Forex Tutorial

This forex tutorial will have you understand the basics of forex, which is the first step if you want to learn forex trading.

After you have grasped the basics, you’ll find it easier to start to assess how good a forex trading system is, when you go to sites which offer forex systems through forex training and courses that are currently available.

As an alternative to learning a forex system yourself, consider checking out the new areas of forex signals, and automated forex through a managed forex account, where the trading is done for you. For some people, this is something that would suit them just fine.

But let’s get back to our tutorial on forex basics.

Because whichever type of forex currency trading you choose to get into, you must first understand these forex basics.

If you have traded shares, CFDs (if they’re available in your country), options, warrants or commodities before, you may know some terminology already. But there are some important forex terminology which you must understand, in order to pick up the skills of trading forex easily.

So let’s jump straight in to

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Currency pairs

Forex trading is done on currency pairs. There are many traded currencies around the world, but the four “major” currency pairs which are the most traded, are:

• EURUSD

• GBPUSD

• USDCHF

• USDJPY

When you see a currency price on a chart, it is quoted as a currency pair, and relates how much one unit of the first currency (called the base currency) will buy you in the second currency (called the terms, or counter currency).

So for example, if the EURUSD chart is showing a price of 0.9780, this means that 1 euro will buy you 0.9780 US dollars.

As another example, for the USDCHF with a price of 125.10, 1 US dollar will buy you 125.10 yen.

This is important in a moment when you work out whether you want to buy or sell the currency pair, and what the profit and loss will be, if the trade goes in your favour or against it. We’ll come to this in a moment.

For now realise that when you’re buying say the EURUSD to enter into a long position, that you’re buying the base currency, which is the EUR, and are at the same time selling the terms currency, which is the USD. When you’re selling the EURUSD to enter a short position, then you’re selling the base currency which in this case is the EUR, and at the same time buying the USD.

Also realise, that when you’re buying a currency pair (say the EURUSD) to enter a long position, that you’re looking for the chart of that currency pair (EURUSD) to go up, in order for you to make a profit on the trade. That is, for the EUR to strengthen against the USD. Similarly for a short trade on the EURUSD, you’d want the chart to go down, for you to profit on the trade. That is, for the EUR to weaken against the USD.

There are many other currency pairs available, with some being more liquid and more popularly traded than others, such as the USDCAD, or the AUDUSD.

Some currency pairs are referred to as “cross rates” because they don’t involve the USD, such as EURGBP, EURCHF, EURJPY etc.

And some are called the “exotics” because they involve currencies that are not popularly traded, and therefore have much less liquidity, and they typically also have much bigger spreads.

Face value

When you’re trading a currency pair, say the GBPUSD, the amount that you’re trading, is referred to as the face value. And the face value refers to how much of the base currency that you’re trading. So for example, if you want to buy 100 000 GBPUSD, you are in fact buying 100 000 pounds.

So if your account was in US dollars, then the amount that this position would take up in your account, would be however much 100 000 pounds is equivalent to in US dollars at the time. Eg if the GBPUSD rate was 1.8990, then this would be $189 900 USD.

On the other hand, if you buy say 100 000 USDJPY, then you are buying $100 000 USD, as the USD is the base currency. So in this case $100 000 USD is your face value.

Doing a trade of 100 000 in face value, is also known as 1 “standard contract”. Your forex trading platform however will probably ask you for how much face value, rather than how many standard contracts, you want to trade.

Pips

What are pips? When the chart for a currency pair goes up or down in forex trading, the amount that the price goes up or down is described in pips (or points).

And 1 pip refers to a movement of 1 in the last decimal point in the currency pair.

For example, for the EURUSD, if the price is currently 0.9780, and moves up to 0.9785 , this is a 5 pip move. If you buy at 0.9780 and sell at 0.9820, then this is a 50 pip profit.

Note that the USDJPY rate has 2 decimal points only, rather than 4 for currency pairs not involving the yen. But 1 pip, as mentioned, is equal to a movement of 1 in the last decimal point. So a 25 pip move will be a move from say 125.20 to 125.45.

Now when you make say 50 pips on a EURUSD trade, realise that the 50 pip profit is in the terms currency, not the base currency.

So, if you’re long the EURUSD, this means you are buying the euro, as we mentioned before. And if you make a 50 pip profit, the profit is in $USD. The reason is this, when you buy say $100 000 worth of EURUSD, you have bought $100 000 worth of euros and sold an amount of USD to get this $100 000 worth of euros. After a few hours, the EURUSD has gone up from say 0.9750 to 0.9800. When you exit the trade, you’re then selling the euro and buying back the USD. But because the rate has gone up (the euro has strengthened), you have bought back more USD, in fact 50 pips more USD.

