If you are serious about trading, it is important to develop a solid plan and follow it carefully. I learnt this the hard way when  I first started – never trade without a plan. Else, you may find yourself glued to the computer screen all day & night in anxiety - and worse, all you achieve at the end of the day is a burnt account!

But once you have a plan in place, it makes trading so much more stress-free. You know exactly when to enter and exit, how much loss or profit you make if your SL or TP is hit. It can be tempting to execute big lot sizes or many trades in an attempt to make fast profits – but don’t! This can lead to a huge loss or even blow up your account equally fast! Don’t be greedy – take whatever the market gives you. A small profit is still a profit – much better than a big loss! If you have no respect for the market, the market will have no mercy on you. Respect the market and the market will be more willing to reward you.

So, always trade with a plan. No written plan or strategy to guide your trading? Better don’t trade! Else, chances are your emotions will run all over you, making you a forex gambler in the process. Even if you want to rob a bank (which I don’t recommend!), you still need to have a solid strategy in place.

So, what does a good trading plan look like? We will discuss more in the next post. So stay tuned!

In the last post, we have established that leverage and margin are inversely related – the higher the leverage, the less margin is required for a given trade. But high leverage can tempt you to execute more trades or bigger lot sizes – and this can be risky if the market goes against you. In the first post, we learnt that the profit of a trade = trade size (in lots) x pip value x price difference (in pips). For a given currency pair and price difference, bigger trade size means bigger profits or loss.

Lets consider two cases.

• Trade A: buy 1 lot EUR/USD at 1.4430 and sell at 1.4530         
• Trade B: buy 0.01 lot EUR/USD at 1.4430 and sell at 1.4530

In both cases, the currency pair and the price difference is the same. Only difference is the trade size. In Case A, the profit = trade size x pip value x price difference = 1 lot x 10 x 100 pips = USD 1000. In Case B, profit = 0.01 lot x 10 x 100 pips = USD 10. Obviously, Trade B with only 1/100 the lot size of Trade A will only have 1/100 of  Trade A’s profit. However if it had been a loss of 100 pips instead, Trade B will suffer a loss only 1/1oo that of Trade A. Small trade size means small profit or small loss. Big trade size means big profit or big loss. Simple? So if there is only USD $1000 or less in your trading account, don’t execute a trade size of 1 lot – unless you want to burn your trading account as quickly as possible!  

How can that happen? Let’s say you execute a “buy” trade for 1 lot of EUR/USD at 1.4430 with a leverage of 400:1. Instantly, a margin of  USD 360.75 is deducted from your trading account. (Recall that margin = TUR/L). If your original trading account balance was USD 1000, you are left with only 1000 – 360.75 = 639.25. So far, so clear? Well, you still have to minus a “fixed cost” or “tax” charged by the broker for executing the trade. This “broker tax” (so to speak) is technically called the “spread“, which is the difference between the buy and sell price at any given instant. Let’s say the spread is 3 pips for EUR/USD. The moment you execute the trade, this 3 pips is registered as a loss for this trade (in this case = USD 30, being 3 pips x 10 x 1 lot). i.e. you have to earn this 3 pips (or $30 in this case) for the broker first – before you breakeven and earn pips in profit for yourself.

So your allowable margin is further reduced to 639.25 – 30 = 609.25.  i.e. Your starting “Free Margin” is only 609.25, even before the market has even moved a single pip! Now the pip value for EUR/USD is 10 – remember? (assuming your account currency is also in USD). Since you bought 1 lot, every pip movement either adds $10 into your account or removes $10 from your account. Now you only have 609.25 as Free Margin to support the trade. Let’s say Lady Luck is not happy with you and market moves against you. For each pip that the market moves against you, $10 is stripped away from your Free Margin. Every 10 pips against you, $100 will be removed from your Free Margin. If this continues on, it won’t be long before your Free Margin is reduced to zero… and when will that happen? Since your Free Margin is only 609.25, it takes only 60.9 pips (=609.25 / 1 lot x 10) to reach zero Free Margin. Then a “Margin Call” is triggered, your trade is automatically closed at a loss and your trading account is effectively burnt. i.e. All it takes is for the market to move 0.6 of a cent against you and it’s “Game Over” for you!  That’s why trading 1 lot with only a USD 1000 account balance is attempting “suicide”.

