The Everything Guide to Currency Trading

All the tools, training, and techniques you need to succeed in trading currency

David Borman

• Publisher: Everything
• Year: 2012
• ISBN:
  9781440531408
• Topic: Business
• Subtopic: Foreign Exchange
• Index: Business

Currency trading can be profitable or perilous—depending upon your expertise as a trader. In this no-nonsense guide, you'll learn the basics of currency investing, from global macroeconomics to technical analysis, as well as many of the strategies that successful traders use. As you develop key skills, like buying ETFs and back-testing trades, you'll learn everything you need to succeed in this tumultuous world, including:

• What goes on behind the scenes in the market
• How to evaluate currency pairs and look for big opportunities
• Which kind of technical analyses work—and why
• How to minimize risk through hedging with "safe" currencies

With unique trading strategies designed for investors at various levels of budget and risk, The Everything Guide to Currency Trading is all you need to cash in on the ever-expanding Forex market, no matter how new you are to the challenging game of currency trading.

CHAPTER 1

Currency Trading: The What, the Why, and the Rewards

It would be best to know a bit about currency trading before you look at your first chart, read your first broker’s report, or place your first trade. You first have to learn what it means when someone says they trade currencies, and why they do it. You can then evaluate your investing goals and determine if the rewards of currency trading are worth the added risk to your overall investment portfolio, plans, and goals.

What Is Currency Trading?

Currency trading (also called FX trading and Forex trading) is when you buy and sell the money of the different countries of the world. It is a form of trading similar to buying stocks and mutual funds, only the actual investment vehicles are digital money. You can trade this money or currencies with an independently owned retail account, much like an online brokerage account.

The preparation you would take to make a trade in the FX market is similar to the research you would make for a stock purchase. You would spend time reading brokers’ reports, seeking out information from websites, and looking at technical charts.

The difference between stock and FX trading is that with stock trading you are betting that a company will increase in perceived value against the perceived value of other stocks, and therefore the other people in the stock market will pay a higher price for your small slice of that company (represented by shares of stock). With currency trading you go about buying or selling the relative value of one country’s home money in relation to another country’s home money. In stock trading, a company must have a good (and you hope increasing) stream of income to rise in value against its peers. FX trading is different. In order for the money of one country to rise in value against another country’s money, there has to be a wider mix of positive news and expectations.

Traders going long on a currency (placing bets that the money will rise relative to another) usually look for a combination of rising interest rates, increased positive economic activity, political and social stability, and the home country’s debt levels. Other considerations include commodities demand, and that country’s central banking stance and comments. Lastly, a currency trader will consult brokerage reports for an opinion, and consult a chart for technical indicators.

The mechanics of currency trading are also a bit different from stock trading. With stock trading you are usually allowed a 1.5:1 to a 1.75:1 ratio of leverage. This means that if your account has a balance of $10,000, a brokerage house will allow you to buy and trade an additional $5,000 to $7,500 worth of stock. This would bring your possible trading position size to $15,000–$17,500 all while having only $10,000 worth of your actual cash in your account.

With currency trading, the leverage ratios are much higher. Most FX brokerage firms allow you to trade with leverage ratios of 10:1 up to 50:1. With this kind of leverage you would be able to trade $100,000 to $500,000 worth of currency with a cash balance of $10,000 in your account.

Don’t let the availability of the high margins in currency trading make you say “No” to getting started in FX! You can learn to use the margin in your account safely by limiting position size, and using automated take-profits closing triggers. These can be used to keep your FX losses to a minimum and your gains to a maximum!

Another characteristic of FX trading is the ability to make a good profit with a small account. Some currency brokerage firms allow balances as low as $100, which would allow you to trade $5,000 worth of currency (with your leverage set at 50:1).

Finally, since people all over the world trade currencies, the market is open longer than the U.S. stock market. It is possible for you to trade Forex twenty-four hours a day, from Sunday afternoon eastern time, until Friday afternoon eastern time.

