1. The Broker
In the same way that you need to open an account with a share broker if you want to trade shares you need to open an account with a currency broker if you want to trade currencies. The two main types of currency brokers are Market Makers and Electronic Communications Networks (ECN's).
2. The Market Maker
A Market Maker provides its own buy and sell prices that it offers through its own dealing desk. When you trade with a Market Maker they take the other side of your trade. They then either offset it with someone else or hold it themselves. They act as a middleman.
3. The ECN
An ECN does not have a dealing desk but instead provides direct electronic access to a network of multiple Market Makers, Banks and other traders. When you trade with an ECN they simply facilitate your trade by putting you in direct touch with the other party. There is no middleman.
4. The Bid Price
The first price on a broker's trading platform is their bid price (i.e. the broker is offering to buy the currency from you, at that price, should you wish to sell).
5. The Ask Price
The second price on a broker's trading platform is their ask price (i.e. the broker is offering to sell the currency to you, at that price, should you wish to buy).
6. The Spread
The difference between the bid price and the ask price is called the spread. Most Market Makers offer fixed spreads with no commissions on trades whilst ECN's offer variable spreads with commissions.
7. The Pro's and Con's
The advantage of dealing with a Market Maker is the fixed spread. You always know what your trade will cost. The disadvantage is dealing in an unnatural environment that is open to manipulation. The advantage of dealing with an ECN is that the transparent environment ensures no manipulation. The disadvantage is the cheaper but variable spread with flexible commission means you are not always certain what your trade will cost.
8. The Market Order
A market order is an order to enter a trade at the current market price (i.e. at the price immediately available on your computer screen).
9. The Slippage
The market is not static, it is moving all the time. So, sometimes, by the time you hit the button to enter a trade and your order is routed, the price has changed. When it goes against you the difference is called slippage.
10. The Stop Loss Order
A stop loss order is an order to exit a trade at a certain market price should price move against you (i.e. a negative minimise loss order executed if price reaches a certain level).
11. The Take Profit Order
A take profit order is an order to exit a trade at a certain market price should price move in your favour (i.e. a positive take profit order executed if price reaches a certain level).
12. The One Cancels Other Order
A one cancels other order is a combined stop loss order and take profit order to exit a trade at one of two certain market prices should price move either way (i.e. if the positive take profit order is executed first then the negative stop loss order is cancelled or vice versa).
13. The Margin
The margin is the balance the broker requires you to maintain in your account before they will allow you to trade. If, for example, they specify a 1% margin you must maintain at least 1% of the value of your trade in your account and they will then loan you the balance of 99%.
14. The Leverage
Leverage is the ability to trade more currency than you buy or sell. It is essential in the currency market because the average daily percentage move of a major currency is less than 1% whereas a stock can easily have a 10% price move on any given day. Leverage is the act of borrowing money from your broker in order to increase the size of your trade and therefore its rate of return. Leverage gives you the ability to increase profits (and losses) whilst keeping your risk capital to a minimum.
Disclaimer
The information contained in this article is provided as a general guide only. In the interests of simplifying a complex subject some of the detail may be an oversimplification. It also may vary from one market participant to the next so please ensure you verify everything before taking any action.
This article is provided by Graham McAlpine from the Pound Trader's Club, a club established by MDO Business Solutions Pty Ltd to help people make money trading the British Pound. Visit http://mdo.com.au/ for more detailed information on Currency Trading Basics and to find out why joining the Pound Trader's Club could help you supplement or even replace your existing income. |
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