First things first

If you are new to Forex trading, this is not the time to open a Forex trading account. Here are two good rules to follow:

• Rule 1 - Learn about Forex trading until you feel ready to try out some of your knowledge and then open a free Forex demo account. With this type of account, you will trade in real-time but not with real money. Practice in this account until you feel confident enough to open a micro or mini account and then practice with small amounts of real money until you feel ready to advance further.
• Rule 2 - Do not ignore Rule 1.

OK, I’m ready to open a Forex trading account. How do I do it?

First, choose the type of account you want to open.

1. A free demo account
2. A micro account
3. A mini account
4. A standard account

Forex trading is done through Forex brokers or dealers. A Forex broker is an entity (individual or company) that buys and sells currencies per a Forex trader's orders. Since you will need a broker to trade Forex, you should do some comparison work before you choose one. Let's start with some basics:

Does the broker provide 24 Hour Support?

Since Forex is a 24-hour market, 24-hour support is very important. So make sure you can contact the broker 24 hours a day should you need support.

You should also check on the quality of support by assessing the expertise, general manners, and overall responsiveness of the broker's representatives. One way to do this is to contact their help desk either by phone, chat, or email (or all three) and notice how promptly and effectively they respond to you.

The Broker's Online Trading Platform

Good Forex brokers try to make your trading experience on the Internet as easy as possible. The core element in their effort to do so is their "Trading Platform." This is the sofware they use to enable you to place your orders easily and quickly. The part you will see is what is displayed to you on your computer screen.

Here are some things you should look for:

• Real-time currency exchange rate quotes
• An account summary that shows the following items:
  • Your current account balance
  • Realized and unrealized profit and loss
  • Available margin
  • Any margin that may be locked in open positions.

Trading platforms are, typically, either Web based (Java), or client-based programs you can install on your computer. So ...

1. Since Web based trading platforms are hosted on your broker’s web site, you won’t have to install any software on your own computer and you’ll be able to log in from any computer with an Internet connection.
2. With client-based trading platforms, which you download and install, you can only trade on your computer.

Most brokers prefer Java-based software programs because they consider them to be safer and more reliable.

Mini and Micro Accounts

Most brokers offer both Mini Accounts and Micro Accounts. These accounts are a good way for new traders to get started in real-money trading after they have become somewhat experienced and comfortable trading in a free demo account. Check with a few brokers to see what money requirements they have for these two accounts. But be sure to practice first in a free demo account before you risk real money.

Features and policies to look for:

• Available Currency Pairs: At the very least, the broker should offer the seven major currencies (AUD, CAD, CHF, EUR, GBP, JPY, and USD).
• Transaction Costs (Remember, transaction costs are calculated in pips.): The fewer pips the broker charges per trade, the more profit you the trader can make. So be sure to compare the pip spreads for each broker. A bid/ask spread of 2 pips, is better than a spread of 3 pips.
• Margin Requirement: Lower margin requirements produce higher leverage while also creating a potential for bothhigher profits and losses. So be wise about margin percentages and remember that while a low margin requirement can appear to be very attractive when trades are working in your favor, it can also hit you hard when trades are going against you.
• Minimum Trading Size Requirement: Lot sizes can vary from broker to broker, though, typically, a "micro lot" is 1,000 units; a "mini lot" is 10,000 units; and a "standard lot" is 100,000 units. There is also something called an "odd lot" that is offered by some brokers, which allows the trader to set the size of the lot.
• Rollover Charges: Check the broker's policy on Rollover Charges. For a review of what rollover charges are and how they work, see "How Forex Works."
• Margin Account Interest Rate: Typically, a broker will pay interest on the money you have in your margin account. The interest the broker pays can fluctuate according to national rates. The main point here is that while your money is in a margin account, it accrues interest. Therefore, you may want to compare interest rates from broker to broker and also check on their policies regarding margin account interest. Most brokers don't allow traders to accrue interest unless their margin requirement is at least 50:1 (2%).
• Trading Hours: Virtually all brokers are open for business during the hours of operation of the global Forex market, which are 5:00 pm EST Sunday through 4:00 pm EST Friday.

