Forex Trading Examples
The key principle of forex trading is simple. You buy one currency with another currency at the present exchange rate, so you are in effect going long of the first currency and short of the second currency. That is, your position will increase in value if the relative strength of the first currency against the second currency increases, as you can now sell the first currency back for a greater amount.
For instance, if you had bought GBP 10,000 in mid-January 2017 it would have cost you around USD 12,100 at the prevailing GBP/USD exchange rate. By mid-September 2017 the pound had increased in value against the dollar, so you could now have closed out your position by selling your ?10,000 for around $13,500. You began with $12,100 and you now have $13,500, a profit of $1400.
Example: buying the euro
Say the euro is trading against the dollar at 1.20504-1.20510 (remember we quote forex to fractions of a pip) and, due to a variety of factors, you think the euro is set to rise. You can choose either to buy a certain stake per pip as a spread bet, or to buy a certain number of CFD contracts, at the offer price of 1.20510.
For example, you might buy 10 CFDs at 1.20510. Each CFD contract (on the web-based platform) is the equivalent of 100,000 of the base currency, in this case the euro, so you are buying the equivalent of ˆ100,000 at 1.20510 which equals $120,510.
Suppose you are right and the euro rises against the dollar to 1.21700-1.21706 later in the day. You decide to close your position by selling your 10 CFDs at the bid price of 1.21700. You are effectively selling at $121,700, making a profit of $1190 (this is converted into your account currency if necessary).
Alternatively, if you are spread betting, you might have bought ?10 per pip at the offer price of 1.20510. To close your position you sell at the bid price of 1.21700. The difference between your opening price and your closing price is 119 pips so in this case your profit is 119 x ?10 = ?1190.
Whether you are spread betting or CFD trading, you will need to put down a margin deposit to open your position. This is typically a fraction of the full value of your position. The ratio of your margin to the value of your position is known as leverage. Getting great leverage on your position can help maximise the return on your spread bet or CFD investment, making it a critical element of the trade.
Forex Trading Examples (part 2)
You believe that signals in the market are indicating that the British Pound will go up against the US Dollar. You open 1 lot for buying the Pound with a 1% margin at the price of 1.49889 and wait for the exchange rate to climb. At some point in the future, your predictions come true and you decide to sell. You close the position at 1.5050 and earn 61 pips or about $405. Thus, on an initial capital investment of $1,000, you have made over 40% in profits. (Just as an example of how exchange rates change in the course of a day, an average daily change of the Euro (in Dollars) is about 70 to 100 pips.)
When you decide to close a position, the deposit sum that you originally made is returned to you and a calculation of your profits or losses is done. This profit or loss is then credited to your account.
Prices of foreign exchange are indicated by FOREX quotes in pairs of currencies. The first currency is the 'base' and the second is the 'quote' currency. In this example:
USD/EUR = 0.8419
. the currency pair is US dollars and European euros. The base currency (USD) is always at '1' and the quote currency shows how much it costs to buy one unit of the base currency. In this example, 1 US dollar costs 0.8419 euros.
EUR/USD = 1.1882
. tells us that it costs 1.1882 US dollars to buy 1 euro.
Example OCO Transaction:
Buy: 1 standard lot EUR/USD @ 1.3228 = $132,280
Pip Value: 1 pip = $10
This is an order to buy US dollars at 1.3328 and to sell them if they fall to 1.3203 (resulting in a loss of 25 pips or $250) or to sell them if they rise to 1.3328 (resulting in a profit of 100 pips or $1,000).
Here's another example:
The current bid/ask price for US dollars and Canadian dollars is
. meaning you can buy $1 US for 1.2152 CDN or sell 1.2157 CDN for $1 US.
If you think that the US dollar (USD) is undervalued against the Canadian dollar (CDN) you would buy USD (simultaneously selling CDN) and wait for the US dollar to rise.
This is the transaction:
Buy USD: 1 standard lot USD/CDN @ 1.2157 = $121,570 CDN
Pip Value: 1 pip = $10
Margin: $1,000 (1%)
You are buying US$100,000 and selling CDN$121,570. Your stop loss order will be executed if the dollar falls below 1.2147, in which case you will lose $100.
However, USD/CDN rises to 1.2192/87. You can now sell $1 US for 1.2192 CDN or sell 1.2187 CDN for $1 US.
Because you entered the transaction by buying US dollars (buying long), you must now sell US dollars and buy back CDN dollars to realize your profit.
You sell US$100,000 at the current USD/CDN rate of 1.2192, and receive 121,920 CDN for which you originally paid CDN$121,570. Your profit is $350 Canadian dollars or US$287.19 (350 divided by the current exchange rate of 1.2187).
The US dollar is normally considered the 'base' currency for Forex quotes. In the major pairs, this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the second currency quoted in the pair. For example, a quote of USD/CAD 1.193 means that one U.S. dollar is equal to 1.193 Canadian dollars.
