

As a general rule, a position is kept open until one of the following occurs: 1) realization of sufficient profits from a position; 2) the specified stop-loss is triggered; 3) another position that has a better potential

appears and you need these funds.

Specific and fact Information

If you want to trade forex you simply have to know what margin requirement is, how margin call occurs and what does it affect. You also need to know why your forex broker will charge you interest or premium. While you chat with traders they will often use slang to express their thoughts in a shorter form: "what is going on with kiwi this morning?". Please see below explanation to read more about the trading specifics and the language used in the forex world.

Trading Terminology

Traders often chat with one another about a variety of topics related to the forex market, giving their perspectives and discussing trading ideas and current moves on the market. While communicating with each other they often use slang to express their thoughts in a shorter form. You can read about the slang and other trading terminology in these pages.

EUR/USD: Euro / US Dollar is often called Euro;

USD/JPY: US Dollar / Japanese Yen is often called Dollar Yen;

GBP/USD: British Pound / US Dollar is often called Cable;

USD/CHF: US Dollar / Swiss Franc is often called Dollar Swiss, or Swissy;

USD/CAD: US Dollar / Canadian Dollar is often called Dollar Canada, or C-Dollar;

AUD/USD: Australian Dollar / US Dollar is often called Aussie Dollar;

EUR/GBP: Euro / British Pound is often called Euro Sterling;

EUR/JPY: Euro / Japanese Yen is often called Euro Yen;

EUR/CHF: Euro / Swiss Franc is often called Euro Swiss;

GBP/CHF: British Pound / Swiss Franc is often called Sterling Swiss;

GBP/JPY: British Pound / Japanese Yen is often called Sterling Yen;

CHF/JPY: Swiss Franc / Japanese Yen is often called Swiss Yen;

NZD/USD: New Zealand Dollar / US Dollar is often called New Zealand Dollar or Kiwi;

Margin Requirements

As you know, the margin deposit is not a down payment on a purchase. Rather, the margin is a performance bond, or good faith deposit, to ensure against trading losses. The margin requirement allows you to hold a position much larger than your actual account value. Forex online trading platforms have margin management capabilities that allow you to get as much as four times the leverage of a typical futures contract. The trading platforms often perform automatic pre-trade checks for margin availability, and will execute the trade only if you have sufficient margin funds in your account. These systems also calculate the funds needed for current positions and display this information to you in real time.

For example, a broker might require only $1,000 in the trader's account in order to trade a 100,000 EUR/USD currency position. The $1,000 is referred to as "margin". This amount is essentially collateral to cover any losses that you might incur. Since nothing is actually being purchased or sold for delivery, the only requirement, and indeed the only real purpose for having funds in your account, is for sufficient margin.

Margin should reflect some rational assessment of potential risk in a position. For example, if a currency is very volatile, a higher margin requirement would normally be justified.

In the event that funds in your account fall below margin requirements, most forex platforms will automatically close one or more open positions. This prevents your account from ever falling below the available equity even in a highly volatile, fast moving market.

Overnight Interest

Every currency and commodity has a "cost of carry" associated with holding the position for more than one day. It is called "overnight interest" or "premium". In currencies, this cost is a function of the "interest rate differential" of the two currencies that comprise the exchange rate.

For example, in USD/JPY, the interest rate differential is the difference between short-term U.S. interest rates and short-term Japanese interest rates. If, for example, U.S. interest rates are 5.0% and Japanese interest rates are 1.0%, the interest rate differential is 4.0% (5.0% - 1.0%). This means that if a trader was to sell USD/JPY, he would have to pay 4.0% of the notional amount of the contract per year to hold the position. If position quantity is 100,000, the trader would have to pay approximately $4,000 to hold the position for one year. This translates to approximately $11.00 per day for holding the USD/JPY position ($4,000 / 365).

  CONTROLLING RISK

Controlling risk is one of the most important ingredients of successful trading. While it is emotionally more appealing to focus on the upside of trading, every trader should know precisely how much he is willing to lose on each trade before cutting losses, and how much he is willing to lose in his account before ceasing trading and re-evaluating.

Risk will essentially be controlled in two ways: 1) by exiting losing trades before losses exceed your pre-determined maximum tolerance (or "cutting losses"), and 2) by limiting the "leverage" or position size you trade for a given account size.

Cutting Losses

Too often, the beginning trader will be overly concerned about incurring losing trades. He therefore lets losses mount, with the "hope" that the market will turn around and the loss will turn into a gain.

Almost all successful trading strategies include a disciplined procedure for cutting losses. When a trader is down on a position, many emotions often come into play, making it difficult to cut losses at the right level. The best practice is to decide where losses will be cut before a trade is even initiated. This will assure the trader of the maximum amount he can expect to lose on the trade.

The other key element of risk control is overall account risk. In other words, a trader should know before he begins his trading endeavor how much of his account he is willing to lose before ceasing trading and re-evaluating his strategy. If you open an account with $2,000, are you willing to lose all $2,000? $1,000? As with risk control on individual trades, the most important discipline is to decide on a level and stick with it. Further information on the mechanics of limiting risk can be found in the foreign currency trading literature.

Determining Position Size

Before beginning any trading program, an assessment should be made of the maximum account loss that is likely to occur over time, per your standard trading quantity. For example, assume you have determined that your worse case loss on your standard trade (quantity of 100,000) is 30 pips. That translates into approximately USD 300 per 100,000 EUR/USD position size. Five consecutive 100,000 EUR/USD losing trades would result in a loss of USD 1,500 (5 x USD 300); a difficult period but not to be unexpected over the long run. For a $10,000 account trading 100,000 EUR/USD, this translates into 15% loss. Therefore, even though it may be possible to trade 5 such positions or more with a $10,000 account, this analysis suggests that the resulting "drawdown" would be too great (75% or more of the account value would be wiped out).

Any trader should have a sense of this maximum loss per their standard trading quantity, and then determine the amount he wishes to trade for a given account size that will yield tolerable drawdowns.

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