Forex.com Tutorial

Placing a Currency Trade

Careful analysis of the market will ultimately play the critical role in trading success (full discus-sion of this later). However, it is equally as important for new Forex traders to understand the mechanics of actually executing a currency trade. The thought process for a typical Forex trade is as follows: First, careful analysis on the market is performed. Then, from this analysis, the trader decides which currency pair to trade. Next, the trader decides whether to go long or short, and what size position to take on.

In Forex trading, currencies are traded in units called “lots”. Depending on the account type, traders can trade standard lots or mini lots. A standard lot is comprised of 100,000 of a particular currency, while a mini lot is comprised of 10,000. For example, if a trader decides to open a 1 million Euro position, they may do so by trading 10 standard lots or 100 mini lots.

Once a trader knows what they want to trade and how much, the next step is executing the trade and establishing an open position. There are several ways that a trader can enter the market. The quickest method is simply entering “at market”—buying or selling at the current market price. This is what traders typically do when they want to get into a position right away. (See the illustration below.)

The dealing panels from the FOREX.com trading platform show the current bid (the price at which you can sell) and offer (the price at which you can buy) for each of the currency pairs. A trader can buy or sell into a position with a simple click of the mouse.

Often, however, a trader might want to establish a position at a price other than the current market price. In these situations, traders enter the market using a variety of order types. Orders allow a trader to specify a price at which they would like to enter the market, along with an expiration directive for how long the order should remain active. Orders may not necessarily limit losses, but they do allow traders to step away from the market without missing potential entries and exits, and can be an important tool for managing risk. The type of order used is usually dictated by the desired entry price, and can include limit orders, stop loss orders, and other contingent orders (each of these is described below).

Limit Order

A limit order is one of the most commonly used entry order types. Traders use limit orders to enter the market at a more advantageous price than the current market price. For example, if a trader would like to go long EUR/USD but wants to buy at a price that is a little cheaper than the current rate (say it’s currently 1.3150), the trader can enter a limit order to buy EUR/USD at a price that is less than the current price (i.e. 1.3125). When the market touches 1.3125, the order is triggered and a new long position is established. Limit orders are commonly used to enter long positions at the bottom of a trading range, or to enter a short position at the top of a range.

Limit orders can also be used to exit the market when used as an associated order. An associ-ated order is an order that is part of an open position and is typically used to close the position at a predetermined rate. When used in this capacity, the limit order is used to set a level at which to take profit. For this reason, it is sometimes referred to as a take profit order. When the market touches a predetermined rate, the order is triggered and the open position is closed and any unrealised profit becomes realised.

Stop Loss Order

While everyone loves a good deal, there will be times when traders look to enter the market at prices that may seem less advantageous. In these instances, a trader is usually looking for confirmation of a move up or down before establishing a position. In this kind of situation, a stop order (also known as a stop loss order) is used. For example:

• A trader has been watching the EUR/USD for a few days and notices that it is stuck in a range, trading up and down between 1.3140 and 1.3175.
• Currently it is at the lower end of the range (1.3150), but the trader believes that if it can break out of the range to the upside, it may continue upward for some time.
• The trader sets a stop order to buy the EUR/USD at a price of 1.3180.
• When the market touches 1.3180, which is above the current range, a new long position will be established.

Much like the limit order, stop loss orders can also be used as an associated order to exit the market or close open positions. In this capacity, the stop loss order acts to limit potential losses. Traders will usually set the stop loss at a level in which the trader has reached their maximum risk tolerance for that specific position. Stop loss orders serve as an invaluable tool in risk management because they allow a trader to more or less predetermine their downside risk.

Contingent Orders

In addition to simple orders, such as limits and stop losses, Forex traders can use more complex orders called contingent orders. As the name implies, contingent orders contain multiple orders that are reliant upon the execution of one or more of the contained orders.

The first type of contingent order is called an “If, then” order. “If, then” orders allow a trader to define both a price at which to enter the market, as well as a price at which to exit the market if the entry order is executed. This order type is typically used by a trader who knows his risk tolerance, but is unsure of the reward desired.

A sample "If, then" order being entered on the FOREX.com trading platform.