When the U.S. dollar is the base unit and a currency quote goes up, it means the dollar has appreciated in value and the other currency has weakened. If the USD/CAD quote increases to 1.231, the dollar is stronger because it will now buy more Canadian dollars than before.
The three exceptions to this rule are the British pound (GBP), the Australian dollar (AUD) and the Euro (EUR). In these cases, you might see a quote such as EUR/USD 1.3027, meaning that one Euro equal 1.3027 U.S. dollars.
The initial margin to enter into a forex currency pair at Terra Nova is 3%. For example, an account is funded with $100,000 USD. A Forex currency trader feels that the US dollar is undervalued compared to the Canadian dollar. To capitalize on this strategy, the trader buys US dollars and simultaneously sells Canadian dollars. The current bid/ask for USD/CAD is 1.1835/1.1843 (purchase $1 US for $1.1843 CAD or sell $1 US for $1.1835 CAD).
The available leverage is 100:3 or 3%. To purchase a one lot, this trader buys $100,000 USD and sells $118,430 CAD. Using the above leverage, the initial margin is $3000 ($100,000 x 3%).
Trading on margin means that you can buy and sell assets that represent more value than the capital in your account. Forex trading is usually done with relatively little margin since currency exchange rate fluctuations tend to be less than one or two percent on any given day. To take an example, a margin of 2.0% means you can trade up to $500,000 even though you only have $10,000 in your account.
In terms of leverage this corresponds to 50:1, because 50 times $10,000 is $500,000, or put another way, $10,000 is 2.0% of $500.000. Using this much leverage gives you the possibility to make profits very quickly, but there is also a greater risk of incurring large losses and even being completely wiped out. Therefore, it is inadvisable to maximise your leveraging as the risks can be very high.
A pip is the smallest unit by which a cross price quote changes. When trading forex you will often hear that there is a 5-pip spread when you trade the majors. This spread is revealed when you compare the bid and the ask price, for example EURUSD is quoted at a bid price of 0.9875 and an ask price of 0.9880. The difference is USD 0.0005, which is equal to 5 "pips". On a contract or position, the value of a pip can easily be calculated. You know that the EURUSD is quoted with four decimals, so all you have to do is the cancel-out the four zeros on the amount you trade and you will have one pip. Thus, on a EURUSD 100,000 contract, one pip is USD 10. On a USDJPY 100,000 contract, one pip is equal to 1000 yen, because USDJPY is quoted with only two decimals.
A very common mistake made by novice forex traders is that they do not use a positive Risk/Reward ratio. By positive Risk/Reward ratio we mean the difference between the take-profit trade and the level of trade entry is greater than the difference between the stop-loss trade and the level of trade entry. In other words it means that you should not be willing to lose more than you want to make on a single trade.
Here is an example of a positive Risk/Reward ratio:
Buy EUR/USD 100,000 at 1.1500
T/P Sell EUR/USD 100,000 at 1.1600
S/L Sell EUR/USD 100,000 at 1.1440
In the above example the take-profit is 100 pips higher than the level at which the position was entered, and the stop-loss is 60 pips lower than the level at which the position was entered. The Risk/Reward ratio is 1:1.66.
Forex Trading Examples (part 1)
Many beginning traders don't fully understand the concept of leverage. Basically, if you have a start up capital of $5,000 and if you trade on a 1:50 margin you can effectively control a capital of $250,000. However, a two percent move against you and your capital is completely wiped out. If you are a beginning trader you should not use more than 1:20 margin until you get comfortable and profitable and then and only then you can attempt to use higher margins.
What does 1:20 margin mean? It means that with your $5,000 you will control a capital of $100,000. Let's say you are trading EUR/USD and by using our entry strategy you have decided to enter the trade on a long side. That means that you are betting that USD will depreciate against Euro.
Let's say current EUR/USD rate is 1.305. Again, if your trading capital is $5,000 and you are using 1:20 leverage you will effectively be exchanging $100,000 to Euros. If the current rate is 1.305 you will receive 100,000/1.305 = 76,628 Euros.
If the trade goes in your direction margin will work in your favour and 1% decline in USD will mean 20% increase in your start up capital. So if EUR/USD rate moves from 1.305 to 1.318 you will be able to exchange your 76, 628 Euros back to $101,000 for a profit of $1,000. Since your start up capital was $5,000 it is effectively a 20% increase in your account. However, if the trade went against you and USD appreciated 1% vs. Euro your account would be reduced to $4,000. That would not have happened as our strategy has built in hard stops to prevent such outcome.
The most frequently asked question of aspiring traders is "How much money can I make?" Unfortunately there's no easy answer, because it depends how much you are willing to risk.
Trading is a function of risk and reward: The more you risk, the more you can make. Here's an easy example: Let's say you start with a $5,000 account and you're willing to risk $1,000. Now you could place a trade to go long at the opening, set a profit goal of $1,000 and a stop loss of $1,000. Let's say you investigated the market behavior in the past couple of months and realized that your chances of achieving your profit goal are 60%.
