Pluses And Minuses In Forex Trading

Pluses And Minuses Of Forex Trading

Economic factors Forex Trading that affect the value of currency include trade (imports and exports), employment, manufacturing, and a country’s interest rates. The knowledge of how market forces influence the behavior of a particular currency is crucial. 

This is particularly so as you forge ahead on your path to making money through forex trading. An investor looks at the prospects of the weakening of an economy. For instance, upon observations, a trader may establish that the US economy is likely to weaken because of some of the factors mentioned. As such, he may purchase Euros with the expectation that as the dollar weakens, the value of the Euro will rise.

Take the following example. Based on the synopsis given, this section will focus on the EUR/USD currency pair. Presently €1 is equal to $1.1100. If a trader purchases €10,000, he/she will have spent $11100. Due to the weakening mentioned above, the exchange rate is bound to change in the coming weeks. For instance, if the investor holds this position for three weeks, €1 will be equivalent to $1.3000. The forex trader may choose to sell his €10,000 by subsequently buying US dollars.

In exchange, he/she will receive $13,000. Over the three weeks, he will have made a profit of $1,900 (+$1,900). Also, the value of his initial investment may drop if the assessment regarding the weakening of the US economy was wrong. For instance, if the new exchange rate after three weeks will be 1.0500, the trader, upon selling his €10,000, will receive $10,500. He/she will have lost $600 (-$600).

This informs the disclaimer that brokers give. However, the availability of other currencies cushions such an investor since he/she may choose to focus on another currency pair. Notably, maintaining the status quo for a given period after making an initial investment is known as position trading. The tables below give the overview if a trader uses $100.

Profit Representation Using $100

  EUR USD
EUR/USD = 1.1100 (Presently) +90.09 -100*
EUR/USD = 1.3000 -90.09 +117.1**
Profit   5.41

 

* - Represents selling

** + Represents buying

Loss Representation using $100

  EUR USD
EUR/USD = 1.1100 (Presently) +90.09 -100
EUR/USD = 1.0500 -90.09 +94.59
Loss   5.41

 

This possibility for losses informs the requirement that a beginner should always use the available analytical tools prior to deciding to buy or sell a currency. Also, knowing when to trade is an essential prerequisite to making money in the foreign exchange market. The anticipation for the depreciation of a currency relative to another is referred to as speculation. The potential for losses makes forex trading a substantially risky venture, particularly when the investor spends a large amount of money. Nonetheless, the enormous risks also imply that the likelihood of making money (gains) is also considerable. Moreover, you should take note of some special terms and points that will aid in the seamless execution of your trading.

They are summarised in the list below:

Base and Quote Currency

In the example detailed above, the EUR/USD currency pair was used. In forex terms, the exchange rate stated above would be represented as “EUR/USD = 1.1100”. In the example, EUR is the base currency, while USD is the quote currency. In this regard, an exchange rate refers to the ratio of the base to quote currency. The figure (1.1100) shows the number of units of the quote currency that constitute one unit of the base currency.

Bid and Ask Price

A broker provides two values for a particular base currency and currency pair. The bid price relates to the amount at which a seller can trade the base currency. The ask price refers to the price at which an investor can buy the base currency.

Spread

The spread refers to the difference between the bid and asks prices.

Pip

A pip is the last decimal in the price of a given currency. It represents the numerical value of the spread. It also refers to the difference in the original and new value of either the bid or ask price. For instance, if the bid price of a currency moves from 1.2311 to 1.2315, it will have moved up by four pips. Additionally, if the bid price is 1.8651 and the ask price is 1.8653, the spread is 2 pips. In such a case, for a trader to make a profit, the value of the currency should increase by more than 2 pips, this could be 3, 4, or 5 pips. The more the pips, the higher the profits. However, these are small profits and are crucial for traders who engage in scalping.

Scalping

This refers to the trading style whereby the investor holds a position for a brief period sells it, thereby only getting small profits. Such an individual makes numerous trades in order for the small profits to accumulate. This method of trading is only suitable for forex traders who do it as a full-time job. A trader intending to make a lot of money uses this strategy. For instance, in 1 minute, such an individual may aim for a profit of 5 pips. In addition, in 5 minutes, he/she may target a 10-pip profit.

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