In this trading community blog we talk about online trading
what is forex trading?
what is binary options trading?
what are the risks of online trading?
Forex trading Definition
The trading of currencies of different countries is called Foreign Exchange Market or, in the shorter form, Forex. The Forex Market sees the most important international banks playing the leading role, and the broker, the buyers and the sellers as ‘supporting actors’.
So when we deals with Forex Trading, we are dealing with the trading of different currency pairs (for example Euro versus United States Dollar or versus United States Dollar versus Pound) from different countries that are considered each against the other. The Forex trading works completely on line, and this is probably its most important characteristic. International trades, investments, curreny conversions, are all negotiation of interest of the Forex trading. All these Trades in the Forein Exchange Market are based on the payment in different currencies and on the exchange from a currency to another one. The exchange can be advantageous or not and this is one of the basic of the Forex trading.
Let’s try to understand better what is the meaning of trade different currency pairs.
The first point that probably everybody more or less know, is that those operate in the Forex Trading hope they can gain money through this channel. This is true, but not always true. All those that approach the Forex should have always clear in mind that earn and losses are both probable, so in the same way a trader can earn money or can lose it. Or, to be really precise, for those that are not very skilled, losses are the most probable results.
So, how does it work the Forex Trading? How is it possible to earn money with the trading of currency pairs? Let’s have an example with two very common currencies, that are United States Dollar (USD) and Pounds.
A trader buys one thousand pounds in a certain period that could be, for example, march 2013. He purchase them with the US Dollars, so he spend about one thousand and six hundred dollars (we have supposed that the exchange pound versus dollar is 1:1.6). At the end of May of the same year, our trader realizes that the value pounds versus US dollars increases, so that the exchange is 1:1.7, that is that one pound is equivalent to one thousand and seven hundred dollars. For this, the trader can decide to sell his dollars (or to close his trade) so that he would have earn one hundred dollar. Of course, if he is not a good trader, he can do a wrong play, and sell his currencies in a moment in which the exchange is disadvantageous, because the exchange is, for example, 1:1.5. In this case he would have lose one hundred dollar.
To trade with currency pairs or with stocks, a broker or a market maker is needed. To be sure to ask to a real Forex broker and not to an impostor, the trader should check the lists of qualified broker available on line. Of course, today, all the trading procedures are made on line, with few clicks, without meet people, without offices and without appointments. This means that everything is faster, but at the same time, this can be more dangerous for the inexperienced traders. To avoid risks, several on line brokers make available on line customer support that explain the basic of the on line trading.
Forex Trading language
When start trading in the Forex, what is important is that all the terms used are really clear in the meaning. It can be very easy for a novice to make mistakes due to the misunderstanding of the used terms. The first important term is the ‘lot‘, that is, usually, a precise quantity of asset or currency. During the trades is very probable that the purchases are done in terms of lots or, for small quantities, in terms of mini lot or micro lot. As it is easy to understand, mini and micro lots are parts of the lot, and in particular, they represent the tenth part and the thousandth part of the lot.
Another term very often used in the Forex trading is the Pips, that is the Percentage in Points. It is a small measure, very useful in the change of the currency pairs, In fact, the relationship among the different pairs is always complex and needs of the multiples and submultiples of the units. So the use of the Pips allows to work with the decimal numbers.
In the Forex language there are both terms connected to the quantity of the currencies or stocks and terms connected to the actions. For example very common terms, also entered in the everyday languages are the bid and the ask. The bid is the offer that is made by the investor or the trader, or better, it is the price at which you (or the broker for you) want to but a currency pair, or an asset. On the contrary, the ask is the price at which you (or again the broker for you) want to sell. Of course to have a transaction, usually the buyer and the seller have to make an agreement that can be more or less convenient for the buyer or for the seller depending on several conditions. In the best cases, the agreement find a price that is in the middle of the one asked and the one bidden.
Another very used term is the spread. The spread is the quantity of pips (see above) between the ask and bid price, that is the difference between these two parametres. So all these terms are connected and it is very important to understand what they mean to understand what the spread is. If a broker buys a currency for 100 and sell it for 102 the spread is the difference between 102 and 100. These terms have been used to better undestand the meaning of the difference between dib and ask, but in the reality, the spread goes on the decimal terms, so true values could be for examples 10.0004 and 10.0002.
