How to Trade Forex - For Newbies
How to Really Trade Wisely When You are a Novice Trader
New traders need to learn few basic things about the forex market, and then apply these to their everyday analysis and trading plans. The very first thing you will need, is access to a trading account, be it demo or live trading account. This way you will get a feel as to how to navigate through the broker’s trading platform, and how to use the basic tools.
All currency pairs in forex, are shown in X/Y format, where X is called the base currency, and Y is called the quote currency. For example EURUSD is about trading the Euro, quoted in US dollars. Price movement is measured in pips, pip stands for percentage in point, and in the forex market the value of each pip is not fixed, but it changes as the exchange rate changes.
The minimum price increment shown in most brokers’ platforms is 1/10 of a pip, that is the right most digit. So if you see EURUSD = 1.17627 the right most digit (7 in this case) measures 1/10 of a pip, the second right most digit (2 in this case, measures pips), and so on. For all forex pairs, except Japanese Yen type pairs, when you want to measure pips as the market moves from one level to another, you are only interested in 4 decimal digits, you can practically ignore the rightmost digit. So if EURUSD moves from 1.17627 to 1.12627, you need to remember that whole pip counting starts from the second rightmost digit. The market will have moved lower by 762-262 = 500 pips. Each pip is worth different every day, as the exchange rate moves up or down, the change in pip value is smooth and small but it is there. The formula used to calculate the exact value depends on the size of the lot you are trading. A standard lot, in forex, is worth $100,000, that’s how much money you would need for the trade if you traded cash, simply buying and selling actual, physical currencies. But because forex brokers usually provide leverage, they essentially lend you most of the money, while you are only required to put down a small margin.
You just need to remember that a standard lot is worth $100,000, and all other smaller lots are fractions of this standard lot. So in the case of a standard lot, for all non Japanese Yen pairs, each pip is worth an amount of money at a specific point in time, this is a function of the exchange rate also. And the pip value calculation formula takes into account the pip as a decimal number, which is expressed as 0.0001 (remember one pip it’s the 4th decimal digit, and when brokers quote 5 decimal digits, you can ignore the 5th rightmost digit).
For a forex trading account based in Euros, a pip value for non Japanese Yen pairs, is given by the formula (0.0001 x 100,000) / exchange rate. 0.0001 times 100,000 is always 10, so the formula is simply 10 / exchange rate. You can use the full length of digits, for more accuracy, though the difference will be too small to matter. So if EURUSD is 1.17627 then the pip value will be 10/1.17627 = 8.50 Euros, and at 1.12627 it will be 10/1.12627 = 8.87 Euros. As you can se, pip vale changed by 37 euro cents as the market moved lower 500 pips. But it’s too small to make any difference, because forex trading account balances fluctuate much more because of the larger part of the pip value, and to a second degree because of interest rate paid or charged by the broker. So you don’t need to bother too much about it, just know roughly how much a pip is worth in your trading, so that you can estimate profit and loss. To double check your calculations you can use an online pip calculator, for the lot size you trade.
And if you are wondering how much a EURUSD pip is worth in a USD based trading account, it’s always fixed at $10 per pip. So you can always convert $10 into Euros, through a simple exchange rate conversion to find how much that pip is worth in a Euro based trading account.
Some new traders for example, make the mistake of thinking that all pairs have the same pip value, such as USDCAD and EURUSD, this important to know for planning your trades. At the time of writing this article, EURUSD pip value in a USD based account, is $10 whereas USDCAD pip value is $7.94. So pip for pip, a movement in EURUSD is more valuable than a movement in USDCAD!
You may find all this information intimidating, but it’s really simple. Just check the value of your pips, in every trade, and also check the policy of your broker on interest rates, also known as swaps. These interest rates are either charged or credited to your account, depending on the net interest rate of a currency pair, and whether you buy or sell that pair.
Other Things to Consider
When opening a forex trading account, choose your broker according to your strategy. Notice that brokers who require huge margins, tend to charge/credit little or no interest rate on open trades. Whereas brokers who require too small margins, tend to charge/credit much higher amounts of interest rates, and interest rates are a function of time, and proportional to the leverage used in the trading account.
So a day trader is better off using a low margin broker, because the trades will be of limited duration, so this makes this broker affordable in every way, and a small trading balance can cover all trading needs. Whereas a swing forex trader, will leave trades open for days or weeks, and interest rates will matter, in this case using a broker which requires huge margins, but has low or no interest rate policy, will be a better choice.
