The whole point of getting involved with Forex trading is to make a profit obviously, and that means a refined strategy for when to buy or sell a currency pair is something that every trader should have in his or her back pocket. It doesn’t make a lot of sense to get into Forex trading if you aren’t going to plan ahead. So, you must ask yourself when is the right time to buy or sell a particular currency pair?
We are going to look at some fundamentals of when to buy or sell a currency pair that may be of use to you. If you are prepared to learn these basics, then you should have a better understanding of why a currency pair is behaving a certain way when new information hits the market. Importantly, we don’t want to overload you with boring economic terms that are of no use to your trading strategy, so we will skip past the boring economics lessons at this time and move on to the juicy and important stuff that you really care about.
The Example of the AUS/USD Pair
One pair worth looking at as an example to start is the AUS/USD pair. This, of course, is the Australian Dollar as the base currency against the US Dollar. When a trader places a buy order on the AUS/USD pairing, they purchase Aussie Dollars against the value of the US Dollar. Essentially, they are purchasing AUD with the expectation that they will rise against the value of the US Dollar. A trader will do this if he or she believes that the US economy overall will weaken relative to the Australian economy.
If that turns out to be true, then the US Dollar will weaken in relation to the Aussie Dollar and likely many other currencies as well. This would cause the price of the AUS/USD pair to rise, and the trader would see profits on their buy order.
The Example of the USD/JPY Pair
This pair also has the US Dollar in it, but you will notice that the USD is the first currency listed in this pair. This means that it is the base currency for this trade. A trader who buys the USD/JPY pair is making the statement that they believe that the USD will rise relative to the Japanese Yen. One would only do this if they believe that the strength of the US Dollar will outpace the strengthening of the Japanese Yen.
Thus, one makes two declarative statements at once when you purchase this currency pair. Their statements are that they believe that the US economy is headed in the right direction, and they believe the Japanese economy may not be (or at least not as much as the US economy). If those things are true, then the USD/JPY will rise in value, and the buy order will show profits.
How About The GBP/USD?
Don’t get confused here. The GBP/USD pair is essentially the same scenario as the AUS/USD in that the British Pound is the base currency on this pair, and it is being compared to the US Dollar. This means that one would purchase the pair if they felt that the British Pound would rise in strength relative to the US Dollar.
On the flip side, one might sell the GBP/USD if they felt that the US Dollar was likely to continue to strengthen against the British Pound. Selling a currency pair largely operates the same way as buying the pair, except that you are doing everything in reverse. That is to say that you would sell the GBP/USD pair in the event that you felt the British Pound was weak relative to the US Dollar.
This strategy can be used on any currency pair, and some have found it helpful to make this type of trade when they decide that they want to get involved in currency markets. Some people simply prefer to sell currencies rather than buy them. It makes no difference from a profit/loss point of view, but some traders simply see the market in certain ways that makes it psychologically easier for them to place a buy or a sell order.
Spend any time on Forex forums and you are bound to hear people talking about lot sizes or other terms that may have you tilt your head to the side. It is actually a fairly straightforward concept once you understand what they are getting at, so don’t let their shop talk be something that intimidates you.
A lot refers to purchasing 100,000 units worth of a particular currency pair. In the example of the GBP/USD pair, the trader who buys 1 lot of the pair is purchasing 100,000 British pounds against the value of the US dollar. They are likely doing so on margin, but that is a topic for later.
There are other lot sizes that you should know about:
- Micro Lot: 1,000 units
- Mini Lot: 10,000 units
- Standard Lot: 100,000 units
Each of these is important in the sense that it gives you an idea of how much money can be made or lost on a single trade. If a trader is gaining or losing $1 per pip on a standard lot trade, then they are only gaining or losing $0.10 per pip moved on a mini lot, and just $0.01 per pip on a micro lot. This matters because it gives you an idea of what size account they likely have, and how much they are really trading. Just because two people own the same currency pair does not mean that their fates are going to be the same. Much of the money made or lost in Forex trading comes down to lot size. It is important to only trade in lot sizes that your account and your bankroll can handle.
Perhaps $10,000 or even $1,000 sounds like a lot of money to you. You might think that you cannot possibly get involved in the markets because you don’t have that kind of money to put into an account. The good news for you is that you do not have to put up the full amount of what you plan to trade. Trading on margin or leverage allows you to get into a trade for just a fraction of the true cost of what you are buying or selling.
If you want to purchase $10,000 worth of the AUS/USD currency, you may need just about $250 to make that happen. You would need to deposit a bit more than that amount to make sure you have enough margin to cover the trade, but that would be the amount of money you have locked up in that trade when you execute it. When you complete your trade, the excess margin funds will be returned to the broker, but you get to keep any profit (or suffer any loss) that your trade netted for you.
An Example with NZD/USD
- You think the New Zealand Dollar will go up against the US Dollar.
- With a 50:1 margin, you buy a standard lot of 100,000 NZD at a price of 1.20000.
- At that price, you bought 100,000 NZD, which is worth $120,000.
- Since the margin requirement on 50:1 leverage is 2%, you opened the trade for $2,400 — or $120,000 x 2%.
- You turned out to be right and the price action moves to 1.20500.
- You earn about $500.
A currency needs only to move a tiny amount in value to make significant gains (or losses) on a trade. It is all dependent on your lot size and how much margin you are using. If you have just $1,000 to trade with, you aren’t going to gain or lose very much trading that $1,000 as even money in a currency pair. However, when you leverage it up to say 50:1, you can start to see bigger gains. You wouldn’t be trading just $1,000 in that scenario, you would be trading $50,000 worth of the currency, and that can start to make a difference in your bottom line.
Don’t Abuse Margin
If there is one thing to take away from the information presented to you here today, it should be this. You do not want to abuse margin!!
There are too many people who open accounts, take as much leverage as their broker will allow them to, and then blow through an account with just a small amount of movement in the currency pair that they have decided to trade in. This can happen so easily because someone gets over-leveraged in their account and is trading well beyond the limits that they should have set for themselves. Movements in the currency markets happen all the time, and you can easily lose your entire account if you risk too much of it on a single play. It is best to use margin wisely and conservatively and to not wager away your entire account on one trade.