Trading 101

For participating in the financial markets, you need a computer and Internet access, and normally a Broker to handle your trades (unless you have direct access to the electronic markets). Your broker connects you to the networks, places your orders, and even lends you money for trading. Most brokers offer Demo Accounts (also called Paper Accounts or Game Accounts) where trading can be practiced without risking real money.

The point of trading is making a profit from the difference between the buying price and the selling price. Day trading is the buying and selling of financial assets in short time intervals. There are several different styles of day trading, ranging from extreme short term trading such as Scalping where positions are only held for a few minutes, to longer term Swing trading where a position may be held for many days or even weeks. If you keep stocks for years, you're not a trader but an Investor..

A financial Asset - also sometimes called Instrument or Symbol - is the object you trade with, such as a currency, commodity, stock, future, or other derivative. In Currency trading (or 'Forex trading', Forex = Foreign Exchange) you buy or sell one currency and pay in another currency. For example, when you buy the asset "EUR/USD", you buy in fact the Euro and pay in US Dollar, and when you sell "USD/JPY" you sell the US Dollar and get paid in Japanese Yen. You always trade the first currency against the second currency. It becomes funny when you're European and buy EUR/USD, which means you buy EUR and are charged in US Dollar for which you pay with EUR.

The Ask Price of an asset is the price at which you can buy; the Bid Price is the price at which you can sell. The Ask price is normally higher than the Bid price. The difference between Ask and Bid is the spread: Ask = Bid + Spread. For currencies, the spread is usually in the range of 0.01..0.05 percent of the price (or about 1..5 pips, see below). That's a lot less than the ~2% that you usually get charged by banks or exchange offices, also called tourist rip-offs! If you buy an asset and sell it immediately, you lose the spread.

When you think the price will move up, you Buy Long (or just 'buy'). That means that you buy a certain amount of the asset at the Ask price, and have to sell it later at a higher Bid price for making a profit. The price must rise by at least the spread for making profit at all.

When you think the price will move down, you Buy Short (or - somehow confusing - 'Sell Short', or just 'short'). That means you sell an asset at its current Bid price without owning it. Therefore you have to Cover it - i.e. buy it back at its Ask price - at some point later. The asset price should have been moved down inbetween by at least the spread for making profit. Buying short is a little counterintuitive, but is in fact the same procedure as buying long, only with the Ask and Bid prices reversed. Many human traders prefer to buy long rather than short, for psychological reasons or because they didn't grasp the concept. This is visible in the charts, especially with stocks - the price movements are not symmetrical in time, but show a sort of sawtooth pattern. You can exploit this in your strategy.

Entering or opening a long/short position, and Exiting or closing a position are just other words for buying and selling an asset.

A CFD (Contract For Difference) is an agreement to pay the difference of the buy price and sell price of an asset. It's a sort of bet on a rising or falling price. Many brokers don't offer real stocks, they offer CFDs instead. When you buy a CFD, you are not buying the underlying asset, although the movement of the CFD is directly linked to the asset price. You just have the right to pocket the gain (if any), and have to cough up the loss (if any). Since you do not own the asset, you do not need to pay for it - instead you place a deposit with your broker, called Margin. This deposit is for covering the possible loss, as the broker doesn't want to have to go after you for collecting his money. The margin can be as low as 0.5% of the real price of the asset. This means you can trade a volume of up to 200 times your capital. This factor of 200 is called Leverage, and is a very convenient way to realize huge profits, or to lose all money in no time.

The Balance is the current money in your broker account. The Equity is the money you had if you closed all currently open trades. Due to leverage, the value of the trades can be negative, thus the equity can be less than the balance. The equity changes all the time together with the prices of your assets, while the balance only changes when you buy or sell something. When the trades don't go well and your equity drops below your total open margin - the deposit for open trades, see above - your broker will close all your trades, like it or not. This is the notorious Margin Call. It does not necessarily mean loss of all capital: you normally keep the margin. But if your trades cannot be closed immediately, for instance due to low market volatility, you can indeed lose everything and even end up with a negative balance.

