Margin-based Forex Trading

The popularity of forex trading is partly due to margin accounts using leverage effect. Without this margin, trading currencies on the forex would be out of reach for retail investors. Margin accounts are available to trade on all sorts of markets, going both up and down. You can therefore trade the market online through a CFD broker, currencies through a forex broker as well as commodities, indexes, ETFs, precious metals, etc… 

What is margin and leverage effect? 

Margin accounts allow one to control large sums of money with a relatively small deposit. Opening a margin account with a forex broker allows you to borrow money from the broker to trade currency lots that typically have a value of $100,000. The amount of money you can borrow from a margin account is defined by the leverage effect. Leverage of 100:1 means that you can control assets that are 100 times larger than your deposit.   

With a 1% margin account (leverage of 100:1), you can trade a standard lot of $100,000 with a deposit of $1,000. Trading with leverage increases both the potential for profits as well as losses. The trader can therefore quickly lose his initial deposit if he doesn't respect strict risk management rules. Typically, brokers have a system in place which limits the maximum loss to the amount of the initial deposit by automatically closing positions if the loss is too high. This is called a margin call or a stop out. 

The advantages of leverage in a forex trading strategy. 

The advantage of margin accounts is that it allows you to profit from small currency market movements. It is possible to make profits even if the market is not very volatile. Forex currencies are quoted with small units, sometimes up to 5 decimals. The reference unit is the pip, which represents a variation of 0.0001, or the fourth number after the decimal. For example if you trade with a lot of $100,000 on the EUR/USD pair, each pip is worth $10. However, the value of a pip depends on the currency cross.

If the price of the EUR /USD goes from 1.4050 to 1.4150, there is a difference of 100 pips which represents a profit or loss of $1,000. If you had traded without margin with $1,000, a price move from 1.4050 to 1.4150 would have yielded a profit or loss of just $10. 

The risk of using leverage

Using leverage increases the potential for profits, as well as losses! If you're not careful, your margin account can quickly evaporate. With a 1% margin account, a 1% move in the wrong direction can make you lose $1,000. 

Forex traders nevertheless have several tools at their disposal to limit losses. They can notably use stop loss orders to automatically close their positions if the value of the currency reaches a previously defined point. Stop loss orders allow them to define a maximum tolerated loss in advance, this is a key aspect of money management.

Building a successful forex trading strategy

Any forex trading system requires individual choices.

Trading requires thought!

To become a successful day trader you need a specific trading plan, as not all trading strategies fit the profiles of all traders. Each trader must develop his own trading strategy that matches their trading style and personality. Some traders rely solely on technical analysis while others prefer fundamental analysis, but many traders successfully use a combination of both to get an overview of the market and for finding entry and exit points.

Technical analysis relies on a key concept: Prices move with the trend. As stated by the dictum of all forex traders "The trend is your friend.". Movements in the markets lead to identifiable patterns that have been studied for many years, a thorough understanding of these trends and chart patterns provides a good basis for developing forex trading strategies.

There are many analytical tools available to understand market movements. The beginning trader can initially consider each of these indicators separately to obtain a working knowledge of their concepts and their application. Each tool tends to reinforce the other, so traders must then examine the trading signals generated by the confluence of several indicators.

Support and resistance levels are used in many forex trading strategies. The support means a lower price level is tested repeatedly, and when the price reaches that level, it tends to bounce over. Resistance means a price level above which prevents the course of moving beyond. Levels of support and resistance can contain prices in a trend channel for a certain period of time before a possible fracture "break-out.

Moving averages are also frequently used in forex trading strategies. All forex brokers provide moving averages in their trading platforms. The simple moving average (SMA) shows the average price of the market at a given time and over a period of time. Moving averages serve to eliminate short-term fluctuations in prices to give a clearer picture of price movements. Traders can plot a SMA to determine the direction of the trend and possible reversal of course. If prices move above the SMA, the trend is bullish, conversely, if prices move below the SMA, the trend is downward.

These two examples of forex trading strategies can be used individually or in combination. In practice, the trader must have a range of trading tools to examine market conditions and to confirm his analysis. If several indicators show that the market moves in a particular direction, the operator can then act with more assurance than when relying on a single indicator.

