Currency (FOREX) Trading

Currencies

What is it?

One of the most versatile money-maker out there lies within the Foreign Exchange market whereby currencies are traded. Other names for Foreign Exchange are currency, FOREX, and FX.

The market happens and money is made whenever one currency is traded for another.

For retail investors/traders like us, we can trade through specialised FOREX brokers offering online FOREX trading platform. There are also traders out there who trade FOREX using Contract-for-Difference (CFD), like myself.

The price change of the exchange rate is called PIPS. 1 pip, 2 pips, 3 pips, and etc. 1 pip is the smallest movement an exchange rate can make.

Say the quoted exchange rate for AUD/USD is 0.9000. 1 minute later, it is 0.9005. That means the AUD/USD pair has moved by 5 pips.

FOREX are always traded in pairs. You are exchanging one currency for the other.

Now, let’s look at the costs involved, advantages of FOREX trading, and disadvantages of FOREX trading.

Costs?

On the outset, there’s no inherent costs related to FOREX. That means, no commissions or fees. However, there’s a thing called bid/ask spread. FOREX brokers make money through their bid/ask spreads. Different brokers have different bid/ask spreads. What is bid and ask? In the most simplistic sense, bid is the buy price, ask is the sell price. Spread on the other hand is simply the gap between the bid price and the ask price.

The price you buy or sell the currency pair will not be the same.

Say the bid price for AUD/USD pair is 0.9003 and the ask price is 0.9000. The 3-pip difference is the bid/ask spread.

That means, if you open a LONG position of $10,000 at 0.9003, an immediate loss of $3 is recorded on your screen. That also means, your broker has just made $3 of you.

It is a good idea to go for brokers that offer the tightest spreads. Logic to this is that, the tighter the spread, less currency rate movement needs to be made before you break even and make money.

Apart from the spread, some brokers also charge fees for using their trading platform, and sometimes, there are also financing charges to think about. This is true with my Contract-for-Difference (CFD) broker. I am not so sure about the traditional FOREX broker. Anyone can clarify this, do share in the comments section below.
Advantages?

LEVERAGE

The most attractive feature of FOREX is leverage. What is leverage you ask? Well, simply put, it means that you can control a larger position with a small amount of money.

For example, my broker requires only 2% margin. That means, to open a position of $10,000, I need to put up only $200.

With leverage, your returns can be magnified exponentially. Same goes to losses as well, remember that!

EXCELLENT LIQUIDITY

The FOREX market is arguably the largest and the most liquid market in the world. The average daily trade volume, globally is USD 3 trillion.

That means, theoretically, the level of volatility is controlled and it is also rather easy to get in or out of your position.

ABILITY TO GO LONG OR SHORT

With FOREX trading, you can easily profit from rising market as well as falling market. You can BUY LOW, SELL HIGH or you can SHORT SELL whereby you SELL HIGH FIRST, BUY LOW LATER. More on short selling, refer to my article here.

NO COMMISSION

No commissions are charged, unlike trading stocks. Thus, the cost of FOREX trading is lower.

MARKET OPEN 24 HOURS A DAY

The FOREX market is open 24 hours a day from 5pm EST Sunday until 4pm EST Friday. That means, you can trade not only during the day, but also before you go to bed!

LOW AMOUNT OF CAPITAL NEEDED

Due to the leverage feature, a rather low amount of money is needed to start.

With share trading, most of the time, you need to have $10,000 or more to begin but with FOREX, you need less than this. Much much less.

Disadvantages?

LEVERAGE

As they say, leverage is a double-edged sword. While your returns can be magnified exponentially, it goes the same thing with your losses as well. In fact, the risk of losing more than what you have is also there.

For example, you have $1,000 to start trading FOREX and the margin rate is 2% and you decide to utilise all your capital.

You then opened a long position of $50,000 (2% of that is $1,000). Then something bad happened. The exchange rate tumbles down by 5%, recording a loss of $2,500 on your screen.

Bear in mind that you have only $1,000 and now you have incurred a loss of $2,500. See what I mean by losing more than what you have? You now owe money to your broker!

MARKET OPEN 24 HOURS A DAY

It may be great that the FOREX market is open 24 hours a day but it can be a detriment to us traders as well.