So what lot size should you trade? If you only have $1000 in your account, you can have a trade size so that your trade can exit at a predetermined loss set by you. e.g. you decide you want to risk only max of 5% of your account balance or $50 (=5% of 1000). You can limit your loss by setting a Stop Loss (SL) at a level such that only $50 is your max loss. If you think that the trade calls for a 80 pip Stop Loss, your max trade size should not exceed = 50 /10 x 80 = 0.0625  lot. Then perhaps you can trade 0.05 lot with a SL of 80 pips and your max loss is only 0.05 lot x 10 x 80 = $40. In general, the max trade size (Tmax) for a given risk level (R%), Capital balance (K), Stop Loss (SL) and Pip value (Pv) is given by  Tmax = RK / Pv x SL.

Example, if you have a $5000 trading account balance and your trade Stop Loss ideally is at 150 pips, Currency Pair is EUR/USD (i.e. pip value = 10), and you wish to risk only max 3% of your trading account balance, then the max trade size you should have is  Tmax = 0.03 x 5000 / 10 x 150 = 0.1 lot.

As to where or what level you should place your Stop Loss, it depends on your trade strategy. We will discuss more in the next post. So stay tuned!

What is Margin and Leverage?

In the earlier post, we talked about buying 1 standard lot of euros (or 100,000 euros) by paying USD 144,300 – if the rate of EUR/USD is 1.4430. Unless you actually want to hold 100,000 euros in your wallet/bank account, you wouldn’t want to pay USD 144,300 for it. For the purpose of trading, you’ll just need to come up with a certain deposit and the rest comes as a “loan” from the broker. This deposit amount required (also called the “margin”) depends on how much the broker wants to lend you.

If the broker is willing to lend you 98%, you just need to come up with 2% x USD 144,300 = USD 2,886 from your own pocket. i.e. broker is giving you a “loan” 50 times of your own deposit. (you only come up with 1/50 of USD 144,300 = USD 2,886). This USD 2,886 is known as your required ”margin” and the “50 times” is known as the leverage offered by the broker. The max leverage differs from broker to broker and can be 50:1 (50 times), 100:1, 200:1, 400:1 or even 500:1. E.g. for a 200:1 leverage, your margin requirement is only 1/200 x USD 144,300 =  USD 721.50. If you want to use even less margin, you can trade 0.1 lot instead of 1 lot for example. Then your margin for 0.1 lot is only = 0.1 x 721.50 = 72.15. In general, your margin requirement for a given trade is given by

M = T x U x R / L

where T = trade size (in lots), U = units in 1 lot, R = exchange rate of currency pair, L = leverage  

e.g. for EUR / USD –> R = 1.4430, trade size T = 0.05 lot, Units in 1 lot = 100,000 euros, leverage = 400:1,  your required margin = 0.05 x 100,000 x 1.4430 / 400 = USD 18.04   

Therefore with a high leverage broker, you need not come up with so much of your own money for a given lot size. But this can make it more tempting for people to execute more trades or/and bigger lot sizes. This can make you a lot of money quickly if the market moves in your favour. BUT if you get the market direction wrong, high leverage will cause you to lose money equally fast (or even wipe out your account). High leverage can magnify your profits or magnify your losses – so use with caution!

If you have enough self-control not to overuse leverage, my personal opinion is go with a broker that can offer you high leverage – but trade with small lot size (small in relation to your trading account balance) and use a Stop Loss. In the next post, we will discuss more about the trade/lot size, Stop Loss, Take Profit, Spread and how a Margin Call is triggered. Stay tuned!

