Introduction to Forex Trading

Buy Hold Sell Cube What is Forex Trading?

Forex trading is when you attempt to generate a profit by speculating on the value of one currency compared to another. Foreign currencies can be traded because the value of a currency will fluctuate, or its exchange rate value will change, when compared to other currencies.

Forex trading is normally conducted through 'margin trading', where a small collateral deposit worth a percentage of a total trade's value, is required to trade.

Is Forex Trading Right for You?

To successfully trade in forex, you will need to have good knowledge of foreign exchange, leverage, volatility and the conditions of each country whose currency you are trading.

You will need to predict how these conditions affect the relative value of those currencies. This is difficult as so many factors come into play, including politics, economics and market confidence. Some of these can be unexpected and even random events.

You will also need to:

  • Know how forex works in detail
  • Have time to do research and monitor your trades
  • Understand the online platforms used for trading and their functionality
  • Read the product disclosure statement and discuss the risks with your financial adviser
  • Be able to afford to lose more than the amount you invested.

Should I Buy or Sell?

Buying a currency pair, for example GBP/USD, means that you buy the first currency in the pair (GBP) while simultaneously selling the second currency in the pair (USD) on expectations that the cross rate price will rise in value and your profits will rise in line with any increase in that price.

Conversely, selling a currency pair means that you sell the first currency in the pair (GBP) while simultaneously buying the second currency in the pair (USD) on expectations that the price will fall and your profits rise.

Forex Trading Examples

Going Long on GBP/USD (Sterling/US Dollar)

It is the first Friday of the month and let’s assume that GBP/USD is currently trading at 1.6286/1.6288.

Traders are concerned about the employment situation in the US. They expect the level of actual non-farm payrolls to come in worse than economist estimates.

You expect that the US dollar will weaken and the British pound will strengthen against the US dollar, and decide to buy (go long) £10,000 on GBP/USD at 1.6288.

The trade size is in units of the first, or base, currency in the pair. For the purpose of this example, let's say your account leverage is 50:1.

This requires an initial deposit of (£10,000*1.6288/50) $325.76.

As you anticipated, the pound strengthens against the dollar, and when it reaches 1.6350 you decide to cash in your profits. Our new price is 1.6350/1.6352 and you sell to close at 1.6350.

Result: You bought at 1.6288 and sold at 1.6350, a rise of 62 pips. This gives you a profit of:

(1.6350 – 1.6288) x 10,000 = $62.

Profit/Loss is calculated (and denominated) in the second, or counter currency of the pair.

Profit/Loss calculation: The difference between the closing price and opening price x size of trade.

Alternative scenario: If however, the actual non-farm payroll data had come in better-than-expected, the US dollar would have strengthened against the pound.

If GBP/USD would have gone down, say, to 1.6230 you would lose (1.6288 - 1.6230) x 10,000 = $58.

Profit/Loss Conversion: To help simplify the trading process, Forex FS automatically converts trading PL into the client's denominated account currency at the prevailing market rate at the time that the trade is closed.

Going long on AUD/USD (Aussie/Dollar)

Let’s say AUD/USD is trading at 1.0500/1.0501 at the moment. 

Traders are bracing themselves for the worst, ahead of the release of US Q2 GDP figures. 

You expect the Australian dollar will appreciate against the US dollar, i.e. the Aussie dollar will strengthen against the US dollar, and decide to buy (go long) AUD10,000 on AUD/USD at 1.0501. 

For this trade, you choose a leverage scale of 20:1. This requires an initial deposit of (AUD10,000*1.0501/20) $525.05. 

As anticipated, the Aussie dollar strengthens against the US dollar. AUD/USD rises to 1.0591 and you decide to cash in your profits. Our new price is 1.0591/1.0592. You sell to close at 1.0591. 

Result: You bought at 1.0501 and sold at 1.0591, an increase of 90 pips. This gives you a profit of: (1.0591-1.0501) x 10,000 = $90. 

Alternative scenario: The actual US Q2 growth rate meets expectations, thus pushing the US dollar up against the Aussie dollar. AUD/USD declines to 1.0411. In this case, you would lose (1.0501-1.0411) x 10,000 = $90.

Going short on EUR/USD (Euro/US Dollar)

It is mid-July, and let’s say that EUR/USD is trading at 1.4360/1.4361.

Investors remain worried about the impact of the sovereign debt crisis and you expect the euro will fall against the US dollar. You decide to sell (go short) €10,000 on EUR/USD at 1.4360.

For this trade, you choose a leverage scale of 20:1. This requires an initial deposit of (€10,000*1.4360/20) $718.00.

You were right. Euro depreciates against the dollar to 1.4251 and you decide to close your trade and take your profits. Our new price is 1.4250/1.4251 and you buy to close at 1.4251.

Result: You sold at 1.4360 and bought at 1.4251, a fall of 109 pips, giving you a profit of: (1.4360 - 1.4251) x 10,000 = $109.

Alternative scenario: If however, a weaker dollar across the board overnight had pushed the Euro up by 130 points to 1.4490, you would have lost (1.4490 – 1.4360) x 10,000 = $130.

Going long on USD/JPY (US dollar/Japanese Yen) 

It is mid-March 2011 and USD/JPY is trading at 76.39/76.40.

The Japanese yen has surged since its worst earthquake in history due to high demand for yen as international businesses attempt to redevelop the devastated areas.

You believe that the yen is too strong and will fall back against the US dollar, i.e. the US dollar will strengthen against the yen. You decide to buy (go long) $10,000 on USD/JPY at 76.40.

For this trade, you choose a leverage scale of 25:1. This requires an initial deposit of ($10,000*76.40/25) 30,560 yen. As you predicted, USD/ JPY bounces back to 78.66 and you decide to take your profits. Our new price is 78.66/ 78.68. You sell to close at 78.66.

Result: You bought at 76.40 and sold at 78.66, a rise of 226 pips, giving you a profit of: (78.66 – 76.27) x 10,000 = 22600 yen.

Alternative scenario: If the dollar had continued to weaken against the yen, falling further to a record low of, say, 76.25, you would lose (76.40 – 76.25) x 10,000 = 1500 yen.

Going short on USD/CAD (US dollar/Canadian dollar)

It is mid-summer and let’s say USD/CAD is trading at 0.9520/0.9524.

A lack of progress in talks aimed at raising the US debt ceiling has weighed down on the US currency.

You expect USD/CAD will decline further and decide to sell (go short) $10,000 on USD/CAD at 0.9520.

You were right. The US dollar continues to weaken against the Canadian dollar and reaches a low of 0.9434. You decided to take your profits at this point. Our new price is 0.9430/0.9434 and you can therefore buy to close at 0.9434.

Result: You sold at 0.9520 and bought at 0.9434, a drop of 86 pips. This gives you a profit of: (0.9520 – 0.9434) x 10,000 = CAD86.

Alternative scenario: If the dollar had bounced back against the Canadian dollar to 0.9600, you would have lost (0.9600 – 0.9520) x 10,000 = CAD80.

RISK WARNING:Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.