Required for the forex course
Forex account: free account at Markets.com
Duration per lesson: about 10 minutes
Now that you know what forex is and how to interpret prices and price changes, it is about time to open a position yourself. In this fourth lesson of the Forex trading course for beginners, we will explain how to do it and what to be aware of.
Leverage ensures that participate and trade on the Forex market, even with a small starting capital.
When observing the fluctuations in the prices of currencies you will notice that they are very small. From minute to minute prices often fluctuate only a few pips and if a currency pair rises or falls a whole cent within a few hours (i.e. 100 pips), that is rather exceptional. You may wonder how one can make money when price fluctuations are this tiny. The answer is simple: by trading large amounts at once.
If you invest one dollar in the GBP / USD and this currency pair increases by 50 pips, that’s not really worth it. If you invest $ 100,000, you earn $ 500 with the same price increase. Considering that such fluctuations happen a couple of times a day, you can see how Forex trading can quickly become a lucrative source of income.
The amount of $ 100,000 was not chosen out of the blue. 100,000 units of a currency pair is typically called a “Standard Lot”. This is the basic quantity to trade in the forex world. If you buy a standard lot, a price change of 1 pip corresponds to approximately $ 10. Because an increasing number of individual traders with smaller investment funds are entering the forex market, there are now also “mini-lots”. A mini-lot equals 10,000 units and the value of 1 pip equals about $ 1. And there are even “micro-lots”, where 1 pip equals $ 0.10.
In order to buy a standard lot, you do not actually need $ 100,000 in capital. If that were the case, Forex trading would be a privilege for the rich. Instead, you only need enough capital to cover any losses on an open position. This is the concept of “Leverage”.
With Leverage you trade larger positions than you could actually purchase. In the markets.com trading platform you can set the desired lot size when opening a trade. The smallest lot size is 0.01 lots, or 1 micro lot, where 1 pip is $ 0.10.
The maximum leverage at Markets.com is 200:1. This means that you only need $ 5 to buy a micro lot. Because every pip equals $ 0.10, if the price increases by 30 pips, you make a profit of 30 * 0.10 = $ 3. On the other hand, the price can drop a maximum of 50 pips before your position is closed. In that case, you would lose 50 * 0.10 = $ 5, which equals the initial purchase amount, and you can never lose more than the initial purchase amount.
Because forex positions involve Leverage, your position is automatically closed whenever it reaches a certain value (in the example above that is 50 pips). This is called a “stop loss”. You can also set a stop loss yourself which is higher than the minimum stop loss. For example, if you want to open a position with a higher price target, you may also want to give the trade some more space, and thus a more distant stop loss. When your stop loss is hit, the broker automatically closes your position. This means you can never lose more money than you deposit.
On the one hand, a tighter stop loss offers more protection, but on the other hand it is also more likely that your position will be closed due to a very small price fluctuation. A wider stop loss gives your position more space to move but it also exposes you to larger potential losses. One of the most important, and often overlooked, things in forex trading is applying the right stop loss. We highly recommend you always apply a stop loss. If you walk away from your computer to get some coffee, the price may have suddenly made a large unanticipated move with some nasty consequences if you didn’t apply a stop loss.
In the same way as a stop loss, you can also apply a “take profit”, or a limit to your profit. At first sight this may seem weird of course; after all, you want to make as much money as possible. But the price of a forex pair often moves in waves, going up and down. If the price has increased and you have theoretically made a profit, but if you do not close the position and the price drops again, you have lost your profit again.
To prevent this from happening, it could be wise to apply a take profit; a price target at which the position is automatically closed with a profit. You should place the take profit at a level which you believe is reasonable, and after which the upside potential is limited.
Your first position
Now that you have come this far in the forex trading course you have all the information required to be able to open your own positions. You know how to interpret bid and ask prices, how to limit risk by applying a stop loss and take profit, and how to use the concept of leverage. We always recommend practicing a couple of trades with a demo account before starting to trade with real money.
The remainder of the course proposes various more advanced tools to better predict future price movements. We recommend you start applying the information you learn as you work your way through the trading course. By trading with a demo account you can immediately the concepts we explain in this course, while gradually expanding your knowledge about forex and trading techniques. Experience is an important success factor in forex trading. Ultimately, success depends on applying your theoretical knowledge in practice to gain hands-on forex trading experience.