How to Trade Forex

Base and Counter Currencies

Forex trading works via the pairing of currencies, such as EUR/USD. The first currency listed on the left is known as the ‘base’ currency, while the other one is referred to as the ‘counter’ currency. So if for example the EUR/USD was valued at 1:1.35, it would mean that one Euro (the base currency) is worth $1.35 (the counter currency).

How leverage works

HOW LEVERAGE WORKS

How Leverage Works

HOW LEVERAGE WORKS

If you were to actually buy and own the currency you were trading, you would only be able to trade with as much money as you actually had. So if you only had £100 to trade with, this would be the total amount that you could spend on trading.

However, with leverage you can trade beyond the limits of your available funds, allowing you to take a bigger position within the markets than your total stake would ordinarily enable you to.

The leverage rates offered on varying currency pairs can be different depending on the perceived risk. ETX Capital offers leverage rates ranging from 14:1 for EUR/HUF, right up to 400:1 in certain circumstances for pairings such as EUR/USD and GBP/USD (traders should keep in mind that leverage settings can change based on market conditions).

So if we had £100 and were trading GPB/USD, with a leverage rate of 200:1 we could take a position that was two hundred times our stake of £100. This would allow us to trade significantly in excess of the funds we had available to trade with.

Just a small amount of money can give traders access to a large stake, which means that if the trade move in the direction that you predict you can make substantial profits. However, should the markets move in the opposite direction, significant losses can be incurred. Increasing leverage not only increases the potential profit you can make, but also your potential losses.

Forex Trading: Going Long or Short

There are two options for traders with currency pairs. You can either buy or sell.

When you buy you are said to be ‘going long’ - you’re buying the base currency and therefore selling the counter currency. If you sell you’re ‘going short’ - selling the base currency and therefore buying the counter currency.

going long

Going long

Imagine that we have decided to go long, using a currency pairing of EUR/USD.

In the following example, there is substantial market tension in regards to forthcoming US GDP figures. In addition, there is an election coming, in which the favourites are a party that is generally considered to be antagonistic in its approach regarding major corporations. However, the economic situation in the Euro zone appears to be quite stable.

Taking this information into account, we come to the conclusion that the Euro will get stronger in relation to the dollar. We therefore go long on EUR/USD, at a bid/ask rate of 1.6774/1.6780. By using the maximum leverage rate of 200:1 we ‘buy’ €10,000 at the level of 1.6780.

So how big does our initial deposit have to be to allow us to complete the trade? It’s worked out like this:

(The total amount we want to buy) x (counter currency exchange/leverage scale)

In this instance that equates to 10,000 x 1.6780/200 = €83.90

So the total amount that we deep to initially deposit to make the trade is just €83.90. The trade goes as we expect and the Euro gets stronger against the dollar. The bid/ask rate moves to 1.6821/1.6827 and we feel that it’s time to close the trade. We sell our €10,000 at the rate of 1.6821.

Remember, we bought at 1.6780, so having sold at 1.6821, we have seen a rise of 41 percentage points.

So how much profit did we make? It’s worked out like this:

(Level sold at) - (level bought at) x (amount we bought)

Which in this instance is 1.6821 - 1.6780 x 10,000 = $41

If however, the markets had moved in the opposite direction to which we expected and the dollar got stronger against the Euro, we would incur a loss. The bid/ask rate moves to 1.6730/1.6736 and we decide to cut our losses and sell our €10,000.

Our losses are worked out like this:

(Level we bought at) - (level we sold at) x (amount we bought)

Which works out as 1.6780 - 1.6730 x 10,000 = $50

 
Going Short

Going short

Let’s imagine that macroeconomic data coming out of the US suggests that both output of trade and the number of sales have increased. At the same time, the Euro zone is in the grip of a financial recession. As a result we feel that the Dollar will get stronger against the Euro and decide to sell, or as it’s otherwise known ‘go short’.

We sell €10,000 at a price of 1.4999, using a leverage rate of 1:50.

The funds we need to cover this transaction are as follows: (10,000) x (1.4999/50) = €299.98

We’re proved correct and the Euro gets weaker against the Dollar. At this point we ‘buy’ €10,000 to close the trade. The price is now 1.4912 which is a fall of 87 percentage points.

Our profit is worked out like this: 1.4999 - 1.4912 x 10,000 = $87

If however, we were proved wrong and the Euro strengthened against the Dollar, we would incur a loss. We buy and close out at €10,000 at the bid/ask rate of 1.5124/1.5130. Our loss would be as follows:

1.5130 - 1.4999 x 10,000 = $131

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