Forex Trading Fundamentals

While potentially profitable, forex trading carries inherent risks, so applying basic risk management strategies is crucial. These include:

• Using stop-loss and take-profit orders to protect against emotion and greed
• Using money management to limit risk per trade
• Diversifying capital across different currency pairs
• Avoid excessive leverage

Psychology is also crucial for staying disciplined, avoiding impulsive decisions, and managing expectations. Focusing on long-term consistency is essential.

Find out more about Risk Management in forex in Axi’s Risk Management course.

Understanding forex jargon

When traders talk about bulls 🐂, bears 🐻, hawks 🦅, and doves 🕊, are they really obsessed with animals? Watch our video to find out what the most important terms in forex trading.

An example of a forex trade

Consider you have a $5,000 balance in your trading account. You anticipate that the euro will strengthen against the US dollar and want to benefit from the change in price.

You place a ‘long’ (buy) EUR/USD trade at the current market price of $1.20.

Your analysis tells you that you should set a ‘stop-loss’ (a limit to minimize potential losses) at $1.1950 and the ‘take-profit’ (a target where you conclude the transaction and secure your earnings) at $1.21.

The maximum loss is therefore 50 pips*, while the maximum gain is 100 pips, giving you a healthy risk-to-reward ratio of 1:2.

* A ‘pip’ is the smallest unit of price for any foreign currency. If EUR/USD moves from 1.1970 to 1.1971, that is a one-pip move.

What about the trade size?

A popular method is to express the maximum risk you are willing to take as percentage of your balance. For example, if you are willing to risk 2% of your balance per trade, you can allocate 100 USD ($5000 x 0.02) to this specific position.

The size of a trade is expressed in Lots. A standard lot represents 100,000 units of the base currency in a forex trade. For instance, in a EUR/USD trade, one standard Lot would be €100,000.

Your preferred trade size would therefore be 0.20 Lots, as:

0.20 lots = $10 x 0.2 = $2 per pip
and
50 pips x $2 = $100

Consequently, your effective transaction value is $20,000, surpassing your actual $5,000 capital. This is facilitated by leveraging, which amplifies your transaction capacity beyond your available funds. In this case, 4 times more than what you have.