Forex Trading Lesson 4

Gifts for completing this Forex lesson: Since you actually made it that far, you should realize that it's only two lessons away from completing your course. Which means you will be able to to practice on trading for the period of time that suits your preference. Every new day is a further step towards trading live forex trading online. As a gift for today\s forex lesson, you will be provided with one of the easiest, most effective, ready-made, well-tested and profitable forex trading systems around. Please focus on the info we provide in this lesson as it is crucial for completing your knowledge base.

Perfectly understanding price in Forex trading


See this lesson will change the way you understand price and the value of currencies forever. Whenever we go buy something from the store, we more likely think of how much will we pay for an item. And when we buy something, we are familiar with digits that look that way: $20.99 - $97,99 etc.. In Forex trading, prices has more digits added to the price. Say if you buy 1 euro, you must pay $1.3866 at the time of this writing.

Why we said 1.3866 instead of approximating the number down to 1.38 is simply because those two added digits can make huge difference in your trading. In fact, if you have a big forex account funded with say 1 million dollars, the difference between the price 1.3800 and 1.3899 could mean 50,000 dollars in profit or loss. To understand this more, let's move to the next point, it will show us how exactly profit and loss are calculated through the forex prices.

What is a PIP?


According to Investopedia, a pip is a very tiny change in currency pair price/value in Forex. Actually, one pip (french call it point) is the smallest unit in price. For example, If the price of EUR/USD has changed from 1.3800 to 1.3801 this means that price of buying euro has risen by 1 pip, which also, logically, means price of euro has risen by $0.0001

In brief, the very first digit on the right is pips from 1 to 9. Example: 1.0001, 1.0002, 1.0003 and all the way to 1.0009

The more you move to the next digit, the more the number of pips increases. Example: A change in the price from $1.0000 all the way to $1.1000 means price has risen 1000 pips! And trust me, if those 1000 pips happened to be a change in your favor (a profit), then you have earned a sh*t load of money in a standard forex account. More on forex accounts later.

Identifying profit and loss


Profit is generally the change of price/pips "in your favor". Let's just use an example right away to absorb this: Say i bought Euro at a price of $1.6600 and waited for one day only to find its price has changed to 1.6666. This would mean one thing and one thing only. I made a profit of 66 points/pips. Well, depending on my account type and the level of risk i have taken, this could mean different profit potential in money. It could vary from $66 to $66,000. See how Forex can be powerful? A lousy change of 66 pips could make a cash that you wouldn't have dreamed of.

On the other hand, if i bought Euro at 1.6600 and waited for a day or so, then came back to check my trade only to find that Euro has decreased in price/pips/value all the way to 1.6500. This means that i have a loss of 100 pips. To understand this more clearly, read on.

Rules of profit and loss identification

Buy EUR/USD then EUR has risen in value = profit.
Buy EUR/USD then EUR has decreased in value = loss.
Sell EUR/USD then EUR has decreased in value = profit.
Sell EUR/USD then EUR has risen in value = loss.
Remember the first lesson when we talked about the business of reselling cars? We want the car (or in this case the Euro) to rise in value so that we can sell it in higher market price and make profit. en Same goes as above. Now here is something new to you, if i were to sell the car on the current market price which was $10,000 and then bought it from somewhere else when its model decreased in price for only $9,000. Doesn't it mean that i get to have the same car back plus a $1,000 in profit? :D

And this is how forex becomes the best investment ever. You can make profit in forex trading when buying or selling. Profit is not only for buying a currency in a low price to resell it in a higher price, no. Profit can also be by selling a currency in a high price and re-buying it back in a much lower price. This way, you got your money back, plus profit, just like the car example above. Sweet. To simply understand the nature of the loss rules above, treat them as exactly the opposite of what i said.

Floating profit or floating loss


When you have a trade that is still open in your forex trading platform, every change in the stats of your trade's profit or loss is just a floating profit/loss. This means that it's never your actual profit/loss until you "close" the trade. This is actually what brings greed and fear into play, some traders watch their floating profit or loss closely that they lose themselves in it. Some would close the trade quick whenever they see a slight rise in profit. Thus wasting a huge potential of even bigger profits if they were to let the trade develop. Others would close the trade quickly if they spot a slight floating loss in the active trade. We call this phenomenon: "Fear".

On the other hand, monitoring your floating profit or loss could result in a different but similarly harmful phenomenon, greed! some novice traders once they notice a sudden big profit floating in their trade, they force themselves to wait and wati till they subject their position to the risk of losing all current floating profit and end up closing the trade on a minor profit instead of closing when they have earned enough.

Now i can hear you asking yourself, so how the hell i should know if i was too early (fear) or too late (greed) to close a trade. And this my friend is what disciplines will come into play. The right trader would use a trading system and stick to it. And no matter things might seem tempting for the trader to close a trade, he doesn't abandon his trading strategies until the strategy itself gives the green light (In forex we call it a signal) to close the trade. Well, guess what, your forex gift in the end of this lesson is one of the smartest trading systems for you to train on, play with and even effectively apply till you master trading with. :)

Forex accounts and their types


Forex trading accounts types have increased in the last decade. I shall explain all of them one by one because someday you will be choosing one of those account types to trade your forex money.

