The bid to the USD means trouble for risk even as equities hold big gains from Asia and Europe follo...
Forex Trading: The Ideal Home Business?
08/06/2012 6:00 am EST
Andrei Knight shares this fine primer on forex trading, and the benefits for new home traders.
Most of us think of the financial markets in terms of investment. Either putting money aside for the long-term, or even better having someone else who is more qualified manage it for us, so we don’t have worry about it. The recent financial crisis showed us, however, that we do have to worry about it.
But what about trading for a living? When you think about it, beyond just the obvious benefit of being in control of your own finances, trading is actually the perfect home business.
Aside from an initial investment in computer hardware and the ongoing costs of a good Internet connection, there is virtually no overhead. There’s also no staff to pay, no boss, and unlike so many “work from home” opportunities, there’s actually nothing to sell.
Back in the early era of daytrading (the 1980s), real-time market feeds were prohibitively expensive, and the independent trader was at a severe disadvantage to the big institutions. Today, most brokers will give you not only the trading software, but also a direct connection to the markets at no charge. They make a commission from each trade you place, so it is in their own best interest to give you all the tools that you need.
What Is Forex?
Forex, or foreign exchange, is a term for the trading of one currency for another. Even without realizing it, you’ve probably already participated in this market if you have ever traveled abroad and needed to exchange US dollars for the local currency.
The next time you returned to the booth to exchange some more, you likely noticed that the rate of exchange had shifted. Like any other commodity, world currencies are subject to the laws of supply and demand. The more something is needed, and the less of it that there is, the more its value goes up. When there is a lot of something and no one particularly needs it, its value tends to decline.
Banks, multinational corporations, and governments are exchanging large amounts of currency with one another all the time. Perhaps a big auto manufacturer in Japan needs to source parts from Europe, pay workers at the assembly plant in Mexico, and sell the final product in the United States. When Canada receives payment for the oil that it exports, it must also convert currency.
In forex, currencies are always traded in pairs. To buy a particular currency, you have to simultaneously sell another, hence the exchange. When we write currencies in pairs, the first (or base) currency is always equal to one. The second (or quote) currency is the value you see on the right edge of your chart in your trading software, or see quoted in newspapers and business news on television.
If the price of the currency pair in question goes up, that means that either the quote currency is declining in value (since more units of it are needed to buy one of the base currency), or that the value of the base currency is going up. If the price of a pair instead declines, that suggests that either the quote currency is gaining in value (since you need less of it to buy one unit of base currency), or the base currency itself is losing value.
So if you believed that the Canadian dollar would benefit from an increase in the worldwide demand for oil, for example, you would look to sell USD/CAD. In trader talk, this is often referred to as going “short.”
If your assumption proves correct, as the Canadian dollar rises in value it would take less and less of them to equal one US dollar, and thus the price of the USD/CAD pair would drop. You can then buy it back at a cheaper price than what you sold it for, making a profit on the difference.
If, on the other hand, the National Housing Price Index indicates a decline in real estate value, it suggests a weaker demand for homes, and also for the Canadian dollar, since any homes that do get sold are being sold for less money. You would then look to buy USD/CAD, because as more Canadian dollars are needed to buy one US dollar, the price of the $/CAD would rise. This is called taking a “long” position.
The smallest unit a currency pair’s price can move up or down is known as a pip, or percentage interest point. A pip is 1/100th of a cent. In other words, for the exchange rate of the Canadian and US dollars to change by one cent, the USD/CAD would have to move by 100 pips.
1/100th of a cent does not seem like much profit potential at first, until you consider that currencies trade in lots of 100,000. Just like you buy a share of a stock, you would buy or sell currencies in lots. These days many brokers offer mini lots of 10,000, and even micro lots of 1,000.
If that still seems like a lot of money for one trade, you’ll be glad to learn that forex is also a highly leveraged market, with many brokers offering 100:1 or even greater. What this means is that for every dollar of your own that you put into a trade, you are actually controlling 100 units of currency. Thus it takes only $10 to control a micro lot, $100 to control a mini lot, and $1,000 for one standard lot of currency.
If 100,000 units of currency shift by just one pip, the balance on your trading account would go up or down by $10. It is not uncommon for a currency pair to move 100 or more pips in a single day of trading. Just be careful, though: leverage is a double-edged sword, which can swing both ways when you’re wrong.
Next: Forex vs. Other Markets|pagebreak|
Forex vs. Other Markets
Leverage is just one advantage of forex over other financial markets. By comparison, most stock brokers will only offer 2:1 leverage, and even that only to select clients.
Trading forex is very similar to trading stocks, except instead of investing in the future of a company, you are speculating on the future economic health of various countries. The financial figures of an entire country are much harder to manipulate than those of a corporation, and countries tend to go bankrupt far less frequently.
Forex is also a market which trades around the clock, because just as the sun sets where we live, it is always coming up somewhere else. It also tends to lend itself particularly well to technical analysis, a fancy way of saying chart reading, and allows you to trade in both directions, taking long or short positions with relative ease.
Treat it Like a Business
If I may offer one final piece of parting advice, it would be to treat your new trading venture as a business.
Too many people view it as “get rich quick,” and their unrealistic expectations lead them to take on large positions, which often go devastatingly wrong when the market does something other than what they anticipated. If your highly-trained and experienced fund manager could manage only 10% per year, why would you expect to double your money your first few months out?
Like any new business, you will need to invest both time and money in educating yourself, giving yourself every edge you possibly can over the competition. And in the global financial markets, competition is fierce. Some great starting points for your journey include: BabyPips.com, ForexFactory.com, fxKnight.com, and FXStreet.com
Whether you are planning a career change, or just looking for some supplemental side income, I hope that your diversification into this new and exciting asset class will prove to be a fruitful and successful one!
Andrei Knight is a fund manager, trading coach, and a highly sought-after keynote speaker who has appeared at events including the World Money Show, Traders Expo, IX Investor, and the International Traders Conference. He is the author of "Trading Forex for a Living" from Harriman House, provides strategic market analysis for leading Swiss broker Dukascopy, and is featured in the forth-coming documentary "Fibonacci: Unlocking the Market Code". His Web site, fxKnight.com, provides news, software, and educational services for active traders. He tweets regularly as @BlackKnightFX
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