ForexRX - How It Works

All things considered, Forex is not much different from trading equities, commodities, or other futures. This is a safe assumption, except for two very big differences – available leverage and the size of the market.

The leverage available to the average Forex trader is a significant advantage over other vehicles, if you use it and you are on the right side of your trade. If you use it and you are on the wrong side of the forex market, the disadvantage can be just as significant. Nevertheless, skilled Fx traders have greater opportunity in this marketplace than in any other because of the leverage available to them.

The math makes this a simple observation, when you start at the bottom of the forex margin ladder – unleveraged equities. If you buy 100 shares of stock at $50 per share without margin, you have to put up $5,000 to make the investment. If that stock appreciates by 50%, it will be worth $75 per share. Your investment is now worth $7500. The return on your investment capital is 50% ($2,500 profit divided by $5,000 invested).

If you buy 100 shares of stock at $50 per share on the 50% margin that is usually available to you (2:1), you have to put up about $2,500 to make a $5,000 investment. If the stock appreciates by 50%, it will be worth $75 per share. Your margined investment is now worth $7500. The return on your investment capital is 100% ($2,500 profit divided by $2,500 margin).

If you buy one contract of soybeans at $6.00 a bushel on the 5% margin that might be available to you (20:1), you would have to put up about $1,500 to make a $30,000 investment. If that commodity appreciates by 50%, it will be worth $45,000 per contract. Your margined investment is now worth $45,000. The return on your investment capital is 1000% ($15,000 profit divided by $1,500 margin).

If you buy one lot of a normal size Forex currency trading pair at $100,000 on the 1% margin that is usually minimally available to you (100:1), you would have to put up about $1,000 to make a $100,000 investment. If that pair appreciates by 50%, it will be worth $150,000 per lot. Your margined investment is now worth $150,000. The return on your investment capital is 5000% ($50,000 profit divided by $1,000 margin).

This exponential growth in potential ROI is why it becomes more and more important to cut your losses short in each of these forex markets to preserve capital. While the opportunity for profit becomes greater and greater through the use of leverage alone, the opportunity for loss increases proportionately. So, there are equal upsides and downsides to it. Nevertheless, the ability to profit so greatly from such a small investment has many speculators very excited. It is difficult to find a downside to the other major difference, though – the size of the arena itself. The liquidity that the Forex market has is nothing but good, it seems.

You must have volatility in your trading vehicle to make any money. If you buy something, and it just sits there, you might as well have your money in something else. This volatility is what attracts speculators to hi-tech stocks, certain commodities, and, of course, index futures. However, many of the high-volatility vehicles are volatile because the size of the supply or demand pool is rather small compared to the size of the fund of orders coming into them. Large orders or large bunches of orders can cause price to move in spurts, and it is these spurts that cause slippage. More and more Fx traders have turned to the electronic S&P Mini market to avoid such slippage. It is not uncommon to get an entry confirmation two points away from the price you are quoted at the time you place an order in the big S&P contract pit. That same order placed in the more liquid electronic market will come back to you confirmed for the price you saw when you placed the order.

Our experience has been that there is little trouble finding mechanical systems that work very well on paper in commodities like lumber and cotton. Quite often, testing results in these “thin” and volatile forex market yield spectacular results – until you factor in the slippage you will experience in real-time trading. We’ve tested many systems in lumber and cotton specifically (as well as other commodities) that yield well in excess of 100% annual ROI on paper. The slippage is so great in these markets (and others like them) that it is not unusual to see all those profits slip into net losses when such costs are encountered in real time.