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TradingCurrencyOnline.com presents...
The Mechanics of FOREX
How money is made...and lost.
We continue
our FOREX trading education with the mechanics of
how money is made and lost trading FOREX.
As with most
any other investing endeavor, you want to obtain
something that will increase in value at which time
you can sell and make a profit.
Hence the
old adage, buy low and sell high. FOREX trading adds
a new twist to this old financial proverb because
when trading the FOREX, you can just as easily make
money…
Selling
high first and later buying low
In other
words, it does not matter if the price is going up
or down, there is an opportunity for profit.
When you
trade currency online, you need to determine whether
you are going to be a BULL or a BEAR.
Being a Bull
just means that you expect that prices are going to
go UP and of course that means that if you take a
bearish position, you expect that prices will be
going DOWN.
This
terminology is the same for most any financial
market.
As a FOREX
trader there are several tools at your disposal to
help you determine whether whether you will want to
be a Bull or a Bear of which we will discuss in
other lessons but for now let’s play the Bull role
and enter a trade.
Because we
have a bullish view of the market, in this case the EUR/USD, we expect that prices are going to rise so
our objective is to buy low and wait for prices to
go up at which point we can sell and make a profit,
hopefully.
When we take
a bullish position, also referred to as taking a
“LONG” on the EUR/USD currency pair, we will be
BUYING Euro and SELLING the US Dollar.Whenever you
buy one currency in the pair, you are simultaneously
selling the other, and vise versa.
Remember
from earlier lessons that in the case of EUR/USD,
because the Euro is on the left hand side of the
forward slash, it is the BASE currency for this
pair. The price scale on the right-hand side of
FOREX charts represents the currency on the right
hand side of the forward slash, in this case the US
Dollar.
Because the
price on a EUR/USD chart represents how many US
Dollars it takes to buy one single Euro, the higher
the price goes, the “weaker” the dollar gets.
It also
costs Americans more to travel to Europe!!
So anyway we
have decided to become a Bull and take a "long"
position in this EUR/USD trade,
let's check it out...
# 1 –
Price has broken through the down trend line so we
decide that there is a high probability that the
price is going to continue up. More on trend lines
in later articles.
#2 –
We place a buy order with our broker which is
automatically executed through our trade station.
We enter the
market at $1.1950
Because we
are buying the EUR/USD pair, we are actually buying
Euros and selling dollars because we believe the
Euro is going to appreciate in relation to the
dollar.
#3 –
The Stop-Loss
A stop loss
is a buy or sell order set at a predetermined
location that acts as a safety net limiting your
risk in case the price does not go the way you
expect it to.
There are
many different methods for determining how and where
to place the stop loss, but if there was ever one
rule you should live by when trading, it would be…
NEVER EVER trade without
a stop loss order in place.
One
method for determining the location of a stop
loss when buying is to place it under the last low
which is the method used in this example.
So we enter
the market at 1.1950 and place a stop loss order at
1.1700. This means we have determined that 250 pips
( 1950 minus 1700 ) is an acceptable risk on this
trade. If you are trading a FOREX mini account 250
pips (Price Interest Points) would be $250.00.
If the price
does not go up, but instead goes down, when it hits
your stop loss order it is automatically executed
and you are taken out of the market at your
predetermined loss.
Of course
you could lessen your risk and place your stop loss
only 50 pips or even 30 pips or less below your
entry price. But as we will see in later articles,
price usually does not go straight up or down but
instead it waves up and down so if you place your
stop to close to your entry point and the price
waves back down a little before continuing up, it
could hit your stop loss if it is set to close and
take you out of the market at a loss just before
price continues in your anticipated direction.
# 4 -
It is often said that exiting the trade is harder
than entering. Think about it, you are in a
profitable trade and the question now is where do
you get out? What if price turns around and starts
to go against you? How much of your profits are you
willing to give up before you exit? What if you
panic too soon and exit just as the price turns your
way again and climbs 80 more pips?
There are
many methods to determine when you should exit, in
our simple example we will connect the price lows
with a line creating a up trend line. Once price
starts to trend, which will be discussed in later
articles, it usually continues in that direction for
some time.
When the
price completely breaks through a trend line, the
chance of a reversal is high so that is usually
considered a good time to get out of the market.
The trend is
no longer our friend but has come to an end so it’s
time to bail out.
In this case
we exited at 1.2650
#5 –
We can see from the TIME scale at the bottom of the
chart that this trade lasted 30 trading days. A
trade that lasts this long is called a POSITION
trade.
While we are
on the subject, the different types of trades are:
Position
Trade – A trade that lasts several days to weeks or
even longer.
Swing Trade
– A trade that lasts one day to several days
Day Trade –
A trade that lasts less than one day. Day traders
may trade several times in one day.
Which type
of trader you are will depend on your personality,
style, objectives, etc.
So let’s
look at our trade –
Entered the
market at 1.1950 on a trend line break – we bought
Euros
Exited the
market at 1.2650 on a trend line break – we sold the
Euros which increased in value 7 cents
Total pips =
700
On a mini
account that would be a profit of $700.00
On a full
size account that would be a profit of $7000.00
That is a
simple example of how you make money going “long” or
by being a “bull.”
The next
page will give an example of a "bear" trade or going
"short."
NEXT >>>
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