What Is Forex?

Introduction to Forex.

Foreign exchange (aka forex) is an off-exchange retail foreign currency market where participants purchase currency in exchange for another (at the current exchange rate).

Forex and You

Forex can affect the lives of everyone, regardless if you don't travel overseas or don't invest in currency. Today's world of commerce is such an international one that happenings on the other side of the world can ripple out to all nations.
China is a perfect example of this. The government in China regulates the exchange rate of their currency, and many believe the currency to be undervalued. A undervalued currency means Chinese made goods can be purchased for "less" on the international market. Were the Chinese government to allow the market to dictate the exchange rate the effects would definitely be felt across the globe, even for Americans who've never left America.
The reasons why an individual - or institution - would want to exchange money range to a myriad of different reasons, but the 3 main demographics include large corporations and institutions, speculators (investors) and tourists.
Tourists - A tourist traveling from the United States to England, for example, will need the local currency (Great British Pounds), as common shops, taxi cabs, etc. will most likely not accept US Dollars. Typically the airport, hotels and other tourist destinations will have services to exchange just about any currency into the local tender.
Large Corporations and Institutions - A large portion the global foreign exchange market consists of corporations and institutions, who often exchange currency for non-investment purposes: the need to meet payroll in other countries, to pay for services from a foreign factory, mergers and acquisitions, etc.
Investors - Investors are attracted to the forex market because of its possibilities and advantages (which will be discussed in more detail in the 3rd email of this series). For example, investors enjoy the added liquidity and volume forex has to offer.
Unlike other financial markets, the Forex market operates 24 hours a day, 5.5 days a week (6:00 PM EST on Sunday until 4:00 PM EST on Friday). Through an electronic network of banks, corporations and individual traders exchange currencies, Forex trading begins every day in Sydney, moves to Tokyo, followed by Europe and finally the Americas - making the market available 24 hours during the week.

Forex Market Hours

Unlike other financial markets, the Forex market operates 24 hours a day, 5.5 days a week (6:00 PM ET on Sunday until 4:00 PM ET on Friday). It is conducted through an electronic network of banks, corporations and individual traders exchanging currencies. For retail traders Forex is primarily used as a means for speculative investing and actual physical delivery of currencies is almost never intended. Forex trading begins every day in Sydney, moves to Tokyo, followed by Europe and finally the Americas.

How to Choose a Forex Broker.

With so many different choices out there, how does a Forex "newbie" pick a broker? Chances are most new traders have no idea on where to start - and that's okay!  We're here to help!  We have put together a simple three step process to help you find a broker that YOU think will best suit YOUR needs.  You might be thinking now, "Three steps? That's it?"  Yesssiirrrr!
In the first step, you will go through some of the main questions you need ask yourself when reviewing different brokers.  Then you will take a look at different brokers and their available features. We have put together a comparison guide by taking some of the most frequently asked questions across the internet, and surveyed some of the most frequently asked about brokers out there, so that you don't have to. 
With this guide, you can narrow your choices down and take the final step of talking with different brokers and demo trading on different platforms. Simple, right? Let's begin...

Step 1: Do your research

Before comparing brokers, do you know what to look for? No? Well, here are a few of the main questions you should ask yourself:

1. Is this broker registered with any regulating authorities? Check to see if your broker of choice is registered with the National Futures Association (NFA) or Commodity Futures Trading Commission (CFTC) if they're based in the US. If the broker is based in the United Kingdom, check with the Financial Service Authority (FSA). If the broker isn't registered with any of these or any other recognized regulating firm, then you may want to think twice before signing up with them.
2. Dealing Desk or Non-Dealing Desk broker? Does the broker offer fixed or non-fixed spreads? How wide are the spreads? These questions are more significant to those traders who like to take quick profits on a few pips. Large and/or variable spreads can cut into the profits of this type of trading strategy.
3. How much or how little leverage will a broker give you?  We highly recommend you review "Leverage The Killer"before deciding on how much leverage would be suitable for your trading style. The phrase, "Less is More," can save every newbie
4. Of course, you’re not going to start trading with real money right away, right? Well, when you do having a winning strategy and you are ready to trade live; knowing how much risk capital you have to start with makes a big difference. If you have $2000 or less to start with then you probably want to start trading "micro" lots. Not every broker has this feature.
5. Does this broker credit or debit daily rollover interest? Some brokers either do both, deduct interest, or neither.  This information is important to traders who hold positions overnight.
6. Does this broker over premium services such as charting, news feeds, and market commentary? How important are premium services to my trading?

