One of the big reasons that foreign currency trading is an totally different animal than stock investing or futures trading is leverage. Forex currency trading leverage can be huge, as high as 400:1, and in most cases you get to choose the amount of leverage or gearing you wish to invest
.
Super large leverage can be a selling point for most online forex brokers. How frequently have you seen the tout 'control $100,000 of euro for $250'? Those numbers are correct, and, yes, the net income possibilities of super high leverage is powerful.
This informative article neither promotes nor discourages forex trading at very high leverage. This is a personal choice, but a choice that can simply be made properly by using a professional knowledge of every one of the risks of leverage and what they mean to your likelihood of prospering at forex currency trading. It's probably fair to mention that unless you have a very professional perception of leverage that a prospect of even enduring at forex trading is slim to none.
Among the fundamental terms of forex currency trading is PIP. You will see that XYZ Broker charges 3 PIP per deal, or that this XY currency pair has an average daily range of 100 PIP. Everybody knows that the price of a PIP is really a variable that is different with each currency pair, but did you know that the value of a PIP also varies along with the current price of the base currency, and with the gearing with your account?
For instance, with EUR/USD at 1.2723 and leverage at 100:1 the level of a PIP is $7.86. At 200:1 leverage the PIP value doubles to $15.72. For forex traders with some other gearing a 100 PIP shift indicates completely various things on their account equity.
This is a new method to have a look at leverage along with the "K Factor". The 3 most frequent leverage ratios offered by online foreign exchange brokers are 50:1, 100:1 and 200:1. The K Factor for your 100:1 leverage ratio is 1. The K Factor for any leverage ratio of 50:1 is .50, and the K Factor for your leverage ratio of 200:1 is 2.
How will you use the K Factor?
There are 3 ways to implement the K Factor. The foremost is using the K Factor to calculate the price of a PIP for the currency pair you're trading.
Because 100,000 individual currency units (usually dollars or euros) is the regular size of a single lot you are able to calculate the value of a PIP with this formula:
(100,000/current price with no decimal) * K Factor = PIP
Here's an example of this: The EUR/USD current price is 1.2723 along with your leverage is 100:1. Using these facts the formula is:
(100000/12723) * 1 = 7.86.
The value of a PIP is $7.86. If the forex broker executes your trade at a spread of four PIPs you will be paying $31.44 for performing the trade whatever euphemism the broker actually is using for 'commission'. If your leverage or gearing is 200:1 that execution will cost you $62.88.
Your second method for you to use PIP along with the K Factor would be to swiftly decide the possible profit in the trade, or to know to a certainty the actual dollar risk within a stop-loss setting.
As an example, if you go long the EUR/USD at 1.2723 and foresee a move to 1.2850 what profit are you able to anticipate at 100:1 gearing?
12850 - 12723 = 127 PIP * 7.86 = $998.22 - execution cost.
Should you objectively set your stop loss at 1.2715 what sum are you risking in this trade?
12723 - 12715 = 8 PIP * 7.86 = $62.88 + execution cost.
The third approach to work with the K Factor would be to steer clear of what the forex brokers call the "safety net", and what I call "kill but don't dismember."
Margin is not a down payment. It's cash-on-hand, your money, which the broker uses to safeguard its capital account from the mistakes. That's great because global currency markets will work only when all collaborating brokers have enough capital to fulfil their customers' settlement obligations.
If losing trades from current open positions result in the equity in your account to fall below that needed to take care of the final amount of open positions, the broker's trading platform will immediately close all your open positions, even when the unrealized loss on any individual position is very small. Whatever is lost will be the aggregate number of PIP per position * K Factor + execution costs. In nearly every case that's almost everything inside your account. Here is the broker's back-up because you will not shed more cash than you possessed inside your account (as can and can take place with commodities futures accounts.)
The formula is:
(Commencing Balance - Open Position Losses) / (($1,000/K Factor)* No. Open Positions) -1 < 10% =
Kill But Don't Dismember.
Nearly all if not all broker platforms maintain a running balance of your readily available margin to help you avoid this lethal situation. If you plan to trade numerous positions and fade into suspected price turning points you should consider putting together this formula within a spreadsheet which means you receive an early warning well before the problem goes critical.
Mini accounts provide 10,000 individual currency units with different margin requirements so result in the needed adjusting in the above formulas before doing the calculations
To make Forex currency trading easier a Forex software is often a worthy investment. For that starter I suggest the Pipjet Forex system. Obtain your copy by simply clicking the link below.
http://tinyurl.com/d48xmrr
Thank you for reading my post.
Dennis Sampson
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