That means that the movement of the exchange rate happens all day long while you are awake and while you are asleep… Now, who has the time to monitor the market 24 hours a day right?

For some, this may mean sleepless nights and unnecessary worries. This is especially true for some position traders whereby they hold their positions for quite some time.

HIDDEN COSTS

Often, people think that there are no costs at all related to FOREX trading. People overlook the fact that there’s a built-in cost which is known as the bid/ask spread. The bid/ask spread has been explained earlier.

So, always take note of the bid/ask spread. The tighter the spread, the better.

My verdict?

While this is one of best money-making instruments out there, due to the leverage feature, I regard FOREX trading as a high-risk venture. As with any leveraged products, you can lose more than what you have. Thus, caution needs to be exercised at all times. As General Patton used to say, only “… take calculated risks”

When I first started, it did worry me throughout the night. I sometimes wake up a few times to check on my position. Of course, that problem is under control now. Well, I sure like to think so. Hehe 🙂

Is FOREX trading easy? Personally, I don’t think so. If it was easy, everybody would have made truckloads of dough from this venture right?

So, what you need to do is: Read a lot of books, get a lot of knowledge, start small and get some experience first, and… always always always implement a capital management plan. Also remember, always know what you’re doing. Don’t just trade blindly without any systems or methods. If you are trading without any systems or methods, you’re no worse than gamblers.

Disclaimer: This article is not a specific nor general advice on managing or investing your money. This article does not constitute a recommendation nor does it take into account your investment objectives, financial situation nor particular needs.

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When can I consider myself financially free? Part 1
Why Everyone Should be Wealthy
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About nadlique

This blog is about the journey of a 28-year-old Malaysian towards financial freedom. This blog was started back when the blogger was 21 years old. However, his journey towards financial freedom had begun way before that. Materials such as investing, business, entrepreneurship, equities, and real estate are presented. The author also posts his thoughts and observations on life in general.

Comments

  1. notatraderyet says:

    With capital of $1000,leverage 1:500 and 20pips a day.I calculated I can achieve about 100,000 in 8 weeks.But ofcourse,FOREX is still a very high risk investment if u dont know what u’re doing..

  2. Well, the question is, can you achieve 20 pips a day consistently. Plus, that’s with the assumption that your account balance don’t get blown up, considering you’re utilising the whole $1,000. It kind of shows that there’s no proper capital management model put to place.

    There’s this broker who told me that he had a client who managed to make $2,000,000 in the market within 2 months and lost it all in the third month. Definitely not a place to be.

  3. Yup, you are right by saying FOREX is a high-risk money-making method. Even the best traders lose money sometimes.

  4. Fariehaz says:

    Hey,nice article.Can u explain to me more how does the market determine those bid price and ask price.For example,how come our currency becoming Rm 3.18 for one US dollar.And also,way back then in 1998,we tagged our currency at one rate from US dollar.I am confused, how was then suddenly we can fix our ringgit at certain value ?

  5. Hi Fariehaz! 🙂

    I’ve done an entry to explain your first question. Refer here:

    http://www.nadlique.com/index.php/2008/04/21/what-determines-foreign-exchange-currency-rates/

    For the second question, I will post in a few minutes.

  6. Thank you for this really Good Topic.

    Great tutorial. I’m especially impressed with the fact that you are sharing such great tips. Keep up the great work .

  7. aku agak berminat dengan forex nih, tapi tak faham sangat ape ko citer sebab tak nampak.

    nanti explain kat aku face 2 face ya. =)

  8. hehe. entah bilalah aku dapat jumpa kau nazar 😀

  9. hai!
    i’m currently working as forex analysis!
    forex is not as risky as you said.
    we do have risk management to reduce your loses if the market is against your prediction.

  10. fazlan iswandy says:

    helo nadlique,
    info yg sgt berguna, but i have an enquiry.JAKIM said FOREX ada unsur riba.but i heard,ASB also. but JAKIM declare ASB harus.sedgkn ada org bg tahu yg pelabur terbesar ASB ialah Calsberg.aku dh xthu mcm mana skrg ni.tp aku mmg main forex pn skrg ni.can u please advise me?tq:)
    or contact my email.mybe kita blh discuss more detail lg.

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