Placing A Currency/FX Trade

Several trillion dollars flow through the Foreign Exchange (FX) markets every day, making them easily the largest and most liquid markets available to traders.

Like many new traders, I was immediately attracted to these markets but I stayed away because I couldn’t quite comprehend how to trade them.

In this article I’m going to talk you through how to place an FX trade on the optionsXpress CFD platform, using the Australian Dollar/U.S. Dollar as an example.

New FX traders sometimes get stuck because they don’t know what it is they are actually buying or selling. In a standard equities market, if you buy BHP shares you know you are buying a share or a percentage of the company called BHP.

FX trading is different. There are always two currencies involved, traded against each other.

At the time of writing, one Australian Dollar is buying $US1.0690, as shown below:

Australian Dollar/US Dollar Price, optionsXpress CFD Trading Platform

That means if you had a $A100 bill in your pocket, you could exchange it for approximately $US107. To be even more precise, if you were an Australian going to the United States for a holiday and you had $A10,000 spending money, your money would be worth $US10,692 (before transaction costs).

As you can see from the red and blue buttons above, you have a choice of buying or selling this “1.0692/1.0694” price. This can be confusing, because every FX trade is really two trades – you are buying one currency and simultaneously selling the other currency.

If you were to click ‘Buy’, you would be buying Australian Dollars and selling an equivalent amount of U.S. Dollars.

If you were to click ‘Sell’, you would be selling Australian Dollars and buying an equivalent amount of U.S. Dollars.

Note the order in which the currencies are expressed – if it says ‘AUD/USD’, and you click BUY, you are buying Australian Dollars.

The next step is deciding how much to buy or sell.

The table below covers some of the more common currency pairs available:

The Position Size and Margin are always calculated using the first currency listed (e.g. For Australian Dollar/U.S. Dollar, the position size and margin are worked out in Australian Dollars.)

The tick value (which determines your profit/loss on the trade) is worked out using the second currency listed (e.g. Australian Dollar/US Dollar, the profit/loss is worked out in US Dollars).

Note that this table expresses most currencies to four decimal places, although many brokers now deal FX to five decimal places. That extra decimal place is worth 10 cents per tick (using the Australian Dollar example above). So if a trade that moves 0.0001 is worth $1US, a trade that moves 0.00012 is worth $US1.20.

Let’s go back to the original example of the Australian Dollar/US Dollar. Take a moment to read all the detail from the screenshot of the optionsXpress CFD Platform below:

Australian Dollar/US Dollar Price, optionsXpress CFD Trading Platform

If you were to click the blue BUY button, you would be buying $A10,000 and simultaneously selling $US10,694. Note that you BUY at a higher price than you SELL - in this case, the difference is 0.0002. This is called ‘the spread’ and is effectively your brokerage cost. When you hear an FX broker say “we don’t charge brokerage”, they are telling the truth. They are just not telling you there are other ways they make money aside from brokerage.

If you have clicked BUY, your account would now show that you are the proud holder of +$A10,000. Unfortunately, you can’t just go out and spend that $10,000, because you also owe -$US10,694. The two positions start out as being of equal value. That is until the currency moves.

Scenario 1:

Imagine the Australian Dollar falls in value against the U.S. Dollar, so that one Australian Dollar now buys only 1.0594 U.S. Dollars.

You still have $A10,000 sitting in your account – that hasn’t changed, so you might think you haven’t lost anything. But you still owe $US10,692. If you were to sell your $A10,000, you would only realise $US10,594. While this clears out most of the original trade, the arithmetic reveals the true position:

-10,694 + 10,594 = negative $US100

You have incurred a loss of $100.

Scenario 2:

The Australian Dollar rises in value against the U.S. Dollar, so that one Australian Dollar now buys 1.0794 U.S. Dollars. You could sell your $A10,000 and bring in $US10,794 and after repaying the -$US10,694 from the original transaction, you would be left with a profit of $US100.

Note that the profit/loss on a currency trade is always denominated in the second currency. This is because when we enter an FX trade we are always buying and selling the same amount of currency number one (in the above example, 10,000 Australian Dollars). What we are left with at the end is a positive or negative balance of currency number two (in the above example, the US Dollars).

I placed my first currency trade on the Australian Dollar/U.S. Dollar by clicking the Sell button to see what would happen. I would STRONGLY advise new traders NOT to do this! Instead, I would suggest you open a practice account (also called demo/virtual accounts) and place an FX trade with pretend money before placing your first live trade.

Work out where you are going to get in, where you will place a stop loss, how much you are prepared to risk and how much you expect to gain from the trade.

Remember that in the FX markets, a 100 tick move can happen in minutes. While this is not so bad if it goes in your favour, it is not so good if it goes against you and you are holding a large position.

Get it right in your practice account first!

Be Prepared!

Mathew Barnes