Introduction to Forex - Profit and Loss

Profit and Loss (P&L) for every position is calculated in real-time on most trading platforms. This enables traders to track their P&L tick by tick as the market fluctuates.
Approximate USD values for a one (1) "pip" move per contract in our traded currency pairs are as follows, per 100,000 units of the base currency:

1 pip = 0.0001
1 pip move per 100k (lot) = EUR 100'000 x .0001 = USD 10.00
1 pip = 0.01
1 pip move per 100k (lot) = USD 100'000 x .01 = JPY 1'000 /spot = approx USD 9.7
1 pip = 0.0001
1 pip move per 100k (lot ) = USD 100'000 x .0001 = CHF 10.00 /spot = approx USD 8.5
1 pip = 0.0001
1 pip move per 100k (lot ) = GBP 100'000 x .0001 = USD 10.00

1 pip = 0.01
1 pip move per 100k (lot ) = EUR 100'000 x .01 = JPY 1'000 /spot = approx USD 9.7
1 pip = 0.0001
1 pip move per 100k (lot ) = EUR 100'000 x .0001 = CHF 10.00 /spot = approx USD 8.5
1 pip = 0.0001
1 pip move per 100k (lot ) = EUR 100'000 x .0001 = GBP 10.00 /spot = approx USD 19.00
1 pip = 0.0001
1 pip move per 100k (lot ) = USD 100'000 x .0001= CAD 10.00 /spot = approx USD 8.00
1 pip = 0.0001
1 pip move per 100k (lot ) = AUD 100'000 x .0001 = USD 10.00
On a typical day, liquid currency pairs like EUR/USD and USD/JPY can fluctuate a full point (.0100, 100 pips). On a EUR 1'000'000 position a full point on EUR/USD equates to 10'000 USD.

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Forex Trader Tips

1. Forex Money Management

There are many definitions of Money Management, from the use of a stop loss to how many lots you trade on each trade. My definition of Money Management is safety of funds. The most important money in trading is the money you already have. Yes, it is important and required to risk some money to make profits, yet a true Money Management plan maximizes profits with as little risk as possible.

Once you have established a trading plan, practice your plan through some form of simulator or demo account. If you need a good trading plan, choose one of fifteen forex trading systems with Smart4xTrader. Log each trade and note all your orders (i.e. entry, stop loss, targets, etc.). After you have logged at least 30 trades, go back over these trades and look for the highest risk trades - those trades with the largest stop loss yet with the smallest potential return (Risk Reward Ratio). Establish rules to minimize this drawdown potential and test them over and new set of 30 trades. If these better your results then implement them into your trading plan. It is wise to evaluate your money management techniques every 100 trades to perfect your trading.

NOTE: Using Money Management techniques may actually lower your total return, but remember that Money Management is safety of funds first, profits second.

2. Forex Long-Term Hold Strategy

Is it possible to hold your cash in a bank and make a 12 percent plus annual rate of return with zero risk? It is if you know the Forex market. As mentioned earlier, the goal in cash investing is not obtaining the most money, but retaining the most valuable money. So how is it done? Place your cash reserves in the currency that is appreciating over your countries currency. You may need to find a worldwide bank, however, many international banks will allow you to save your cash in the currency of your choice. If you live in the US and you wish to save your cash in Euro's when you deposit your funds, make a request to the bank that the US Dollars be exchanged over to Euro's. When you withdraw your funds you will exchange back toUS Dollars for a profit if the Euro appreciated over the US Dollar. There are also many forex brokers that will allow you to do the same thing. AC Markets is a good example. Of course you need to have a system on when to exchange and when to not exchange your cash into the other currencies. Smart4xTrader teaches this Forex strategy in their Forex Training.

