To enter a FOREX trade, a trader must first analyze a currency pair, comprising a base currency and a counter currency. When a trading strategy indicates a profitable opportunity, a trader submits an entry price to buy or sell the currency pair. A trade will not execute unless and until the market price is equal to or more favorable than the entry price. FOREX traders use real-time trading platforms to place trades in their brokerage accounts.
Traders use technical and fundamental analysis to identify a trade entry point. Exchange rates are expressed as a fraction which specifies how many units of the counter currency (the denominator) are required for one unit of the base currency (the numerator). Rates are calculated to 1/100 of a percent; this is known as “percentage in point”, or pip, pricing. For example, a DOL/CHF (US dollar vs. Swiss franc) rate of .9507 denotes that $100,000 can be exchanged for 95,070 Swiss francs. A trader might set a buy entry point of .9505; the transaction will not execute unless the U.S. dollar weakens by two pips.
To manage risk, a trader will usually limit the size of any one FOREX order to some maximum percentage of available funds. A standard contract is 100,000 units of the base currency – in our example, the U.S. dollar. Accounts set up for min-contracts can place 10,000 unit orders, and flexible accounts can be used for any size order. An example strategy would be to limit any single order to five percent of investment funds.
Margin is the amount of cash a trader must use to collateralize a trade – the remainder of the trade amount is lent by a broker. Leverage is the degree to which a trader will borrow trading funds. Higher leverage translates into higher risk and higher returns. A trader’s strategy will dictate how much leverage to use. Leverage levels up to 100:1 are available to risk-seeking traders, but prudent investors may limit their leverage to 5:1 or less.
Traders forecasting an uptrend in the price of the base currency relative to the counter currency will enter a position with an order to purchase the currency pair – a long position. Conversely, a short position on a currency pair profits from a downtrend in the base currency. You establish a short position by entering an opening order to sell the currency pair.
Trade discipline helps limit losses not only from losing positions but also from failure to promptly close profitable ones. A critical strategic component of successful trading is establishing a stop-loss price coupled to the entry price. The stop-loss specifies how much loss a trader will tolerate before closing a position. Traders quickly learn never to enter a trade without also entering a stop-loss, as the market may turn quickly against a position. A further refinement is the take-profit order, which closes out a profitable position at a specified price.