The foreign exchange market—known by most as the Forex market or currency market— is unique in many ways.
The Forex market’s gargantuan presence, boasting a global daily currency turnover of US$6.6 trillion per day, is enough to leave most open-mouthed.
Until the 1990s, Forex trading, or currency trading, was a practice reserved for large corporations and institutional investors.
Nowadays, traders are almost spoilt for choice in terms of resources. Though often more of a curse than a blessing, this unfortunately leaves many new traders overwhelmed.
To help, the research team at Global FT Market have banded together and provided an overview of some of the most useful Forex trading tools available to establish more informed trading decisions.
What to look for in forex tools?
At the top of the list, we have MetaTrader 4 and MetaTrader 5. These are trading platforms that offer a lot of tools of their own that can help you create your own version of EA (Expert Advisor) software. As a result, you can automate your trading to a pretty large extent, so that you don't have to analyze every situation yourself.
MetaTrader 4 — or MT4, as it is also called — gives you access to a built-in editor, and a compiler with access to a free library of software, created by users themselves. It will provide you with fresh articles, and all the help you need for making successful trades and learning the software.
Simply set up the parameters and wait for the software to generate a trading signal.
MetaTrader also offers two different types of trading orders :
The first ones, Pending orders, are executed when the price reaches a predefined level. Meanwhile, Market orders can be executed in one of four modes :
MetaTrader offers great real-time trading functionality, and the number of charting and other tools for technical analysis is rather impressive. Even its interface can be customized in a way that will suit you best. Meanwhile, there is also no lack of community-created add-ons that you can include.
However, be aware of the fact that MT4 and MT5 were created to act as stand-alone systems with the broker. There are software bridges created by third parties that can allow you to integrate MT with other financial trading systems, however, although MetaQuotes Software really did not like this.
Having access to an economic calendar is crucial, both for fundamental and technical analysts.
An economic calendar displays scheduled macroeconomic news data, events associated with economic performance and the financial markets.
As evident from Global FT Market dedicated economic calendar , you will note events are characterised by way of time, currency and expected impact (colours [red signifies high impact, yellow refers to a potential medium impact and grey signals limited impact could be seen]). Actual, forecast and previous values are plotted to the right of the calendar.
Entering trades a few minutes ahead of a high-impacting news event can trigger sharp price fluctuations. While the move may generate profits, it can just as easily elbow the position into negative territory and, at times, even beyond protective stop-loss orders. It should only take technical analysts a minute at the beginning of their trading session to scan and note upcoming news events—a minute well spent.
Fundamental analysts are likely to require more dedicated news feeds. Free options are available, such as the news feeds on MT4 and MT5, yet some traders are likely to opt for premium news feeds.
This is a type of calculator that uses the data regarding how the currency changed in the past, to help you determine its potential moves in the future. Provided that there are no major unexpected influences, such as big announcements or geopolitical events, most currencies tend to 'repeat their history,' meaning they would drop or jump in a similar way and at the similar time. By knowing the currency's historical volatility, you can use this calculator to predict its movement, and use that to your advantage.
Pip is the smallest unit of movement in a currency pair's exchange rate. A pip calculator can, therefore, allow you to determine the exact amount of worth per pip. To do this, it uses the local currency's position size.
The calculator can display a specific currency pair's value based on a standard-lot (100,000 currency units), mini-lot (10,000 currency units), or a micro-lot (1,000 currency units).
Next, there is a margin calculator, which you can use to determine the amount needed to open a position in a trading account and maintain it. It uses several aspects for its calculations, such as the contract size, the specific currencies in the pair, your accounting currency, and alike. In return, it gives you the required margin, the margin percentage, and how much you need in order to hold a position.
A currency converter is, obviously, a calculator that allows you to calculate the value of one currency in the form of another, based at the prevailing exchange rate. You simply choose a currency you wish to convert, the currency you wish to convert it to, and the amount. This can help speed up the process of calculating equivalent currency values and alike.
Next, there are profit calculators, which are very simple tools that allow you to determine whether a trading position would result in a profit or loss at different levels of the exchange rate.
Another very useful thing to have and use is a time zone converter, which is important, as time zones can mean a big difference. As you may know, the leading forex trading centers are placed all around the world. You've got the ones in New York, Tokyo, London, and Sydney, all of which are in different time zones. Even so, some of them have their trading sessions overlap, and these overlaps could be the most liquid moments of the day.
