How To Use Leverage For Great Results With Forex
When you execute a Forex trade, you are purchasing an amount of currency, termed a lot. The amount of currency in one lot depends upon the type of account you have. In a standard account, one lot is usually equal to U.S. $100,000; in a mini account, one lot is $10,000.
But Forex trading accounts are leveraged, which means you don’t have to own that expensive lot of currency; you just have to control it, and if you do, any profit it earns is yours. To obtain the right to control a lot of currency, you put up a much smaller amount of money in a sort of rental agreement called a margin deposit. In a standard account, to control that U.S. $100,000, you must put up $1,000 of your own money; in a mini account, to control $10,000, you need to put up $100.
The leverage influences the amount of profit you earn, as well. In a standard account, one pip of a currency pair that has the U.S. dollar as the base is equal to U.S. $10; in a mini account, one pip equals to $1. This means that, should you correctly forecast the movement of the market and execute a trade that earns you two hundred pips (not an unrealistic goal), if you have a standard account, your profit will be $2,000; if you have a mini account, it’s $200.
To maximize your profits in Forex trading, you don’t have to trade a standard account; not every beginning trader can afford to. Instead, if you believe you have a good forecast on the market, you can trade more than one lot. To continue the above example, if your successful trade earned you two hundred pips and you had purchased five lots of that currency, in a mini account you would have put up $500 of your own money—but earned a profit of $1,000 (two hundred pips times five lots). In a standard account, you would have put up $5,000—and earned $10,000.
The number of lots you can trade depends upon the margin in your account. That’s not the amount you deposited; that also includes any open trades you have running, taking into account any profits or losses you may incur.
There are two types of orders that can be placed in Forex trading. The most common type is called a market order, and it simply purchases or sells the currency pair at the going market rate. This sort of trade is quickly arranged—with some online trading platforms, one click can do it—so it’s the order you want to place when the market is moving rapidly. (If you do the one-click thing, always edit the trade to put in a stop-loss; more on that in a minute.)
The other kind of order is called an entry order, and it’s what you use when you want to purchase or sell a currency pair but only at a certain price. For example, say the GBP/USD is range-bound, moving sideways in a channel, going up and down but not far enough to entice you into a trade.
But there are indications that the Cable might soon break out of that channel. So you could place an entry order to purchase but only after the price rises above a certain point. If the Cable breaks out, your entry order would be triggered, and you would purchase the currency pair when the price rises above your pre-arranged point. If it doesn’t, you aren’t stuck with a currency pair that’s going nowhere, and the still-dormant entry order would cancel after a certain length of time.
A stop, also called a stop-loss, is a pre-arranged point where you decide you would like to get out of a losing trade. A limit, also called a take-profit, is a pre-arranged point where you decide you would like to exit a winning trade. Although it may not seem so on the surface, both are important. Properly using stops and limits defines the extent of your risk and encourages disciplined trading.