Step 2: Compare brokers

Let's not beat around the bush.

Step 3: Open demo accounts and ask questions. 

Pick at least two brokers that fits most of your criteria and open up demo accounts. Trade in different market environments. Learn all the different features of each trading platform. If you have questions, don't be afraid to ask. Many brokers have excellent customer service support and would be happy to answer your questions.
 
Most demo trading platforms are very similar to their live counterparts, but not exactly the same. There may be a difference in speed of execution, slippage, and platform reliability (most of the time live accounts are more reliable than demo accounts). When you do have your strategy down and you are ready to move to a live account, start off small, test the waters, and see if this particular broker will suit your trading needs.

Margin Defined

So what about the term “margin”? Excellent question my bright padawan learner.
Let’s go back to the earlier example:
“For example, in forex, you can control $100,000 with a $1,000 deposit. Your leverage, which is expressed in ratios, is now 100:1. You’re now controlling $100,000 with $1,000.”
The $1,000 deposit is “margin” you had to give in order to use leverage.
Margin is the amount of money needed as a “good faith deposit” to open a position with your broker. It is used by your broker to maintain your position. Your broker basically takes your margin deposit and pools them with everyone else’s margin deposits, and uses this one “super margin deposit” to be able to place trades with the interbanks.
Margin is usually expressed as a percentage of the full amount of the position.  For example, most forex brokers say they require 2%, 1%, .5% or .25% margin.
Based on the margin required by your broker, you can calculate the maximum leverage you can wield with your trading account.
If your broker requires 2% margin, you have a leverage of 50:1. Here are the other popular leverage “flavors” most brokers offer:

Margin Required	Maximum Leverage
5%	20:1
3%	33:1
2%	50:1
1%	100:1
.5%	200:1
.25%	400:1

Aside from “margin required”, you will probably see other “margin” terms in your trading platform. There is much confusion about what these different “margins” mean so I will try my best to define each term:
Margin required: This is an easy one because I just talked about. It is the amount of money your brokers requires from you to open a position. It is expressed in percentages.
Account margin: This is just another phrase for your trading bankroll. It’s the total amount of money you have in your trading account.
Used margin: The amount of money that your broker has “locked up” to keep your current positions open. While this money is still yours, you can’t touch it until your broker gives it back to you either when you close your current positions or when you receive a margin call.
Usable margin: This is the money in your account that is available to open new positions.
Margin call: If the equity in the account drops below your used margin, a margin call will occur and some or all open positions will be closed by the dealing desk at the market price.

Margin Call Example.

Assume you are a successful retired British spy who now spends his time trading currencies. You open a mini account and deposit $10,000. When you first login, you will see the 10,000 in the "Equity" column of your "Account Information" window. 

Usable Margin

You will also see that the "UsedMrg" ('Used Margin') is "$0.00", and that the "UsblMrg" ('Usable Margin') is 10,000, as pictured below:

Your Usable Margin will always be equal to Equity less Used Margin.
Usable Margin = Equity – Used Margin
Therefore it is the Equity, NOT the Balance that is used to determine Usable Margin. Your Equity will also determine if and when a Margin Call is reached.
As long as your Equity is greater than your Used Margin, you will not have Margin Call.
            ( Equity > Used Margin ) = NO MARGIN CALL
As soon as your Equity equals or falls below your Used Margin, you will receive a margin call.
            ( Equity =< Used Margin ) = MARGIN CALL, go back to demo trading
Let’s assume your margin requirement is 1%. You buy 1 lot of EUR/USD.
Your Equity remains $10,000. Used Margin is now $100, because the margin required in a mini account is $100 per lot. Usable Margin is now $9,900.

If you were to close out that 1 lot of EUR/USD (by selling it back) at the same price at which you bought it, your Used Margin would go back to $0.00 and your Usable Margin would go back to $10,000. Your Equity would remain unchanged at 10,000.
But instead of closing the 1 lot, you, the adrenalin junkie chopsocky retired spy that you are, get extremely confident and buy 79 more lots of EUR/USD for a total of 80 lots of EUR/USD. You will still have the same Equity, but your Used Margin will be $8,000 (80 lots at $100 margin per lot). And your Usable Margin will now only be $2,000, as shown below:

With this insanely risky position on, you will make a ridiculously large profit if EUR/USD rises.  But this example does not end with such a fairy tale. 

