Know When to Buy or Sell a Currency Pair
In the following examples, we are going to use fundamental analysis to help us decide whether to buy or sell a specific currency pair.
In this example, the pound is the base currency and thus the “basis” for the buy/sell. If you think the British economy will continue to do better than the U.S. in terms of economic growth, you would execute a BUY GBP/USD order. By doing so you have bought pounds in the expectation that they will rise versus the U.S. dollar.
If you believe the British economy is slowing while the American economy remains strong like Chuck Norris, you would execute a SELL GBP/USD order. By doing so you have sold pounds in the expectation that they will depreciate against the U.S. dollar.
When you go to the grocery store and want to buy an egg, you can’t just buy a single egg, they come in dozens or “lots” of 12.
In forex, it would be just as foolish to buy or sell 1 euro, so they usually come in “lots” of 1,000 units of currency (micro), 10,000 units (mini), or 100,000 units (standard) depending on your broker and the type of account you have (more on “lots” later).
“But I don’t have enough money to buy 10,000 euros! Can I still trade?”
You can! With margin trading! Margin trading is simply the term used for trading with borrowed capital. This is how you’re able to open $1,250 or $50,000 positions with as little as $25 or $1,000. You can conduct relatively large transactions, very quickly and cheaply, with a small amount of initial capital.
Let us explain.
Listen carefully because this is very important!
- You believe that signals in the market are indicating that the British pound will go up against the U.S. dollar.
- You open one standard lot (100,000 units GBP/USD), buying with the British pound at 2% margin and wait for the exchange rate to climb. When you buy one lot (100,000 units) of GBP/USD at a price of 1.50000, you are buying 100,000 pounds, which is worth US$150,000 (100,000 units of GBP * 1.50000). If the margin requirement was 2%, then US$3,000 would be set aside in your account to open up the trade (US$150,000 * 2%). You now control 100,000 pounds with just US$3,000. We will be discussing margin in more detail later, but hopefully, you’re able to get the basic idea of how it works.
- Your predictions come true and you decide to sell. You close the position at 1.50500. You earn about $500.
When you decide to close a position, the deposit that you originally made is returned to you and a calculation of your profits or losses is done.
This profit or loss is then credited to your account.
What’s even better is that, with the development of retail forex trading, there are some brokers who allow traders to have custom lots.
This means that you don’t need to trade in micro, mini or standard lots! If 1,542 is your favorite number and that’s how many units you want to trade, then you can !