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The market offers private investors attractive leverage and
exciting opportunities, but how do you get started and
minimise the risks involved? Philip Battley gives his advice
FOREX TRADING
an example
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Currencies: British Pound (GBP) and US
Dollar (USD)
Spread quoted by FX broker: 1.6112/1.6116
This means the FX broker believes the
number of dollars in every Pound (exchange
rate) will be between 1.6112 and 1.6116. This
is the spread
You are only allowed to BUY at 1.6116 (the
higher number) and SELL at 1.6112 (the
lower number)
Margin (deposit): £2,000
Leverage: 50:1
Size of trade: £2,000 x 50 = £100,000
Buy example (or 'going long')
You think the pound will strengthen against
the dollar (perhaps you think the US is about
to announce bad trading results)
You BUY at 1.6116
You were right: Profit: The rate rises . the
broker is now quoting a spread of
1.6150/1.6154
You sell at 1.6150 - that.s 0.0034 higher
Your profit is £100,000 x 0.0034 = £340
(before Capital Gains Tax and any
commission)
You were wrong: Loss: The rate decreases,
and the broker is now quoting a spread of
1.6050/1.6054
You sell at 1.6050 - that's 0.0066 lower.
Unless you have a stop-loss order in place,
your loss is £100,000 x 0.0066 = £660
(before any commission)
Losses can be minimised by using a stoploss
order, which many brokers recommend
and often insist on
Sell example (or 'going short')
You think the pound will weaken against the
US Dollar (perhaps you think the UK is about
to announce bad trading results)
You SELL 1.6112
You were right: Profit: The rate decreases,
and the broker is now quoting a spread of
1.6050/1.6054
You buy at 1.6054 - that's 0.0058 lower.
Your profit is £100,000 x 0.0058 = £580
(before Capital Gains Tax and any
commission)
You were wrong: Loss: The rate rises - the
broker is now quoting a spread of
1.6150/1.6154
You buy at 1.6154 - that's 0.0042 higher
Unless you have a stop-loss order in place,
your loss is £100,000 x 0.0042 = £420
(before any commission)
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One of the reasons often given
for the explosion of the
dotcom bubble three or four
years ago was that so many
website companies were trying
to sell products to people who were not yet
ready to make purchases or transactions
online. The irony of course is that we.re now
ready. We're using the internet as never
before, not just for buying and selling, but for
organising our personal finances. If they were
still around, you imagine many of those
companies that went under could be doing
well.
For example, the sheer volume of online
trading in the UK has exploded. And not just
stocks and shares. Areas that were once the
domain of the specialist professional dealers
and brokers have been opened up to the
individual investor in ways previously
unimagined.
One of the most rarefied regions used to be
the currency markets - foreign exchange. Once
the plaything of the classic `80s yuppie
brokers, now the FX markets are available for
all of us to toy with from our own living
rooms. Even if you look over the last year or
so, the number of brokers offering forex
dealing to the private investor has more than
doubled in the UK. It seems that every month,
more companies join those who have
developed online systems to help individuals
get into what was once an institution-only
world.
And for good reason - in a time of volatility
in the equity markets, the foreign exchange
markets are a viable addition or even
alternative to investing in stocks and shares.
This is because when dealing in stocks and
shares, absolute value is important - but
when buying and selling currency, you care
only about the difference and movement in
prices. As a result, with FX you benefit from
the very volatility which can make stocks and
shares so risky.
Active share trading has nothing on the
pure form of short-term dealing which is the
FX markets. You can wake up to the Far East
markets, go to work in Europe and wind down
in the US at night.
So how can you get involved? How does it
work? What are the potential gains and risks?
There are two principle ways to play the
forex markets: the first, through actually
speculating in the currencies themselves;
secondly, dealing in Contracts for Difference
(CFDs) or spreadbetting.
Forex speculation
Speculating on currency movement involves
buying or selling one currency against another
in the expectation that the exchange rate will
change in your favour. This can be confusing,
as it looks like you need to perform two
transactions. In reality, it is no more difficult
than buying or selling shares.
That said, because of the greater risks
involved, many brokers will demand evidence
of experience in general trading before they
will let you speculate. If you are a first-time
speculator, there are many ways to get
experience which we will come to later.