Let me paint a horrific picture of a Margin Call which occurs when EUR/USD falls.
The EUR/USD starts to fall. You are long 80 lots, so you will see your Equity fall along with it. Your Used Margin will remain at $8,000. Once your equity drops below $8,000, you will have a Margin Call. This means that some or all of your 80 lot position will immediately be closed at the current market price.
Assuming you bought all 80 lots at the same price, a Margin Call will trigger if your trade moves 25 pips against you.
25 PIPS!
Humbug! The EUR/USD pair can move that much in its sleep!
How did I come up with 25 pips? Well each pip in a mini account is worth $1 and you have a position open consisting of 80 freakin’ lots. So…
$1/pip X 80 lots = $80/pip
If EUR/USD goes up 1 pip, your equity increases by $80.
If EUR/USD goes down 1 pip, your equity decreases by $80.
$2,000 Usable Margin divided by $80/pip = 25 pips
Let’s say you bought 80 lots of EUR/USD at $1.2000. This is how your account will look if it EUR/USD drops to $1.1975 or -25 pips.

As you can see, your Usable Margin is now at $0.00 and you will receive a MARGIN CALL!
Of course, you’re a veteran international spy, you’ve faced much bigger calamities. You’ve got ice in your veins and your heart rate is still 55 bpm.
After the margin call this is how your account will look:

The EUR/USD moves 25 PIPS, or less than .22% ((1.2000 – 1.1975) / 1.2000) X 100% and you LOSE $2,000!
You blew 20% of your trading account! (($2,000 loss / $10,000 balance)) X 100%
In reality, it’s normal for EUR/USD to move 25 pips in a couple seconds during a major economic data release.

Oh I almost forget…I didn’t even factor in the SPREAD!

To simplify the example, I didn’t even factor in the spread, but I will now to make this example super realistic.
Let’s say the spread for EUR/USD is 3 pips. This means that EUR/USD really only has to move 22 pips, NOT 25 pips before a margin call.
Imagine losing $2,000 in 5 seconds?!
This is what happened to our popular British spy all because he didn’t understand the mechanics of margin and how to use leverage.
The sad fact is….most new traders don’t even open a mini account with $10,000. Because our spy friend had at least $10,000, he was at least able to weather 25 pips before his margin call.
If he only started off with $9,000, he could only weather a 10 pip drop (including spread) before receiving a margin call. 10 pips!

Leverage the Killer

Most professional traders and money managers trade one standard lot for every $50,000 in their account.
If they traded a mini account, this means they trade one mini lot for every $5,000 in their account.  
Let that sink into your head for a couple seconds.
If pros trade like this, why do less experienced traders think they can succeed by trading 100K standard lots with a $2,000 account or 10K mini lots with $250?

No matter what the forex brokers tell you, don’t ever open a “standard account” with just $2,000 or a “mini account” with $250. The number one reason new traders fail is not because they suck, but because they are undercapitalized from the start and don’t understand how leverage really works.

Don’t set yourself up to fail.

We recommend that you have at least have $100,000 of trading capital before opening a “standard account”, $10,000 for a “mini account”, or $1,000 for a “micro account”.

So if you only have $60,000, open a “mini account. If you only have $8,000, open a “micro” account. If you only have $250, open a “demo account” and stick with it until you come up with the additional $750, then open a “micro account”.

If you don’t remember anything else in this lesson, I plead that you at least remember what you just read above.
Okay, please re-read the previous paragraph and ingrain it in your memory. Just because brokers allow you to open an account with only $250 doesn’t mean you should and I’m going to explain why. 

I believe most new traders who open a forex trading account with the bare minimum deposit do so because they don’t completely understand what the terms “Leverage” and “Margin” really are and how it affects their trading.
It’s crucial that you’re fully aware and free of ignorance of the significance of trading with leverage. If you don’t have rock solid understanding of leverage and margin, I guarantee that you will blow your trading account. 

If you don’t remember anything else in this lesson, I plead that you at least remember what you just read above.