The purpose of Forex trading is to make money and diversify your investment portfolio. The mechanism is very simple. You purchase and sell different currency pairs. If you purchase a currency and its price increases, you can sell it at a profit. In this case, you sell the base currency and purchase the quote currency. The value of a currency in the pair purchased is compared with the value of the other. Therefore, there is a close relationship between them. The currencies are always bought and sold in pairs. In practice, when you trade in the Forex, you exchange one currency to another, expecting the price of the purchased currency increases compared to the price of the currency sold. A position is called long when you want to purchase the base currency and sell the quote currency. It is called short when you want to sell the base currency and purchase the quote currency.
If you buy a base currency and you hold it for a while, you have an open position. Its value changes depending on the fluctuations in market interest rates. The trade of the currency pairs is simultaneous and symmetrical. This means that you will be always long in one currency and short in another.
The unit used to measure the size of transactions in the Forex is the lot. In general, brokers recommend two types of account: standard and mini. The size of a standard lot is $ 100,000, while the size of a mini lot is $ 10,000. There are also brokers that allow you to open micro accounts and nano accounts. The size of a micro lot is $ 1,000, the size of a nano lot is $ 100.
We often talk about trading on margin, which is equivalent to borrow money from a bank or a broker to buy a currency pair. The margin depends on the leverage offered by the broker and represents the guarantee required to control a certain amount of money. For example, if you use a 100:1 leverage, you can control a lot of $ 100,000 with only $ 1,000 on the margin. A higher leverage allows you to control greater amounts of money, but this is dangerous as it can generate significant losses.
The so-called levels of stop-loss and take-profit are commonly used in the various trading strategies. They can be set when you open a position, or subsequently. You can cash partial profits or move the entry prices, waiting for stop-loss or limit orders. These are different ways to manage trading.
A position will be automatically closed to the achievement of the levels of stop-loss or take-profit previously set up. It can also be closed manually through the platform provided by the broker. When you close a position manually, you are subject to the same condition as when you open a position at the market price, such as re-quotes, if the prices have changed. Positions may also be closed by opening an opposite position on the same currency pair. For example, if you open a long position on a lot of a certain currency, you can close it by opening a new short position on a lot of the same currency.
The pip is the smallest price movement of a currency pair. Its value depends on the currency pair traded and the respective exchange rates. Only in the case when the pair contains the dollar as the quote currency, the pip value is always the same. To calculate the loss or gain of a particular operation, it is necessary to establish the value of a pip and multiply it by the variation of pips that the pair has undergone. If the price of the base currency increases relative to the quote currency, you will get a profit equal to the difference between the current value in pips and the value in pips at the time when the base currency has been bought.
It is important to point out that if the quote currency is the dollar, the value of one pip is always equal to 0.0001 U.S. dollars for every dollar traded.
The value of one pip is generally calculated in U.S. dollars, as this is the main currency used in most trading accounts. However, some brokers allow you to open accounts in local currency. In this case, the calculation of the value of one pip must take account of exchange rates.
A market order is an order to buy or sell a particular currency at the current market price. This type of order should be used with caution, since in highly volatile markets there may be a difference between the price seen at the time when the order is given and the actual price of the transaction. This phenomenon is called slippage. It is the difference between the estimated cost of the transaction and the amount actually paid. Slippage can cause a loss or a gain of several pips.
A limit order is the order to buy or sell a given currency when the price reaches a specified limit. It is commonly used to buy a currency below the market price or sell a currency above the market price. In case of limit orders there is no slippage. This type of orders contains two variables, price and duration. The trader specifies the price to buy or sell a certain currency pair and the period of time in which the order should remain active.
A stop-loss order is commonly used to limit losses if the market moves in the opposite direction to that expected by the trader. The latter establishes a minimum level of price to the achievement of which the position will be closed. It contains two variables, price and duration. The main difference between a limit order and a stop-loss order is that stop-loss orders are used to limit a potential loss while limit orders are used to enter the market at the best time.
The OCO orders (One Cancels The Other) allow simultaneous use of a limit order and a stop-loss order. If either is executed, the other is canceled. This allows the trader to make a transaction without monitoring the market.
The concepts above are very important. A beginner should study them before opening a position in the Forex. In the currency market, such as in all financial markets, it is very easy to lose money. The study of fundamental concepts, together with a period of training on demo platforms, is a must for each investor.