By way of review, keep the following in mind while you're looking for a good broker:

1. Low Spreads: Remember, the "spread is the difference between the buy and sell price of a currency pair. The lower the spread, the better.
2. Low minimum account reqirements: This is especially important for new traders and/or those who do not have large amounts of cash to put at risk in the Forex market.
3. Instant automatic execution of your orders: This is very important. When you place an order, you want it to execute NOW, not at some later time when the market might be quite different than when you placed your order. So make sure you choose a "WYSIWYG" (What-You-See-Is-What-You-Get) broker so that the price you see when you place your order is the price you actually get.
4. Free charting and technical analysis: Free professional charting services that will allow you to trade directly on the charts is a good thing, as is free technical analysis. So look
5. Leverage and margin accounts: Leverage can work for you or against you. If you are new to Forex trading and you choose to trade in a low-margin (high leverage), real-money account, the chances are good that it will work against you. So the wise approach is to practice in a free demo account until you feel experienced enough and feel comfortable enough to try your new skills in a real-money account. Even then, you should proceed with caution when choosing the amount of leverage to use. Some say that a good rule of thumb is to not use more than 100:1 leverage for Standard (100k) account or not more than 200:1 for Mini (10k) account.

Finally, here are some other things you may want to consider:

• If you are considering a broker in the United States you can check to see if the company is registered as a Futures Commission Merchant (FCM) with the Commodity Futures Trading Commission (CFTC) and if it is an NFA member. These two entities were created to protect the public against fraud, manipulation, and abusive trade practices.
• You can also check the registration status of a broker with the CFTC and membership status with NFA. Additionally, you can inquire about any disciplinary history the broker may have by calling NFA at (800) 621-3570 or by visiting the broker/firm information section (BASIC) of NFA's Web site at http://www.nfa.futures.org/basicnet.

Whether you are trading in a demo account or a live "real money" account, when you are ready to make a trade, you will need to place an order with your Forex broker. You will place an order to start a new trade or to end a trade. So now, we'll talk about the types of orders that apply to the Foreign Exchange Market.

Basic Order Types

Market Order

This is an order to buy or sell at the current market price. If you wanted buy EUR/USD at its current price you would simply click "Buy" and your order would be executed, instantly, at the quoted price.

Limit Order

You use a limit order to buy or sell a currency at a specific price and only within a specific period of time. So, the order has two parts: price and duration. Here is how it works:

1. Your own analysis or your FOREX System indicates that it is a good time to buy EUR/USD if and when its price hits 1.3938 within the next two days.
2. You place a buy limit order and set the price at 1.3938 and you specify exactly how long you want the order to remain active.

By using the limit order, you can avoid having to sit in front of your computer while you wait for a currency pair to reach a specific price at which you want to buy or sell.

Stop-loss Order

This type of order does just what its name implies. It is designed to prevent additional monetary loss if an existing (open) trade goes against you. It remains in effect until the stop-loss order is activated (the position is liquidated) or until you cancel the order. Here is how it works:

1. You place an order to buy (go long) EUR/USD at 1.3938
2. At the same time, you place a stop-loss order at 1.3908 so that if your judgment is wrong and the trade goes against you (EUR/USD depreciates), you will not lose more than 30 pips. If EUR/USD depreciates to 1.3908, your broker would automatically execute a sell order and close your position for a 30 pip loss.

So this is one more type of order that relieves you from having to sit in front of your computer while you wait for something to happen. The stop-loss order is extremely useful and can prevent you from losing more than you can afford or want to lose.

GTC (Good ‘Til Canceled)

A GTC order is just what it sounds like: It remains active until you cancel it. There is nothing automatic about it. Once you have placed the order, it is up to you to keep your eyes on it.

GFD (Good For the Day)

If you want to place an order that will remain active only until the end of the day's trading, this is the one for you. For the U.S., this usually means it will remain active until 5 PM EST but check with your broker to be sure about this.

OCO (Order Cancels Other)

This type of order works with two other orders: a Limit Order and a Stop-Loss Order. When one of the two orders is executed, the other one is cancelled. Here is how it works:

1. The current market quote for EUR/USD is 1.3930.
2. Your own analysis or your FOREX Software indicates that it is a good time to buy (go long) EUR/USD if it hits 1.3938, or sell it (go short) if the price hits 1.3922.
3. You place an OCO order that tells your broker to buy at 1.3938 or to sell at 1.3922, depending on which price level is realized.
4. If the price hits 1.3938 a buy order will be triggered and your sell order will be cancelled. Or, if the price hits 1.3922 a sell order will be triggered and your buy order will be cancelled.