A PIP (Point In Percentage) is a certain fraction of the price of an asset. Prices normally only move a little tiny bit during a day, so it's more convenient to say "The EUR/USD is down 15 pips" than "it's down 0.0015 Dollars". One pip is a unit of the last digit of the price. In most currencies the price is normally displayed with 4 digits after the decimal - like 1.2345 - so one pip is 0.0001 in units of the second currency. One exception is USD/JPY, which has only 2 digits after the decimal - 123.45 - and thus one USD/JPY pip is equal to 0.01 Japanese Yen. There are different pip values for stock, index, or commodity CFDs. Many brokers display PIP Costs for their assets. That is not the price of one pip, but your profit or loss when you buy one lot (see below) of that asset and the price moves up or down by one pip.

A Lot of an asset is the smallest amount of units you can buy. Very rarely do brokers allow you to buy currencies in multiples of 1 unit; usually brokers offer chunks of 100K (100000) currency units. So you can buy 100000, 200000, 300000 EUR/USD contracts, but not 1, 100, or 4711. For other assets the lots are different, but they are normally all in the range that one pip loss or gain is about 10 dollars. The margin required for buying one standard lot is in the $500...$1000 range. Most brokers also offer accounts with mini lots that are 10K currrency units, or micro lots that are 1K currency units. For starting trading, a micro lot account is highly recommended. The lot/pip system is an abstraction layer that puts all prices, losses, gains and margins in about the same range, and makes assets easily exchangable.

Trading Methods

If you have your TV running 24/7 on a news channel, read 12 newspapers per day and base your trade decisions on news from CNN or the Wall Street Journal, you're a Fundamental Trader. If your trade decisions are based on price curves, you're a Technical Trader. Technical trading does not require that you know anything about the asset that you buy or sell; you don't care if it's pork bellies or the Euro, you're only interested in its price curve.

A Strategy is a systematic method to enter or exit trades when certain conditions are fulfilled, such as trade signals by Technical Indicators. There are many different strategies, like Trend trading, Counter-Trend trading, or Cycle trading. Trend trades are in the direction of the previous price movement (like buying when the price was moving up), and counter-trend trades are against the previous trend direction (like selling when the price is high). Cycle trades are trades that go periodically up and down, and are used when the price is moving Sideways, i.e. jittering about without taking a certain direction. You can find more about this in the Strategy and the Indicators chapters.

A strategy can be executed manually by Discretionary Traders - that's the poor guys staring on their screens all day and waiting for the moment to hit the buy button. Or it can be Automated through a Script - that's the enter and exit conditions written in a programming language and executed by a computer. A special kind of automated strategy is High Frequency Trading (HFT), where minimal price differences between markets are exploited.

Some brokers offer Binary Options for trading. A binary option is basically a bet on whether the price will be above or below the current price at a certain time in the future. Winning such a bet does not win the full stake, but only about 70% or 80% - this way the broker is on the safe side to never lose money with binary options. Which means that you're also on the safe side of always losing your money. Compensating an average >5% loss is almost impossible, even with the best trading system. There's one advantage to binary trading, though: it is equivalent to gambling and thus tax free in some countries. Not that it would matter...

Trading institutions employ both automated systems and human traders. Studies show that employed professional traders can achieve an average annual profit of 3% above the market*. Interestingly, talent or experience has no influence on trading success; no institutional trader could consistently trade better than his colleagues. There are no studies about the success of private discretionary trading, but all information suggests that there is no such. Private traders are usually not as disciplined, but more susceptible to gut feelings, emotions**, and superstition. This makes long term trading success very unlikely, but it does not mean that private traders lose money all the time. As shown in workshop 8, even totally random trading can produce profits for months and even years, giving the lucky traders the impression that they know what they are doing.

That was most of the trading terms and methods in a nutshell. A free ebook with a comprehensive introduction - Forex for Beginners - and free trading introductory courses can be found on the links page. Of course there are thousands of other books, courses, seminars, and trading tools readily available - most are not free, though. Will you need to spend money in order to really learn trading? Read on.

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Bars and Candles, Strategies, Indicators, Income

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