Handbook for Forex Trader
In the following examples, we are going to use fundamental analysis to help us decide whether to buy or sell a specific currency pair.
Each currency belongs to a country (or region). So forex fundamental analysis focuses on the overall state of the country’s economy, such as productivity, employment, manufacturing, international trade, and interest rate.
If you believe that the U.S. economy will continue to weaken, which is bad for the U.S. dollar, you would execute a BUY EUR/USD order.
By doing so, you have bought euros in the expectation that they will rise versus the U.S. dollar.
If you believe that the U.S. economy is strong and the euro will weaken against the U.S. dollar, you would execute a SELL EUR/USD order.
By doing so, you have sold euros in the expectation that they will fall versus the US dollar.
If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order.
By doing so you have bought U.S dollars in the expectation that they will rise versus the Japanese yen.
If you believe that Japanese investors are pulling money out of U.S. financial markets and converting all their U.S. dollars back to yen, and this will hurt the U.S. dollar, you would execute a SELL USD/JPY order.
By doing so you have sold U.S dollars in the expectation that they will depreciate against the Japanese yen.
If you think the British economy will continue to do better than the U.S. in terms of economic growth, you would execute a BUY GBP/USD order.
By doing so you have bought pounds in the expectation that they will rise versus the U.S. dollar.
If you believe the British economy is slowing while the American economy remains strong like Chuck Norris, you would execute a SELL GBP/USD order.
By doing so you have sold pounds in the expectation that they will depreciate against the U.S. dollar.
If you think the Swiss franc is overvalued, you would execute a BUY USD/CHF order.
By doing so you have bought U.S. dollars in the expectation that they will appreciate versus the Swiss Franc.
If you believe that the U.S. housing market weakness will hurt future economic growth, which will weaken the dollar, you would execute a SELL USD/CHF order.
By doing so you have sold U.S. dollars in the expectation that they will depreciate against the Swiss franc.
In forex, it would be just as foolish to buy or sell 1 euro, so they usually come in “lots” of 1,000 units of currency (micro), 10,000 units (mini), or 100,000 units (standard) depending on your broker and the type of account you have (more on “lots” later).
“But I don’t have enough money to buy 10,000 euros! Can I still trade?”
Margin trading is simply the term used for trading with borrowed capital.
This is how you’re able to open $1,250 or $50,000 positions with as little as $25 or $1,000.
You can conduct relatively large transactions, very quickly and cheaply, with a small amount of initial capital.
Let us explain. Listen carefully because this is very important!
- You believe that signals in the market are indicating that the British pound will go up against the U.S. dollar.
- You open one standard lot (100,000 units GBP/USD), buying with the British pound at 2% margin and wait for the exchange rate to climb. When you buy one lot (100,000 units) of GBP/USD at a price of 1.50000, you are buying 100,000 pounds, which is worth US$150,000 (100,000 units of GBP * 1.50000). If the margin requirement was 2%, then US$3,000 would be set aside in your account to open up the trade (US$150,000 * 2%). You now control 100,000 pounds with just US$3,000. We will be discussing margin in more detail later, but hopefully, you’re able to get the basic idea of how it works.
- Your predictions come true and you decide to sell. You close the position at 1.50500. You earn about $500.
|You buy 100,000 pounds at the exchange rate of 1.5000||+100,000||-150,000|
|You blink for two seconds and the GBP/USD exchange rates rises to 1.5050 and you sell.||-100,000||+150,500|
|You have earned a profit of $500.||0||+500|
When you decide to close a position, the deposit that you originally made is returned to you and a calculation of your profits or losses is done.
This profit or loss is then credited to your account.
What’s even better is that, with the development of retail forex trading, there are some brokers who allow traders to have custom lots.
For positions open at your broker’s “cut-off time” (usually 5:00 pm EST), there is a daily rollover interest rate that a trader either pays or earns, depending on your established margin and position in the market.
If you do not want to earn or pay interest on your positions, simply make sure they are all closed before 5:00 pm EST, the established end of the market day.
Since every currency trade involves borrowing one currency to buy another, interest rollover charges are part of forex trading.
Interest is PAID on the currency that is borrowed.
Interest is EARNED on the one that is bought.
If you are buying a currency with a higher interest rate than the one you are borrowing, then the net interest rate differential will be positive (i.e. USD/JPY) and you will earn interest as a result.
Conversely, if the interest rate differential is negative then you will have to pay.
Note that many retail brokers do adjust their rollover rates based on different factors (e.g., account leverage, interbank lending rates).
Please check with your broker for more information on rollover rates and crediting/debiting procedures.
Benchmark Interest Rates
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