For an international investor with a traditional investment portfolio, trading foreign exchange can provide a welcomed modicum of geographical, volatility- and duration-related diversification. Forex is the most global capital market in the world. Operating through all major banking systems, the industry processes approximately $5.3 trillion every 24 hours. Since more than 80 currency pairs are involved, a wide range of volatility patterns are available, including regional variations that can be arbitraged rather effortlessly. Trades as short as 1 minute can be made – or, as long as “forever” (i. e., a buy and hold, carry position). Since there are no fees or regulations against short positions, all types of hedging transactions can also be arranged. Better yet is the fact that this marketplace bears almost no correlation to any other asset class in the world.
In order to trade forex effectively, you have to come to grips with the issue of leverage. For day foreign exchange trading, high leverage (i. e., 100:1 or more) is needed. For medium-term or longer-term trading, it’s not.
Leverage In Foreign Exchange
In foreign exchange, the term “leverage” means borrowed money. Most trading accounts will offer you leverage of “100:1”, which means that if you have $1 in cash, you can control $100 of a forex contract. Some accounts will allow you to go up to 200:1 (where $1 in cash controls $200 of a forex contract). Theoretically, the more you borrow (i. e., the higher the leverage ratio), the faster your profits should pile up. Realistically, however, the only traders that should even attempt to profit by using any leverage ratio in excess of 100:1 are “day traders”, who are zipping in and out of the foreign exchange market in as little as 1 minute. For most, higher leverage ratios are simply too dangerous.
How Foreign Exchange Can Make You Money
If you want to try to make a profit, using a very high leverage ratio, you are going to have to resort to working off of a 5- or 15-minute chart. For example, the EUR/AUD’s weekly chart has a bullish “inverse head and shoulders” on it, but taking advantage of such a situation implies shorting the AUD (a very expensive proposition beyond 23.99 hours). Enter day trading! On a 5-minute, EUR/AUD chart, use a pair of 10- and 20-period exponential moving averages plus an “Awesome Oscillator” (to gauge momentum) and a “Know Sure Thing” indicator (to confirm entry and exit points that the crossover of the 10-period moving average is signalling). Use as much leverage as you feel comfortable with.
Watch Out For Foreign Exchange Downside Risks
In forex trading, risks come in 3 basic flavours. First, there’s structural risk. This is the risk that you didn’t structure your trade correctly and the poor thing is doomed to fail (e. g., using a 200:1 leverage ratio on an overnight trade of a very volatile currency pair, like the GBP/NZD). Second, there’s market risk. This is the risk that something in the market is about to make your trade potentially terminally ill, such launching a trade in the highly illiquid conditions before Auckland opens up. Lastly, there’s “event risk” (also, sometimes known as “economic risk”). This is the risk that an expected event doesn’t happen or an unforeseen event happens (e. g., the assassination of a country’s president).