Forex trading entails attempting to forecast which currency will gain or fall in value relative to another.
When should you purchase or sell a currency pair?
In the following cases, we will utilize fundamental analysis to determine whether to buy or sell a specific currency pair. The supply and demand for a currency fluctuate to a variety of economic factors, causing currency exchange rates to rise and fall. Each currency is associated with a certain country (or region). As a result, forex fundamental analysis focuses on the general status of the country’s economy, such as productivity, employment, manufacturing, international commerce, and interest rate movements.
The euro is the base currency in this example, and hence the “basis” for the buy/sell.
If you think the US economy will continue to deteriorate, which is terrible for the US currency, you would place a BUY EUR/USD order. You have purchased euros with the idea that they will appreciate in value against the US dollar.
If you feel the US economy is robust and that the euro would fall in value versus the US dollar, you would place a SELL EUR/USD order. You have sold euros with the anticipation that they will decline against the US dollar.
The US dollar is the base currency in this case, and thus the “basis” for the buy/sell.
If you believe the Japanese government would lower the yen to benefit its export economy, you would place a BUY USD/JPY order. You have purchased US dollars with the hope that they will appreciate in value against the Japanese yen.
If you believe that Japanese investors are withdrawing funds from US financial markets and changing all US dollars back to yen, which will harm the US dollar, you would place a SELL USD/JPY order. You have sold US dollars with the anticipation that they will fall in value versus the Japanese yen.
The pound is the base currency in this example, and hence the “basis” for the buy/sell. If you believe the British economy would continue to outperform the US economy in terms of economic growth, you would place a BUY GBP/USD order. You have purchased pounds with the idea that they will appreciate in value against the US dollar.
If, like Chuck Norris, you believe the British economy is faltering but the American economy is strong, you would place a SELL GBP/USD order.
You sold pounds with the idea that they would fall in value versus the US dollar.
How to Trade Forex with USD/CHF
The US dollar is the base currency in this case, and thus the “basis” for the buy/sell. If you believe the Swiss currency is overvalued, place a BUY USD/CHF order. You have purchased US dollars on the expectation that they will appreciate against the Swiss franc.
If you believe that the weakening of the US housing market will harm future economic growth, which will weaken the currency, you would place a SELL USD/CHF trade. You have sold US dollars on the belief that they will devalue against the Swiss franc.
Trading in "Lots"
When you go to the supermarket to buy an egg, you can’t just buy one; they come in dozens or “lots” of 12.
It would be equally dumb to purchase or sell 1 euro in forex, thus they normally come in “lots” of 1,000 units of currency (micro lot), 10,000 units (mini lot), or 100,000 units (standard lot), depending on your broker and account type (more on “lots” below).
“But I don’t have the funds to buy 10,000 euros!” “Can I continue to trade?”
You certainly can! By utilizing leverage.
You wouldn’t have to pay the 10,000 euros up front if you traded using leverage. Instead, you would make a tiny “deposit,” known as margin.
The ratio of transaction size (“position size”) to actual cash (“trading capital”) utilized for margin is known as leverage.
For example, 50:1 leverage, often known as a 2% margin requirement, means that $2,000 of margin is required to establish a $100,000 position. Margin trading allows you to open significant positions with a fraction of the capital ordinarily required. This is how you can open positions for $1,250 or $50,000 with as little as $25 or $1,000.
With a minimal amount of starting capital, you can perform relatively big trades.
- You feel that market signs indicate that the British pound will rise versus the US dollar.
- You open one ordinary lot (100,000 units GBP/USD), buying using the British pound and requiring a 2% margin.
- You sit back and wait for the exchange rate to rise.
- When you purchase one lot (100,000 units) of GBP/USD at 1.50000, you are purchasing 100,000 pounds, which is worth $150,000 (100,000 units of GBP * 1.50000).
- Because the margin requirement was 2%, you would need to set aside US$3,000 in your account to open the deal ($150,000 * 2%).
- With just $3,000, you can suddenly command 100,000 pounds.
- Your forecast comes true, and you decide to sell. You close the trade at 1.50500. You make around $500.
When you want to close a position, the initial deposit (“margin”) is returned to you, and your gains or losses are calculated. This profit or loss is subsequently sent to your account. A tiny margin deposit might result in significant losses as well as gains.
This also implies that a very modest change might result in a proportionately much larger shift in the extent of any loss or profit, which can work both for and against you.
You might have easily LOST $500 in the same twenty minutes.
High leverage sounds fantastic, but it can be dangerous. When trading on margin, keep in mind that your risk is based on the whole amount of your position size. If you don’t understand how margin works, you can quickly blow your account. We want you to AVOID doing this.
There is a daily “rollover fee,” sometimes known as a “swap fee,” for positions open at your broker’s “cut-off time” (typically 5:00 pm ET), that a trader either pays or earns, depending on the positions you have open.
If you do not wish to earn or pay interest on your holdings, simply ensure that they are all closed before 5:00 p.m. ET, the market day’s set finish.
Interest rollover charges are an element of forex trading because every currency deal includes borrowing one currency to buy another.
Interest is PAID on the currency that is borrowed.
Interest is EARNED on the one that is bought.
If you buy a currency with a higher interest rate than the one you borrow, the net interest rate differential will be positive (i.e. USD/JPY), and you will earn income as a result.
If the interest rate differential is negative, you must pay. It should be noted that several retail forex brokers vary their rollover rates based on various circumstances (e.g., account leverage, interbank lending rates).
Please contact your broker for further information on their specific rollover rates and crediting/debiting procedures.
Here’s a table to assist you to figure out the interest rate differentials between the major currencies.
Benchmark Interest Rates