If you haven't already noticed, with an OCO order, the price of the buy order will always be higher than the current market price of the currency and the price of the sell order will always be lower than the current market price of the currency.

Trading Platforms

A trading platform is a fancy term for the software FOREX brokers provide for their clients to enable them to trade in the FOREX market. Trading platforms vary in scope and quality from broker to broker so it is important that you visit different brokers to compare their trading platforms. Also, after you choose a broker you should spend some time to learn how it all works and to become comfortable with everything before you begin trading.

Let's talk about Pips again

We gave a brief description of pips in How It All Works. Now, we'll go into more detail about what they are and how profit and loss is calculated using them.

Pip Basics

1. A Pip is the smallest increment in any currency pair rate. Since a pip is the smallest increment in a rate quote, it is represented at the last digit to the right of the decimal point. For example, in the currency rate EUR/USD = 1.3904 the last digit on the right is what you will use to calculate pips. If the currency rate has only two decimal places like the USD/JPY pair (USD/JPY = 119.56) the last decimal place is still a Pip.
2. Pips are used to calculate profit and loss in FOREX transactions. For example, if you buy when the rate is EUR/USD = 1.3901 and sell when the rate is 1.3906, you earned 5 pips on the trade. (1.3906 - 1.3901 = .0005 or 5 pips)

How to Calculate Pip Values (If you really want to.)

The math in this part gets just a little tiresome but there is good news: You really don't need to do these calculations yourself because most FOREX brokers do it for you, automatically. Still, the formula is offered here in case you just want to know how to do it.

So just how much in dollars is the movement of one or more pips worth—for example, per 10,000 Euros in EURUSD? How much is one pip worth per 10,000 Dollars in USDJPY? To demonstrate, we will refer to 10,000 units of the base currency, as the "Notional Amount."

The formula for calculating a pip value is:

(One pip, (with proper decimal placement)/currency exchange rate) x (Notional Amount)

Example with USDJPY: (.01/130.46) x USD10,000 = $0.77 or 77 cents per pip

Example with EURUSD: (.0001/.8942) x EUR10,000 = EUR 1.1183

Now, in the EUR/USD example, we want the pip value in USD, so we must multiply EUR1.1183 x (EURUSD exchange rate): EUR 1.1183 x .8942 = $1.00

This is a phenomenon you will see with any currency where the currency is quoted first (such as EUR/USD, GBP/USP, or AUD/USD): the pip value is always $1.00 per 10,000 currency units. This is why pip (or "tick") values in currency futures, where the currency is quoted first, are always fixed.

Approximate pip values for the major currencies are as follows:

(per 10,000 units of the base currency)

USD/JPY: 1 pip = $.77. A change from 130.45 to 130.46 (1 pip) is worth about $.77 per $10,000.

EUR/USD: 1 pip = $1.00 (.8941 to .8942 is worth $1.00 per 10,000 Euros.)

GBP/USD: 1 pip = $1.00 (1.4765 to 1.4766 is worth $1.00 per 10,000 Pounds.)

USD/CHF: 1 pip = $.59 (1.6855 to 1.6866 is worth $.59 per $10,000.)

At this point, you may be thinking that 1 pip multiplied by 10,000 units of a currency doesn't add up to much money and that you will need a lot of capital to become a viable trader! Not to worry; just keep reading.

Lots, Margin Accounts & Leverage!

We also covered "lots" and "margin accounts" in How It All Works but we will expand these topics now to show you why trading in lots is so important and how trading in lots with leverage makes it possible to earn high profits.

Remember these four things:

1. Currencies are measured in pips, which is the smallest increment of a currency exchange rate.
2. Spot FOREX is traded in lots.
3. The size of a standard lot is US$100,000 and the size of a mini lot is US$10,000.
4. Margin accounts give traders tremendous leverage.

To take advantage of the small monetary increments represented by pips, a trader must trade large amounts of a currency in order to realize any significant profit potential. This is where leverage comes in. Remember that in FOREX traders can trade large amounts of currency with relatively small amounts of capital by using the leverage they have with their margin accounts.