To trade in FX, you first need to open an
account with a broker who - unlike if you were
to deal in shares - will ask you for a deposit,
usually around £3,000. This is to provide you
with what is known as a 'margin'.
The margin means that you can control a
much larger amount of foreign currency - that
is, you can use your deposit to leverage from
anything up to 400 times the amount of
currency. For example, at a leverage of 80:1
with a margin of £2,000 you can control
£160,000-worth of currency.
You then use your leveraged money you
buy and sell a pair of currencies through a
broker, online in real time. See the box on the
opposite page for an example.
Most online Forex trading firms require
customers to maintain 100% margin balance at
all times. This means you must always reserve
enough funds in your account to withstand
even a small, brief decline against any of your
positions. If not, you run the risk of having
your open positions liquidated at a loss. For
novice traders, this type of margin policy can
help protect against excessive losses.
Experienced traders, on the other hand, find
this policy restrictive and especially
problematic when market conditions are
volatile.
What should I look for in a broker?
Most importantly, look for a broker that offers
a 'dealable rate'. This means the rate you see
on the screen is the one you trade with. If you
opt for a 'requestable rate', you could find the
rate you are given has ticked up a notch in the
broker.s favour, not yours, when it comes to
completing the deal.
Secondly, work out how the firm is charging
you and therefore which system is best for the
way that you plan to deal - some charge a
percentage of every deal; some charge a set
commission and others no commission at all.
It must be said that speculating on the
currencies themselves can be a big risk - the
recommendation of the experts is that overall
you should never invest more than you can
afford to lose; and more specifically, never
invest more than a small amount of your
capital - no more than around 2% - into any
one position.
Brokers advise that whether investors are
speculating or spread betting, they should use
stop-loss orders to protect themselves. A stop
loss will automatically close your bet in order
to limit your losses while at the same time not
limiting your potential gains.
Spreadbetting and CFDs
The other ways to play the currency markets
are to use spreadbetting or contracts for
differences (CFD) accounts. As with
speculating, bets are usually only made on a
short-term basis and again your transactions
are geared - so you need a margin.
A contract for difference is, as the title
suggests, a contract with your broker to
exchange the difference between the opening
value and the closing value over a period of
time. Essentially spreadbets and CFDs operate
in a very similar fashion although there are
two main differences. Firstly your gains on
CFD trading are liable to Capital Gains Tax,
unlike spreadbetting (and you can offset
losses against other taxable gains that you
make). Secondly, you can often deal inside the
quoted spread with a CFD account.
Spreadbetting is perhaps the simplest and
easiest, but not necessarily a less risky,
method of playing the currency markets. But it
is becoming very popular indeed. One provider
estimates that currency trading on its site has
increased 100-fold over the last two years.
The principle of spread betting is the same
whatever the subject - from cricket scores to
the currency markets. When you spread bet,
the amount you win or lose varies depending
on how many 'points' you are away from the
spread bet firm's initial prediction (or
'spread'). When betting on a currency market,
1 point is equal to a 0.0001 movement in a
currency rate.
The three largest FX markets are euro/dollar,
dollar/yen, and £/$ (referred to in the market
as the 'cable' rate). Let's say you expect the
pound will gain against the dollar, then you
'buy' the cable rate. If you expect the pound to
weaken against the dollar, then you 'sell' the
cable rate.
If, for example, the pound was trading at
1.7700 against the dollar, you bet £1 per point
that the pound will continue to strengthen
against the dollar. By the end of the day, the
rate has increased to 1.7800 - a rise of 100
points. At £1 a point, this would have made
you a £100 profit.
You can hold your position for as long as
you like - if your trade expires at the end of the
day, it's known as a 'spot' trade, but you can
'roll' it over to the next day if you wish.
Training in foreign exchange
The best advice for any newcomers is to
practice, practice and practice. There are a
number of companies that offer virtual trading
platforms for would-be traders to hone their
skills offline before having a go for real, so all
you have to sacrifice is your own time. And
many actually run courses to help you learn.
For example, GNI Touch (www.gnitouch.com)
runs regular free training sessions across the
country on CFD Forex trading, while Deal4 Free
(www.deal4free.com) offers a 14-day, risk-free
demo trading with a virtual $10,000 demo
account.
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