Trading with Foreign Exchange (FX)

To become a successful trader, it’s very helpful to develop a sound trading strategy and have sufficient risk capital.

Risk capital is the amount of funds that you could afford to risk without a significant impact on your financial and overall well-being if those funds were to be lost.

In addition to financial resources, to be successful at FX trading you should also invest in time and education and experiment with various strategies, sometimes through trial and error. You will also need to understand multiple trading strategies as no single strategy is foolproof - the effectiveness of each will depend on the specific market circumstances at the time you make a trade.

If you don’t already have an FX trading strategy, here are a few questions which might help you get started in developing one.

How experienced am I?

FX and CFDs are sophisticated trading products, and their pricing is influenced by a host of factors that might not be obvious to a novice trader, and sometimes aren’t even obvious to advanced ones.

If you are a beginner, one way that you can gain experience is by taking the time to learn about capital markets, how they work, and the trends that move them.

Your next step could be to practice demo account trading with virtual funds. When you’ve built up your confidence through working with demo accounts, you could migrate to a live account where you are trading real funds. However, it’s important to note that there is a real difference between a practice and live account in terms of the psychological impact good and bad trades can have on you - be careful not to overestimate your skills.

When you’re first trading with real money, one option could be to start with trading with smaller contracts (micro or mini sized) in order to acclimate yourself to the market, volatility, risk exposure, and how the changes in profit and loss can impact you emotionally.

What is my risk tolerance?

As a trader you should define the level of acceptable risk you are willing to expose yourself to and be strict about staying within that level. This can help you maximize the potential returns, while not exposing yourself and your investments to excessive risk.

How much time can I invest in trading?

As part of any strategy, you will need to decide how much time you can allocate to trading and monitoring the markets.

If you have only a limited time available each day, it’s unlikely that a day trading strategy would be suitable for you. You can’t just consider the time you’ll spend trading either - you should account for preparation and research time as well. In order to simply identify the trading opportunities you want to pursue, you might need to review charts, read up about the markets in other countries, or review economic calendars.

One interesting factor of FX trading is that the time you are available (and the time zone in which you live) can influence the product and markets you might want to trade in. If you live on the east coast of Canada, it might be easier to trade the active times on European markets, while on the west coast it might be easier to trade the Asian markets.

What product do I want to trade?

FX offers a lot of choices. If you choose to focus on a smaller list of currencies, you make it easier to stay on top of the news and prices involved, which can help you make more informed trading decisions.

Do I have any expertise in technical and fundamental analysis?

Are you a technical trader who prefers to use charts and analytical tools, or a fundamental trader who prefers to study news and economic indicators for your trading decisions? Either way, it’s worth knowing a bit about the opposing school of thought.

Knowing both technical and fundamental analysis can help you with your trading decisions as they provide you with different information and perspectives. We talk more about market analysis later in this article.

Do I have the discipline to adhere to my strategy?

There can be a lot of temptation to simply react to random news or market movement rather than sticking to your strategy. You should only enter a trade if it makes sense to you based on your analysis at the time, and if circumstances change, you shouldn’t let your ego deter you from selling a losing position before the loss grows. One tool you might consider to manage the risks of your open positions are stop loss orders.

Analyzing the market is a critical component of any strategy for trading. As we mentioned earlier, there are two main types of market analysis used as part of FX trading - fundamental analysis and technical analysis. Many traders choose one over the other, but both types can be handy in different situations.

Fundamental analysis

In fundamental analysis you compare the relative strength and economic performance of countries in order to determine the fair value of their currency. As part of this analysis, you might be considering factors such as: economic output, inflation, productivity, the central bank interest rate, political stability, and the overall national deficit or debt. This is just the beginning - there are a host of other factors as well.

In the modern age, there’s a seemingly endless variety of analysis and economic indicators put out by governments and private groups regarding different aspects of the economy. Traders who make use of fundamental analysis try to use this data to understand the strengths and weaknesses of economies and predict future trends and activity. They believe that, over the long-term, these fundamental factors support and influence the overall direction of currency markets.

Technical analysis

In technical analysis you use past market data to forecast future price movements within the market. While a fundamental analysis of an investment might focus on the “intrinsic value” a technical analysis of the same investment would look at historical price patterns and trade activity to help make a prediction of future price movements.

