To novice investors, the world of investment can seem complex and mysterious, fraught with volatility and unanticipated investment twists and turns. Surely, one of the most tantalizing investment options available to small and larger investors alike is margin trading in forex.
While forex seems complex, particularly the jargon used to describe how it works, once you understand how the market works, it becomes an interesting option for investing. However, like many forms of investment, when it is broken down into its elements and the different strategies used in trading forex become clear, it is suddenly a lot more accessible. Whether you prefer to be a long-term forex investor or have a passionate desire to learn short-term day-trading, there is a forex strategic suitable for whatever your investment objective.
Entry Level Strategies
Two of the most common entry-level forex trading strategies are tracking daily or weekly forex trends.
Tracking Daily or Weekly Trends
This is one strategy that represents a fairly simple entry point into the forex trading system. You focus your trading activity on tracking the daily or weekly trends and identify an emerging trend that holds the potential for profit. Review the daily and weekly forex charts for a trend that seems to be supported by the overall market and follow the market. One caveat about tracking the daily or weekly trends as an effective forex trading strategy is that movements that look small on the forex chart can span 100’s of pips (or price interest point”. A pipe measures the amount of change in the exchange rate for a currency pair. One pip is equal to 0.0001). Hence, your trades need to be small. Be conservative when you buy in and allow your trade to develop. Always set a “stop” trigger point and plan your investment target.
Investors new to forex trading find tracking daily or weekly trends as a strategy more convenient as they don’t have to watch the market continuously. Rather, they can trade when they have time available.
Carry Trading involves buying and holding a currency that is paying a high-interest rate against a currency that has a lower interest rate attached to it. Each day a rollover is paid for the interest differential between the two matched currencies.
The advantage of this strategy is that even when your trade is static, money is deposited daily into your account courtesy of the difference in interest. Similarly, since the majority of forex trades are leveraged, your payment reflects the size of your trade, not the limitations of your capital. The downside to a carry trade strategy is the degree of risk inherent in the forex trading position.
Moreover, currency pairs that represent good options for a carry trade strategy generally typically respond strongly to any downside risk news that hits global markets. Hence, while market conditions are good, these forex pairs will rise in value and reliably pay their interest differential. However, if unexpected bad news breaks, these currency pairs will plunge very quickly and steeply! In this situation, if you are overleveraged, your trading account will be exposed.
Advanced Forex Strategies
Like most capital markets, the international forex market is ceaselessly trading somewhere in the world, 24 hours a day, 6 days a week. While peak market periods are clear, the forex market itself is always ticking over, even if the movements appear small. Depending on what currencies you like to trade, these movements allow you to be selective about when you choose to trade.
The majority of day trading strategies are focused on a complex real-time analysis of forex currency patterns. This technical aspect of the forex market enables day traders who identify a pattern to take a profitable position based on short-term currency movements.
While the world of day trading increasing revolves around running complex analytical algorithms to detect trading opportunities, some forex investors prefer to invest in a currency’s fundamentals, rather than be driven by movements on a forex chart. Essentially, fundamental forex trading is based on an assessment of the economic outlook of countries with robust or strengthening economic performances and outlooks, compared to struggling countries with weakening economic outlooks.
This strategy is less dependent on access to high-performance analytic software programs instead, looking at market intelligence on the more long-term underlying economic indicators for a country. However, this does involve having access to accurate economic reports and indicators and being able to analyze the reports and compare them to competing countries.
One of the aspects of the forex market that makes it accessible to smaller retail traders is the industry’s high leverage options. Leverage provides a trader with the means to increase the potential return on an individual investment. However, leverage works both ways. While it increases potential returns, it also exacerbates potential losses. Therefore leveraging a forex position like any investment magnifies both potential gains and potential losses.
Leveraging a forex position requires depositing initial collateral, called a margin, in order to adopt a position that exceeds the value of the investor’s underlying investment capital. Currency pairs are conventionally traded in standard lots of 100,000 units or alternatively mini lots of 10,000 units. Consequently, a trader buys 100,000 of a base currency and simultaneously sells an equivalent number of units of the paired currency as set by the prevailing exchange rate at the time of the trade. For example, if an asking price for EUR/USD is 1.2500, 100,000 Euros are purchased, and 125,000 Dollars are sold. For a standard contract involving the USD as a counter currency 1 pip equals $10 ($1 for a mini lot).
While some of the investment thresholds represented by these trades may seem intimidating to retail traders, trading modernization induced smaller retail forex traders to be involved in the Forex market by permitting high-leverage trading. A stockbroker may offer a client 2:1 leverage facility. Hence, the investor would require $500 in their account to make a $1,000 trade. In the Forex market, leverage ratios of 50:1, 100:1, or 200:1 are not uncommon. A leverage of 100:1, requires just $1,000 to purchase one standard EUR/USD lot. This leverage enables a Forex trader to increase their prospective profits from a given price movement, while losses are also similarly magnified.
High-leverage margin trading is a distinguishing feature of the retail forex market compared to other investment sectors. These margin trades are possible due to the typically small daily movements in mainstream currencies. A one-cent (or approximately 100 pip) movement in a currency’s value is considered a substantial change. The small scale of typical Forex movements enables dealers to limit the amount of collateral they are obliged to tie up to support a given forex position.
Should the market shift against a trade position triggering losses that exceed the trader’s margin, an automatic margin call is activated to offset the losses. The forex dealer will close the trader’s positions, limiting the client’s losses.
While the Forex trading market can feel complicated to new investors, it’s an investment market that anyone with discipline, patience and the ability to learn quickly from their mistakes can acquire some skill in over time. To be a successful forex trader demands persistence, regardless of your investment strategy. Smart investors will always keep one eye on the big political and economic picture, and trade conservatively in the beginning. It’s also wise not to invest those forex day trading systems so popular on the Internet until you have gained experience in how the market operates.