The nuts and bolts of forex trading

Forex remains one of the preferred assets for traders. It’s volatile and allows trading day and night.
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Forex trading has earned a bad reputation for encouraging reckless trading, with extreme levels of leverage that magnify both profits and losses.

The statistics show that most people lose at trading for a variety of reasons, from lack of education to insufficient understanding of the risks. Add leverage of 500:1 or more and those losses quickly mount.

IG Markets South Africa’s senior market analyst Shaun Murison says tighter regulations have forced brokers in well-regulated jurisdictions to limit leverage to around 30:1, which reduces the potential for a wipeout.

“There’s been a definite improvement in trading results among our clients due to more reasonable leverage, but we’ve also invested heavily in educating our clients on the basics of responsible trading, and that’s also having an impact. For example, understanding how much to risk in a trade, and waiting for a proper trade set-up.

“Those who lose in trading usually risk far too much of their capital in a single trade and then don’t exit the trade when it goes against them.”

Forex market trading is growing in popularity because of its size – it trades an estimated $6.5 billion a day – and online brokers like IG Markets are open for trading between Sunday midnight through to Friday evening.

There is no formalised forex exchange, like the JSE, as most trade happens through the inter-bank market. Brokers scan this inter-bank market for the best prices and then offer them to their clients. In the case of IG Markets, clients are purchasing a derivative known as a contract for difference, or CFD, which tracks the price movement of a particular currency pair, but does not give them ownership of the actual currency.

The preferred currency pairs are those such as the US dollar-euro which offer the greatest liquidity and market depth. This means you can enter and exit a trade instantly.

Benefits of forex trading

  • You can trade a currency pair in either direction, long or short. The ability to profit from currency movements in either direction is a major attraction for traders, and is far simpler and cheaper than trading equities on a stock exchange.
  • Forex is a highly liquid market open 24 hours a day, five days a week.
  • The ability to hedge currency risks. For example, if you are an importer purchasing a consignment of goods that will only arrive in the country at some point in the future, an adverse movement in the currency can impact your profits while waiting for the goods to arrive. You can hedge out those risks using CFDs.
  • Forex trading is becoming popular in Africa, where weak national currencies are a perennial risk.
  • Forex can also be a commodity play. For example, the US dollar against the Canadian dollar (USD-CAD) has been shown to have an inverse relationship with crude oil.
  • Certain currency pairs are notoriously volatile, such as sterling against the Japanese yen (GBP-YEN). Many traders actively seek out volatile currency pairs, particularly scalpers (those looking to take small profits quickly) and swing traders (those looking to ride out a trade for a longer period lasting perhaps days or even weeks).

“Forex is suitable for people looking at more short-term rather than long-term trading strategies,” says Murison.

“There are a variety of trading strategies that traders employ. Some identify the upper and lower price ranges of a currency pair and short it when it reaches the top of the range and go long when it hits the bottom. This can be quite workable provided traders do not risk too much capital doing it, and exit a trade when it breaks out of that range.

“We explain most of the more common strategies as part of the education material we make available for free on our website. And we also have regular webinars with market experts to go over the key events for the day or the week, as these events – usually news releases – have the potential to move the market. We explain to clients how to position themselves for these moves.”

Costs

There are no commission charges at IG Markets, so the company makes its money from the bid-offer spread (also called the bid-ask, or buy-sell). Two prices are displayed when buying or selling a currency pair. When buying a currency pair, you will pay the higher of the two, and when selling you will receive the lower of the two.

The gap between the bid-offer spread will vary depending on the amount of liquidity in the market, but the USD-EUR usually offers the lowest spread, as low as 0.6 pips (of 60c if you are trading $1 a pip).

Currency pairs are quoted in ‘pips’ which is the smallest increment in price. It stands for ‘percentage in price’ and most currency pairs are priced in four decimal places, so a pip is one-hundredth of a percentage point (0.0001).

That’s a tiny increment in price, but add 30:1 leverage to this and very small movements in price can work in your favour quite quickly – or work against you.

There is an additional finance cost if you hold a forex position overnight which, though small, can add up if you hold a position for weeks. That finance charge is the differential between the interest rates applicable to the two currencies. As an example, an overnight charge of about $0.25 would apply on the EUR-USD position equivalent to $1 000.

Demo account

Murison advises those interested in getting going in online trading to open a demo account and, study up on the educational material on the IG Markets website and experiment with various trading styles and strategies. When you’re ready to go, you can fund your account and start live trading. IG Markets offers a vast library of training tools on its website, with webinars every week from seasoned analysts from around the globe providing market insights and tips.

About IG Markets South Africa: IG Markets South Africa was established in 2010 and is regulated by the Financial Sector Conduct Authority (in South Africa) as an over-the-counter derivative provider and an authorised financial services provider (FSP No 41393). It has an office in Sandton to service its thousands of South African clients. Its board and senior management in South Africa consist of largely South Africans making it a truly South African operation. As one of the biggest employers in the online broking category, it is proud to be playing a leading role in the growing financial services industry in South Africa.

Note that CFD losses can exceed your deposits.

IG Markets is part of the LSE-listed IG Group, which has a market cap of £3.4 billion (R71.4 billion). It has more than 330 000 active clients worldwide.

Brought to you by IG Markets South Africa. 

Moneyweb does not endorse any product or service being advertised in sponsored articles on our platform.

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