Technical analysis assumes that the historical performance of currencies and markets can be repeated, and they then use that historical data (along with a wide variety of charts and other analytical tools) to forecast future performance. While the general warning that past performance is no guarantee of future results always applies in investing, many investors use technical analysis to help them project price changes and make more informed trading decisions.

As with any kind of investing and trading, there are potential risks. In fact, you could say that managing risk is an essential component of any trading strategy.

Traders should learn to limit their downside risk. Basically, you work to minimize potential losses while trying to maximize your potential profits.

Every trader needs to identify what the most optimal trade-off between risk and reward is for them. Thankfully, there are some opportunities for traders like yourself who might be looking to manage those risks.

Risk capital

Risk capital is a uniquely Canadian regulatory concept for traders of highly speculative, leveraged products such as futures and FX and CFDs. It is the amount of funds that a trader can risk in the market, which, if lost, will not have a significant impact on the trader’s financial well being and lifestyle. You will be asked to provide a risk capital limit when you open an FX trading account.

The risk capital limit will specify the maximum amount you can deposit to the trading account. The risk capital limit request must be approved during account opening by Questrade and is subject to a determination of your financial condition, trading experience, and investment knowledge, among other factors.

The risk capital limit should not be confused with the stop loss order to limit losses on an open position. It is the maximum amount of risk funds that the trader, subject to Questrade’s approval pursuant to its policies and procedures, can deposit to his trading account on a cumulative basis over the lifetime of the account.

The risk capital limit may be revised at the request of the trader and at the discretion of Questrade based on changes in your financial condition. A financial update form has to be completed and approved by Questrade before the risk capital limit can be increased.

Drawdown limit

This is a risk limit that you can impose on the funds in your trading account by setting a maximum loss limit that will trigger a halt in trading. This gives you the opportunity to review your trading strategy for any flaws.

Sometimes market conditions undergo changes that can nullify some of your strategies that have worked in the past. Under these circumstances, you might need to re-evaluate your strategy, and would prefer to do so without further risk to capital. Drawdown limits of 25% to 40% are common for experienced traders.

Risk per trade

You have the ability to assign a risk limit to each trade. A risk limit is usually expressed as a fixed dollar amount or a percentage of the funds in the account. This risk limit works in tandem with a stop loss order on the open position that usually coincides with, and is confirmed by, price action trading through support or resistance levels.

Stop loss and take profit

Since it is impossible to monitor markets 24 hours a day, you can utilize the important risk management tools offered in the form of a stop loss order and a take profit order to protect their open position. You can also protect your standing entry orders that are triggered in a similar manner. It is important to note that the addition of stop loss and take profit orders are a best practice to protect your position but are not guaranteed. Extreme market volatility may drastically move prices outside the range of your stop loss or take profit order. While this is less common it is still a possibility when trading FX.

Trailing stop

This type of stop order is actually designed to protect the unrealized profit of an open position. You should note that the trailing stop will not activate until your open position has become profitable by a minimum number of pips specified by the trader when setting the order. The trailing stop order available on the Questrade platform will not trigger or afford any protection if the open position has not achieved the minimum defined profit.

Hedging

Traders sometimes use hedging strategies to help limit their risk exposure. In order to hedge your position, you’ll need to take a trade in the opposite direction to an open position for an identical amount.

Although some may argue this is equal to paying an additional spread to eliminate the exposure without closing the open position, others think differently. During fast markets after major news events, you may wish to temporarily shield open positions from extreme volatility while updating your analysis of the latest technical chart pattern before making the next decision.

Hedging your open positions can achieve that purpose by providing you with a bit of breathing room. Another use for hedging is an example where you take a long-term position, which has become profitable, but your position is encountering temporary counter-trend price action. The hedging feature allows you to take a trade in the opposite direction without closing your long-term position, and this provides the opportunity to capture a short-term profit with the counter-trend trade.

Price alert

You can set audible price alerts on our platform to receive notification of price action reaching the pre-defined level.

To learn more about trading FX and CFDs at Questrade, check out our article Introduction to FX Trading or our article on trading CFDs.

We also offer practice accounts to learn more about the advantages and disadvantages of FX trading before committing funds for trading in a live account.

To learn more about the fees associated with trading FX at Questrade, you can visit our fees page.

If you have any other questions about FX Trading, you can contact us - we’ll be happy to help. Once you open and fund an FX trading account you will get access to complimentary training sessions helping you to learn how to trade FX within our platform.