Similarly, fundamental analysis can be used to reinforce technical findings, or vice versa. Ideally, the trader must master several indicators to develop a forex trading strategy effectively.

The technical and fundamental analysis to determine entry points and exits in a trend, but the management of risk (money management) is one of the most important elements to be defined in advance. The trader must know the maximum risk it takes on each trade. It must ensure cut its losses quickly and let the trades earn maximum benefit from the trend. The first goal of the beginner trader must not make profits, but does not lose his money.

Keep a diary of trading allows the trader to remember the past trades and make an assessment on the effectiveness of the strategy. It is also useful for improving the system that must evolve with experience and market fluctuations.

Comparing Forex Brokers

Deciding which forex broker to use can be a tricky task. Although your choice of a regular bank may not be so important (all banks are pretty much the same), forex brokers vary widely in terms of quality and in terms of the services they offer. Here's a quick guide to help you pick the one that's right for you.

Step 1 - Know your needs in relation to your forex trading style

Start by creating your own list of features needed for your forex trading style.
- What instruments are you trading? Currencies, stock indexes, gold/silver, commodities?
- What kind of spreads are used: fixed, variable, how many pips?
- What is your minimum initial investment?
- Do you trade with mini lots of 1000 units or more?
- How much leverage do you need?
- What tools and forex trading indicators do you use for forex trading?
- Do you use trading via telephone and/or trading alerts?
- Do you need a specific trading platform (such as MetaTrader 4 for automated trading)?
- A platform without downloading software to trade in your browser?
- Do you want to use scalping?
- Do you use an easy hedging strategy?
- Do you need a trailing stop?
- Should your broker be an ECN/STP or a dealing desk broker?
- Does the broker have a good reputation on forex-related forums?
- How will you deposit funds (bank transfer, PayPal, credit card, etc.)?
- What are the costs of deposits and withdrawals to fund your account?
- Does customer support speak your language at the broker, is it easily reachable if something goes wrong?

You can of course improve this list with your specific needs.

Step 2 - Make a selection based on your criteria. A comparison of forex brokers and CFD brokers will allow you to make a preliminary selection of several brokers who might meet your expectations.

Step 3 - Visit the broker's website

After selecting a few forex brokers, it is time to do some research by visiting websites to read their respective trading rules and conditions to get an idea of their corporate transparency. An online broker cannot afford to have a website that looks amateur, the site must have a pro design. The presence of information such as address, telephone numbers of customer support, information on accreditation and regulation bodies needs to be present on the broker's site. If a broker has no physical address listed on the website or on the Contact page, do not sign up with them.

Another important factor is to choose a broker and open an account with a broker that is regulated and/or accredited to provide services in your country.

Here is a list of some regulatory bodies:
- USA: NFA, CFTC
- Canada: BCSC, CIPF, OSC
- United Kingdom: UK FSA
- France: MFA
- Germany: BaFin
- Switzerland: SFDF, ARIF, FINMA (As of 2009, all Swiss forex brokers need to have a banking license)
- Sweden: Swedish FSA
- Denmark: Danish FSA
- Spain: CNMV
- Japan: Japan FSA FFAJ
- Hong Kong: SFC
- Australia: ASIC
- Dubai: DMCC, DGCX, DFSA, ESCA This is not a complete list, for other countries, there will be other regulators of financial markets.

Choosing a broker 

Step 4 - Open a demo account

Demo accounts don't always reflect reality in terms of timeliness of slippage and higher spreads during economic news announcements, but they help one to become familiar with the trading platform.

During this trial period, you can also seek advice from customer support to see if it is responsive and responsible. After the initial start with a small amount of starting capital, you can then make additional deposits if trading conditions meet your expectations. Remain cautious with brokers who encourage you to deposit more funds or who offer deposit bonuses.

 Stay cautious, forex trading is a risky activity that requires a significant personal investment. Follow Forex training to learn the basics of trading and, most importantly, do not use leverage to try to recoup your losses, instead, diversify your positions or increase your exposure during winning trades.