Time Crunch Trading

Opening an Account

It is quite easy to start trading forex. There are many forex brokers available and opening an account is pretty straightforward. However, some things you should consider as you look to identify the one best suited to you are:

• Account minimum deposit (if any)
• Transaction size flexibility
• Spreads
• Execution
• Commissions (if any)
• Security of deposited funds
• Allowable leverage
• Currency pairs available for trading
• Usability of the trading platform

The great thing is that nowadays the vast majority of brokers have available demo trading platforms you can use to evaluate their system. Be sure, though, to make note of any differences there are between the real platform and the demo one. Some brokers’ platforms are the same across the board, but some have noticeable differences in aspects like execution speeds. It wouldn’t hurt to check around the discussion boards to see what others are saying.

If you are new to forex trading it is well worth it to spend a while trading via a demo platform first. It will help you develop and understanding of how it all works. That way, when you do go live, you will be more confident and ready for action.

Making Trades

Forex trading is not very different from an execution perspective in most other markets. You can buy or sell. In most cases, the same types of orders (stops, limits, etc.) are available. The trading platforms are very modern and trades can be done very quickly. Anyone who has ever used an online trading platform for any other market will have no trouble making the move to forex and executing trades easily. For that matter, even those new to trading will find entering and exiting forex positions a breeze.

Understanding the Trades

The best way to understand what happens in a forex trade is to demonstrate by way of example. In this case we will outline a trade in which we buy EUR/USD at 1.2100.

Remember, when buying or selling in the forex market you are doing so in regards to the base currency (the first one listed in the pair). That means for EUR/USD we are long the Euro, and by extension, short the USD.

This diagram shows the way the transaction runs its course:

Simple Spot Forex Trade
Buy 100,000 EUR/USD at 1.2100
Borrow 121,000 USD (100,000 x $1.21)
<Pay USD Overnight Rate>
||
Convert USD to EUR at 1.2100
||
Deposit 100,000 EUR
<Earn EUR Overnight Rate>

When we close out this trade, it is a simple reversal process. The EUR position is converted back in to USD and we pay-off the USD loan we took out. If the exchange rate increased, then we would have Dollars left over, which would be our profit. For example, if the rate went to 1.25 we would have $4000 left over after paying back our loan (100,000 x $1.25 = $125,000 - $121,000 = $4000) If the rate had dropped, we would have a shortfall on our loan repayment, and thus a loss on the trade.

For a trader whose account is denominated in US Dollars, the above example is pretty straightforward. There is only one exchange happening each way. When one is trading cross-rates, however, things get more complex.

Essentially, everything remains the same when we enter the trade. If, for example, we were buying 100,000 EUR/JPY at 131.00 we would borrow 13,100,000 JPY (100,000 x 131), exchange that in to EUR, and deposit it. We would pay interest on the JPY loan and earn it on the EUR deposit, just like we did in the EUR/USD example.

The complexity of a cross trade comes when unwinding the trade. Assume EUR/JPY rises to 132.00, and see how the long position unwind would look:

Cross-Rate Trade
Unwind 100,000 EUR/JPY long
(Entered trade at 131.00)
100,000 EUR
||
Convert EUR back to JPY at 132.00
(100,000 x 132 = 13,200,000 JPY)
||
Repay 13,100,000 JPY
(13,200,000 - 13,100,000 = 100,000 JPY remains)

You will note that there are 100,000 JPY remaining after the original JPY loan is repaid. That is our profit, but as USD-based traders we need to convert that back in to USD for our accounting purposes. That happens by exchanging the JPY for USD at the current USD/JPY rate. If that rate is 107.00, then we have a gain of $934.58 on the trade (100,000/107.00). Of course, we must also take in to account the interest carry when determining our net profit.

Calculating Profits & Losses

The above examples of forex trades may seem complicated, but as an individual trader, you don’t see all that stuff. When it comes down to determining your profit or loss (P&L), it’s pretty simple. The essence of determining one’s P&L boils down to starting value and ending value (as set by the market).

Here are the formulas for calculating your profit or loss on a forex trade:

Non-USD Base (i.e. EUR/USD):
Long: (Units x R2) - (Units x R1) or Units x (R2—R1)
Short: (Units x R1) - (Units x R2) or Units x (R1—R2)

Where R1 is the starting rate and R2 is the ending one.

Ex: Buy 100,000 EUR/USD at 1.3000 and sell at 1.3100:
(100,000 x 1.31 = $131,000)—(100,000 x 1.30 = $130,000) = $1000
 
USD Base (i.e. USD/JPY):
Long: ((R2/R1) - 1) x Units
Short: ((R1/R2) - 1) x Units
Long Ex: Buy 100,000 USD/JPY at 110.00 and sell at 111.00:
(( 111.00 / 110.00 ) - 1) x $100,000 = $909.09
 
Short Ex: Short 100,000 USD/JPY at 110.00 and cover at 109.00:
(( 110.00 / 109.00 ) - 1) x $100,000 = $917.43

As we know from the EUR/JPY example, cross trades require an additional step. The same calculation can be used as above (the non-USD base is probably the easiest, though either could be used), but the Profit/Loss figure would then have to be converted using one of the currencies involved to get it back to the account currency as demonstrated earlier.

