How to Trade Forex
Now that you know some important factors to be aware of when
opening a forex account, we will take a look at what exactly you can trade
within that account. The two main ways to trade in the foreign currency market
is the simple buying and selling of currency pairs, where you go long one
currency and short another. The second way is through the purchasing of
derivatives that track the movements of a specific currency pair. Both of these
techniques are highly similar to techniques in the equities market.The most
common way is to simply buy and sell currency pairs, much in the same way most
individuals buy and sell stocks. In this case, you are hoping the value of the
pair itself changes in a favorable manner. If you go long a currency pair, you
are hoping that the value of the pair increases. For example, let's say that you
took a long position in the USD/CAD pair - you will make money if the value of
this pair goes up, and lose money if it falls. This pair rises when the U.S.
dollar increases in value against the Canadian dollar, so it is a bet on the
U.S. dollar.
The other option is to use derivative products, such as
options and futures, to profit from changes in the value of currencies. If you
buy an option on a currency pair, you are gaining the right to purchase a
currency pair at a set rate before a set point in time. A futures contract, on
the other hand, creates the obligation to buy the currency at a set point in
time. Both of these trading techniques are usually only used by more advanced
traders, but it is important to at least be familiar with them. (For more on
this, try Getting Started in Forex Options and our tutorials, Option Spread
Strategies and Options Basics Tutorial.)
Types of Orders
A trader looking to open a new position will likely use
either a market order or a limit order. The incorporation of these order types
remains the same as when they are used in the equity markets. A market order
gives a forex trader the ability to obtain the currency at whatever exchange
rate it is currently trading at in the market, while a limit order allows the
trader to specify a certain entry price. (For a brief refresher of these
orders, see The Basics of Order Entry.)
Forex traders who already hold an open position may want to
consider using a take-profit order to lock in a profit. Say, for example, that
a trader is confident that the GBP/USD rate will reach 1.7800, but is not as
sure that the rate could climb any higher. A trader could use a take-profit
order, which would automatically close his or her position when the rate
reaches 1.7800, locking in their profits.
Another tool that can be used when traders hold open
positions is the stop-loss order. This order allows traders to determine how
much the rate can decline before the position is closed and further losses are
accumulated. Therefore, if the GBP/USD rate begins to drop, an investor can
place a stop-loss that will close the position (for example at 1.7787), in
order to prevent any further losses.
As you can see, the type of orders that you can enter in
your forex trading account are similar to those found in equity accounts.
Having a good understanding of these orders is critical before placing your
first trade.