Indtroduction to Forex

Aaron Clarey of Captain Capitalism has some amusing and informative videos. Disagree with the video about trading Forex. It’s not as difficult as he makes it seem:

He says Forex is hard to learn, has a lot of risk and that you should spend a couple thousand dollars at a Forex class. He is right about the risk, but stocks are just as risky. The class is not necessary, because Forex is no harder than trading a stock, except with a few extra rules that you can learn with some Google searches and practice. First, although Forex has a lot of leverage, the moves are much smaller than stocks. You can typically trade the common currencies (USD – United States, JPY – Japan, CA – Canada, AUD -Australia, EUR Euro) and their pairs with around 50-1 leverage. However, big moves are rare. Typically the major currencies only fluctuate half a percent a day at most. If you are wrong, that is a $500 loss on a $10,000 account assuming 10-1 leverage. But it’s not uncommon for a stock to fall 5%, producing the same loss. Furthermore, the extreme 100-1 or more leverage is uncommon for most accounts, because the broker doesn’t want to take on the risk.

A Forex pair is in the format XYZ:ABC, such as USD:JPY. This is a US dollar and Japanese Yen pair, or the ratio of the two currencies. If you think the US dollar will outperform the Yen on a relative basis, you buy this pair. Right now the ratio is 101.7, meaning that that about 1 US dollar buys about 101.7 Yen. A 1% move of the US dollar relative to the Yen would bring the ratio to 102.7. Assuming you bought at 101.7 with 50-1 leverage, that is a $2500 profit from $5000 starting capital (50 times 5000 times .01).

You also need to know the tick size, which is provided by the broker. Trades are entered in lots of 10,000. The amount of money risked per tick is 10,000 * tick size. So for the USD:JPY, the tick size is .001. Different pairs have different tick sizes. For a 10,000 lot, each tick is 10 cents. If you go long a single lot of 10,000 USD:JPY and the ratio rises from 101.7 to 102, you’re profit – assuming you sell the pair – would be $30. From this information, you can asses risk and determine how much you are willing to lose. Let’s say you want to risk no more than $1000 on a 1% move. Then you would buy 10 lots of 10,000. Describing how Forex works is much more time consuming than explaining a stock transaction, but it’s easy to pick it up once you begin trading. To learn more, buy a good book on the subject and or read the Wikipedia entry and other free resources.

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