In this article we look at risk and buzz words in forex. A lot of money making methods have risk, whether its P2P lending with defaults on loans, the stock market tanking because of a crash ruining your investments, dips in crypto and purchasing real estate to name a couple there is risk involved how you can reduce that risk is key.
Also like many financial systems there are a few buzz words in forex – we will take you through some of them as well.
One of the most important aspects of protecting your investments is balancing your risks with reassurances. There are several ways to do this, and we will discuss those in this chapter.
Limit Orders And Balancing Risks
A limit order is a standing amount at which you have agreed to buy or sell a particular security or other commodity. For instance, you have designated to your stockbroker that you will not sell X Security until its value reaches a minimum value of Y dollars. At the same time, you will not purchase the same X Security if it exceeds a value of Z.
Setting limits for the price you pay for a particular security, as well as the price you will accept to sell it, protects you and your investment in several ways.
First of all, you are maximizing your gains, but mostly, you are avoiding loss. Any loss that occurs with limit orders will always be unrealized loss, or a loss that is not measurable in liquid assets or cash.
In other words, until you sell the stock and reap the net loss, it will not affect your net worth. Since you have set a limit that does not allow your commodities to be sold for less than the original cost, you cannot possibly have a loss in your net worth.
At the same time, you are also assuring at least a certain amount of profit by setting your sell point high enough to reap that particular profit.
Another way to protect your assets is to hedge. This means that you create and sell a futures contract stating that, when your shares reach a certain value in the future, you will sell your holdings at this predetermined price.
When that price is reached, the order will be processed and the transaction completed. Of course, if you ever change your mind about a limit that you have set, you can place a stop order with your broker, which designates that you no longer wish to trade at the specified dollar amount.
You can also buy on margin. This is very similar to short selling, but instead of borrowing stocks to sell, you are essentially borrowing money to purchase stocks on your own when the market value is down.
Then, when the value of the securities you have purchased rises and you are able to sell for a profit, you repay the loan and keep the excess from the sell, minus the broker fees.
Of course, all dealings with a stockbroker incur a premium, or fee for services rendered, and it is nearly impossible to trade without a broker or broker service. However, online services are often less expensive than live agents, but you can research to determine what your best option is.
How Do I Handle a Whipsaw?
No, we are not referring to anything in the garage, the bedroom, or a country band. A whipsaw is market trend that defies the odds. It can be thought of as the “fender bender”.
Despite how careful you are as you learn to drive a car and become coordinated, sometimes you cannot do anything to avoid being rear-ended.
Whipsaw is a term for what happens when everything points toward a specific direction in market trend, causing you to buy (if it looks as though prices are going to rise) or sell (if it seems they are about to fall), then the opposite effect occurs.
For example, if you purchase a security at five dollars per share because the stock seems to have fallen as far as it can go and appears to be starting an upward trend, then unexpectedly, the stock plummets to one dollar per share, this is considered a whipsaw effect. If this happens to you, as it surely will if you play the market long enough, the best thing to do is wait it out.
The stock will do one of two things – it will either dissolve entirely, and the company will go bankrupt (this is what you do not want to happen), or it will rebound, and you can opt to wait for a chance to turn a profit or you can get out as soon as the purchase rate is reached.
Whipsaws are not the end of the world, and no one can expect to gain with every stock market purchase. However, if you find that you are involved in several of these instances, you should seriously reconsider your investment options.
You may be reading the signs incorrectly, or you could be picking bad stocks. You should seek advice for any future investments you expect to make prior to purchasing any further stocks or securities.
Another way to overturn a bad investment like this is to proceed with an offset transaction – a purchase or sell that offsets the loss of a previous transaction.
You could either purchase additional stock in the same company at the lower price if you expect it to recover, or you can opt for another hot commodity that is about to explode in price, either of which will help you offset your loss.