Lastly, we have a correlation matrix. Basically, this is a tool that helps you determine how the exchange rate of one currency pair impacts that of another. That way, you can keep track of one pair's behavior, and predict how the other one might follow. A set of currency pair correlations is what we call a correlation matrix.
There are some pairs that correlate rather strongly, due to some common elements that may impact both of them. As a result, when you see the more volatile of them move, you can expect that the other one will start moving as well, and invest accordingly.
The foreign exchange market serves as an online platform to buy and sell currencies — think euros (EUR), US dollars (USD), British pounds (GBP), Japanese yen (JPY), Swiss franc (CHF) and Australian dollars (AUD).
Fundamental analysis and technical analysis are primary research tools employed by Forex traders on a daily basis. Irrespective of the trading strategy used, understanding the calculation behind profit and loss is important as a reduction in account equity reduces margin. This is also known as free margin—the difference between equity and used margin (used margin represents the deposit value required to open a trade).
This article assumes the reader is familiar with currency pair quote conventions and position sizing.
All trades executed in the Forex market are marked to market.
This provides a real-time view of unrealised profit and loss. Unrealised refers to active open positions. In other words, potential profit and loss.
Currency pairs are valued through quote currency. EUR/USD—where euro is the base currency and US dollar represents quote currency—trading at $1.3000 means to purchase 1 euro it’ll cost 1.30 USD. If EUR/USD advances to $1.3100, the cost to purchase 1 euro is 1.31 USD. Any price fluctuation is in quote currency: dollar value, in this case.
The current rate for EUR/USD is 0.9517/0.9522 (where 0.9517 is the sell price and 0.9522 is the buy price. The spread is 5).
Let’s say you decide to sell 10,000 EUR at 0.9517.
This means you sold 10,000 EUR and bought 9,517.00 USD (10,000 EUR * 0.9517 = 9,517.00 USD).
After you trade, the market rate of EUR/USD decreases to 0.9500/0.9505. You decide to buy back 10,000 EUR at 0.9505 (10,000 EUR * 0.9505 = 9,505.00 USD).
You sold 10,000 EUR for 9,517 USD and bought back 10,000 EUR for 9,505 USD.
Your profit is 12.00 USD (9,517.00 - 9,505.00).
You see that the current rate for USD/JPY is 115.00/115.05 (where 115.00 is the sell price and 115.05 is the buy price. The spread is 5).
You decide to buy 10,000 USD at 115.05.
This means you bought 10,000 USD and sold 1,150,500 JPY (10,000 USD * 115.05 = 1,150,500 JPY).
The market rate of USD/JPY falls to 114.45/114.50 and you decide to sell back 10,000 USD at 114.45 (10,000 USD * 114.45 = 1,144,500 JPY).
Your loss is calculated as follows: 1,150,500 - 1,144,500 = 6,000 JPY.
Note that your loss is in JPY and must be converted back to dollars.
To calculate this amount in USD :
6,000 JPY / 114.45 = $52.42 USD or 6,000 JPY *1/114.45 = $52.42 USD.
Calculating profit and loss is a straightforward exercise, achieved by multiplying trade size (or position size) by pip movement.
Account denominated in US dollars.
Long (bought) EUR/USD 10,000 units (mini lot size) at $1.2130 which rallies to $1.2150.
This represents a 20-pip gain.
Assuming the trader takes profit at $1.2150, we must multiply 10,000 units (trade size) by 0.0020 (pips [currency pairs are usually priced to four decimal places]), which equates to a 20 USD gain (or 1 USD per pip). If trade size was 100,000 units (standard lot), the return would be 200 USD (100,000 * 0.0020).
The problem is not all accounts are denominated in US dollars.
Account denominated in euros.
Using the same example above, the EUR/USD long trade (10,000 units) from $1.2130 to $1.2150 profited by 20 USD. Nevertheless, the account in this example is based in euros. For that reason, the trader must convert dollar profit into euro. We do this by dividing 20 USD by $1.2150 (EUR/USD current rate) which equates to €16.46 profit.
Account denomination with no relationship to either the base or quote currency.
For example, a trade on GBP/USD with an account denominated in euros.
To calculate profit and loss, you must locate the EUR/USD exchange rate and repeat the same process as demonstrated in the second trade example (20 USD / EUR/USD exchange rate).
Dividing 20 USD by the GBP/USD exchange rate measures profit and loss in GBP. By dividing 20 USD by the EUR/USD exchange rate, we know we’re calculating profit and loss for euros.
