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How to profit with forex trading

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Lesson 2

Many forex traders tend to believe that having the best trading system will make them big profits. The need to make a big profit has enabled vendors to make their own profit by selling black-box trading systems that claim to make one rich.

However, the truth is far from that, and sooner or later, just about every new trader realizes there is more to it that meets the eye.

If you look at forums, you can often find trading strategies dominating the content. This is because traders still continue to see a trading system as the first step in making a profit.

To make profits with forex trading, a trader needs to create a mix of risk management, trading strategy, familiarity with the markets and, most importantly, patience. It is quite easy to make a profit with forex, and any trader who has traded for a while certainly has made a profit.

The trick is in managing to keep the profits. Many times, after a trader makes a profit, sooner or later, they end up giving all the profits back to the markets.

Consistency is, therefore, the key to the forex markets. Making profits on a regular basis does not happen due to a trading system but is instead due to the above-mentioned factors that traders need to understand.

So how does one make a profit in forex trading, and how you keep the profit?

How you know when to Buy or Sell

If you look at the forex markets, or any speculative markets, you will know the basics of buy low and sell high. Simple as it may sound, it is indeed difficult to make a profit. To trade successfully, you must know the basic concepts in forex trading.

Trading requires considerable knowledge and intuition, which needs to be developed over time. This can come only through proper practice and dedication to following the forex market. Traders need to develop the skills required to trade.

To make better trading decisions, you need to have a pulse on the market. This can come by keeping an eye on the developing market news and the fundamentals. Many traders tend to miss out by only focusing on the technical aspects. However, the fundamentals are behind the price moves, and it is in our best interest not to ignore them.

Confidence is also essential in forex trading. The more confident a trader is, the better decisions he or she can make. You can build confidence by getting more familiar with the markets and by spending more hours analysing the charts.

Losses are another important aspect traders should accept. Even the best traders suffer losses, but they know how to manage their risk and money. Without good money management, you will end up losing much quicker than you can make a profit.

On the other side, greed and fear will most often jeopardize your trading decisions, and you must learn to control your emotions.

As you can see, there are many things in play when trading forex. The trading system is simply one of the puzzles, but traders tend to give this high priority and end up ignoring the other important aspects of trading.

What is lot in forex

A lot is the position size in forex. When you trade the forex markets, you will always trade in a multiple or a fraction of the contract size. The lot size is basically how much you will be trading. The lot size is divided into the following:

  • Standard lot - 100,000 units
  • Mini lot - 10,000 units
  • Micro lot - 1,000 units

The lot in forex is the same as the position size. For example, in the futures market, depending on the commodity you trade, the contract size can vary. Similarly, the lot size is the contract size that one trades in the forex markets.

To better understand lot size, let’s take an example. If you want to buy EUR/USD at 1.2000, then this is your position:

  • Standard lot - 120,000 units of euro
  • Mini lot - 12,000 units of euro
  • Micro lot - 1,200 units of euro

The profits (and losses) you make based on the lot size also vary. If the price of EURUSD increases to 1.2100 (+100 pips), then your profits would be $1000, $100 and $10, respectively, for each of the lot sizes. Now, if EURUSD fell to 1.1900 (-100 pips), then your losses would be -$1000, -$100 and -$10, respectively.

The lot size you trade with is determined by two factors: the capital that you have and the leverage that you choose.

What is leverage in forex

Leverage in forex, as the name suggests, acts like a lever and allows you to control large positions in the market with little capital. Leverage is expressed in a ratio, such as 1:10 and 1:100. You can also see leverage expressed as 100:1 or 10:1. Both these expressions mean the same thing.

For every $1 you have in your account, you can control $10 in trading position for a 1:10 leverage. Similarly, for 1:50 leverage, $1 in your account helps you control $50 in trading positions. You can select your leverage when you open your trading account.

It should also be obvious by now that while you can control bigger positions, the profits and losses are equally big. Therefore, traders need to be very careful when choosing the amount of leverage so they minimize the risk to their accounts.

How you calculate the pip value

The pip value is an essential aspect in trading. The pip is the minimum price movement in the forex markets. It is expressed in the fourth decimal (except for JPY crosses). For example, if EURUSD moves from 1.2000 to 1.2001, that represents a 1 pip move.

Most forex brokers use fractional pricing, which is the fifth decimal, in which the pip value is 0.1. The value of each pip is $1. The pip value can change depending on your lot size. The following table gives a quick summary of the pip value based on your lot size.

  • Standard lot - 1 pip - $10
  • Mini lot - 1 pip - $1
  • Micro lot - 1 pip - $0.10

This is applicable for non-JPY currencies. To calculate the pip value for JPY currencies, the second decimal represents the 1 pip move. So, USDJPY moving from 120.10 to 120.11 represents a 1 pip move, which translates to $10, $1 and $0.10, respectively.

Understanding leverage, lot size and pip value is important for traders if they want to succeed in the forex markets. Although it sounds basic, knowing these terms and how they are calculated can help you in your risk/money management.

By continuing to learn price action and fundamentals, you will significantly increase your chances to profit on the forex markets. Booking profits and knowing when to cut your losses are also important techniques that will help you in your trading.