So the short cut to remember this is:

a) When you buy or sell a currency pair to enter the trade, the face value is in the base currency.

b) When you have a profit or loss as you exit the trade, the number of pips is in the terms currency.

Now, let’s go on…

So how do these 50 pips relate to dollar profits?

Your profits in dollars depends on a) your trade size, and b) the terms currency of that currency pair.

For currency pairs where the terms currency is the USD, a 1 pip profit relates to a profit of $10 USD, for every $100 000 worth of face value.

That is, $100 000 USD x 0.001 = $10 USD. So if you traded $100 000 of EURUSD or other currency where the terms currency is the USD, then 50 pips would be $100 000 x 0.005, which is $500 USD profit. Of course, if you traded only a $10 000 face value, then the 50 pips would be a $50 USD profit.

For currency pairs where the USD is not the terms currency, the value of a pip will not be in USD, but will be in whatever the terms currency is. So if you want to know what it is in USD, you’ll have to convert it to USD from that terms currency.

This can be summarised as...

To work out how much a pip profit is when trading a different face value to 100 000, you simply adjust the numbers in proportion to the face value. So if you're trading a face value of 50 000 instead of 100 000, then each pip profit on the GBPUSD will be 5 US dollars.

So this is how pips relate to profits. If you want to find out about how trade sizes or face value for systems are worked out in the first place, see the page on forex money management for more information.

Spread

Most traders will be familiar with the concept of the spread. If you’ve never traded before, then you’ll need to understand this term.

In forex trading, like in other types of trading, the spread refers to the difference between the bid and ask (or offer) price of a currency pair at any one time. For example, for the GBPUSD, the bid and the ask may be:

Bid price: 1.9022

Ask (or Offer price): 1.9026

The ask (or offer), which is the higher price, is the price that you pay if you want to buy the currency pair. The bid, which is the lower price, is the price that you’ll get if you want to sell the currency pair. The difference between these two numbers is the spread, which in this case is 4 pips.

So if you bought the GBPUSD now and then sold immediately and the bid and offers were the same, then this would result in a 4 pip loss. So if you’re long this position, the currency will have to go up beyond 4 pips to be in profit.

And the reason for the spread?

It is the way the market makers make money, and you’ll encounter the spread in all types of trading. There are also other ways market makers make money, such as ticket fees if you trade below a certain face value, depending on the market maker. In the forex trading market, there are many, many different forex trading brokers or market makers. And each one will set their own spread.

But for the major currency pairs, as well as for other popular currencies, there won’t be a very large difference in the spreads between different providers. There may be 1 or 2 pip differences for the majors and perhaps 1 to 4 pip differences for other currency pairs. So the different brokers will make some difference here. Have a look at the discussion on forex brokers to find out more about how to choose between brokers.

Margin

Forex is traded on margin. That is, you can make use of leverage. And margin requirements vary from 1-4% generally. If the margin requirement of your forex broker is say 1%, this means that with a starting capital of $1000 in cash, the total value that you can trade with is $100 000. That is, you are using 100:1 leverage.

If your provider requires 2% margin, then you would need $2000 in order to trade the same amount of $100 000. What this means is that you don’t need a massive float in order to gain decent profits in forex. This is one of the factors that have made forex an effective trading vehicle for many people.

Note that whenever you’re trading with margin, you have to be responsible, and use appropriate money management rules. If you have insufficient funds to maintain your margin requirements, then you’ll get a margin call. This applies to all types of margin trading, including forex.

Lets’ say that your leveraged float is $200 000 USD, from a cash float of $2000 USD, with a 1% margin requirement. And let’s say that you take a trade with a face value of $100 000 USD, for example, you buy the USDJPY, and so you use up $1000 worth of margin. This $1000 is “held” as margin for this trade, so you have $1000 margin remaining. If the trade goes against you by $1000 USD (100% of your remaining cash float), this will mean that you have no spare margin at all, and you’ll get a margin call for more funds to be deposited to your account.

If no funds are provided, the market maker will usually close out the position for you because you have used up your remaining available margin of $1000. The funds that remain will be the funds “held” as margin, which was $1000. This is an example which reflects inappropriate money management or not putting in a stop loss.

This is why it’s important to be fully aware of using money management models to handle risk, in order to not have such relatively large losses from only 1 trade.

Note that margin requirements will typically be higher on weekends. For most providers, the margin requirements may go from, for example, 1% to 2%, or 2% to 4%. This is because gapping may occur on weekends. The increased margin requirements will have a bearing especially if you’re in many open positions at once, over the weekend. In many forex systems, you may not be holding positions over the weekend anyway, or you’ll be exiting the position on Friday night and re-entering on Monday when the market re-opens, if this is in your forex system rules.

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