Financial trading has its own language that can seem complicated to beginners and those learning the trade. Once you understand the way things work you can start to construct a solid trading strategy, which is one of the most important factors in successful trading. At Infinox, we offer CFD trading (contract for difference) which is the most accessible way to start trading. Contract for difference allows you to speculate on the movement of the major financial markets without buying the actual stock. As CFDs require a smaller outlay it means that trading on the markets is accessible to more people. So if you’re planning your forex trading strategy or you just wondering how invest in the stock market with CFDs, read on…
Foreign exchange trading is the act of buying one currency with another. They are presented as currency pairs. So when the price is listed it refers to how much one unit of the first currency will buy of the second currency. Traders buy or sell these pairs based on how they think the currencies will perform against each other. In the GBP/USD pair, if you think that the Pound will increase in value against the Dollar you would buy GBP/USD. If you think the Pound will lose value against the Dollar, you would sell GBP/USD. However you are not simply buying multiples of currency, as if you were going to a bureau de change at the airport. You are investing in ‘lots’ of currency. A standard lot is 100,000 of whichever currency. You can also trade mini lots (10,000) and micro lots (1,000). But when you start trading forex, you don’t need to buy $100,000. Instead, you use a CFD to speculate on the changing value of the total ‘lot’.
Let’s say you have a trading account with £1,000 deposited in it. You think that the Pound Sterling is going to rise in value against US Dollar, so you decide to buy a GBP/USD contract for difference (CFD). Your broker offers you a margin of 30:1. This means that for each Dollar you put in, you have access to thirty. This increased margin gives you ‘leverage’: that is, the capacity to invest in the larger lot size using a smaller investment from your own account. Bear in mind that you are not ‘buying’ the asset. You are simply purchasing a contract that says you are prepared to invest in the movement of the market, which you are hoping will be upwards. To work out the required margin. To understand how much you will need to deposit for 1 lot of GBP/USD, with the Pound worth $1.400. Of course, you only have £1,000 so in this instance, you could to trade on a mini or micro lot.
Mini lot margin: £2,142
Micro lot margin: £214
Once you have your CFD you are now looking at the movement of the market to monitor your profit and loss. One unit movement in any market is called a pip (price index point). A pip is measured from the fourth decimal number. The exception being the Japanese Yen where it is the second decimal number. As this number moves up or down, it represents a gain or loss of one unit of your investment. A pip always refers to the currency listed second on your currency pair.
For example if your account is in GBP and you’re trading EUR/GBP, then one pip is £10 (1 lot), £1 (mini lot) and £0.10p (micro lot). Whatever your currency pair, the pips will be 10, 1 or 0.1 of the second currency, depending on your leverage/margin. To work out the value in your home currency, simply divide the pip value by your currency’s exchange rate. So whatever the total pip movement, in either direction, multiply this by your pip value to work out your profit/loss.
When trading CFD in other markets, the margin and leverage still applies. However the lot size and value varies. In equities its 100 in a lot. In commodities and futures trading it can vary depending on the item, with gold being 100 troy ounces, or 5000 troy ounces for silver. As with any CFD, your profits and losses are determined by the movement of the pips, or the change in the value of the asset. For an in depth explanation of spreads and margins, take a look here.