The Best Ways to Trade Forex (Part 2)

09/24/2010 12:01 am EST

Focus: FOREX

Sam Evans

Instructor, Online Trading Academy

This week, I have been on the road with my own mentor and the Online Trading Academy director of education, Sam Seiden, for a series of all-star events throughout the United Kingdom and Ireland. As well as having a good catch up, we have also had the pleasure of meeting a number of Online Trading Academy graduates and new students alike, sharing with them our own experiences of the market and detailing the full package of both the classroom and virtual extended learning track (XLT) educational paths that are available to anyone seeking the very best trading education in the world today. Sam and I have discussed the various benefits of all the various asset classes available to the business-minded speculator, with my area of specialty being the world of forex trading. Following on from our last article, now is pretty much the best time to continue with our explanation of the different tools with which we can take part in trading the currency markets. Last time, we looked at the two areas of forex that account for nearly a third of all currency volume traded, and those were the forex spot market and the direct access forex futures. Today, we will explore the lesser-known areas of:

  1. Forex forwards
  2. Forex ETFs
  3. Forex options

While these categories actually enjoy far less popularity than spot and futures, it does not mean that they should be ignored. In fact, the smart trader would pay careful attention to the advantages and disadvantages of each, and with a further explanation of them, you may see something that could work for you. Let's get started.

Forex Forwards

Forex forwards are rarely spoken of and mostly enjoy a role in the world of the commercial trader. A forward contract involves negotiation now to take delivery of the product later. A buyer and a seller would enter an agreement and draw up a contract for a specified amount of a commodity or currency for exchange at a later date and at an agreed upon price. Considering this dynamic, the seller is protected should prices fall, but cannot change the deal if prices were to rise further.

The advantage of using forex forwards is in the fact that prices can be secured and the contracts can be used as a hedging tool with the added bonus of the flexibility of varying sizes on each individual contract. However, once a contract has been agreed upon, it is non-transferable and must be honored, making forwards a better option for commercial players as opposed to the individual trader looking to speculate and profit on price fluctuations.

Forex ETFs

ETF is short for exchange traded fund, and these products have been popular vehicles in the equity markets for many years. Over time, these products have also extended into the world of currencies and are becoming a popular choice for the portfolio investor. The way an exchange traded fund works is simple. An ETF management firm first buys and holds currencies in a fund. They then sell shares of that fund to the public. You can buy and sell ETF shares just like you buy and sell stock shares. Investors value the shares of the ETF at 100 times the current exchange rate for the currency being held. For example, let's assume that the Currency Shares Euro Trust (FXE) is currently priced at $129.80 per share because the underlying exchange rate for the euro versus the US dollar (EUR/USD) is 1.2980 (1.2980 × 100 = $129.80).

You can use ETFs to profit from the exchange rate of the dollar versus the euro, the British pound, the Canadian dollar, the Japanese yen, the Swiss franc, the Australian dollar, and a few other major currencies.

Currency ETFs are opening doors for investors to diversify. You can now easily mitigate systematic risk in your account and take advantage of large trends around the world by putting your money not only into the stock market, but also in the forex market through these funds. If you think about it, this gives the serious investor the ability to not only profit from their portfolio holdings, but also protect the newly acquired capital by hedging against the strengthening and weakening of their domicile currency through the use of trading and investing in ETFs, all of which can be simply executed through one single trading account.

Forex Options

Before I go any further, I would highly recommend staying away from options trading until you are consistently profitable in your current area of trading. Novices often make the mistake of getting into options as a way of securing high degrees of leverage on their positions, however, overcomplicated strategies and time decay often lead to big losses for the amateur. The irony in this is that options were originally introduced as a way to reduce risk, not increase it, but without the right guidance, they can be a costly endeavor. Do not make the mistake of thinking that options are a market as such. Instead, think of them as a way to trade the various markets out there once you gain a level of consistency in your trading.

An option is an agreement that grants the right—but not the obligation—to buy or sell an underlying asset at a specified price and before a specified time. When you own an option, you have the right to buy or sell the underlying asset, but you do not have to. You can instead let the option expire. The ability to choose to use the option—or not—means that the option hedge will give speculators the locked-in price they need, but unlike a futures contract, it will also allow them to take advantage of price movements in their favor due to the fact that only the premium (or the price we pay for the option itself) is actually at risk. When used in this way, it gives the serious-minded trader the ability to take a position in the marketplace, and then, instead of placing a stop loss, they can buy a put or a call. This way, the risk has already been accounted for, and rather than taking a monetary loss on a regular stop out, you pay for the option, and this covers the risk and maybe even pays out a profit when it moves against you!

As much as I would like to expand upon each of these areas further, it would take far too long, but if you were not already aware of what is available to the forex trader, then hopefully you have a far better idea now. Start with spot and move on from there. Remember that Rome wasn't built in a day!

By Sam Evans, instructor, OnlineTradingAcademy.com

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