Unfortunately the trade you just placed is a loser, and you lose the whole $1,000. Since this was the amount you were wiling to risk, you close your account, transfer the remaining $4,000 back in to your checking account and that's it for you.
Now let's assume you wanted to risk only $100 per trade and you adjusted your profit goal to $100, too. Now you can make at least 10 trades, because only if all 10 trades are losers you'll lose the $1,000 you are willing to risk. I don't want to become too mathematical, but statistics says that the probability of having 10 losing trades in a row is less than 1%. Therefore it's highly likely that you will have a couple of winners within the 10 trades. If your trading system shows the same performance as it did in the past (60% winning percentage), you should make $200: 4 losing trades * $100 = -$400 + 6 winning trades * $100 = $600. Make sense?
Compare these two options:
The risk of losing your money in scenario 1 is 40%. But if you won, you would have made $1,000.
In scenario 2 the risk of losing your money after 10 trades is less than 1%, but you have a fair chance of making $200. Therefore you need to define first how much you are willing to risk, since the amount you can make is a function of that risk. Make sense? I'll give you more specific examples later in this chapter.
Keep in mind that there's a difference between the amount you need to trade and the amount you're willing to risk. Your broker is always asking your for a "margin", and you need to fund your account with that margin requirement + your risk. In our previous example you funded your account with $5,000, but you only risked $1,000. More on that later.
50:1 Leverage: what does it mean?
With a minimum account of USD 10,000, for example, you can trade up to USD 500,000. The USD 10,000 is posted on margin as a guarantee for the future performance of your position.
The AUD/USD rate is quoted at '0.7500/04'. This quote represents the bid/offer spread for AUD vs USD. The offer rate of 0.7504 is the rate at which you can purchase AUD (or BUY AUD and SELL USD). The bid rate of 0.7500 is the rate at which you can Sell AUD to buy USD.
You believe that the Australian Dollar will strengthen against the US Dollar, and decide to BUY or 'go long' A$100,000 @ 0.7504 (the offer price).
Quote (bid/offer) 0.7500/04
Buy Price 0.7504
Initial Outlay (1% margin) A$1,000
In the example above you have purchased A$100,000. But because FX is traded on margin with CMC Markets you will only need A$1,000 (1%) to maintain the same market exposure.
The risk on this AUD/USD trade is equivalent to US$10 per each point movement. Each point is valued at 0.0001. For example if the AUD/USD rate moves from 0.7504 to 0.7505 you will receive a profit of US$10.
Your prediction is correct and the Australian Dollar appreciates against the US Dollar. The quote on AUD/USD is now 0.7590/94. To close your position, you decide to SELL A$100,000 @ 0.7590 (the bid price).
Quote (bid/offer) 0.7590/94
Sell Price 0.7590
Profit/Loss US$860 Profit
Your profit and loss is usually calculated in the secondary currency. Therefore the above AUD/USD trade profit/loss is calculated in US Dollars. With CMC Markets no brokerage or commission charges will be subtracted from your gross profit. You will only be charged a financing cost if you hold your position overnight.
Size of trade x (sell price - buy price) = profit & loss USD
100,000 x (0.7590 - 0.7504) = US$860 profit
Or, converting the US$860 back to A$ at a rate of 0.7590
(Profit/loss ? AUD rate) = profit & loss AUD
(860 ? 0.7590) = A$1,133.07 profit
By closing your position you realise a gross profit of A$1,133.07
If you anticipated incorrectly and sold AUD at 0.7500 and later bought AUD at 0.7594, a loss of US$940 would have been experienced.
If you want to buy/sell a specific amount of GBP, first enter the symbol GBP as the transaction currency. Then choose USD as the settlement currency from the drop down menu. You will then receive the quote USD/GBP, e.g. Bid: 1.5300 Ask: 1.5310
This means that GBP 1 = US$1.53XX
If you want to buy GBP 10,000, click on the ask and enter 10,000 as the quantity of GBP that you wish to buy. You will pay $1.5300 for each GBP. Thus, you will pay $15,310.
If you want to sell GBP 10,000, click on the bid and enter 10,000 as the quantity of GBP that you wish to sell. You will receive $1.5300 for each GBP. Thus, you will receive $15,300.
If you want to buy/sell a specific amount of USD. First enter the symbol USD as the transaction currency. Then choose GBP as the settlement currency from the drop down menu. You will then receive the quote GBP/USD, e.g. Bid: 0.6530 Ask: 0.6536
This means that USD 1 = GBP 0.653XX
If you want to buy USD 10,000, click on the ask and enter 10,000 as the quantity of USD that you wish to buy. You will pay GBP0.6536 for each USD. Thus, you will pay GBP 6,536.
If you want to sell USD 10,000, click on the bid and enter 10,000 as the quantity of USD that you wish to sell. You will receive GBP0.6530 for each USD. Thus, you will receive GBP 6,530.