Forex options – a great alternative way to trade forex
Rather than opening an ordinary forex account and trading one or more currency pairs, there is another great alternative to trading in the forex market. That alternative is trading forex options.
A forex option is simply the right, but not the obligation, to buy (call option) or sell (put option) a given currency at an agreed exchange rate (the strike price), on a certain future date (the expiration date).
There are two types of options: call options and put options. The strike price of a call option is normally above the current market price, and the strike price of a put option below the current market price, but that does not necessarily have to be the case.
With a call option the trader wants the price of the currency to move above the strike price at expiration, because then he or she has the right to buy it at the (lower) strike price and sell it again at the higher market price.
With a put option, a trader wants the price of the currency to drop below the strike price, because then they can buy the currency at the lower market price and sell it again at the higher strike price.
Buying call options is attractive because the option only costs a fraction of what buying the actual currency would have cost and, if you are right about the market, you will get the full benefit of the amount by which the market price moves beyond the strike price.
The same is true for put options, but in this case the profit for the trader would be the amount by which the price drops below the strike price.
Another reason why forex traders love options is because what you pay for the option is the maximum you can lose on the deal. The risk, therefore, is lower than with a straight currency deal.
Why novice traders should spend time learning forex
Many novices get involved in the world of online currency trading after attending some sort of introductory seminar. They get excited with what they perceive to be a get-rich-quick opportunity and start to trade forex without taking time off to first learn forex. Unsurprisingly, the probability that such a trader will become successful is low.
There are numerous websites providing free forex training tutorials. They cover technical indicators, fundamental indicators, how to red charts, trading systems and many other aspects of trading. There really is no excuse for the novice investor not learning the basics of the forex market before entering into a trade.
There are websites such as the Forex Factory, which specialise in providing forex training and vital tools to both novice and professional traders. Anyone new to the market is advised to study the basics of the market by checking out one or more of these sites before opening a demo account. Once you feel comfortable with the core principles of trading you are ready to open a demo account and start making ‘paper’ trades.
This is the point where you should start developing your own trading system; before, not after you make your first live trade. During this stage feel free to experiment with various systems. Try using different technical indicators and or combinations of them. Somewhere along the line you will learn which technical indicators work best for you.
Keep records of your demo trades. It is vital to learn what worked for you and what did not and to identify why.
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Online trading and the Martingale method
Many investors who become involved in trading forex are perpetually looking for the holy grail of trading; a single technique or system that will guarantee a quick way to riches. In their search they often stumble across the Martingale system.
This system originated in the world of gambling. What it basically boils down to is that you start betting small and if you are wrong, you place exactly the same bet again, but this time doubling the bet size. If playing roulette, for example, you keep on betting on one colour, red or black and every time you are wrong, you double your bet. Statistically, the argument goes, you have to be right sooner or later, in which case you will have a guaranteed profit.
Applying this method to forex trading implies that you start off by going long or short on a particular currency with a relatively small short term trade; for example, five minutes. If you go long and the price of the currency goes down during the next five minutes, double the money on your next trade and go long again. If the theory works as it should, you will eventually be right and hence make a guaranteed profit.
If all of this sounds too good to be true, it probably is. It requires virtually unlimited funds to ensure an eventual ‘win’. For instance, if you go long and the market suddenly nosedives, it can keep on going the wrong way for a very long time. It is likely that by that time you will be placing very large trades and you might eventually wipe out your entire trading account before the market turns around.
The Martingale method, when used as a forex trading system, is one that looks very good on paper, but in real life has probably wiped out more gamblers and most likely traders as well, than any other ‘system’ we know of.
Trading on the move
Noticing and acting on signals in a timely fashion is one of the most important elements of forex trading. Most traders work during a set period of time each day. As the market is constantly open during the week, traders inevitably miss out on some excellent opportunities.
It seems foolish to forgo valuable market movements, simply because they occur at an inconvenient time. Many forex brokers now offer the opportunity to trade using portable devices. Their apps offer enjoyable and profitable ways to make money on the move. For many, this has expanded the time during which they can make money on the forex markets.
