Trading the Forex Market - Part 2

How do I choose a broker and start trading?

Shameless plug: Please make sure you have read Part 1 of this series if you are new to Forex Trading, or you may find yourself a bit lost.

The first thing you need to do in order to trade the Forex is to have an active account with a broker. And the most important thing when picking a broker is to make sure you select a solid and reputable one. Not all brokers are created equal. Some will offer fantastic terms, but they are either small operations who run the risk of being wiped out due to calamitous events, taking your money with them, and others may be run of the mill, shady operations where even without a calamitous event, you may find them gone one fine day and you'll be left with little to no recourse.

Commissions, Spreads and PIP Price

Forex trading has no commissions. Let me repeat that: Unlike other trading, like stocks, options, commodities, futures, you will not have to pay the broker a commission on each trade. That in itself is a huge advantage. So how does the broker make money? Do you remember in Part 1 that we showed you a picture of a price board from a retail (Airport) Currency Exchange shop? It showed 2 prices for each currency, a Sell and a Buy price, and there was a small difference in pips between one and the other. This difference is called a spread. A broker will allow you to buy a pair at one price and sell at a different price, anywhere between a 3 to 11 pip difference depending on the pair and its volatility at that point in time. You will clearly see the spread for each pair on your trading screen, and we will look at this in a later post. So if I were to buy a pair and sell it at the exact same instant, without the price having changed, I would take an immediate loss equal to the spread, and that amount of money is what the broker makes. It is also the number of pips I need to make before I am at a breakeven point where if I exit the trade, I neither won nor lost any money. Once I have made that number of pips, any further movement of the pair I traded in the direction I predicted becomes my profit, free and clear. Of course, if I end up losing money on the trade, my loss will be equal to the number of pips the pair moved against me, plus the spread.

Lastly, I also said before that your profit/loss per pip would be US$10 on a full standard lot. That's also a nice approximation, with the real value being somewhere between US$7 and US$10, again, depending on the pair. Just like margin requirements and spread, the pip price will also be clearly stated for every pair.

Profit in a Trade = (PipsCaptured - PipsInSpread) * PricePerPIP
Loss in Trade = (PipsLost + PipsInSpread) * PricePerPIP

Margin

In addition to the spread and pip price, each pair will have a margin requirement, which is the amount of capital needed in your account in order to control a full standard lot, a minilot, or a microlot. For all our examples, I will be using a standard lot (US$100,000) and the margin requirements will be for that, as will any other variables you need to keep in mind. If you need to reference minilots (US$10,000) just divide by 10. And if you are trading microlots (US$1,000), then divide by 100. While in the prior article I stated a margin requirement of US$2,000 per lot, that is an average, and the actual margin will vary between US$1,600 and US$4,500 depending on the currency pair. Again, this will be very clearly indicated on the trading screen.

Caution! If at any point in time, due to interim losses (that is, when you are still in a trade and losing, but haven't closed it out yet) you have less capital in the account than is required for your margin on the open trades, you can get a margin call. This is when the broker closes out your trade(s) automatically at a loss to you. The market may then move back in your favor, and would have returned you to positive territory, but you are no longer in the trade!

Due to the above situation, I recommend you always have at least 50% of your account unused so that you have a safety cushion against margin calls. That is to say, if my trade requires US$2,000 of capital for margin purposes, I would actually prefer to have US$4,000 in my account at that time.

Pick a Broker

Now that you know all of the above, and without trying to tell you which specific broker to pick, it will depend to some degree on where you live. If you are in the US, you can't go wrong with FXCM, eTrade or Thinkorswim. If you are in Europe, then your best bet is probably IG. There are many others, but the ones I mention are financially solid and also have a stellar reputation. If you choose not to use one of these, for God's sake, do your research properly and make sure you're not signing up to a Fly By Night operation.

Paper Trading

All of these brokers will allow you to paper trade. What does this mean? They'll allow you to open an account funded with imaginary money and execute practice trades. They will allow you to track your imaginary profits and losses, so you'll always know how well (or poorly) you're doing. This is one way to get some knowledge under your belt and get comfortable with the idea of trading, the tools you'll be using, and how to actually enter and exit trades. That said, and I can tell you this from experience, it's one thing to paper trade, and quite another to actually risk real money that belongs to you. I've seen many a brilliant paper trader who destroys a funded account in days, simply because they can't follow the same strategies in real life as they can when there's no risk. Be careful of that.

Real Account

When you do sign up for a real account, be prepared to answer a lot of questions, including providing your real name, physical address, Social Security Number and, of course, banking information in order to fund the account. There will normally be a period of time between providing all the information and being told you now have a valid account and how to access it. This can take 2-3 business days, and has to do with verifying your information. This is exactly the same process you'd go through if you step into a bank to open an account, except while a bank may verify you on the spot, a broker may take those 2 to 3 days.

I personally use FXCM for my trading, as I like their interface, trade execution speed, spreads and access to support. But like I said, don't let me force you into any specific broker. This is your life, start owning it.

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