5 Basics in Forex Trading
New to forex trading? Read on for a quick introduction.
FX is a Massive Market
The FX market is large. Massively large by reported numbers, over $4 Trillion dollars traded each day. Sounds like a lot when compared to the notional turnover of any equity market. But it’s also deceptive since FX is almost always traded off of leverage that can range all the way up to 500:1. Yes, some brokers offer you the ability to control $100,000 for just $200.
What’s a FX Pair?
Before we get further let’s go over some basics. What exactly is a FX pair? Currency trading comes quoted in pairs, EUR/USD is the most actively traded. This is the Euro Dollar / US Dollar ratio or if I give you 1 Euro how many US dollars I expect in return for a fair trade. The two currencies are referred to as Base and Term currencies when quoted — Base / Term. This is important because we always talk about a ratio as the term in relation to the base. Another example — if I have USD/JPY at 120.14 I expect 120.14 Japanese Yen for every 1 US dollar.
Even equity markets work this way — AAPL / USD, this might look weird but every time you buy a share of Apple stock you are trading away your US dollars in exchange. So for every 1 AAPL share you have to trade away the required term amount (most recently 109.32).
Now that we know what a currency pair is we can tackle how FX markets are quoted. FX markets are quoted like equity instruments, with a Bid and an Ask.
A EUR/USD quote at 1.1104 / 1.1105 shows you a two-way market. Keep in mind the difference between the two prices, this is the spread. Each FX pair has its own normal spread. EURUSD is normally the tightest, and something like USD/MXN would be much larger.
How do we use this quote? Most retail brokers set a minimum trade amount, in the US this is commonly $10,000. But as we mentioned above you don’t actually need to have $10,000 to trade. You only need $200 at 50:1 leverage. When you trade however your profits and losses are based off of the $10,000 notional where leverage is a double edge sword. This is why over 80% of retail FX (a conservative estimate) traders are not profitable after 1 year of trading.
Back to our quote, we can sell EUR/USD at 1.1104 (think of this as going short in the equity markets) or we can buy at 1.1105 (going long). There are no commission fees in FX (normally) so most new traders get lulled into a sense of trading is ‘free’ this is most definitely not the case. A critical difference between equity markets and FX markets is that FX markets do not have to have any one price. One broker could show you a quote of 1.1104 / 1.1105, another could show 1.1102 / 1.1104, another could be off market and show 1.1100 / 1.1103.
FX Trading Costs
Let’s take a fairly active trader example — you trade 5 times a day and you have $2,000 in your account. You trade your full notional each time at max leverage 50:1 and your broker has a rather standard 1.3 pip spread on EUR/USD.
.00013 * $100,000 = $13 for one round-trip (buy and sell or sell and a buy to open and close a trade)
$13*5 = $65
If prices never move and you only enter and exit each time you trade you will have lost $65 just from paying the spread. This is the hidden cost of FX trading that most new traders lose sight of. You managed to lose 3.25% of your account balance by trading fees alone in a single day. This is the primary culprit for why most retail traders lose money.
We founded ZeroSum because we wanted a place where we could trade without worrying about our cost of trading. We are not brokers, we are not market makers and no FX trading occurs on our site. What we do offer however is the ability for you to compete against other people to win cash prizes. Think of us as a Daily Fantasy Trading Platform. Similar to Draftkings and Fanduel we provide competitions for our traders. We pay you off of how much better you are than your peers, not by what the market is doing. That trading fee example above? You can enter and trade 100 times in a day and pay $0 in trading fees because there is no FX being traded. We are the competitive version of simulators. Be a better trader, get paid. Simple.
Good luck out there, we’ll be back with more FX knowledge later. In the meantime you can register for competitions at our site.