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The Name of the game is to protect your capital and to profit from any currency inefficiencies. Trading the Forex market is certainly not easy and it requires a maximum degree of understanding and discipline.

Introduction to Foreign Exchange

Foreign Exchange or Forex or Fx refers to a financial market where currencies are traded one for another. Forex is a huge global market with 4-5 trillion USD turnover in a daily basis. The world's largest Forex trading centers are London, New York, Singapore, and Tokyo.

Participants in the Global Forex Market

There are various players in the Forex market, from banks and institutional investors to interest-rate speculators and intraday traders.

Here are some categories from those executing regular transactions in the global Foreign Exchange Market:

(1) Central Banks, Commercial Banks, and Investment Banks

(2) Large Retail Companies (Importers/Exporters)

(3) Forex Brokers (ECN and STP Brokers)

(4) Institutional, Private, and Individual Investors

(5) Retail Traders

(6) Tourists and other Travelers

Why the Forex Market Attracts Investors?

Investors are participating in the Forex Market due to 3 main reasons:

(i) Hedging (Open positions in the Forex Market in order to eliminate the risk deriving from the usage of other Financial Instruments)

(ii) Speculation (Buying/selling currency pairs in order to make quick profits -Speculation strategies can be implemented manually or automatically via Expert Advisors)

(iii) Investing on Interest Rate Differentials (Taking advantage of excessive differences between the interest rates of two economies -Carry Trading)

 

Most Traded Currencies

Individual Currencies

The following table presents the most traded Forex Currencies. The US Dollar is involved in 87% of all Foreign Exchange transactions.

Table: Most commonly traded Forex Currencies (Source: BIS)

Forex Currency

% in Aggregate Daily Volume

US Dollar ($)

87.0%

Euro (€)

35.0%

Japanese Yen (¥)

23.0%

British Sterling (£)

12.0%

Australian Dollar ($)

8.5%

Swiss Franc (Fr)

5.0%

The Most Traded Currency Pairs

The most traded pairs enjoy higher liquidity and thus considerably lower spreads.

Forex Pair

Symbol

Daily Volatility (1)

Compare Spreads (2)

US Dollar against the Euro

EURUSD

0.87%

0.5 - 1.4 pips

US Dollar against the Japanese yen

USDJPY

0.87%

0.7 - 2.0 pips

British Sterling against the US Dollar

GBPUSD

0.78%

0.7 - 2.5 pips

US Dollar against the Swiss Franc

USDCHF

0.95%

1.0 – 3.0 pips

Australian Dollar against the US Dollar

AUDUSD

1.08%

1.3 – 3.0 pips

US Dollar against the Canadian Dollar

USDCAD

0.77%

1.5 - 3.0 pips

New Zealand Dollar against the US Dollar

NZDUSD

1.17%

2.0 – 4.0 pips

(1) Based on TradingCenter.org research (2000-2013)

(2) Based on Estimations (Zero-Commission ECN Account)

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Time Frames & Trading Styles

Based mainly on timeframes used, all Forex traders are categorized in 3 main trading styles:

(a) Intraday Traders / News-Traders

  • Time-Frame: Some minutes to several hours
  • Risk: High/Very High
  • Leverage: 50:1 up to 500:1

This type of trading means Buying and Selling Currencies intraday via manual or automated methods. The target profit and stop-loss orders are placed very tight. This category of traders is highly exposed to market risk and market noise.

(b) Swing Traders

  • Time-Frame: 2-7 days
  • Risk: Medium/High
  • Leverage: 10:1 up to 50:1

Swing traders are targeting mid-term trends in the currency market. They usually follow strong trends but sometimes they may trade price reversals. Swing Traders mainly avoid upcoming news and place their stop-loss very wide in order to avoid the annoying market noise. Swing traders are exposed to medium risks and many times they prove very profitable traders.

(c) Long-Traders / Carry-Traders

  • Time-Frame: 2 weeks to 6 Months
  • Risk: Medium/Low
  • Leverage: 1:1 up to 10:1

This type of traders is targeting long-term trends or seeking to exploit excessive differences in the level of interest rates (carry-trading). Long traders are risk-averse and ignore completely market noise.

 

The Hazards of High Capital Leverage

Two simple features are distinguishing the Forex market from other large financial markets:

(1) Huge liquidity which is translated into low spreads (the distance between buyers and sellers)

(2) Enormous Capital Leverage (up to 1,000 times)

Forex trading offers minimal spreads and that enables the use of high leverage (50:1, and up to 1,000:1).

Here is how these two characteristics are linked to its other:

The more we leverage our positions two things happen:

(i) Our profit and risk potential are leveraged too

(ii) Our trading cost is leveraged too

■ Higher Leverage = Higher Profit Potential / Higher Loss Potential + Higher Trading Cost

High capital leverage should be used avoided, especially when trading Minor or Exotic pairs. Trading pairs such as USDNOK or NZDTRY using high leverage will probably lead to great losses.

 

The combination of frequent trading and high leverage is catastrophic as it leads to a great trading cost.

  • High Leveraged Trades
  • Many Daily Trades

This means that your broker wins money from your volumes and you probably lose everything in a matter of time.

“Frequent Trading and High Leverage is the shortest way to Lose your Capital”

The Name of the game is to protect your capital and to profit from currency inefficiencies. Trading the Forex market is certainly not easy and it requires a maximum degree of understanding and discipline.

 

Trading Cost Sources

When you trade Forex you must be extremely careful on what you pay. The trading cost will prove more than important especially for those executing a great number of trades in a daily basis / and or use high leverage. Here are all charges when trading Forex:

Trading Spread

The difference between ask and bid, the most liquid assets enjoy the narrowest spreads.

  • Ranging: For example, on EURUSD, the spread ranges from 0.25 to 3 pips (1 pip = 0.0001)

Trading Commissions

Forex Brokers usually charge commissions in zero-spreads accounts.

  • Ranging: from zero to $45 per standard lot (1 standard lot = $100,000)

Deposit / Withdrawal Fees

Usually depositing and withdrawing funds is free but some brokers may charge such fees

  • Ranging: Zero to $20-$30 USD only on withdrawals

Inactive / Maintenance Fees

Only a few Forex Brokers charge such fees for Non-Active Accounts

  • Ranging: Usually $30 every 3-months for inactive accounts

Overnight Rates / Swaps

This charge is taking place if we keep our position overnight. It is a rather complex issue that involves the level of the interest rate of the two currencies forming a pair.

  • Ranging: It may have a positive or a negative effect on a trading account

 

Trading Strategy and Money Management are the Keys

An effective trading strategy and strict money management are the two keys when trading online:

-Trading Strategy

Every trader must design and implement a trading strategy. An effective strategy must include specific goals, trading setups, loss-limit rules, etc. Most importantly, a strategy must reflect each trader's individual risk profile.

-Money Management

Effective Money management starts when we realize that when we are trading we are exposed to high levels of risk. The second step after realizing the risk exposure is to take measures against it. The most important issue here is to use capital leverage wisely and furthermore to leave sufficient space for your stop-loss orders. Here are some basic mechanisms:

Measuring the Risk Exposure with Accuracy (Potential Loss plus your total Trading Cost per lot)

Taking Measures against High Risk-Exposure

Leveraging Trades wisely (50:1 is usually more than enough)

Placing always a Stop-Loss (Place stop-loss at the right levels and avoiding the annoying market noise)

Choosing only trades with high Profit/Loss Ratio (that means the potential winning pips are at least 2 times the potential losing pips)

Running Profits without hesitations

■ Cutting Losses whenever necessary

Withdraw some funds when achieving profits more than 100%

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George Protonotarios

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