by Duane Davis
When trading in the Forex markets, there are three types of trading accounts:
- Standard Forex Account
- Mini Forex Account
- Micro Forex Account
In a Standard account, a move in the EURUSD from 1.2600 to 1.2700 is worth $1,000. During an average day, the range from high to low in the EURUSD is around $500 to $600. In a standard account, a trade is based on a ‘lot size’ of $100,000.
In a Mini account, the value is 10% of a standard contract. Thus, the same move from 1.2600 to 1.2700 is worth $1000 and the range in the EURUSD on an average day is around $50 to $60. As a general rule, accounts with less than $10,000 should consider trading a mini account.
In a Micro account, the value is 1% of a standard contract. A $1,000 move in a standard account is only a $10 move in a micro account. If you want to get your feet wet, a micro account is a good way to start.
Calculating the Value of a Forex Trade
In many markets, a change in price is referred to in terms of ‘points’. In the Forex markets, a change in price is referred to as a ‘pip’. A pip is the smallest increment of a Forex pair and the value of a pip is determined at the end of a trade. When the last 3 letters of a Forex pair is USD, the pip value of a standard contract is $10. Thus, a move of 100 pips from 1.2600 to 1.2700 is worth $1,000. When the last 3 letters are not USD, then the calculation is a bit more complicated and can range from around $8.00 to $11.00 in a standard contract.
Trading with Margin
Margin trading is simply the term used for trading with borrowed capital. In the case of a standard contract, you’re able to trade a $100,000 position with as little as $1,000. The use of margin allows traders to conduct relatively large transactions with a small amount of money. For example, in a standard contract, for $1,000 it’s possible to buy the EURUSD at 1.2600 and sell it at 1.2700 for a gain of $1,000.
The Use of Leverage
Trading in a margin account with a small amount of money is referred to as ‘leverage’. The use of leverage allows a trader to make excellent profits while keeping the risk capital to a minimum. If you happen to be trading with a Forex broker that offers 200 to 1 leverage, a margin of $500 would allow you to buy or sell $100,000 worth of currencies. But be careful, the use of leverage can lead to large losses as well as large gains.
Margin Calls
You want to try and avoid a margin call. To prevent your account from going into a negative balance, if the money in your account falls below the margin requirements, your broker will have to close some or all of your open positions.
To illustrate, let’s look at this example. Let’s say that you only have $2,500 in your trading account and you want to trade a standard $100,000 lot. Even though this is a very bad decision on your part, you’d be able to buy 1 lot of the EUR/USD, with a margin requirement of $1,000. Because you started with only $2,500, after buying 1 lot, you’d only have $1,500 left as your usable margin. If your trade happens to go down in value by $1,500 it would be closed out as a result of a margin call. You’d still have $1,500 left in your account, but you wouldn’t be able to trade. Margin calls are designed to prevent you from losing more money than you have in your account.
How Prices are Quoted
Forex pairs are bought and sold based on ‘bid and ask’ prices. The difference between the bid price and the ask price is referred to as the ‘spread’. The bid price is always lower than the ask price.
Rollover
The term ‘rollover’ refers to interest that is earned (or paid) each day that you’re in a Forex trade. The amount of interest is calculated at the end of each day. If you’re buying a currency with a higher interest rate than the one you’re selling, the difference will be positive and you’ll earn interest as a result. If you close out a Forex trade before your broker’s daily ‘cut-off time’ (usually 5:00 PM ET), the rollover calculation is avoided.
Types of Orders
When you place an order for a Forex trade, it can be done in several different ways. Below are some basic order types that all brokers provide.
Market Order – A market order is an order to buy at the current ask price or sell at the current bid price. Therefore, if the EUR/USD pair is being ‘offered’ at 1.2600 and you enter an order to buy the pair at the market, your fill price will be 1.2600.
Limit Order – A limit order allows you to buy or sell at a specified price. With a limit order, you choose the price at which you wish to buy (or sell) a particular Forex pair as well as how long you want the order to remain active. For example, if the ‘Ask’ price for the EUR/USD pair is 1.2675 and you want to be a ‘buyer’ if the price trades down to 1.2600, you would place a limit order to buy the pair at 1.2600. You’d also have to specify how long you’d like the order to remain ‘active’, either at the close of trading (which occurs at 5:00 PM ET) or until you decide that you want to cancel the order. In the case of a limit order that cancels at the close of trading, if the Forex pair did not reach your limit price and your order has not been executed, your trade is automatically canceled. This type of order is referred to as a ‘God-For-The-Day’ order or GFD. A limit order that remains in the market until you decide to cancel it is referred to as a ‘Good-Til-Cancel’ order or GTC.
Stop-Loss Order – To protect your trade against a catastrophic loss, you should always use a stop-loss order. A stop-loss order remains in effect until the position is liquidated or until you cancel the stop-loss order. In our earlier example, if you were filled on the EUR/USD at 1.2600, you would place a stop-loss order down at 1.2550. If the trade should go against you, your maximum loss would be .0050 or 50 PIPs. Stop-losses are extremely useful if you want protection and you don’t want to watch the market all day.
GTC (Good ‘til Canceled) – A GTC order remains active in the market until you decide to cancel it. Your broker will not cancel the order at any time. When you place a GTC order, it’s your responsibility to remember that your order is still ‘active’.
GFD (Good for the Day) – If you place a GFD order, it will remain in the market until it is executed or until the end of the trading day (5:00 PM ET).
OCO (Order Cancels Other) – An OCO order is used when two different orders are placed for the same Forex pair. The two orders are placed above and below the current price. When one of the orders is executed, the other order is automatically canceled. For example, if the price of EUR/USD is 1.2675 and you want to either buy above the current price at 1.2725 or you want to initiate a sell position if the price drops below 1.2600 you could specify that the order is OCO. An OCO order means that if either of these orders is filled, the other is automatically canceled.
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