Trading Concepts and Mechanisms

Currency Pairs

Currency prices can only fluctuate relative to another currency, so they are always traded in pairs. Two of the most common currency pairs are the price for euros in US dollars EUR/USD and the price for the British pound in US dollars GBP/USD

Leverage

Most Forex brokers permit 100:1 leverage, some as much as 200:1, but also require that you have a certain amount of money in your account to protect against a critical loss point. A $100,000 position held in GBP/USD on 100:1 leverage means the trader has to put up $1,000 to control his position. However, in the event of a decline in value, Forex brokers do not allow traders to go negative. In order to make sure the trader does not lose more money than is held in the account, forex brokers employ automatic systems to close out positions should a client run out of margin (the amount of money in their account not tied to a position). If, for example, you have $2,000 in your account, and buy a $100,000 lot of EUR/USD, $1,000 of your $2,000 is tied up in margin, with $1,000 left to allow your position to fluctuate downward without being closed out.

An online trading platform will show three important numbers associated with your account: balance, equity, and margin remaining. If you have a $10,000 account and open one $100,000 position using 100:1 leverage, this has committed only $1,000 of your money plus you must maintain $1,000 in margin. While this leaves $9,000 free in your account, it is possible to lose it all if the position moves the wrong direction.

Commissions or Spreads

Brokers take part or all of the spread in all currency pairs traded. Here is an example:

EUR/USD. Prices are always quoted with both bid and offer prices ( Buy EUR/USD 1.2000, Sell EUR/USD 1.2003). That difference of 3 pips is the spread and can amount to a substantial amount of money. Because the standard lot is 100,000 units of the base currency, 3 pips on EUR/USD means $30 paid to the broker. A pip is the smallest amount the currency is traded in - 1/100th of a percent in the case of the US dollar. The currency pairs are always purchased by buying 100,000 of the quote currency , also known as the counter currency. For the pair EUR/USD, the base currency is USD, therefore 1/100th of a percent on a pair with USD as the base currency will always have a pip of $10. If, on the other hand, your currency has British Pounds as a base instead of US dollars, then 1/100th of a percent is now worth around $20, because you are buying 100,000 units of British pounds. Retail forex brokers make a lot of money without charging commissions.

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