To give you an example of the potential of a Long-term hold, in the Premier System provided by Smart4xTrader we were given a signal for a premier time to move over to Euro from US Dollars the week of April 15, 2006. By holding that position until May 2007, if we were going to withdraw our funds to US Dollars, we would now have 7.17 percent more US Dollars then we started with. Plus, we would also have any interest that we would have made in the savings account. If we look to the New Zealand Dollar and its run against the US Dollar our system gave a premier signal to be long the New Zealand Dollar the week of October 7, 2006. Today you would be up 13.23 percent over the US Dollar in less than 8 months. (Premier Trading Strategy offered by Smart4xTrader)
Add a little leverage and diversification in the mix and now you could have some serious profits over the long term. It pays to understand the foreign exchange market!

3. Forex Fundamental Trading

Most of the time we talk about Technical trading strategies and systems. The On Target Trading System and other trading systems used and taught by Smart4xTrader, use technical analysis exclusively in making trading decisions. What about Fundamental Analysis? Does it have the potential of creating consistent profits over time? Fundamental Analysis is the study of the market strengths and weaknesses. Due to the global environment of the Forex, Fundamental Analysis is more focused on news catalysis's than the strengths and weaknesses of the currencies themselves. If you used fundamental analysis to trade stocks you would spend a great deal of time focused on the make-up of the company, its CEO, earnings per share, and future product line. The same isn't as true with Forex, you spend more time focused on the changing of interest rates than anything else. It is impossible to teach Fundamental Analysis in a single paragraph, but if you desire to explore further this trading technical my suggestion is to start by taking a look at the current news events of each day and spend some time seeing how the market reacts to the price fluctuations. Be careful as price can move on a dime with one single word change in the news. One of the best free sources on the web is Even though I don't trade on fundamental analysis I still from time to time like to see what the other guru's are talking about. This is a great resource to hear the buzz of the market. Check them out and happy trading.

4. Look Both Ways Before you Cross the Street – Forex Street
"Look both ways before you cross the street," is a phrase that we all heard as a child and now is a phrase that I say constantly to my own children. Why do we say this? Because we want our children to look for the potential dangers in front of them as well as those behind them. The same principle can be said with the forex market, but instead of looking for cars we are looking for support and resistance lines. Levels of support and resistance are what gives the markets shape and form. It is what keeps price from just drifting to the ends of the earth. Now to understand why these levels create shape to the markets you need to understand how they came about.

First, the why. Support and resistance levels are created by at least one of two major things: volume and/or the mental phenomenon. Volume is the major cause of these levels and creates the strongest level of the two. When price is either bought or sold in a high volume amount at a certain price level, that level now becomes either support or resistance (support if price was bought up or resistance if price was sold down). Since a large body of trades entered the market at that price, lets say 1.2345, if price returns to that area, price is usually held by those initial traders through additional position taking. Traders add additional positions to hold the market from going against them. In addition, other traders that missed out on the opportunity to get in from the beginning, now jump in and follow the crowd. Hence, price is maintained beyond the initial entry level. The greater the volume at a given price, the stronger the level will be. Initial volume levels are strong, but they do tend to weaken overtime as traders close out positions for profits. These high volume levels are usually generate through news catalysts and that is why we see a lot of support and resistance lines initiated at 5:30 AM, 8:30 AM, and 9:30 PM EST as these are the times when most major news releases come out worldwide.
Our other explanation for levels of support and resistance is the mental phenomenon. We are taught from an early age to recognize that the world is made of numbers from price tags to how much we weigh, everything is associated with a number. Just like in sales, where a number ending in .99 makes the product seem less expensive then the even number .00, even though it is only one cent lower, the same goes for the forex. The mental numbers in the forex market are those even-whole numbers like: 10, 50, and 100. Price is going to find some form of support or resistance at these number levels as traders tend to respect price as these numbers are approached. Of course the larger the even number the better (Ex. 1.3000 or 2.0000). Whether there was volume at these levels or not you will find that price tends to hold for a time at these levels.