To conlude, let’s give a look to the ‘leverage’, that is a term used to indicate borrowed funds. In forex the leverage is strictly connected to the gain and the losses, as it magnifies them. Often this involves the risk that borrowing costs will be higher than the income from the asset. This will cause, obviously, a reduction in profits. As an exemple, an investor who buys a stock on 50 % margin will lose 40 % of his money if the stock declines 20 %. Risk may be attributed to a loss in value of collateral assets. Brokers may require the addition of funds when the value of securities hold declines. Also, banks may fail to renew mortgages when the value of real estate declines below the debt’s principal. More,iIf cash flows and profits are sufficient to maintain the ongoing borrowing costs, loans may be called. This may happen when there is little market liquidity and sales by others are depressing prices. It means that as things get bad, leverage goes up, multiplying losses as things continue to go down. This can lead to rapid ruin, even if the underlying asset value decline is mild or temporary. The risk can be lowered by negotiating the terms of leverage, or by maintaining unused room for additional borrowing, and by leveraging only liquid assets.
The term broker derives from the french word ‘broceur’ that means small trader. Today the brokers are agent working in some industry fields but this word is famous especially in the market where the broker is one of the most important role, an intermediary from the market and the traders. Brokers in fact are those that have and give information on the market conditions, or on the prices of the products. Today is unthinkable to work in the trade system without the support of a broker. In fact all the Forex Trading are usually done by the brokers, that are people or platform that act as intermediaries among the trader and his trade and the market. In fact ‘normal people’ are not allowed in operate directly on the market, but only broker can. Today there are a lot of on line platform that act as brokers: they are the on line broker. These platform have the quality to show time after time what happened on the market, so that the trader can track and monitor prices, statistics, purchases, gains, losses and so on. Of course, all the licensed platforms are listed, so that investors can chose their own on-line broker without meet with not authorized brokers. This is a very important point as the open market is a very interesting world, but is also a good way to dupe the simple person or those that expose themselves to the market for the first time. The best broker platform always advises all the investors not only of the possibilities of gain, but also about the risks of investing.
How to stop the trading: the stop loss and the take profit orders.
Forex trading can be a mean to gain money, but also a mean to lose them. So, to avoid this to happen, it is important to know about the ‘stop loss’ order, that, as the name itself suggest, is a way to save from the collapse. When a trader realizes that the market is going in a different direction with respect of his investments, he can decide to retreat and save the money remained. To do so, he must order the stop loss, that freeze the gain and the losses of the currencies at the precise time of the order. Of course, as today everything work with the on-line platforms, to order a stop loss you only need the time of a click.
But a stop order can also be used in the so called ‘long position’ that is the moment in which the trader is gaining, and is gaining well. An investor can decide that he is satisfied of what he has earned so that he doesn’t want to risk no more. In this case, he can give the take profit order, to save his profits. So the investor, in this case, has made a wide choice: this is not easy, because very often those that gain with the Forex Trading have difficulties in realize when they have to stop. There is always the possibility of gain more, but there is always, too, the possibility to lose everything. It is important to remember that the on-line trading is a great risk, but the market itself gave investors the possibility to get out from the trading with these two important orders.
Currency pairs or stocks?
The most of the investors, especially the novices ones, trades in currency pairs, that can be pounds versus dollars or versus euro or vice versa, but also some other less common currency pairs (the choice of the pairs depend on the traders and on the brokers). But there are a lot of people that also trade in stocks.
When an investor trades in stocks, he deals with the shares of some companies. These shares can have different costs, from few units (that can be dollars, pounds, euro or what else) to hundreds or thousand units. But trading in stocks has a limit, that is a ‘physical’ limit, connected to the company’s skill in make money. In some way, to trade in stocks is less complicate, as when the trader decides to buy a certain share of a company, he only has to care about that company financial behaviour. So he has to follow the trend in the market of the company, that can become more or less precious or remain on the same value line. This allows to gain or not, but in anyway, what happen is not strictly connected with the talent of the trader, but only of the company.