Train, bus and taxi journeys can now serve as opportunities to trade, meaning individuals never need to miss out on uptrends again.
Smartphones and tablets also have an advantage over PCs and laptops in that they turn on immediately. This allows traders to act instantly if they receive a signal from websites like forexloft.com.
While mobile applications cannot provide all the functionality of full trading platforms, they make trading on the go simple and extend the period of time during which traders can work.
The basics of an FX trading system
Without a trading system it’s very unlikely that even the best trader in the world would be able to make a profit consistently.
You don’t need a master’s degree to create a trading system. All it really comprises is a set of rules determining when to enter a trade, when to exit it again, how much to risk of a single trade and how many trades to have open at any given time. It will also cover issues such as stop losses, take profit levels etc.
Entering a trade could for example be based on the price trading above or below a simple moving average. It’s possible to use more than one technical indicator, but don’t overdo it.
Exiting a trade is actually trickier. Here you could have a rule that says you exit as soon as you have made a certain amount of profit or loss, or when the price breaks through a certain technical level, e.g. the moving average. Never cling to a losing trade: that is probably the downfall of more traders than any other single mistake.
How much to risk on a trade should depend on the size of your trading account. As a general rule, never risk more than between 2% and 5% of trading funds on any single trade.
Overtrading, i.e. making too many trades open at any given moment or making a multitude of trades per day is another common mistake made by novices. Have a rule in this regard and stick to that rule.
Stop losses should form an important part of your trading system. Don’t set them too narrow – that will kick you out of many trades that eventually turn out to be profitable. Setting them too wide on the other hand will expose your account to catastrophic losses.
Forex services and demo accounts can be very useful to both novice and professional traders and there is a wealth of knowledge available for those who put a bit of time in.
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Is Forex trading for you?
Before opening a Forex day trading or swing trading account, a potential trader first has to ask him or herself whether he or she is really suitable for this type of trading, and what type of person has a better likelihood of becoming a successful Forex trader?
In the first place such a person should have access to some extra cash which he can afford to lose. Do not make a mistake: any type of Forex trading carries risk and it is unwise to trade with money that is needed to pay for food or other household expenses.
Secondly, the aspiring trader has to be able to read charts. By this we do not mean that one needs a PhD in statistics or mathematics, but someone who is not able to understand a basic candlesticks price chart and comprehend a number of simple technical indicators superimposed on such a chart will find it difficult to make good trading decisions.
The ability to interpret technical indicators is another prerequisite if one wants to become a really successful Forex trader. Once again, there is no need to know every technical indicator in the book; it is sufficient if one understands a number of basic technical indicators really well and knows how to apply them under various market conditions.
Last but not least, the ability to control one’s emotions forms a very important part of the personality of all successful traders. People who make trades based on ‘gut feelings’ or emotions such as fear or greed usually find it hard to make profit consistently in any type of market.
The vast majority of successful Forex traders have a system and they follow that system rigorously. When the price of a currency moves in the ‘wrong’ direction, they do not allow fear to set them off-course: they keep on following the system and in the long run this pays off.
FX options compared to ordinary FX trading
For some reason many Forex traders consider trading FX options to be somehow ‘more complex’ and ‘more risky’ than trading ordinary Forex.
The truth is that, in many circumstances, Forex options could actually be more lucrative and involve lower risk than an outright Forex transaction.
Let us take the example of one of the simplest Forex options transactions a trader can enter into - buying a call option. In this case the trader pays a premium and if the price of that particularly currency exceeds the strike price of the call option at expiration, the trader gets the full benefit of the price increase.
With a put option, the situation is reversed. The buyer of a put option gets the full benefit if the price of the currency drops below the strike price of the option at expiration.
In the case of an ‘at the money’ call option, if the price of the currency is higher at expiration than now, the trader will benefit to the full extent of that increase (less the premium). This is no different from what would have happened if the trader had ‘gone long’ in an ordinary Forex transaction.
