Although foreign exchange rates generally exhibit far smaller moves than stocks and bonds, the forex market still presents significant profit opportunities. Several methods allow even individual investors to benefit from very small variations in exchange rates and rack up profits.
Because large moves in the forex market are relatively rare, many traders scalp the market. Scalpers intend to take advantage of very small moves by trading frequently and with large sums of borrowed money. As a result, they are able to magnify relatively small moves, turning miniscule changes in price into modest profits. By repeating the process over and over again, these modest gains add up over time. Many individuals who trade from their home or even on a mobile phone make profits by scalping. Scalpers chase moves as small as five to 10 pips. In the forex market a pip represents 0.0001 point. If the euro to U.S. dollar exchange rate moves from 1.3 to 1.30001 the price is said to have moved by one pip.
Naturally, a lot of money has to be involved to benefit from such miniscule percentage changes in price. Scalpers accomplish this by using borrowed cash. Such a trader might put up $200,000 of her own capital and borrow an additional $1.8 million. She might then buy and sell with a total capital of two million every time. Naturally, the trader will pay interest on the borrowed funds. and must access cheap sources of loans. If you intend to to profit from scalping, you must always be on the lookout for the cheapest lenders. A new trader who has not yet established a long-term relationship with a broker might not be able to borrow nine times his principal, but will still be able access a significant loan. Because of relatively smaller moves and consequently lower risk in the forex market, currency brokers are more willing to lend funds than stock brokers. The exact loan amount will depend on broker, kind of currency and trading experience.
Commissions are another major expense for the scalper and must be very tightly controlled. While the fees paid to brokerage houses are generally very low, so are potential profits for the scalper. Therefore, even modest commissions can potentially wipe out the entire profit from a short term trade. The scalper must shop and find the absolute lowest commissions around. The brokerage that has the lowest interest rates on loans might not offer the lowest commissions. Therefore, the scalper must often balance commission costs with interest expenses and compromise to arrive at the lowest total trading costs.
Scalping opportunities do not last for very long. Because the scalper is chasing extremely small moves, the window for a profitable trade might disappear within seconds. Speed of execution and constant attention are therefore crucial. Especially if you will trade from home, you need a good computer, fast and reliable Internet connection, as well a broker that can execute traders almost instantaneously.
Although most moves in forex are small, sudden displacements in market also occur from time to time as a result of diplomatic crises and key moves by central banks. Do not commit a large portion of your capital to the forex market and do not trade forex with your retirement funds. Until you accumulate significant experience in this arena, you should probably channel no more than five to ten percent of your portfolio to forex trading.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.