Working on currency pairs, on the contrary, can be more captivating and various and allows the traders to evidence their capabilities. In fact, even if the most common operations are to buy or to sell, there are a lot of parameters that must be followed to better understand how to operate, when to buy or to sell and so on. The fluctuation of currency pairs, in fact, depends on factors based on the relationship among the two countries of the currency pairs, the political stability of the two, the growth of job on the first country with respect to the second or vice versa and so on. All these parameters make the currency pairs trading more interesting for most investors that prefer the complexity of social end economical balance and the thrill related to the risk.
Another reason for which it is easier to find people interested in currency pairs trading than in stock trading is connected to the way the trading is managed. With Forex Trading everything is on line, all the trades can be done with a click, nobody have to go in any place, as everything is virtual, and controlled by a net of computers connected each other. This give great advantages, among which, for example, the possibility to operate and trade every day and at every hour. In fact is possible to trade in Forex six days a week and twenty-four hours a day. Forex Trading doesn’t have problem of time zone: on the contrary it follows the time zone, opening on Monday morning with the Sydney session (or sometimes earlier with the New Zealand session) and concluding on Friday evening with the New York session. For those that know something on how the time zone works it is easy to realize that the Forex trading is close to be always operative.
This system doesn’t work with the stock trading, that is limited to the time zone of the company whose stocks the investors are trading in. The stock trading is somehow still related to the old trading way, the one you can see in the movies, where all the buyers and sellers are concentrated to the board that shows the values of the stocks. This is still living for example in the New York Stock Exchange (NYSE), the most important and famous exchange of the world, founded in 1792 and still heart of the stock trading.
Another important exchange, the Nasdaq (National Association of Securities Dealers Automated Quotation), most precisely the NASDAQ Stock Market, is the first example of electronic exchange, and become famous at the end of the ’90s as a consequance of the tech boom. NASDAQ was founded in 1971 by the National Association of Securities Dealers (NASD), and it was the world’s first electronic stock market. The NASDAQ helped lower the spread, but was unpopular among brokerages which made much of their money on the spread.
Binary options trading
Binary options Definition
The binary option is a way to trade the fluctuation of prices of the open global market. It allows to obtain or a payoff of a fixed amount of money (or asset) or nothing. So, in simple terms, it is binary because you only have two possibilities: win or not. On a first approach, binary option can seems a very simple way to earn money, so that a lot of Forex traders start using it. But really, it is not so simple to enrich with it, as strategies and money management must be very well known to avoid the risk of lose everything.
One of the characteristics of the binary option trades is that it can be different in the different country: this is really evident in the United States exchanges, where structures of binary option is different from those available outside of the US. And in fact, in the US, traders deals with the so called exotic options, referring to the investment made outside the US.
Just like the Forex Trading, the Binary Option has different orders, or better, different options. The first one, the most common, is the ‘High-Low’ option, that allows to trade in Forex, stocks, asset and indices. The high-low option allows the buyer to have a payoff deriving from the differences between the higher and lower prices reached by an asset during a period of time. For example, imagine a trader knows that a certain kind of asset is known to rally in the close future: he can decide to risk and believe the market trend (or the market voice) and buy a binary option of this asset (in trading language he is buying a call) . After bought, he had to fix an expiring time, that can be of few minutes, of days, weeks or months, depending on his choice. And he had to wager if the price at the expiry time will be above the starting price. If this happen, the trader gain a good percentage of the starting value. If not, he loses his investment. Depending on the brokers, the investment can be fix or can range from a minimum to a maximum, or, in most case, is limitless.
The brokers also allows binary option outside the traders country. This is very common in the United States, where binary options have fixed risks and payout that, in some way, protect the traders. As already said, it is not uncommon to find unskilled people that start to trade because they hear about wonderful gains, but they really don’t know anything about the rules of the market, of the Forex trading and the Binary Options. It is important, before starting, to realize that the risks can be greater, especially for the novices, that in some case can also entry in trades not legally allowed by their country.