You could also sell shares of a security in which you have a large amount of unrealized gain – gain that cannot be measured in liquid assets or cash due to increase in value of stock and security holdings – in order to replace the lost cash value.
All of these are viable options to recover a loss, but waiting for the share value to rebound is always the first choice. It avoids the loss of funds already invested, retains the option to pursue profit, and reduces the risk of further investment into the market.
As you grow and learn about these various options, you will need to feel more comfortable when surrounded by financial gurus and geeks who speak what sounds like gibberish, muttering words you have never heard left and right.
Now that you know a little more about the stock market, and you have decided to try your hand at investment, you should be more concerned with understanding the jargon you will hear on the trading room floor.
Although you probably will not find yourself amid a group of screaming stockbrokers on Wall Street (and these days, most of the trading is done by computer anyway), knowing that learning to talk the talk is part of walking the walk.
Margins, Spreads, And Other Condiments
Okay, so it is margins, not margarines, but it sounds very similar. In order to understand the stock market, especially on Forex, you need to speak not a language meant for common communication, but the language of trade. For instance, when you think of a margin, for many this means a variable – like the “margin of error” in a statistic.
However, in trade, it refers to the sum of money borrowed from a broker in order to purchase stocks when the market is on a downtrend. Then, when the value begins its next upswing, you sell the stock at the higher price, pay back the margin (along with the premium accrued), and retain the profit.
When you buy on margin, the money lent by the stockbroker is referred to as a margin account. The margin account is provisional based on the value of the stock.
Occasionally, if the value of the stocks purchased should drop too low for the safety margin set forth by the broker, the agent will request that more money be deposited into the margin account to make up for loss. This is referred to as a margin call.
In some trades, the market value does not come into play. For instance, a forward trade is set up between two individuals or two companies outside the open market. It involves a process of negotiation and an eventual compromise in price.
There is usually a bid made – the offer to buy a commodity at a certain price – and an asking price or offer – the price for which the other business entity is willing to sell the securities or other holdings. The difference between these two purchase numbers is referred to as the spread.
If the spread cannot be narrowed and eventually closed, no deal can be made. This agreed-upon price is called the forward price, and all details involved in the trade process when this type of transaction takes place are detailed in a contract and referred to as forward points.
Usually, the forward price is outlined as available for a particular date, and should the transaction not be completed on this date (referred to as the transaction date), then the trade must be renegotiated.
Jobbers, Yards, And Other “British” Terms
One of the major foreign markets that Americans trading on Forex will encounter is that of the British. While several other terms relating to the stock market will be similar because of the common language, there are some specific terms that are very different in the British trading vocabulary.
For example, in the United States, stockbrokers who hold onto securities purchased at low prices for the purpose of selling them to clients in a higher priced market (so that the client can turn around and resell them for the profit on the open market) are called market-makers. However, in Britain, this type of investor is simply referred to as a “jobber”.
Another term you will want to be familiar with is “yard”. This does not refer to a green patch of land, a measurement in inches, or even 36 of something. The term is used in reference to quantity of currency rather than value and is equivalent to one million units of the currency in question.
In other words, you can have a yard of dollars or a yard of yen, and though it is the same quantity of bills, coins, or whatever physical currency is used, it is not necessarily equivalent in value.
In Britain, they do not use the Euro, and they do not use the U.S. dollar. They have chosen to still use the pound sterling, a currency that has been used in the country for hundreds of years. However, Britain is currently on a path to make the conversion to the Euro within the next five years.
Open And Shut
In the stock market, there are various types of orders that can be placed to help protect you from making a bad investment or to limit the amount you pay for a certain security or other commodity.
For instance, if you have made a bad investment and do not want to reinvest in a particular security, you should sell all shares of that stock, regardless of taking on a small loss.
This action is referred to as closing a position.
On the contrary, if you are doing well with your investment, you might participate in a rollover, simply reinvesting any earnings in additional shares of the stock or security.