Remember, forex trades have an interest rate carry based on the interest rate differentials. This can be either positive or negative. For longer-term trades, this can be a significant influence on the final P&L.

Multiple Open Positions

A common piece of advice offered by experienced forex traders to novices is to focus on one currency pair and stick toit. There are two reasons for this. One is to develop a good understanding of one forex relationship and to not spread things too thin. The other reason is to avoid some of the issues which can crop up when a trader has positions open in multiple currency pairs.

The first of those issues is creating excessive exposure to one currency. This is done by going long or short the same currency in different pairs. For example, If you were to sell EUR/USD and at the same time buy USD/JPY you would have two USD long positions. In shorting EUR/USD you are going long USD, and obviously in buying USD/JPY you are doing the same thing. This is a very quick way to put your trading account at serious risk if you are not aware of your total exposure. If the USD were to suffer a decline you would likely lose on both those positions.

The other issue in holding positions in multiple currency pairs is that you can accidentally create a position completely different than what you intended. For example, if you were to buy EUR/USD and buy USD/JPY the USD exposure in those trades would at least partially offset each other (you are selling USD in the first trade and buying it in the second), depending on the values of the two trades in question. What you are left with is a long EUR/JPY position, which has very different trading characteristics than either EUR/USD or USD/JPY.

The combination of the risk factor and the offsets that can happen is why even experienced traders often will only carry one open forex position at a time. It just keeps things simpler.

Foreign exchange rates are both a market unto themselves and an influence on the fundamental situation of other markets. They reflect the strength or weakness of an economy and are a factor in it. This kind of duality can create a truly mind-spinning situation at times. There are a few things, however, which directly influence forex prices.

Interest Rates

Most people will first think of interest rates when the idea of evaluating one currency against another comes in to play. This is appropriate because they are a major part of the forex market equation. Interest rates on the one side determine the “yield” of a currency, while on the other side can be viewed as a barometer of the position of a country’s economy (or of an economic region like the European Union).

To that end, the same sorts of things which impact interest rates also play a part in forex prices. Inflation, or rather the expectations for inflation, is the single largest influence on interest rates. But even that is not a clean scenario. If interest rates are rising because of strong economic growth leading to mild concerns about inflation, that tends to be a positive for a currency. On the other hand, if rates are rising because signs of inflation are starting to show (or significant inflation already exists), that can be a negative.

Keep in mind that the value of a currency is a reflection of its buying power. Inflation erodes that, so a country seeing high rates of inflation will generally have a weaker currency. This can easily be seen in the emerging markets where interest rates are often quite high, but the currencies remain weak because of issues with inflation.

Trade

The forex market exists first and foremost to facilitate trade, and trade is a huge determinant in the value of a currency. The more a country’s goods are in demand, therefore requiring buyers to convert their currencies in to the exporter’s currency, the stronger the market will be. It is a simple supply and demand equation. More demand means higher values.

Because of this influence, forex traders keep a keen eye on trade data. These figures, of course, are historical by the time the market sees them, meaning the trade transactions have already happened and their push or pull on a currency’s value have taken place. What traders want to know, however, is if money is flowing into or out of a country.

Capital Flows

Capital flows are a parallel to trade. Rather than representing the value of goods and services being exchanged, they indicate the investment of capital in to a country. Investment works the same way as trade. A country receiving a lot of investment money is similar to a country selling a lot of goods on the trade market. It’s currency is in demand.

What creates capital inflows? Higher relative real interest rates (rates adjusted for inflation) is one thing. Opportunities for investment profits in a country’s stock market is another. Capital seeks returns. It will go where it thinks it is going to get the highest one for a given level of perceived risk.

Capital flows are seen in the balance of payments information released by the government. Traders look at it the same way they do the trade data. Is money coming in or going out of the economy?

Reserve Currency

You may have heard that the US Dollar is a reserve currency, which means other country’s keep a supply of Dollars on hand as a safety measure against adverse conditions. This helps provide demand for the Dollar, even when the items noted above would suggest a negative scenario.

A similar situation can be found in the fact that global commodities like oil and gold are denominated in US Dollars. Anyone buying them must exchange their own currency for Dollars in order to make a purchase, providing an added layer of demand for the US currency.

Comparison

The thing which makes the forex market so complex is the fact that when one is trying to perform the kind of fundamental analysis we have discussed here, it is a multisided equation. Looking at one country is not enough because a currency is valued and traded against an array of others, all of which have their own sets of considerations.

The comparison if you are a stock trader would be a spread trade in which you buy one company’s shares and sell those of another related company in a bet that the former outperforms the latter. Obviously, you would buy the stock of the firm with the better fundamental outlook and sell the one which looks weaker.

This multiple analysis is enjoyable to some, but is probably the biggest factor behind the extreme popularity of technical analysis among forex traders. Fundamental analysis of the forex market can become a bit dizzying at times!