Why Trade FX?

You might be asking yourself, “Why should I trade currencies?” The answer is simple: for profit (and fun!). Whether you are a big player or a small account holder, the combined elements of studying economies and political climates, using high leverage, and maintaining unconventional hours can add up to a very enjoyable and profitable pastime. Whether you plan on FX trading to earn your weekend fun money, or you plan on drawing a paycheck against your profits, Forex trading can allow you to use your knowledge for real gains.

Currency trading allows you to bring your knowledge of economies, countries, central banking, technical indicators, and research into an arena that provides a chance to profit from these skills. If you feel as though you do not have the skills or are unsure about your skill set, this book will get you up to speed at analyzing market conditions and news, and executing successful FX trades safely.

This book will also guide you through the benefits of starting small and risking nothing but your time, by teaching you to trade in a practice-demo account that you can sign up for at FX brokers’ websites. Downloading trading software for these demo accounts is easy. They offer the same charts and market pricing of a live account, and they will offer you the opportunity to get a feel for the analytical and order-entry skills required for successful and profitable trading. Whether your account is large or small, and whether your risk appetite is high or low, with practice you can gain the skills and knowledge to seek out, recognize, and place successful currency trades.

With the low account minimums and the high chance of success, many people consider currency trading a kind of high-stakes video game. With all of the graphs, charts, information, and fast action, it is easy to see why so many people enjoy FX trading as a video hobby or sport!

You might be asking yourself, “What else can currency trading do for me?” The answer is multifaceted. For one, when played correctly, trading in the currency market can lead to gains in your overall portfolio beyond your usual stock dividends, capital gains, and bond income. If you have a traditional portfolio that includes equity and bond mutual funds, stock and fixed income, the addition of FX trading to your overall portfolio acts as a return enhancer to an otherwise conservative portfolio.

It is also possible to build the bulk of your overall portfolio to an almost risk-neutral position by investing in a very conservative mixture of treasuries, investment-grade corporate bonds, and other high-quality, low-yielding investments and accent the return of your portfolio by actively trading in the currency market. This strategy is one that is often recommended by financial advisors to their high net-worth clients. Financial advisors usually recommend options on the Standard & Poor’s (S&P) 500 as the risk portion of such a portfolio. In this case you would substitute trading the euro, British pound, Australian dollar, Japanese yen, Swiss franc, and Swedish krona instead of S&P 500 options.

If the return enhancement weren’t enough for you to want to trade FX for yourself, then consider the diversification properties of currency trading. It could be (and often is) a time in the market that the U.S. stock market (represented by the S&P 500 index) is underperforming, moving sideways, or just plain going nowhere. It also might be true that your portfolio of bonds, mutual funds, and stock is heavily weighed to a U.S. perspective, with the bulk of the assets relying on a good economy in the United States in order to show any positive gain. Lastly, it could be difficult to structure a portfolio that gains in an economy that is doing poorly or one that has a stock market that is moving downward. In these situations, FX trading can diversify your overall portfolio away from a “good fortunes in the U.S. only” stance and into a worldwide trading arena where you can profit from good news and bad.

While the stock markets might be retreating or stuck, you can build a bond portfolio that preserves capital and enhances its return by trading a small percentage of that portfolio in the currency markets.

What Are the Risks and Rewards?

Before you begin your career in currency trading you will first have to see if the rewards of FX trading outweigh the added risks that it brings. While it is true that currency trading involves the use of high levels of margin, there are a few risk management techniques that can help limit your risk.

It is true that you will be trading with leverage ratios of 10:1, 20:1, or even 50:1. It is also true that things can happen fast at this leverage ratio. It is common for a position to move upward around 1 percent during the heaviest trading times of the day. If you have a big trade in that currency at a high leverage amount and the direction of the trade moves against you, then it is also possible for your whole account to get closed out due to a margin call, which is when your broker will automatically close out your positions before your account gets a negative equity balance. If this happens, you have blown up your account, as the professionals say, and your money will be permanently lost into the great electronic money abyss.

