To show you how Forex trading works, in this chapter we’ll take you through a spot Forex trade on AUD/NZD.
This is the first example of three, we will take you through a worked example of a trade using spot Forex, a CFDs, and a spread bet.
For the sake of the example, we’ll assume our trader wants to go long AUD/NZD. This means they think Australian Dollars will appreciate against the New Zealand Dollar. How they came to that view isn’t relevant for this chapter – but we hope it came from good analysis and was part of a thought out trading plan.
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- In a currency pair, the first currency in the pair – the one on the left – is the base currency. The second currency – the one on the right – represents the quote currency.
- In Forex trading, you’re always exchanging two currencies. If you think the base currency will strengthen against the quote currency, you would buy the currency pair. Conversely, if you believe the base currency will weaken against the quote currency, you would sell the currency pair.
- In a quote from your broker, the bid price – also known as the sell price – is where you can short the pair, while the ask price – the buy price – is where you can go long the pair.
- Spot Forex is traded in lots. Lots are equivalent to 100,000 units of the base currency. Mini-lots are 10,000 units, micro-lots 1,000 units, and nano-lots are 100 units.
For the sake of this example we’ve assumed the trader is based in the UK, they have chosen to trade with an FCA regulated broker and the currency they fund their account with is Pounds Sterling.
Going long AUD/NZD with a spot Forex trade
Our trader opens up their broker’s trading platform and locates the AUD/NZD currency pair and opens up a deal ticket. The base currency is AUD and quote is NZD, so this means 1 Australian Dollar is worth approximately 1.07 New Zealand Dollars.
We are trading spot Forex and our trader wants to trade a standard lot. This is entered into the deal ticket as a volume of 1.00 – this means we are looking at an underlying trade size of A$100,000.
A pip in spot Forex is every 0.0001 in price, so a one pip move has a value of NZ$10.
We can see a quote of 1.07017 – 1.07035. Given our trader wants to go long the pair they must buy at 1.07035.
As well as the spread (in this case 1.8 pips), spot Forex attracts a small commission charge, this will be advertised by the broker on their website. In our case, the trader has a £ account so will pay a commission of £1.25 per lot per leg, so to enter and exit this trade a ’round trip’ commission will be levied of £2.50. Commission charges vary by broker.
AUD/NZD is a minor fx pair and FCA regulated brokers are required to cap leverage at 20:1 on it. This might vary based on where your broker is regulated.
The size of the trade is A$100,000, so dividing by the leverage of 20 gives us A$5,000.
Because the trading account is in £, our trader checks the GBP/AUD rate and it is near enough 1.81. This means they’ll need approximately £2,762 in their trading account to put the trade on. If the GBP/AUD exchange rate changes the amount needed in £ will also change. However, our trader has £50,000 trading capital so this margin is comfortably covered and any small variations will be marginal.
Although we consider it bad risk management, for the sake of this example, our trader does not set stop-loss or limit orders when entering the trade. We’ll show you these when we get to our spread bet example.
Our trader is comfortable with the price and enters the market order by clicking ‘Buy by Market’. This is a request to the broker to place a trade at the market rate so it could get filled at a slightly different price. However, we’re trading at a liquid time of the day without much volatility so this fills at the price on the ticket and is confirmed immediately – Buy 1 lot AUD/NZD at 1.07035 .
What our trader has done is to buy A$100,000 and sell NZ$107,035. The platform shows them their positions, excluding the sterling account balance:
Our trader is a swing trader so plans to hold the trade for about a week. Every night the trade is held – 10pm London time – they will incur a ‘swaps’ charge, on this particular trade the charge is A$7.60 per night.
The price is quoted 1.06631 – 1.06649. Because they are long the pair, to exit they will sell 1 lot at the bid price of 1.06631. This is confirmed by the broker and they are out.
They lost 40.4 pips on the trade:
1.06631 – 1.07035 / 0.0001 = -40.4 pips
We know the value of trade was NZ$10 per pip, so a loss of NZ$404. The broker will convert this loss back into the account currency of £, a £209 trading loss.
What they have done here is to sell A$100,000 to buy NZ$106,631. The NZ$404 trading loss is the extra they had to make up to make good the NZ$107,035 sold in the opening trade.
The trader held the trade open for 6 nights, so has an overnight funding charge of A$7.60 x 6 = A$45.60, again this is converted back to £25.10.
Add in the commission of £2.50 and this trade has lost the trader £236.60 in total.
That is a spot Forex trade, we went into quite a bit of detail, the points to note are:
- The trader lost money on this trade because they went long Australian dollar and it ended up depreciating against the New Zealand dollar.
- They incurred commission and overnight funding costs.
- In practice, most retail spot Forex brokers offer smaller sizes than lots and allow much more granularity on size. When trading using direct market access into a certain liquidity pool traders have to use the standard sizes.
- The trader’s account currency is £, this means they are exposed to several exchange rates when trading two non GBP currencies.
- There was no stop-loss order set, this was bad risk management, had the price fallen further up it could have created a significant loss.
- The loss would likely be tax-deductible. Had they made a profit it would likely not be capital gains tax-free.
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