Learn Forex Trading- The Mechanics

Pips, Currencies, and Currency Pairs- The Basics of Forex

Nov 4, 2009

Learning to trade Forex begins with understanding the mechanics of the market. Learn pips, currencies, and profit and loss to enter the world's largest financial market.

The Forex market is the largest and most liquid market in the world. It offers many unique benefits and advantages not offered in the stock market. Yet many people avoid the currencies market because they believe that Forex trading is complicated and mysterious. And stories abound of the huge losses that can be made in the Forex market.

While there is some truth to these beliefs in the mysterious currencies market and stories of huge losses, the rest of the story is that this enormous, round-the-clock market also offers opportunities for financial independence. The best part is that Forex is now open to even the smallest investors who can, with a bit of education and training, secure good profits and protect themselves from large losses.

Everyone can learn to trade Forex. Today, there is a wide range of resources available, including classes and books, to novice Forex traders and investors so that anyone who makes a small effort can learn to trade Forex quickly. Learning Forex is easier than ever.

The first thing to learn about Forex is the mechanics of the market. It is the part that makes Forex seems mysterious and insurmountable. The good news is that, once a trader learns the mechanics of Forex trading, it is never forgotten.

There is a lot that can be included in this section, but the focus will be to introduce the elements of Forex trading that differ from the day trading in the stock market. A good Forex trading class will teach the mechanics in much greater detail.

The Pip

The basic unit of price in Forex is the pip. It is similar to a point in the stock market or to an American dollar in the U.S. monetary system. However, a pip is a much smaller increment than a point. A pip is usually worth about $0.0001.

These small price fluctuations (or the pip) are one of the reasons that the currencies market has such high liquidity. The pip is unique to the currencies market and is the basis on which all money is made or lost. Getting to understand the pip is an essential part of Forex trading.

The pip is traded in lots. The standard-size lot is 100,000 base currency units. A mini-lot is equal to 10,000 units. Most individuals will purchase the standard lot or mini-lot. Banks or other large financial institutions will lots of one million pips.

The Currencies (or The Majors)

The Forex market consists of currencies. There are hundreds of currencies that are traded every day. However, most traders will focus on the major currencies. They are the following currencies:

While these currencies are extremely important, they are not the basic trading unit in the Forex market. Yet traders must know all or some of these currencies in order to trade profitably. These are known as “the majors.” Novice traders should focus on these currencies because they show strong trends, good liquidity, and reliable central bank activity.

The Currency Pair

While stocks are traded in the stock market, currency pairs are traded in the Forex market. A currency is always traded in pairs written like USD/EUR. This example shows the U.S. Dollar and the Euro currency pair. The currencies are traded to move in opposition to each other.

In this example, the U.S. Dollar is traded against the Euro. If this was a bullish trade, then the USD would be expected to rise and the Euro would be anticipated to fall. The first currency listed is the base currency. The second currency is called the secondary currency.

Every trade will always involve two currencies moving in opposition to each other. This differs greatly from the stock market where the trader purchases or sells a single stock (or group of stocks) alone. In this way, Forex can be considered more complex since the trader must have knowledge of both currencies.

Profit and Loss

The reason that traders enter the Forex market is to make a profit. The high volatility of the market means that profits can be made quickly. However, it also means that large losses can also accrue quickly. A trader needs to know how to assess the profit and loss potential before entering the trade. This is called the risk-reward ratio.

This risk-reward ratio is a calculation that shows the trader how much he or she is risking as well as the potential profit on each trade. Most experienced traders require a minimum risk-reward ratio of 1:3. This means that the trade must have the potential to earn three times the amount of profit in relation to the amount of loss (or risk). Novice traders are also advised to use this ratio as a minimum standard.

How to determine the amount of risk assumed or the potential profit? This is determined by the pips. Look at the last two or three numbers of the currency pair price. Performing simple math will provide the answer.

First Step into Forex

These are the basic mechanics that every trader should know when entering the currencies market. A good class will provide a thorough discussion of this information and all the other details needed to make a solid entrance into Forex trading.

The copyright of the article Learn Forex Trading- The Mechanics in Currencies is owned by Robin Lofton. Permission to republish Learn Forex Trading- The Mechanics in print or online must be granted by the author in writing.