What is “Pipsometry”?

Pipsometry is the art of earning pips in the forex market (This definition is not found in any dictionary – yet.) If you are considering forex trading, you must at least know what a “pip” is.

What is a pip?

A pip is the smallest decimal place to measure the movement of one currency in terms of another. Example, if EUR/USD goes from 1.4430 to 1.4431, we say that the EUR has gone up by 1 pip in USD. If EUR gains 100 pips in USD, that means the price of EUR has increased by $0.01 (or 1 cent) in USD. Conversely, if EUR/USD goes from 1.4430 to 1.4212, we say that the EUR has depreciated (1.4430 – 1.4212) = USD 0.0218 or 218 pips or 2.18 cents. For all currency pairs (except the Japanese yen), the pip is quoted to the 4th decimal place. (although many brokers have up to the 5th decimal place, known as a fractional pip). e.g. 1.44302 – where the last digit “2″ means two-tenth of a pip.  

Buy lower, sell higher

To make money from anything, you need to buy that something at a lower price and sell at a higher price later on. e.g. if I buy a pencil at 50 cents and sell it for $1.20, I would have profited (1.20 – 0.50) = 70 cents for this one pencil. If I sell 10 pencils, my profit would be 10 x 70 cents = 700 cents or $7.

Similarly, to buy 100,000 euros at a rate of EUR/USD = 1.4430, you need to pay USD 144,300 for EUR 100,000. If subsequently the rate rises to 1.4530, i.e. the price has increased by 100 pips (or 1 cent), I can sell my 100,000 euros and get back USD 145,300. Hence I profit (145,300 – 144,300) = USD 1000 just by buying and selling. The 100,000 euros is usually the size of 1 standard lot or 1 standard contract. Since every 1 cent (or every 100 pips) increases my profit by USD 1000, then each pip will give me a profit of USD 10. The value “10″ is the pip value - which in this case, measures the profit or loss (in USD) per pip change (in USD) per lot of EUR.

Calculating profits in forex

The pip value is different for different currency pairs, but if the second currency is the same as your account currency (i.e. if the 2nd currency is in USD as in the case of EUR/USD, GBP/USD, AUD/USD etc… and your trading account is also in USD), then the pip value is always = 10. 

Profits (loss) =  Trade size (or no. of lots) x Pip value x price difference (in pips) 

Examples:

e.g 1.  Buy GBP/USD at 1.6156 & sell at 1.65520,  Trade size = 0.05 lot. Assuming trading account currency is also in USD,

Profit = 0.05 x 10 x [(1.65520 - 1.61562) x 10,000] = 0.05 x 10 x 395.80 pips = USD 197.90.   

  E.g. 2. Sell  1.20 lot of USD/JPY at 77.04 & buy at 78.68. Assuming trading account currency is in USD. Given that pip value = 12.98

In this case, we sell first and buy back later (known as “short” position). But since it is sold lower and bought back higher, the trade is closed at a loss. Only the JPY is expressed to 2 decimal places.

Loss = 1.20 x 12.98 x (78.68 – 77.04) = 1.20 x 12.98 x (1.64 x 100) = 1.20 x 12.98 x 164 pips = USD 2554.46.

Conclusion:

This site is for beginners who are considering forex trading and want to learn the basics as quickly as possible. After you have picked up the different aspects of forex trading, it is up to you how you want to carry on from there. I won’t persuade or cheer you on to go into forex (or any kind of trading) because not everyone is suitable for it. Some people just cannot stomach losses – and can become very nervous each time they execute a trade. If you are the type who cannot sleep peacefully at night because of your trades, stay away from forex or any form of short term trading! You can potentially lose a lot of money. But if you are prepared to lose whatever money you have set aside without getting emotionally affected or losing sleep, forex can be a lucrative source of 2nd income.

Now that you know how you can potentially make (or lose) money in forex trading, we will talk about the various components that make up the profit /loss in the next session. 

All the best (and all the pips) in your trading!

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