The difference is that, if the price of the currency moves the ‘wrong’ way, the ordinary FX trader stands to lose a potentially unlimited amount of money while the options trader can lose no more than the amount he or she paid for the option.
The same is true with short transactions. An FX trader who goes short on a currency can lose a potentially unlimited amount of money if the price of that currency goes up. A buyer of an ‘at the money’ put option on the other hand can only lose what he paid for the option, but he can benefit to the full extent if the price of the currency goes down as expected.
Automated forex trading
Automated forex involves automatically buying and selling orders using an underlying forex system. Once a laid-down set of criteria is met, the orders to buy and sell on the forex market are carried through. An automated forex trading platform removes the element of human psychology from forex trading.
There are two types of automated forex: fully automated and signal-based. A fully automated system uses a forex robot that draws on a computer algorithm to determine elements of an order such as price, timing or the quantity of the trade. The forex trading system also places the orders submitted automatically. The trader using the system works around the technical parameters of the forex platform, with all other aspects of control given over to the technology.
A forex trading system that uses signals in auto-trading mode draws on the manual execution of orders. A commonly used approach leverages a service, whereby, traders make strategies accessible to anyone interested in the forex signals. Traders then decide if they wish to carry through with trades, based on any of these signals in the context of their own forex accounts.
Unlike with a manual trading system, with an automated trading system, it is possible to execute more trades per market than it is possible for a human trader working on his own. Actions are reproduced across different markets and at different times.
A forex system using signals means traders use signals and previously successful strategies, in the hope they continue to generate profitable trades into the future. Automated forex opens up online currency trading to more people because traders must be experts or have the ability to devise their own strategies.
Is scalping a good idea?
The idea of scalping can be very tempting for new traders. Simply put, scalping involves hunting for large numbers of small pip profits. Scalpers typically aim for small profits of around five pips from each position. They usually close their positions less than a minute after opening them.
The strategy can produce high levels of profit over an extended period of time but this is far from guaranteed. There is usually less risk on each individual trade but the scalper needs to be successful with the majority to make the tactics worthwhile.
It is something of a grey area as to whether brokers themselves are welcoming towards scalpers. Many brokers allow people to open and close positions immediately but are wary of traders attempting to exploit the lag between an order being initiated and actually placed. Individuals who do this may have their accounts closed, suspended, or be hit by restrictions.
Many of the brokers that allow scalping, target successful individuals with increased spreads if they persistently make profits. They may also deprioritise the placing of their orders, or change quotes to slow progress.
While scalping is undoubtedly an effective tactic for some, it is certainly not a guaranteed strategy for earning profits and requires a great deal of willpower and unfaltering knowledge of the markets. Websites like www.forexsignalgenerator.com can help scalpers identify opportunities.
For the above reasons, it is not recommended for beginners to try scalping at first. Almost all successful scalpers are experienced traders who have the knowledge and confidence to succeed.
How to use Bollinger Bands for more successful Forex Trading
Even if you use the service of a professional advisory facility such as the Forex Factory, you will still need some knowledge of technical and/or fundamental indicators in order to become a successful trader.
Whilst the simple moving average is sufficient for many novice traders, you could most likely enhance your chances of success significantly if you combine this with another technical indicator. Our recommendation in this regard is the well-known Bollinger Bands.
These bands are actually quite easy to read. The way they work is this: when the market becomes very quiet, the lines start moving closer together and form something that looks similar to a tunnel. When the market becomes very active with large price movements, the Bollinger Bands move further apart.
One of the most popular ways to use Bollinger Bands is the famous ‘Bollinger Bounce’. The underlying premise here is that when the price of a currency reaches the upper or lower band, it usually bounces back to the middle. So if you have a range-bound market with narrow Bollinger Bands and the price of the currency hits the upper band, there is a very high likelihood that it will bounce back and move towards the middle of the bands.
Bollinger Bands can also be used to do ‘breakout trades’. This is when the price reaches the boundary of the bands and does not bounce back as expected, but break out of the bands. This is usually a signal that we can expect higher highs or lower lows.