  1. Forex demo accounts: They are free account for the sake of practicing. Once you open a demo trading account, you will be able to monitor price changes, open currency pairs' charts and even open trades/positions but with virtual unreal money. It's like you're trading forex in stimulation till you get the feel of it. Forex demo accounts also are very important for testing your chosen trading system. Some people test their trading systems for months on demo accounts to see the profit potential and success rate of them before they put them into play on real live accounts with real money.
  2. Forex micro accounts: This type is best to choose if you are a beginner and have passed the phase of trading virtual money on demo accounts. Micro accounts enable you to trade a very small amount of your money. Such account could accept funds starting from $1 and above. Unfortunately, the profit potential on these accounts as not as lucrative as the big pockets make. You will understand why when we talk about "leverage" later in this lesson.
  3. Forex mini accounts: Slightly different from micro account. The only difference is the way it calculates pips and their profit. Forex mini accounts can accept depositing amount into the account starting from $100 or above.
  4. Forex standard accounts: This type of accounts is the big dog's playground. A pip equals $10. This means if you make a profit of 1000 pips, then you make $10,000 in cash ready for withdrawal! Forex standard accounts are advanced because big money is being traded in them, mostly traders would fund such trading accounts with more than $10,000 to be able to trade safely without imposing themselves to the risk of blowing out the whole account. If this info intimidates you, don't worry, 99% of successful traders took the process step by step. They start with demo accounts, then mini accounts and lastly they ride the wave on standard Forex accounts.

What are Lot and Leverage in Forex and how can they affect my Forex account status?


As there are several types of accounts, there really are different types of lots two. But before we know them, let's first see what a "lot" really is. Listen, if someone told you that they call every drop of water in a bottle is called one lot, would you care to count how many lots in a bottle there are? I didn't think so. In forex, you are forced to learn that a standard lot equals 100,000 units of a currency. So when you open a trade, you always make sure how many lots you are willing to trade with. Note that the term "units" is used to standardize the concept. When you buy one standard lot of euro, you are actually buying 100,000 "units" of euro. Unity is good, it equals 1. Let's see how each type of lots should have different values:

1 standard lot = 100,000 units
1 mini lot = 10,000 units
1 micro lot = 1,000 units

Now that you know what a forex lot is, it's time for you to identify the powerful nature of forex leverage. not to only take advantage of it, but to also beware of its evil face. Look, i have seen tens of traders that act like a know-it-all in Forex. I have seen 99% of them get marbles in their mouths when i test them with questions about leverage. And before i explain, i'll show you one of those simple, stupid and tricky questions right away:

How much money will you make if you have an account balance of 1 trillion dollars and you open a trade of 1 lot on EUR/USD on a leverage of 10:1 then close the trade on 1000 pips in profit?

See how the question can make your head spin? in fact, it's too easy if you understand leverage. And for your information, the answer is: Profit = 1 trillion dollars = double the account balance. Now read on, it's going to be fun.

Assuming this is your first time to read about leverage, chances are you don't know until this moment that forex brokers actually can lend you money on each trade you open on your account. And they take their money back after you close the trade. It's called leverage. When a broker declares that the company supports a leverage of 200:1, this means that you can get leverage from 1:1 all the way to 200:1. It's important to realize this now. Because many novice traders think that this 200:1 leverage is an implications. No, it's the "max" that you can borrow not the minimum. Ok, any leverage looks like this: "Number:1"

To calculate leverage, divide "the amount of units you are willing to borrow from your broker" by "your account size". So if you have an account of 1000 and you borrow 10,000 units (means trading 1 mini lot as we have learned above) this results in that you are using 10:1 leverage because 10,000/1000 = 10/1 or 10:1 leverage. Simple as that.

I recommend that you take a more thorough reading on forex leverage that my all time favorite, DrForex, wrote about in this article.

Conclusion for forex lesson 4:

  1. Price is the Godzilla of Forex trading. You will sell, buy, apply trading systems, assume potential profit or loss and develop a trading career just through trading the price action.
  2. A pip is the smallest unit in the price. However, few pips change in price could make a difference in terms of profit and loss.
  3. Forex trading accounts can be demo,micro,mini or standard live accounts.
  4. Lots are the number of units of a currency. Lots can be standard, mini or micro lots depending on what your broker allows you to use.
  5. Forex leverage is what makes Forex more tempting that stocks. It enables a trader to trade much more of what he already has in his trading account. However, leverage can blow accounts away if it was misused or misunderstood. Briefly, the more leverage you utilize, the more risk you expose yourself to.
What's next in Forex online trading?

- Snatch your fourth lesson's gift. Get your forex trading system now!

- Run to learn forex trading lesson 5.