As most know, the U.S. dollar is getting a lot of airtime. Some blame its weakness for causing the rise in oil prices and inflation in the United States and around the world. By trading currencies, the average retail investor can take advantage of the opportunities available in the foreign exchange market.
Like stock execution platforms, some foreign exchange market makers have online trading platforms that give retail clients the ability to trade online wherever an Internet connection can be found. Most of these firms have been in business for five to 10 years, have solid reputations, and are well capitalized. They tend to cater predominantly to global retail clients, but they have also extended execution service to small hedge-fund managers who may not be on the radar of the money center banks.
Margin in the Forex market is very small. A client need only apply 1% to 2% of the face amount of the underlying currency pair. For example, a $100,000 position in USD/JPY would require $1,000 to $2,000 of margin in the account. This is referred to as leverage.
Leverage is a double-edged sword if it’s not managed properly. On one side, it gives the trader a large profit potential with little money down. On the other side, it can lead to large losses just as quickly.
For example, a trader could purchase one standard lot of EUR/USD, which controls a 100,000-euro position, with $1,000 of margin. A pip move in the EUR/USD would result in a profit or loss of $10 per pip, the minimum price movement of a currency pair. If the trader paid 1.5720 for a one lot EUR/USD position and later sold it out at 1.5770, the gain would be 50 pips and the profit on the position would be $500 or 50 pips x $10 per pip x 1 lot. The return on investment would be 50%.
Such a return is certainly attractive; however, the opposite is also possible. The trader could buy 1 lot at 1.5720 and be stopped at 1.5670, resulting in a 50-pip loss. The return on this position would be less than 50%. Currency trading is suitable for those who have a greater risk tolerance and the wherewithal to absorb potential losses.
Some platforms allow traders to program strategies that auto-execute according to specified parameters. Having this flexibility is essential for those who want the ability to trade with the rhythm of the market, even when away from a computer.
When choosing a Forex broker, check whether the firm offers a free demo that replicates the pricing and full functionality of the live trading platform. Clients should be allowed to sample and customize the look and feel of the tool they will use to execute their trades. In addition, if the trader wants to program systematic trading strategies and test them, they should be allowed to do so without having to commit capital.
Transparent pricing—which replicates the pricing in the interbank market—is also an important consideration. Transparency extends to the various currency pairs offered for dealing in the spot market and for rollover rates on positions that are kept past the end of the day. A rollover rate is a debit or credit that is applied to all open positions held over the day’s end. If your broker doesn’t give credit when a credit is due, or simply charges for all open positions, it’s time to find a more professional one.
Finally, the brokerage firm should offer 24-hour customer support and manual trade-execution services for those times when there are trade inquiries or your Internet connection goes down at a crucial time.
About the Author:
Greg Michalowski is vice president of trading
and chief FX analyst at FXDD, an online foreign
exchange liquidity provider for retail traders
and investment managers.
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