6. How to Make Money with Support and Resistance – Profit Targets

The first is Profit Targets. The majority of traders trade on emotion and close their trades when, 1- They have made enough money. 2- The problem with most traders is they have never made enough money. Just like Las Vegas, they stay in the game too long and give back all their profits to the house. Using support and resistance lines as levels to take your money off the table is a consistently winning strategy. What I like to do is to look for a close level of support/resistance for my Target 1 and then look at a further away support/resistance for Target 2. Once I hit Target 1, I take half of the lots off the table realizing profits, and then I allow the other half to ride toward Target 2. To conserve capital and eliminate the risk of loss, I will bring my stop loss up to breakeven or even set-up a trailing stop. Remember when you are in Buy trade you are looking for the next level of resistance to place your targets and if you are in a Sell trade then you are looking for the next level of support. Learn Forex Trading Systems at our site.
The second way to make money with these Forex support and Resistance levels is through money management. This actually comprises two aspects: 1) stop loss positioning and 2) Lot Sizing. A smart Forex stop loss is one placed below/above a key level of support/resistance. If you are in a Buy trade, place your stop loss 5 - 10 pips below the next level of support that is below your entry price. If you are in a Sell trade, you are going to place your stop loss 5 - 10 pips above the next resistance line. By doing this, you actually hire other world traders to protect your position. If price approaches your stop, other larger traders will step in to maintain price as explained in our last week’s article. Lot Sizing is another form of management that can be enhanced with these support/resistance levels. It all has to do with risk. If your profit targets compared to your stop loss are not large enough then your risk vs. reward is not exactly in your favor. Instead of trading and missing the trade set-up, minimize your lots to reduce risk. Vice versa, if the risk vs. reward is in your favor or Target 1 sits at a place that has a high probability of being reached, then you can take on more risk and increase your lot sizing and profits.
Make sure that you look both ways before you enter a trade in the Forex. Look behind you for potential risks that may keep price from going where you think it will go and also look for shelter for a solid stop loss. Look ahead of you to establish profit targets where price will most likely go. Support and Resistance Lines are the railings of the markets. Lean on them, trust them, and use them to better your trading.

7. A Losing Month in the Forex
After a losing month in the Forex it is wise to step back and analyze your trading. Understand that to participate in the Forex market long term you are going to have losing months. The goal is to not let the losing month detour you from trading your system and plan into the future. The Fear and Greed Factor will destroy your trading if you let it. Yes, you lost, but if you used proper money management you should still be in the game. I have traders all the time tell me that they are "sitting out for awhile." This I highly suggest against! Why? Well, does Tiger Woods sit out a few golf Tournaments when he doesn't finish in the top five in one tournament? Absolutely not! He is back on the green working out the kinks in his system of golf and so must you as a Forex trader - get back in the game and work out your kinks of trading. Now, don't take out your frustrations on the market, but rather resort to our learning philosophy, "Learn, Simulate, Trade, Profit." Go back, analyze your strategy and trading rules, review them in your mind. Simulate a few months of trading data, including the losing month to see if there was anything that you could have done better - learn from it. Then get back in the game to Trade and Profit. Endurance is more important than returns. If you have a good trading system, like the On Target and Premier Trading Systems, then you simply need to trade your plan and get back in the game. If you do, you will look back and that losing month will be dwarfed by consistent trading profits.

8. Forex Diversification
Diversification is the key to any successful portfolio over the long term. The investor's greed is shown when he/she only wants to invest in the highest yielding investment without analyzing why one is higher and why one is lower. By diversifying in two great forex trading strategies that each have different goals and objectives, you reduce the risk of loss during unpredictable markets. When the market is good, all accounts are making money. The key to diversification is to maintain capital growth even during bumpy markets. Don't put all your eggs in one basket. Diversify between currency pairs and also trading strategies for long-term capital wealth.

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All Trading in Currencies is Done in the Foreign Exchange (FOREX) Market

All trading in currencies is done in the foreign exchange (FOREX) market. However, it is an over-the-market in that there is no physical location for the FOREX market. Trades of currencies between foreign exchange dealers are done via telephone or computer link.

