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My Favorite Market

January 11th, 2013
in contributors, forex

Online Trading Academy Article of the Week

by Rick Wright, Online Trading Academy

Hello traders! This week I’d like to introduce the spot forex market to anyone considering a new or even a first market to trade. I’ll do a basic intro to what the spot market is, and then give a few reasons why I think everyone should trade this terrific market.

First of all, what is the spot forex market? Investopedia defines it is as: “The current price at which a particular security can be bought or sold at a specified time and place. A security’s spot price is regarded as the explicit value of the security at any given time in the marketplace. In contrast, a securities futures price is the expected value of the security, in relation to its current spot price and time frame in question.” What that really means to the spot forex trader is that you are literally exchanging one currency for another, right here and right now, on the spot. You can trade forex on the futures market, but prices will be slightly different as the futures market trades in contracts that have time value built into them as well.

Follow up:

The main difference in the spot forex and futures forex market is the value of the smallest move in the market. Depending on your experience level, capital, and time frames you trade from, this can be a significant difference. In the spot market, our minimum move is commonly called a “Pip”, or “percentage in point.” In the futures market, the smallest move is called a “tick.” One of the odd things about the spot forex market is that not every currency pair has the same value for every minimum move. Your broker will give you a list of what the values are, even before you place a trade so you can adjust your position sizing to follow your risk management rules.

Click to enlarge

In the spot market, this move would have made you about 73 pips. In this currency pair, the EURUSD, the currency on the left side, is called the “base” and the currency on the right is called the “quote.” The prices you see on the left side of the chart are actually how many US dollars, cents, and fractions of a cent that it take to buy one of the base currency.  As the chart prices move up, it takes more and more of the quote currency to buy the base currency (the base is getting stronger), and as the chart moves down it takes less and less to buy the same amount of the base (the base currency is getting weaker).

In this 73 pip move, how much would you have made? Well, it depends on your position size. One of the most important differences in the spot market vs. any other market you want to trade is the customizable position sizing. In the spot market we have three basic types of positions sizes: standard lots, mini lots, and micro lots. Very generally speaking, a standard lot will cost you about $2,000-2,500 to trade, and each pip will be worth about $10. Mini lots will cost about $200-$250, with the pips being worth $1, and micro lots will cost about $20-$25, with pips being worth $.10. Yes, you can trade multiple lots of any of those! In the previous chart, if you had placed a one standard lot trade, the risk would have been about 22 pips, with a reward of about 73-which easily fits our recommended reward to risk ratio of 3:1. You would have risked $220 to make $730. With one mini lot, just drop the zero, so the risk would have been $22 to make $73. In the futures market, ticks are commonly worth about $10, with little or no option of trading smaller size.

In every Online Trading Academy class that I teach, there is a nice diversity of experience levels between the students. Some have never placed a trade before, which is terrific! They have no bad habits to unlearn! Some have been trading for a while, and aren’t happy with their results in the market. The longer someone has been trading, very often the more bad habits have been stuck in their head. This is often difficult to get past, as very often they will attempt to continue using whatever combination of indicators they have been taught to use in the past-which are the same indicators that have kept them from being truly profitable in the market. Bad habits are hard to break! The main point of the position size difference is this: in the spot market, you can trade with VERY small amounts of money with very small risk as you learn to trade. When you are consistently profitable risking (for example) $20 on a trade, move up to two minis where you might be risking $40. Then $60, $80, etc. etc.  Many forex brokers will let you open a trading account with just a few hundred dollars! Try trading stocks or futures with that little money, and you will find out how difficult it is to trade for a living!

Another great reason to trade the spot forex market is the fact that it is open for 24 hours a day, from Sunday afternoon through Friday afternoon.  If your current schedule keeps you from watching the stock market during its regular hours – 9:30 am Eastern time through 4pm Eastern – the spot market allows you to trade when you can. As I write this newsletter at 5am, the EURUSD had moved 60 pips since 3am. Not too bad for you early risers! Placing market orders during the live market is one option you have, but you can also use a “set and forget” strategy. Set and forget is when you place your entry, stop, and profit target at the same time. If you don’t have the luxury or even the desire to watch the market all day and night, the set and forget strategy is a great way to engage in this 24 hour marketplace!

The last reason we’ll discuss is the number of pairs you can trade. In the stock market, you can trade thousands of stocks! In our classes, we narrow that list down to a few dozen potential stocks to trade. In the spot forex market, there are really only about 20 pairs that have the parameters I look for: tight spreads and enough daily movement to earn a few pips when they move. If you are extra picky, you can even narrow that 20 down to about 8 potential pairs to trade. With only 8 or so pairs to choose from, it is very simple to spend just a few minutes a day setting up your trades!

So there you have it, the extreme basics of the spot forex market. With the ultra-low cost of getting into trading, the 24 hour marketplace which is suitable for every style of trading, and the few choices we have to trade, I hope you have been enticed enough to take a look at the most popular market on the planet!

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