Calculating profit and loss through pip value is another simple and effective method. It involves multiplying pips gained (or lost) by pip value and trade size.
The manual calculation to determine pip value depends on the currency pair traded.
For accounts denominated in the same currency as the currency pair’s quote currency, the following conventions are used to determine pip values :
The above assumes a US dollar denominated account. And a USD account trading the EUR/USD currency pair, therefore, follows the aforementioned pip values.
A long (buy) at 1.2000 on EUR/USD, trading 1 standard lot that liquidates at 1.2030 registers a 30-pip gain, or 300 USD gain (10.00 [pip value] * 30).
For accounts denominated in the same currency as the currency pair’s base currency, you must divide 1 pip (0.0001 for most currency pairs) by the value of the currency pair’s exchange rate and multiply this value by the trade’s position size.
For example, an account currency based in Australian dollars, trading the AUD/USD at $0.7746 with 1 standard lot, is calculated by dividing 0.0001 by 0.7746 and then multiplying this value by 100,000. The pip value is 12.91 AUD.
For account currency not included in the currency pair traded, you can follow the same process as above (base currency).
An account based in euros—trading GBP/USD—must locate the EUR/USD exchange rate and divide 0.0001 by this value and then multiply by the trade size.
Risk-Reward Ratio (RRR) = (Take-Profit [TP]-Entry) / (Entry-Stop Loss)
What Is the Risk/Reward Ratio?
The risk/reward ratio marks the prospective reward an investor can earn for every dollar they risk on an investment. Many investors use risk/reward ratios to compare the expected returns of an investment with the amount of risk they must undertake to earn these returns.
This article assumes the reader is familiar with currency pair quote conventions and position sizing.
(Note the above points should be detailed in a trading plan—often a blend of fundamental and technical analysis).
To help explain the mechanics behind a risk-reward ratio, the EUR/USD (major currency pair) H4 timeframe with a straightforward swing support-turned resistance level applied at $1.2213.
The first step is to define entry. The entry is at $1.2213—the support-turned resistance level.
The second step involves arranging a location for a protective stop-loss order to help limit risk (this is the potential loss on the trade). Naturally, this practice is trader dependent. nevertheless, the example places the stop-loss order conservatively: above the high $1.2284 at $1.2286. This is 73 pips.
The final step requires a take-profit objective. Dependent on the trading system employed, multiple take-profit targets may be included. based on price action, selected demand located at $1.2039/$1.2068, a downside objective that provided a reasonable risk-reward ratio:
Risk-Reward Ratio = (Take Profit [1.2068]-Entry [1.2213]) / (Entry [1.2213]-Stop Loss [1.2286]) = (approximately)
Many claim a minimum of a 1:2 risk reward ratio is needed to achieve success in the financial markets.
While a healthy risk-reward ratio is desired, traders must also take into consideration their win-loss ratio. As its name implies, a win-loss ratio indicates the total number of winning trades to the total number of losing trades—a metric traders often place much emphasis on. To calculate this, divide total winners by total losing trades (50 winning trades / 100 losing trades = 0.5 [or 50 percent]).
Say a trader usually works with a 1:2 risk-reward ratio (for every dollar risked you make two dollars), but the win-loss ratio is 20 percent. That means for every ten trades, the trader wins two trades and loses eight. Imagine risk per trade is 100 USD and the gain is 200 USD, this equates to a 400 USD loss despite a reasonably attractive risk-reward ratio. To achieve profitability in this case, the strategy requires either a 40 percent win-loss ratio or a higher risk-reward ratio.
So, while a healthy risk-reward ratio is important, the win-loss ratio must also be accounted for.
Where does the risk reward ratio apply?
The risk reward ratio may seem like just a combination of numbers that are based on your trading patterns, but how exactly do you apply this to your trading?
Well, thankfully the risk reward ratio in Forex trading directly translates into the types of orders you can place in the market.
You may have already heard of stop orders. It is a type of order that helps traders automatically close or “stop” their orders when an asset reaches a specific price point.
The most common types of orders within stop orders are “stop loss” and “take profit”. They mostly do exactly what their names imply. The stop loss order will close your trade once you’ve taken a specific amount of losses, and the take profit order will close your trade once you’ve generated a specific amount in payouts. Now, why are these order types important with risk reward ratios?
The reason is that every Forex risk reward strategy can be visualized with these order types. Let’s imagine that the exchange rate of the AUD/JPY is 100.00. You gain some valuable information which implies that the pair could potentially increase to 150.00 exchange rate, or decrease to 70.00.
