You can begin trading in the foreign currency exchange market for as little as $100. Most brokers allow you to use margin to leverage your account 50 times. So a 2 percent margin account allows you to trade $50,000 worth of currencies with only $1,000, representing a leverage of 50 times. Starting with such a low capital level, however, is not a recipe for success, as the forex market is extremely volatile.
It is common to trade forex on margin. The margin is the equity you must maintain in your account as collateral to hold a certain position. Trading on margin is a double-edged sword. Being right on a trade greatly enhances your profits, however, operating on margin also amplifies your losses. If the loss reduces your collateral below the minimum level, expect to receive a "margin call" by the forex broker asking to replenish the funds in the account. If you fail to do so, the broker can liquidate the account.
Currencies are quoted in pairs. Common currency pairs are EUR/USD (euros to dollars), USD/JPY (dollars to Japanese yen) and GBP/USD (British pounds to dollars). For example, the bid/ask for the euro (EUR/USD) is quoted as 1.4713/19, meaning you can buy 1 euro for $1.4719 or sell 1 euro for $1.4713. A wider spread between the bid and ask price for a currency is an indication that the market of the currency is illiquid, particularly for exotic currencies such as the Thai baht. Price movements in forex trading is measured in percentage in point, or PIPs. The smallest value of a PIP is 1/100th of 1 percent, or one basis point (0.0001).
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Calculating Profit and Loss
Suppose you believe that the euro is undervalued versus the dollar. Using a quote of EUR/USD 1.4713/19, you pay $147,190 to purchase 100,000 euros. If you have a 2 percent margin account, you will need $2,944 to take the position. If the euro appreciates to 1.4728/1.4735, you realized a profit of $90 (($147,280 - $147,190) x 100,000 euros). That is a difference of 9 PIPs. However, if you were wrong and the euro depreciated to 1.4712/1.4718, then your loss would be $70.
If you are considering opening a forex trading account, practice on a demo account first. Determine how much money you can afford to fund your account. In trading, the name of the game is survival and preservation of capital. A bad trade can wipe out your account. Being adequately capitalized allows you the greater longevity to test your trading strategies, perfect your trading style and sustain losses. The learning curve for traders is steep. There are a number of firms that offer training to novice traders.
- Foreign Currency image by Stephanie Mueller from Fotolia.com