One of the most important point to understand before venture in the world of the trading is that is not possible to do any commerce without have the knowledge and a strategy. The strategy is not something that can be learned in one day, an a lot of experience traders take years before realize which one could be a good or a winning strategy. Also because, in the on-line market, there is not only one profitable plan of action. In any case, the best strategy, especially for those that are now start trading, is try to minimize the risks. So, let’s see how is it possible to trade in this way. To minimize the risks, traders usually resort to the hedging strategy. To better understand the meaning of the hedging strategy the best think is to do a pratical example. But before, it is important to remember some terms used in the trading language, that are the ‘call‘, the ‘put‘ and the ‘be in the money‘ (or ‘be out of the money‘). If a trader makes a call, this means that he presumes that the asset he is working with, is going to increase is value in a future. On the contrary, if he makes a put, it is because he feels that his value is going to fall. To be in the money, instead, means that the option chosen is worth working (sometimes it is used in the sense of make profit, even if it is not the precise definiction of the term).
All these movements are done in a fixed lap of time. So, if a trader calls an option on a currency pair or more probably on an asset that will expire in one hour, the best thing to do, before all, is to watch what is going to happen to the chosen asset in the first half of hour or forty minutes. The possibilities, in fact are that the asset moved or not in a position that allows to put in the money. In the first case (the asset put in the money), two different choices are possible: the first is that the trader simply do nothing except waiting that the trade expires. But this is not synonymous of gain. In fact is it possible that, even if in the first half hour or more the asset is in the money, in the last twenty minutes it can drops out of the money. To avoid the risk tha trader can decide to put the option before the time expires. What does it means? That if the trader realizes in the first half hour or forty minutes his option is in the money and he doesn’t want to risk any fall, he put out finding himself in the condition to be in the money in the call and out of the money in the put. the benefit of this procedure is that the trader lose only a little amount of the invesment (usually from four to six percent). If the trader doesn’t recognize the risk he can decide not to put, and there is the possibility that once the time is expired, he find himself out of the money for the call and this can led to losses uo to the eighty-five percent.
To obtain the maximum profit, the trader should find himself in the position in which the asset is under the strike point at the moment the trader makes his put option, but above the strike point when he makes the call. So doing, once the time is expired, both the options result in the money and the traders have the maximum profit.
So it is clear that to decide when and if make a call or a put, the trader should be expert. If not, the best thing to do is start with little investment to avoid great losses. In some cases that can be recognice with the practice, it can be easy to understand if the option will end in or out of the money, so that can be easy to decide when to call and when to put.
Hedging strategy Definition
The hedging strategy can be successfully used in the binary options trade, even if it was not born for this kind of trades. In fact the hedging strategy has been developed to improve the strategies of the Forex market, and only in a second moment it appears perfect if applied to the binary options trades.
For the Forex market this strategy was used to buy or sell the currency pairs at a fixed time or at a fixed price. But this seem to be not a best strategy in this field. In the binary options trade, instead, it soon appeared to be a very easy and serviceable strategy. So, as always happens when things are easy to use, it became the most used strategy for hedge in this field.
So, not only the new traders are advantaged in it, but also the very skinned ones, that evidence how the hedging strategy is easy to understand and to work with. And as probably these line will be read by the not very skilled binary options traders, is it important to underline, again, that one thing is ‘be easy to understand and to use’ and another thing is ‘allows you to make money easily’. Of course, there are also several different strategies methods that the experienced traders know, understand and use more or less regulary, but the hedging one is the one that better protect the investments.
For all those that start in forex, the best thing is to entrust to a broker, that can help in understand a lot of thing on the topic of the market and on the risks. There are some rules of good sense that everybody should follow befor starting any kind of trades, and in particular the Forex. And the first is probably not to extemporize. As said, the first way to avoid risks is to understand how the market works, and find a broker that do what you want and at the same time protect you from the basic mistakes. Becasuse, for example, if you want to work with the hedging strategy, you should also know that, because of several reasons, not all the brokers allow to use it and not all the brokers are allowed to use it. But it is and remain a winning strategy as it use the advantage of the time, or better, of the momentum.