Trading Forex & Order Types

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How to Trade Forex

We'll talk about brokers in a later Module and how to pick and set up the best broker account for your trading needs. For now we'll take a look at what exactly you can trade within an 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 favourable 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.

Types of Orders

A trader looking to open a new position will likely use either a market order or a limit order - The same as in equity markets. 

A market order: 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.  It guarantees execution, and it often has low commissions due to the minimal work brokers need to do. Be wary of using market orders on markets with a low average daily volume: in such market the spread can be high. In other words, you may end up paying a whole lot more than you originally anticipated! It is much safer to use a market order on high-volume markets.

A Limit Order: A limit order allows the trader to specify a certain entry price. Limit orders typically cost more than market orders. Despite this, limit orders are beneficial because when the trade goes through, investors get the specified purchase or sell price. Limit orders are especially useful on a low-volume or highly volatile stock.

Forex traders who already hold an open position may want to consider using a take-profit order (T/P) to lock in a profit. 

Take-Profit Order: Take-Profit orders specify the exact rate or number of pips from the current price point where to close out your current position for a profit. The rate deemed to be the level where the trader wants to take a profit is sometimes referred to as the "take-profit point".  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. More on the stop/loss order can be read in Module 7, which is important in managing risk.

Stop/Loss Order: An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit an investor's loss on a security position. Also known as a "stop order" or "stop-market order".  In our example, 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.

To Sum Up

Having a good understanding of these orders AND position sizing is critical before placing your first trade.  These types of orders are the same as in equity trading and are universal amongst all brokers.  For more on money and risk management please read Module 7.

Technical analysis is not an exact science and although these ideas can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

next...
We'll ask what is shorting?

=======

How to Trade Forex

We'll talk about brokers in a later Module and how to pick and set up the best broker account for your trading needs. For now we'll take a look at what exactly you can trade within an 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 favourable 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.

Types of Orders

A trader looking to open a new position will likely use either a market order or a limit order - The same as in equity markets. 

A market order: 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.  It guarantees execution, and it often has low commissions due to the minimal work brokers need to do. Be wary of using market orders on markets with a low average daily volume: in such market the spread can be high. In other words, you may end up paying a whole lot more than you originally anticipated! It is much safer to use a market order on high-volume markets.

A Limit Order: A limit order allows the trader to specify a certain entry price. Limit orders typically cost more than market orders. Despite this, limit orders are beneficial because when the trade goes through, investors get the specified purchase or sell price. Limit orders are especially useful on a low-volume or highly volatile stock.

Forex traders who already hold an open position may want to consider using a take-profit order (T/P) to lock in a profit. 

Take-Profit Order: Take-Profit orders specify the exact rate or number of pips from the current price point where to close out your current position for a profit. The rate deemed to be the level where the trader wants to take a profit is sometimes referred to as the "take-profit point".  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. More on the stop/loss order can be read in Module 7, which is important in managing risk.

Stop/Loss Order: An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit an investor's loss on a security position. Also known as a "stop order" or "stop-market order".  In our example, 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.

To Sum Up

Having a good understanding of these orders AND position sizing is critical before placing your first trade.  These types of orders are the same as in equity trading and are universal amongst all brokers.  For more on money and risk management please read Module 7.

Technical analysis is not an exact science and although these ideas can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

next...
We'll ask what is shorting?

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