Forex Trading Basics Tutorial 3 – Key Advantages of Forex Trading

This Forex Tutorial will cover advantages and drawbacks associated with trading Forex.  Additionally, this tutorial will cover tips on how to decide if Forex will fit into your financial planning goals as well as topics on leverages and small account minimums.

Higher Leverage Amounts than Stock Trading

Using leverage in Forex is a key tool in the trader’s toolbox.  A majority of trading brokerages have ranges from 10:1 to 50:1.  Other brokerages, depending on domicile (country out of which the business is based), have varying regulations and may allow their clients to set leverage rates much higher, to possibly 250:1 or even 1000:1.

The important thing to remember is, unlike stocks, ETFs, bonds or mutual funds, Forex accounts allow for a much higher leverage amount or “available margin”.

Deciding What Margin Amount to Use

Borrowed money is the definition of trading on margin or leverage.  Also, a normal brokerage account holds you responsible for paying back borrowed amounts or margin amounts that are equal to or even greater than the original borrowed amount, Forex is different.

Setting your Forex account’s margin to a specific level ensures that you use the actual cash balance in your account to give you “buying power” that is a multiple of the margin level.  For example, let’s say your account is set to 20:1 and you have the ability to buy 20 times the cash value.  This pre-set number regulates the sum of currency made available for trading purposes.  Keep in mind that the higher levels of margin cause the percentage movements of currency pairs to amplify.

Another example is if your setting is at 50:1, your Profit/Loss (P&L) of the account is moving at 50x the actual percentage movements of the currency pairs move per day.  A typical movement between the Australian dollar/US dollar “AUD/USD” pair move 0.75% - 1.10% up/down per day.  Now if your margin was set to 50:1, your P/L is tracked at 375%-550% of the cash value of the trade.  This is good for a trade that is gaining, but terrible for losing trade.  It may even wipe out your account if the brokerage firm makes a forced margin call and automatically close out your trades at a loss.

Position Size is tied to Margin Levels

Many professional Forex traders avoid a forced margin call by limiting the size of their trades relative to a percentage of the total cash balance in the account.  If a trader has a 50:1 margin set, they could decide to put only one third of the available margin to all the trades on any one time.  Here is an example:  If a trader starts with a base of $250USD cash balance with a margin set at 50:1, this particular scenario gives the  trader the “buying power” of $250USD x 50 = $12,500 worth of currency, which is the maximum amount of total usable margin value.  In this case, a trader will only use 20 percent to 33 percent of this amount at in a given time frame.  A trader will access only part of their purchasing power for a few trades.  In this case, roughly $2,500 to $4,160 out of the maximum of $12,500 can be accessed.  Keeping back part of your maximum margin in not only good business sense, it also can prevent accidental margin calls from fast shifts in the percentages of currency pairs.  The trader’s leftover available margin, the 80 percent to 66.6 percent, can then be used to help alleviate sudden large shifts of unrealized trading losses in the Forex Trading account.

Small Account Minimums in Multiple Currencies

A great advantage to Forex trading is the margin amounts.  By accessing a very large margin or “gearing”, a trader can earn a good return of profits with a minimal account balance.  Not all United States brokerages insist on having $2500as a minimum to set up an account.  Finding a USA based brokerage that handles Forex, plus allowing accounts to open with $10-$25 cash balance is easy enough.  Many international Forex Brokers based in countries such as Switzerland or Cyprus handle accounts with small balances.  Oftentimes, an account can be opened in whatever currency the owner prefers such as Euros, Swiss francs, or British pounds.

Trading Styles to Meet Different Objectives

A Forex trader that sets an aggressively high net capital gains goal can pursue his or her financial objectives by diligently searching out short term, high leverage trading opportunities that will capture gains quickly with nightly setups.  Also called scalping, overnight trading or position trading, this type of trading aims for the highest returns but may also be associated with higher risks.

Forex Trading for Income

However, a more conservative approach may give the Forex trader the chance to slowly build up a portfolio based on lower risk, but with a very high dividend over an extended period of time to provide consistent income.  Called “carry trading”, it is most often conducted by going “long” with a high interest currency and “shorting” a low interest charging currency.   Most often seen in the Australian dollar/US dollar currency pairing, a Forex Carry trade can pay out net interest rates near 20-25 percent per year, before compounding.  Also, most Forex accounts have interest paid daily and the balance can swiftly accumulate.

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