How to open a position
Like most activities, trading comes with it's own jargon. Pip, spread, bid, ask, long, short etc. Don't let it scare you of because you'll get their meaning soon enough. On the one hand they might seem like a necessary evil, but on the other they'll sound really cool when you want to brag at parties about your trading succes.
Like we said before, currencies are traded in pairs, so basicly it's an everlasting race between one currency and another. You can trade the Euro vs. the USD, or the GBP vs. the USD, but also the GBP vs. JPY (Japanese Yen), or the EUR vs. the GBP. Currency pairs such as the GBP/JPY and EUR/GBP are called cross currencies by the way, because neither currency is the USD. But you don't need to concern yourself with that at the moment.
Example
A typical currency pair quote at a broker like Etoro will look something like this:
PAIRBIDASK
EUR/USD1,42801,4282
The spread
The difference between the BID and ASK is de so called spread. This is what you pay the broker for opening your position. Contrary to other financial markets (stocks etc) the broker doesn't calculate any costs except for the spread. If you've ever traded stocks you know that's a big advantage, because for smaller investors the cost of trading stocks can be quite high. Not in forex. There are no membership fees, commisions or anything like that. And whether you trade with $100 or $100,000, the spread remains the same for everybody.
The spread at
eToro is fixed. A lot of brokers work with a flexible spread (which is higher when more people want to open positions); and altough a difference of 2 pips ( or points, or $2 for a mini contract) might not sound like much, it can really screw with your profits in the long term. It's not for nothing that we prefer eTORO, but if you ever want to change brokers watch out for things like this. Flexible spreads ( 'as low as 1 pip', which is almost never), high minimum deposits, expansive cash outs, we've seen it all. Anyway, back to business.
Ever heard the phrase: 'Beat the spread'. It means the minimum you have to make on a position to break even. So if you open a EUR/USD position, where the difference between BID and ASK -the spread- is 2, the price has to move at least 2 pips in your direction. Only after that the fun really starts of course, because then you'll begin making money.
Back to the example.
PAIRBIDASK
EUR/USD1,42801,4282
The spread here is 2, because the price you can buy for is the ASK price, while the price you can sell for is the BID.
Long Position / Short Position
There are 2 different kinds of positions you can open, a LONG position and a SHORT position.
LONG: You expect that the price of the base currency (in this case the EURO) will go up, compared to the quote currency (USD); in other words, you'll buy EURO's and at the same time sell Dollars.
SHORT: You expect that the price of the quote currency will go up, compared to the base currency; in other words, you'll sell EURO's and at the same time buy Dollars.
So when you go LONG EUR/USD on 1 mini contract you click on buy/long. The broker will then tell the bank to buy $10,000 worth of Euro's and sell $10,000 worth of USD at the same time. If the EURO goes up, you'll get back more dollars for them when you close the position; if the EURO goes down, you'll get back less dollars.
Later on we will discuss how to find out when it's a good idea to open a position, but just to give you a small example:
Suppose you've read that everybody expects that the FOMC (aka the Fed, aka the federal reserve, the American Central bank so to speak) will raise the interest rate on the USD. Such a raise would mean that it will be more expensive for American banks to lend money from the federal reserve. And if it gets more expensive for banks to get their hands on extra dollars, it will get more expensive for everybody else too. Now, to everybody's surprise, the Fed decides to LOWER the interest rate, instead of raising it. What do you think will happen with the value of the USD compared to other currencies? Precisely, it will go down.
So you probably want to go LONG EUR/USD, buying Euro's and selling dollars. But for how much?
Standard Lots / Mini Lots
The forex market trades in LOTS. A standard lot is $100,000. So when you open a LONG EUR/USD position in 1 standard lot, you'll buy $100,000 worth of Euro's and at the same time sell a $100,000 worth of Dollars.
Of course you don't have to come up with $100,000. Since you buy and sell at the same time, the only money you have to have ready, is that which pays the possible losses if the trade doesnt go your way. This means that when you open the position, you have to reserve money for that possible loss.
The great advantages of this system are:
1) you can never loose more than you are willing to risk. If the losses equal the money you reserved for the trade, the position will automaticly be closed. So you can determine IN ADVANCE how much you are willing to risk on any given investment.
2) Because you only have to reserve the money that you are willing to risk, you can get great leverage with that money. For instance, if you buy 1 mini contract (1/10 of a Standard Lot, $10,000) you can limit your risk to only $15. This means that if the position moves 15 points against you, you loose the $15 and the position is automaticly closed. But at the same time, that $15 lets you control $10,000. So profits you could normally never make with that $15 are now within your reach.
We strongly advise you to start with a small bankroll -and thus trading mini lots- so you don't risk more than $15-$25 on any given position.
Back to the example
PAIRBIDASK
EUR/USD1,42801,4282
So the Fed has lowered the interest rate instead of raising it. The USD is under a lot of pressure. You open a LONG EUR/USD positioni for 1 mini lot, at 1,4282. You hope of course that the Euro will rise. You put your stop/loss at 1,4260 -in case you are wrong- which would mean a loss of 22 pips/points, or $22. If the price reaches 1,4260 the position will automaticly be closed. You set your take/win at 1,4370; if the EUR/USD reaches that price, the position will also be automaticly closed, and you'd make 88 pips, or $88. After 45 minutes the EUR/USD does indeed reach that price and you've made $88 within the hour. Not bad, considering your bankroll is only $300!
TIP: There is no trader that only makes winning trades. Every trader, even the very best, will have loosing trades from time to time. The trick is to make more with your winning trades than you loose with your loosing trades. Look at the above example; even if you're right only 1/3 of the time, you'd still make $88-$44 = $44! In later articles we'll talk much more about forex strategy. But the sooner you'll realise that you can control your risk to the Dollar and thus have no need whatsoever for fear, the better it is.
