The Art of Forex – Understanding the Environment

In previous articles we talked about many facets of day trading with the focus on Forex.  What we would like to share with readers in this article are the details of getting set up to start trading using Forex.  If you refer to previous articles written, you will see why our team has chosen Forex over Stocks.  In short, being in a generation of instant gratification, there is no better market than Forex to participate in.

When you decide to take investing into your own hands with day trading, you need to first decide what you can afford to lose.  Outside of the obvious reasons of not trading more than you can lose, you need to consider that it is a new environment where money moves quickly, and you need to test the custodian/broker that is holding your money.  These two points are very important and we would like to expand onto it with detail.

Let us first begin with understanding the Forex environment and then how the broker will come into play.  Once your account is funded, you will have the ability to place trades.  There are a few important terms a beginner Forex trader needs to know:

  1. PIP
  2. spread”
  3. micro lot
  4. mini lot”
  5. standard lot

With understanding these few terms you can get started right away in trading Forex.

Let’s begin with learning what a “PIP” is.  A PIP is an acronym for Percentage in Point.  When you move 1 point in Forex, traders may refer to this as 1 PIP.  Your stop losses and profits obtained will be based on your PIP values.

Another important term is “spread.”  Spread is something your broker puts in place in order to facilitate the trade.  It is essentially their fee or the cost of trading.  Here is how it works; when you are looking for a trade to enter (let us reference the EUR/USD for example), your broker will be setting up the trade for you to buy or sell the EUR/USD.  The broker will offer EUR/USD at a certain price (let’s say 1.3250) and the market will buy it for 1.3248.  You can see there is a 2 point or PIP difference in the price.  This difference is the spread or the cost to purchase EUR/USD at that price.  This means you are buying the Eurodollar against the US dollar or that you are selling the US dollar against the Eurodollar.  It is the same thing or a simultaneous buy/sell agreement you have with the broker.  As the market moves, this cost fluctuates higher or lower.  You always need to pay attention to this spread value, because some currencies cost more to trade than others, and if you are a very short-term trader, you need to consider the additional points or PIPs you have to move in order to be in profit.  For example, if you want a PIP goal of 10 PIPs and the spread is 2 PIPs, you need to move 12 PIPs to reach your goal of capturing your full 10 PIPs because you will be down 2 PIPs once you enter the trade.  The average spread on most of the major currencies will be roughly 2 PIPs.  When or if you get serious in trading and possibly reach an institutional level (trading billions a day), this spread will begin to disappear allowing for better entries.

Now that you have a basic understanding of movement and cost of movements, let us discuss entering trades.  When first starting any type of trading, finding the correct contract sizes and understanding how a contract size affects your account is one of the most difficult processes, especially if you have never done it.  In fact, it can be devastating if you chose the wrong one.  What we will explain below are the different contact sizes available, and when to use them.

The first is a “micro lot”.  This is one of the smallest contract sizes the majority of brokers will let you trade.  There may be smaller contract values called “nano lots”, but the contracts are so small, it may not be worth your time if you are taking day trading serious.  What a “micro lot” represents is $0.10 (cents) per PIP.  For example, if you choose 1 micro as your lot size and the price action moves 10 PIPs, you would have made $0.10 (* 10 pip = $1.00).  Now, if you choose multiple micro lots, for example 4 micros you just change from $0.10 PIP moves to $0.40 per PIP move.  If we use the previous example of 10 PIPs, you would have made $4.00.  Micro lots are the safest way to test your account and make sure you understand how quickly $0.10 can move for or against you.  Starting off, every serious trader should master their accounts on micro lots and aim for the goal of repetition of good trades versus the amount of profit in a few trades.  We recommend a $1,000 account size on micros with a 3-month track record of results before moving up in contract value.

Now the other contract sizes are not different in structure, the difference is what they represent in PIP movement and value.

A “mini lot”, instead of representing $0.10 PIP, will represent $1.00 per PIP move.  So in the example above of 10 PIPs, you would have profited $40.  You want to start using mini lots safely once your account value has reached at least $10,000 trading.

A ”standard lot” is what many traders want to mistakenly start off with because it can potentially generate a higher return.  For example, 10 PIPs at 1 standard lot would represent $100, meaning that 10 PIPs in the Forex world can happen in minutes, if not seconds, which is why higher leverage lot trading is tempting.  We recommend a minimum account of at least $100,000 before trading standards safely.  This puts your trading at a 1:1 leverage, or non-leveraged position.  However, a 1 standard trade moving just 100 points get a return of roughly 1%, that can easily happen within several hours and sometimes even in minutes.  Therefore, even with a non-leveraged position, returns can be attractive within a short period of time.  It is not uncommon to see 200 PIPs in a day which would of course provide a 2% return with a non-leveraged position.

Many brokers will allow you to trade standard lots on accounts as small as $5,000, but just because you believe you can do this kind of movement, doesn’t mean you should.  We can’t stress enough to those wanting to take trading seriously that it is not about how much you can make in a day, but how often you can repeat it.

Now that you have an idea of how your account will react when you enter the Forex market, it is important to discuss the importance of a brokerage or custodian that will house your assets.  Starting off, this may not be as much of a concern, however, you do want to work with a reputable firm that can provide you with the liquidity you need to trade safely.  We will provide you with some issues you may come across with if you do not choose the right firm to work with.

The smaller firms that promise you big account deposits incentives, and near zero on spreads may have issues when you try to request funds out of your account.  The other issues you may run into that are more common are not being able to fill orders or close orders when you want.  You will notice this more often when trying to close your profits.  A non-reputable firm may limit your abilities when you are in profit, because when you trade, they usually take positions against you, and this is because 70% of the time, you will be wrong if you are not a professional trader or at least a disciplined one with a strategy that works consistently.  With that said, when you are in profit, some brokers have the ability to “stop servers” from filling orders until price action is in their favor, at which point they will fill your order.  Unless you are trading over $20 million, you may experience these issues, because you are not plugged into the direct feeds of the banks.  There are ways to overcome these brokerage issues, and that is to find companies such as MIG Bank in Switzerland, or Citi Bank.  These banks require higher minimums, but that is because you would be providing the liquidity to others.  If you can’t meet the minimums, other reputable brokers would be or FXCM.

We continue to mention throughout this article that if you are a serious trader, there are certain things you will need to do.  As you grow in your day trading, a lot of what we have mentioned in regards to finding a good broker to work with will come naturally as you start looking at what is out there.  What we want to accomplish with this article is the basics of trading Forex, so if you are beginning to trade, you will have a general idea of what you need to do.

In follow up articles, we will begin talking about different strategies that you can use to help to become a better trader.  We won’t waste time on talking about every single tool, but rather narrow down the list to ones we feel you should master.  These will include things such as volume trading, price action, and FIB levels, which are tools the professional will use on a daily basis.  We look forward to sharing this knowledge with the Secret Entourage readers, and wish you the best of luck trading!

About Holland Global Trading: Holland Global Trading is a registered commodity-trading advisor (CTA) with a client base that includes a unique blend of both seasoned Forex veterans and people who are completely new to Forex. Our trading team is dedicated to providing research and technical excellence.

As with any investments we MUST state: Disclaimers and Disclosures – Forex trading carries a high level of risk and may not be suitable for all investors. Trading on leverage magnifies the potential for profit and loss. Before deciding to trade forex, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that this website is not rendering investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. The information and opinions found on this website are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this website are subject to change without notice. The reports within the website have been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.