You as a new trader may want to use contingent orders, these are trades that you set up, but are triggered only when the market reaches a specific trigger price level. These orders are the Stop Loss type which gets you out of a losing trade, and the Limit Type which gets you of a winning trade. But most brokers also offer Limit type orders, which can also get you into a new trade when the market reaches a specific, predetermined trigger price level.
Slippage: Slippage is when you go to close a trade at indicated price X, and the trade closes, but it closed at a different price Y, which is less profitable to you, this is natural in the market, and most brokers make the effort to minimize it, but it cannot be totally eliminated during volatile market conditions.
Bid – Askprice: This is confusing to all, even experienced traders, because of the way one tends to interpret the words bid and ask, just remember that Bid is the low price, and Ask is the high price, and when you buy a market in general, you always click on the higher price, and when you sell a market, you always click on the lower price. The difference between these two prices is called a spread, and this is how brokers make part of their money to stay in business. There’s no need to be confused about these, just spot which is the higher price, and which is the lower price, you always buy at the higher price, and always sell at the lower price, moreover, when you click on the numbers to make a trade, on most trading platforms, you will see Buy and Sell buttons, not Bid and Ask. But if your broker happens to use Bid and Ask, just identify which is which by the numerical difference, not by the words. This way you will never make a mistake.
The confusing Bid-Ask trading window… if you only see Bid and Ask, and don’t know which is which, just remember you always buy at the higher price, you always sell at the lower price.
Trading the Forex Market
Trading is based on decisions, but it’s a good idea to refrain from making guesses and predictions on your own. Through some basic trading skills you can slowly develop intuition for the markets, and at least some opinion skills, without having to guess anything. Guessing doesn’t work in the markets, neither does following the financial news and attempting to make sense of it all.
There’s no need to follow false tips and bits of advice, deep down most markets are hard to predict, while other markets are predictable during particular hours or days. And all traders, even veteran traders who make millions, still have losing trades. Losing and winning trades go hand in hand, you are not getting one without the other. And all trades start out as losers, remember that!
New traders can do better when following few proven methods of putting a trading strategy together. These methods can help you learn better, test the markets and take years off the learning curve.
For you as a new trader, is important to test one thing at a time, because testing too many things at a time, such as different indicators and tools, will lead to inconclusive results. The forex industry is full of indicators and trading tools, but really only a handful of them is ever needed.
Risk – Reward
This concept of risk and reward is a poorly defined one, and most articles on risk-reward are actually wrong and of no value to you. Typically traders tend to refer to risk-reward per single trade, and it has to do with how much money you can risk in a trade, as defined by the size of your stop loss order, relative to the potential gain. And it’s expressed in pips. But as I mentioned, these ratios are poorly defined and useless for practical trading.
What really determines risk and reward is probability and probability alone, nothing else really. These old fashion metrics of risk and reward look at one trade, and completely ignore probability. That’s why they won’t help you much in planning your trades or managing your trading capital correctly.
You will hear things such as ‘risk only 1% or 2% of your total account value, in any single trade’ and other similar bits of advice. But reality has proven that traders who make a lot of money do risk more than 2% per trade, and actually never use fixed size stop loss orders. Rather, they look at the market, and use indicators such as Parabolic SAR, or LSS pivots, as levels of support and resistance, and place their stop loss orders at those levels. The market doesn’t care about your 2% account limit, if it wants to reverse at a slightly further away level, it will do so. So do get into the habit of developing money management rules, based on variable stop loss orders, and not static ones. Do use Parabolic SAR and LSS pivots to help you find these levels.
Misunderstanding of risk and reward, as defined by market probability, is the biggest reason why new traders lose money, even when they predict markets right. Because the market will always move more or less against you a little, before it goes your way.
There’s also the concept of drawdown, which refers to how much a trade moved against you before it became profitable, and to how much negative pressure the whole trading account is subject to. Some new traders think they can trade for ever, with a minimal drawdown and the minimum possible risk per trade, but it’s all an illusion. Real profitable trading tends to be messy and it has drawdown of 30% or more. And studies have shown that attempts to reduce drawdown in any trading strategy, instantly make it more risky, and result in less profits. Good profitable forex trading requires a flexible approach, loose rules, probability studies and somewhat messy trading, because markets are messy themselves and perfection doesn’t exist.