Many people new to currency trading have had this blow up happen to them; this is precisely why currency trading has such a bad reputation in certain circles. On the other hand, the currency market is the biggest, deepest, and most widely traded market in the world—not all those traders can be losing big. Quite the opposite! Most of the FX traders of the world are making a living at it, trading in office buildings with posh addresses in New York, London, Zurich, and Tokyo. There is money to be made in trading FX, and if done right, the money can be made with such consistency that you can earn and draw a paycheck out of the profits in your trading account.

You can scale your currency trading to any level that suits your needs. If you would like to learn about the world’s economies and markets, currency trading is for you. You can trade with a practice account, or you can trade with your extra money. You can even go full time and use FX trading to earn a living.

With the right amount of knowledge and training you can make sure that the size of the paycheck that you earn from your currency trading endeavors is in proportion to the size of the balance in your account, and is not related to the amount of risk you have taken in your account.

You can run your trades in such a way that the risk is the smallest required to earn the largest returns. You can also assure yourself that your gains can result in proportionate gains: the larger your account, the larger your gains. It should never be a practice for a trading method to squeeze out the highest level of earnings by pushing the risk level beyond what is acceptable to you. You might be happy with a lower, steady yield from your trading, all while assuming a very limited risk level. On the other hand, you might have the perspective that you and your portfolio can tolerate (and enjoy!) a higher level of risk, and that you relish the bigger gains that those trades offer. Your account can be highly tuned for profit with added risk, or de-tuned for lower gains, but reliability: the choice is yours. Either way, if done right, only FX trading offers the highest level of payoff per dollar invested, along with manageable and adjustable risk levels per unit of return.

Who Trades FX?

Currency trading is an endeavor that is pursued by people and investors all over the world. Some investors are hedge funds that operate in an unregulated environment. These hedge funds work much like a mutual fund with sales of shares and calculation of value. The difference is that only accredited investors, or investors who meet a certain minimum of net worth and annual income, can purchase hedge funds. Other investors of hedge funds include institutional investors such as school endowments and pension funds. All these types of investors are trying to obtain the same thing: a wide diversification of total invested assets, with measurable uncorrelated returns.

While there are many different types of hedge fund investment strategies, many macro funds (a strategy that looks at and invests in the entire investment universe) involve currency trading and currency hedging techniques. Macro- and currency-only funds trade with the same leverage and trade on the same observations as you, the retail, individual FX trader.

What does it take to open a FX account?

You can open a practice account with just a login name and a password. In order to open up a live account and put money into it, you usually need the same information as opening up a bank account: photo ID, proof of residence, social security number, etc.

International Banks

Other players in the market include international banks that buy and sell currencies on behalf of their major customers. These customers might be manufacturing companies with factories or sales that are overseas. A bank might assist these customers in setting a currency hedge to help offset the risks associated with accepting foreign currency payments or paying bills in a foreign currency at a future point. For example, if an auto parts company knows that it will have to pay 10 million Danish kroner to a company based in Denmark in three months, they might lock in the price of the payable DKK with a Danish krone position in the currency markets, much like a form of a simplified derivative.

Central Banks

Still other participants in the Forex are the central banks and treasuries of the nations of the world. While not common, a country or coalition of countries can act in the currency market to put pressure on a currency. If, for example, the Swiss National Bank (SNB) thinks that the Swiss franc has appreciated against the euro too much, or that they feel that the exchange rate between the euro and the franc is beginning to slow the economy in Switzerland, the SNB might intervene. The bank could do this by using francs to buy up short-term government debt issued in euros. This would put more francs in circulation, and also create a demand for euro-denominated debt. The combined effect of more Swiss francs and less euro debt would effectively cause the franc to get cheaper (because of liquidity) than the euro (because of scarcity).

This type of intervention can be a ...