For example: In the order illustrated above, the trader is saying, “If the EUR/USD touches 95.000, buy 1 lot, then attach a stop loss order to exit at 94.500”. Using an “If, then” order in this way allows the trader to predetermine their risk on the trade. In an “If, then” trade, the associated order can be either a limit order or a stop order, allowing you to either set a take profit level (limit) or downside protection (stop loss), but not both.

One kind of contingent order is the “One Cancel Other” order (or OCO), which allows a trader to create two distinct orders. With an OCO order, at the moment one of the orders is executed, the other order is automatically cancelled and it vanishes. Typically, an OCO order is used by a trader who is confident that a big move is imminent, but is unsure as to what direction the move will be in.

A sample "OCO" order being entered on the FOREX.com trading platform

For example: In the order illustrated above, the trader has set two entry orders. One order will enter a long USD/CHF position at 1.1680, in anticipation of a breakout to the upside. The other order will enter a short USD/CHF position at 1.1600, in anticipation of a breakout to the downside. When the USD/CHF broke to the downside, the trader was entered short at 1.1600, while the order to enter at 1.1680 was automatically cancelled.

The final kind of contingent order is an order that combines elements of both the “If, then” and the “OCO” orders. This order is creatively known as the “If, then OCO”. Similar to the “If, then” order, the “If, then OCO” order allows a trader to set both an entry order and two exit orders, all at the same time. Many traders use “If, then OCO” orders as a way of getting in and out of the market without having to physically monitor the market and open positions all day.

A sample "If, then OCO" order being entered on the FOREX.com trading platform.

For example: In the order illustrated above, the “If, then OCO” order shows a trader looking to enter a long EUR/USD position at 1.3175. Once the entry order is executed, both of the exit orders become active. The limit order will close the position at 1.3200 for a profit of 25 pips, while the stop loss will close the position at 1.3150 for a loss of 25 pips.

Using an “If, then OCO” can help a trader stick to a plan of attack for a particular trade. To use this order type, a trader must have an idea of not only where they would like to enter the market, but also where to exit (whether at a profit or loss).

Exiting the market

As demonstrated above, the various order types provide a convenient and effective way to not only enter the market, but also to exit. In addition to using orders, open positions can be closed in other ways. The most direct way of doing so is by manually liquidating an open position.

A trader can also close a position by performing an inverse transaction. For example, if a trader buys 1 lot of EUR/USD, the position can be closed by selling 1 lot of EUR/USD. With this methFor example: In the order illustrated above, the “If, then OCO” order shows a trader looking to enter a long EUR/USD position at 1.3175. Once the entry order is executed, both of the exit orders become active. The limit order will close the position at 1.3200 for a profit of 25 pips, while the stop loss will close the position at 1.3150 for a loss of 25 pips.

Using an “If, then OCO” can help a trader stick to a plan of attack for a particular trade. To use this order type, a trader must have an idea of not only where they would like to enter the market, but also where to exit. In addition to using orders, open positions can be closed in other ways. The most direct way of doing so is by manually liquidating an open position.

A trader can also close a position by performing an inverse transaction. For example, if a trader buys 1 lot of EUR/USD, the position can be closed by selling 1 lot of EUR/USD. With this method, it is paramount that the trader sells the correct amount. If too many lots are sold, the trader will inadvertently create a new short position.

The final method of closing a position is referred to as dealer or broker liquidation, which is when the broker/dealer closes the position rather than the trader doing so. In these instances, some or all of a trader’s open positions are closed by the Forex dealer as the result of the trader falling below the margin requirement. (As stated previously, the margin requirement represents the amount of capital required to open and hold a position.) Because dealer liquidation can be an inconvenience, a trader should always be aware of the margin requirement and set stop losses in an attempt to avoid getting to the point of liquidation.

To quickly illustrate an example of when dealer liquidation may occur, consider a trader with an account balance of $1,500 USD. If this trader decides to buy 1 standard lot of EUR/USD, the margin requirement for the position would be $1,315. This means that the trader’s available margin would be $185 ($1,500 - $1,315 = $185). If the trader incurs any loss on the position that exceeds $185, the trader will have fallen below the margin requirement and the EUR/USD position may be closed, or liquidated, by the dealer.

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