An open order is exactly what it sounds like, meaning that the order remains pending until it is either executed by your stockbroker or canceled by you as the client. A stop order would cancel any pending orders you have placed with your stockbroker.
You also have options like One Cancels the Other Orders. These allow you to have interest in several commodities, leaving orders with your stockbroker to buy all of them, should they drop to a certain price.
Then, should one of those reach this preset low price, your stockbroker will follow your direction and invest your money in that particular security, followed by a cancellation of all additional orders.
When a broker gives you an estimate on the price for a particular stock or commodity, it is considered a quote. A quote is never completely accurate and is usually referred to as a spot price, as the value of a security can change within a few seconds.
However, it is as close to accurate as can be expected. When you put in an order, the broker then processes the fill, or completion, of that order. The actual value at which the trade is completed is called the fill price. The completion of a trade or purchase, referred to as a settlement, can also be called the execution of a transaction or realization of an order.
As you see, there are a lot of terms to take into consideration, and we have not even begun to consider terms used in some of the tougher areas of the market.
Next, we will consider some specialized, more complex trading options that you can use on Forex to take advantage of the volatility of the market and the constantly varying exchange rates.
Expert Trading Options
After spending a lot of time buying and trading on both domestic and foreign markets, you will find that the process becomes easier and almost intuitive. You no longer have to work so hard to determine currency conversion or find the next big explosive commodity. It will be like second nature for you.
What, then, becomes the next big challenge for someone trading on the open market? What keeps things from becoming monotonous and boring?
First of all, there is always something new and different happening on the Foreign Exchange Market. Remember, it operates 24 hours a day, and you never know what you will find when you wake up in the morning.
However, there are various ways that you can take advantage of the variance in currency conversion and a lag in time between markets that can affect trading values.
There are some commodities that are traded in multiple currencies on multiple markets on Forex.
Although computers have made worldwide communication almost lightning fast these days, all of these markets can trade together with fairly equivalent values for the securities shared across currencies.
However, the system is not perfect, and the value may rise or fall in one country and currency prior to the same change in value reaching across another border. Seasoned traders have learned to take advantage of this lag in the market trending by using a process called arbitrage.
In this transaction, you purchase the particular stock or security on the market with the lower price while simultaneously selling the same in a market where the value is higher.
The process is a bit complex, so we will use an example. Let’s say that one U.S. dollar is equivalent to .5 British pounds, meaning that everything is going to be twice as expensive in British pounds.
Now, let’s take a look at the price of a stock that is traded on both markets. If they were equivalent, then the stock would trade for two dollars in the United States and one pound in Britain.
However, if something happens and the stock value drops in Britain, it is six hours ahead of the United States, and this drop may not hit the American market immediately.
If the value of the stock drops in Britain to .8 pounds, the purchase price is now below that of the price in dollars due to the currency conversion.
In this case, arbitrage would take place when you bought shares of the stock in on the British market in pounds and sold it on the U.S. market in dollars, benefiting by the slow communication of the fall in value of the stock. In effect, you will make $.40 per stock.
Volatility of Currency Conversion
Another way to take advantage of the ever-shifting value of each individual currency is to trade based on the changing rates. What exactly does this involve? You must closely watch the changing conversion rates.
When a currency conversion rate changes drastically, it is time to make a move. This is very similar to arbitrage, but the area is much riskier due to high volatility.
For instance, if you have purchased a stock in the scenario above on the U.S. market for two dollars a share, and suddenly the British pound gains value, dropping to a conversion of only half a pound for every two dollars, you would want to sell your shares on the British market because the value of a pound is higher and now has greater purchasing power.
One piece of advice to keep in mind, though, is that it is best to immediately dispose of all liquid assets in foreign currency, usually in the same day.
This is referred to as tomorrow next because it takes two to three business days for foreign currency to be delivered, and by exchanging the currency for value in stocks on the same business day, you avoid having to take delivery of the currency altogether.