There are two parts to the FOREX market:
1) Spot Market
2) Forward Market

The major participants in the market are: large exporters/importers, central banks, foreign currency brokers and the commercial banks. Almost all trades in foreign exchange go through foreign exchange dealers employed by the large commercial banks. Foreign exchange dealers constantly buy and sell large amounts of currency throughout the day and are always ready to buy or sell more (although at a price they set). This means that the FOREX market is very liquid, you will always be able to find someone to buy your currency from you or sell you the currency you need (although maybe not at a price you like). Anyone wanting to trade currencies will do so by buying or selling the currency from one of these dealers.
Foreign exchange brokers are intermediaries who will carry out orders to buy or sell currency. Smaller firms and individuals generally do not have access to trading directly with the currency dealers employed by the banks because they deal with large sums of money. Therefore, if a small firm wishes to engage in currency transactions, it will probably have to be done through a currency broker. In aggregating the orders of many clients, a currency broker has the clout necessary to deal directly with the currency dealers. Currency brokers also possess the expertise and knowledge of the market necessary to trade directly in currencies. Of course, brokers charge clients a commission to perform this service for them. It should be noted that there is really a fine line between brokers and traders, as almost all major banks have both. They will have a trading floor where then actual dealers employed by the bank operate and trades in the FOREX market are carried out, and there will be a currency broker service offered on the retail side.

As one might guess by this point, the commercial banks are the most important players in the FOREX market. Approximately 85% of trades in the FOREX market are done between banks (i.e. FOREX dealers trading with each other).
Spot Market

The spot market is the market for the immediate exchange of currency. It is here that the current exchange rates are set (the spot rate). When someone sells a currency to someone else (in exchange for another currency), they are required to deliver that currency two working days later. Actual delivery of a currency is done through a transfer of bank accounts.
Example: A London bank sells DM to a New York bank for $US. Two working days later, the London bank transfers ownership of a DM deposit (held in a German bank) to the New York bank and gets ownership of a $US deposit in the U.S.

These types of transactions are often carried out through SWIFT (Society for Worldwide Interbank Telecommunications) which is a communications and computer system designed to keep track of and execute these types of trades.

The people that actually set the exchange rates are the banks’ dealers. Dealers set prices at which they are willing to buy and sell each currency (individual dealers will specialize in certain currencies). The dealers guarantee that they are willing to buy or sell the currency at the prices they set. Of course these prices are constantly changing and are only guaranteed up to a maximum trade size. The guaranteed trade size is the depth of the quote. For instance, a dealer may quote a price for £’s in terms of $US, but only guarantee the price on trades up to a value of $5 million US (which is a typical quoted depth). The price for trade of a larger size will have to be negotiated.
The existence of traders quoting prices at all times is an important feature of the FOREX market because of the liquidity it provides. There is virtually no chance that you will not be able to find someone to buy from or sell to.

FOREX dealers make much of their profit on the Bid-Ask Spread. A dealer will quote two prices for a currency:
Bid Price - the price at which the dealer is willing to buy the currency
Ask Price - the price at which the dealer is willing to sell the currency

Ask Price > Bid Price

The difference between the two prices is the Bid-Ask Spread.

Each dealer sets his or her own Bid-Ask prices and attempts to do two things:
1) Match the number of buyers and sellers he/she has at those prices.
2) Keep the volume of trades he/she is making high.

Example: The quoted price for Australian dollars as of September 29,1997 was 1.3878/88 $Aus/$US.
1.3878 $Aus/$US is the bid price.
1.3888 $Aus/$US is the ask price.
If the dealer buys $500,000 Aus. and sells $500,000 Aus. without any change in the exchange rate, what is his profit?
Because of the way the rates are quoted (units of $Aus per $US), they are really the bid and ask prices for the $US. Therefore, you must convert these to prices for $Aus.

Bid for $Aus = 1/Ask for $US

That is, take the inverse to convert $Aus/$US into $US/$Aus and note that the price the dealer will sell $US at is the same as the price at which he will buy $Aus.