Most traders would open their trades, and start placing the following orders. Take profit at 140.00 exchange rate and stop loss at 80.00 exchange rate. This has mostly to do with the highest or lowest points of predictions that tend to be quite hard to reach.
This type of order placement would put us in a unique position. If we use our Forex risk reward calculator, we will quickly see that the ratio is 1:2. Why? Very simple.
Since the exchange rate is 100 and we would like to get a payout at 140 that means that we are looking for 40 points so to say. However, we are also ready to leave the market at 80 points so we are willing to lose 20 points in total. All we have to do is divide the losing points by the gaining points and we get the risk/reward ratio we have been looking for. In this case that is 1:2.
What Does the Risk/Reward Ratio Tell You?
The risk/reward ratio helps investors manage their risk of losing money on trades. Even if a trader has some profitable trades, they will lose money over time if their win rate is below 50%. The risk/reward ratio measures the difference between a trade entry point to a stop-loss and a sell or take-profit order. Comparing these two provides the ratio of profit to loss, or reward to risk.
Trading expectancy refers to what a trader can expect from a strategy over a SERIES of trades (per dollar risked).
Based on Van K. Tharpe’s book: Trade Your Way to Financial Freedom, Tharp states that few people who are actively involved in the markets even know what expectancy means. Even fewer people understand the implications of designing a system around expectancy.
Note that the majority of this segment’s material is derived from Tharp’s aforementioned book.
Tharp also goes on to write that one of the real secrets of trading success is to think in terms of reward-to-risk ratios. Similarly, the first key to understanding expectancy is to think of your trades in terms of their reward-to-risk ratio.
To establish expectancy, you must first determine the risk on a trade—the difference between entry and stop-loss. Tharp refers to this as R. Generally, most traders interpret this as initial risk on a trade: 100 USD, for example. This enables traders to express profit and loss as a ratio of R. An example might be a trade with 1R risk of 100 USD which returns 200 USD on winning trades, on average: a 2R return—a R multiple of 2. The same is said for losses. A 1.5R loss reveals the trader lost 50 percent more than initial risk value (this can happen if price gaps over the protective stop-loss order), while a 0.5R loss equates to only a 50 percent loss of initial risk.
It is important to understand that trading expectancy is measured over a sample of trades. Tharp recommends at least 30 trades to be statically significant, though you should aim for between 100 to 200 trades for a clear picture. When you have a series of profits and losses expressed as risk-reward ratios, you have what Tharp refers to as R- multiple distribution.
By amassing a collection of trades, you have sufficient data to estimate how much a trading system makes over a given number of trades.
Calculation : Expectancy = (Average Winner x Win Rate) – (Average Loser x Loss Rate)
Scenario 1 :
Trader A has a trading system with 200 data samples to work with.
The system, on average, produces a 60 percent win-loss ratio. On winning trades, the system typically returns at least an R multiple of 2. R, in this case, is 100 USD (static position size).
Therefore, on average, Trader A’s system (ignoring commissions) is expected to make 80 USD per trade. In terms of R multiples, this is 0.8R per trade. This is a system with high positive expectancy.
Scenario 2 :
Trader B has a trading system with 500 data samples to work with.
The system, on average, produces a 40 percent win-loss ratio. On winning trades, the system typically returns at least an R multiple of 2. R, in this case, is 100 USD (static position size).
On average, over many trades, Trader B’s system (ignoring commissions) is expected to make 20 USD per trade. In terms of R multiples, this is 0.2R per trade. This is a system with positive expectancy.
Scenario 3 :
Trader C has a trading system with 100 data samples to work with.
The system, on average, produces a 40 percent win-loss ratio. On winning trades, the system typically returns at least an R multiple of 1.5. R, in this case, is 100 USD (static position size).
On average, over many trades, Trader C’s system (ignoring commissions) is expected to make 0 USD per trade. In terms of R multiples, this is 0R per trade. This is a system with negative expectancy after factoring in commissions.
Scenario 4 :
In cases where R is more complex, which is often the case in real-world FX trading, you must find the mean R multiple (a term coined by Tharp).
Consider the following example over 100 trades, with a risk of 100 USD each trade (R) :
To find the expectancy you must total all R multiples and divide this value by the number of trades—the mean R multiple.
The R multiple of all winning trades is 100R while the R multiples of all losing trades is 75R. Therefore, we have a 0.25R expectancy per trade over a series of trades. Or, it can be said, this trading system is expected to make 25 USD per trade, on average.
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