First, calculate pip values:

For these examples, we will use a $100,000 lot size.

USD/JPY at an exchange rate of 119.90 (.01 / 119.80) x $100,000 = $8.34 per pip)

USD/CHF at an exchange rate of 1.4555 (.0001 / 1.4555) x $100,000 = $6.87 per pip)

When the US Dollar is not quoted first, the formula is different.

EUR/USD at an exchange rate of 1.1930 (.0001 / 1.1930) X EUR 100,000 = EUR 8.38 x 1.1930 = $9.99734 rounded up will be $10 per pip)

GBP/USD at an exchange rate or 1.8040 (.0001 / 1.8040) x GBP 100,000 = 5.54 x 1.8040 = 9.99416 rounded up will be $10 per pip.)

Calculating profit and loss

In this example, you will buy US dollars and Sell Swiss Francs

1. The rate you are quoted is USD/CHF 1.4525 / 1.4530 (The first part of the quote is the bid price and the second part is the ask price.)
2. Because you are buying US you will buy at the ask rate of 1.4530, which is the rate at which traders are prepared to sell.
3. You buy 1 lot of $100,000 at 1.4530.
4. Later, the price appreciates to 1.4550 and you decide to close your trade.
5. The new quote for USD/CHF is 1.4550 / 14555. You initially bought the pair to enter the trade, but now since you are closing the trade you must sell the pair at the bid price of 1.4550 (The price at which traders are prepared to buy.)
6. Since the difference between 1.4530 and 1.4550 is .0020 (20 pips), using our formula from before, we now have (.0001/1.4550) x $100,000 = $6.87 per pip x 20 pips = $137.40. You have earned a profit of US$137.40.

More about leverage and margin accounts

You get leverage when you open a margin account. The topic of margin accounts is sometimes controversial because using too much margin can be very risky. However, it all depends on the individual trader. The important thing is to make sure you understand your broker's margin account policies so you can correctly assess the risk.

Leverage gives small investors and large investors, alike, the ability to trade large amounts of money with small amounts of money. For example, if you choose to trade with a 1% margin account, you will be able to trade $100,000 in currencies with a $1,000 deposit. This is how leverage works in the FOREX market.

As you will learn later when you look at different brokers, the amount of leverage available to you depends on the policies of the brokers. Brokers require a minimum account size, which is also known as account margin or initial margin. They also specify how much is required per position (lot) traded. The minimum security (margin) for each lot may also vary from broker to broker.

Margin Call

If the money in your account falls below margin requirements ( also called "usable margin"), your broker will close some or all of your open positions. This prevents your account from falling into a negative balance. It is a safety mechanism.

Example 1

You open a FOREX account with $2,000. You then initiate a 1 lot trade of the EUR/USD pair, which has a margin requirement of $1000. "Usable Margin" is the money available to open new positions or sustain trading losses. In this case, since you started with $2,000, your usable margin is $2,000. But when you opened the 1 lot trade with a margin requirement of $1,000, your usable margin changed; It is now $1,000 ($2,000 - $1,000 = $1,000).

In this example, if your losses exceed your usable margin of $1,000 you will get a margin call.

Example 2

You open a FOREX account with $10,000. You then initiate a 1 lot trade of the EUR/USD pair, which (again) has a margin requirement of $1000. Remember, usable margin is the money you have available to open new positions or sustain trading losses. So prior to opening the 1 lot trade, you had a usable margin of $10,000. After you open the trade, you have a $9,000 usable margin and $1,000 of used margin.

In this case, you will not get a margin call unless your losses exceed your usable margin of $9,000.

If because of trading losses, the equity (the value of your account) falls below your usable margin, you will either have to deposit more money or your broker will close your position to limit both your and his. Therefore, you can never lose more than you deposit. Again, it is a safety mechanism.

IMPORTANT: Be sure you know the difference between usable margin and used margin. Also, learn what your broker's margin account policies are before you open one.

• Leverage = 100 / Margin Percent
• Margin Percent = 100 / Leverage

Now, you know how you can use relatively small amounts of capital to buy and sell relatively large amounts of currencies. It's all about leverage!