Ask for $Aus = 1/1.3878 = 0.7206 $US/$Aus

Bid for $Aus = 1/1.3888 = 0.7200 $US/$Aus

The dealers profit is:
($500,000 Aus.)([0.7206-0.7200]$US/$Aus)
= $300 US

Dealers try to set their bid and ask prices to make the number of buyers coming to them equal to the number of sellers. If the bid price is too high, then people will want to sell to the dealer. The dealer will begin to develop an inventory of the currency that he cannot sell. This means that the dealer becomes exposed to exchange rate risk. If the currency depreciates before the inventory can be sold, the dealer will suffer a loss. Conversely, if the dealer sets the ask price too low, too many people will want to buy at that price. The trader develops a short position in the currency (he needs to deliver currency that he does not have yet). If the currency appreciates, the dealer suffers a loss. (Note: having the currency is a long position, owing the currency is a short position.)
Generally, dealers want to avoid exchange rate risk and so adjust the bid-ask prices to match the number of buyers and sellers that they have coming to them.

The bid-ask spread is set by competition among dealers. Dealers earn profits on each unit of currency bought and sold through them. If their spread is larger than other dealers, then customers will go to those other dealers. Thus, the spread tends to be similar for all dealers.

Occasionally, dealers will speculate on exchange rates by allowing themselves to build up short or long positions. However, these positions are only taken for a short time.

In the end then, it is the expectations of currency dealers that determine the day-to-day changes in exchange rates. Of course, the rates that dealers set are in response to the supply and demand for that currency, and that, in turn, is determined by the various factors we have discussed.

Currency Arbitrage

Currencies are traded in many centres around the world, by many different currency dealers. Arbitrage will tend to make these quotes consistent with one another. An arbitrage opportunity occurs if you are able to make large profits without risk.

You have $1,000,000 US to invest and observe the following quotes:
London: 104.58/68 ¥/$US
New York: 1.5173/83 $US/£
Hong Kong: 158.5158/68 ¥/£

You phone London and buy $1,000,000 US worth of ¥.
Gives you ($1,000,000 US)(104.58 ¥/$US) = ¥104,580,000
Phone Hong Kong and sell the ¥ for £’s.

Gives you (¥104,580,000)(1/158.5168) = £659,740.80

Phone New York and sell £ for $US.
Gives you (£659,740.80)(1.5173 $US/£) = $1,001,024.71 US

You have just earned an instant profit of $1024.71 US with no risk. This is an arbitrage opportunity. It is sometimes referred to as triangular arbitrage because it involves three currencies.
Triangular arbitrage takes advantage of inconsistencies in cross-rates (two non-US currencies quoted against each other, e.g. ¥/£.). Generally, arbitrage opportunities like this should not exist, or at least not exist for longer than a couple of minutes. Everyone involved in the FOREX market will observe this opportunity and try to take advantage of it. Millions (or billions) of dollars will be invested and this will drive up ¥ in London, drive down ¥ in Hong Kong and drive down £ in New York until the arbitrage opportunity disappears. Thus, market forces will guarantee that rates across different markets and different currencies are consistent.

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FX Market

“Forex” is a combination of the words “foreign exchange”. The Forex market deals in the buying and selling of currency and it is the largest financial market in the world. Currency is always traded in pairs. The price of the currency bought as compared to the price of the currency sold is called the exchange rate. The Forex market is often referred to as the “FX” market.

It has a major difference that sets it apart from other markets in that it has no physical location and no central exchange. It operates through an electronic network of banks, corporations and individuals who engage in this type of trading. The lack of a physical exchange makes the Forex a true 24-hour market that extends from one time zone to another without any interruption in trading.

Forex trading begins each day in Sydney, followed by Tokyo, London, and New York. Unlike other financial markets, Forex investors can respond to currency fluctuations caused by economic, social and political events in real time.

The best trading opportunities are usually considered to be the currencies that are the most commonly traded. Their rapid movement makes them the most liquid. Over 85% of all daily transactions involve the buying and selling of these currencies that are sometimes referred to as the “Majors”. They include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar.

The Forex market is considered an Over The Counter (OTC) market because transactions are conducted between two entities either over the telephone or through an electronic network.

There are some specific reasons why entities trade in the Forex market. The most common is to earn short-term profits from fluctuations in exchange rates. Traders also use the market to acquire the foreign currency necessary to buy goods and services from other countries.

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