Trend Lines

They are probably one of the most underutilized ones as well.

If drawn correctly, they can be as accurate as any other method.

 

Unfortunately, most forex traders don’t draw them correctly or try to make the line fit the market instead of the other way around.

 

Trend Lines Example

In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys).

This is known as an ascending trend line.

In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).

This is known as a descending trend line.

How do you draw trend lines?

To draw forex trend lines properly, all you have to do is locate two major tops or bottoms and connect them.

What’s next?

Nothing.

Uhh, is that it?

Yep, it’s that simple.

Here are trend lines in action! Look at those waves!

Forex trend line examples: uptrends, downtrends, and sideways trends

Types of Trends

There are three types of trends:

  1. Uptrend (higher lows)
  2. Downtrend (lower highs)
  3. Sideways trend (ranging)

Here are some important things to remember using trend lines in forex trading:

 

It takes at least two tops or bottoms to draw a valid trend line but it takes THREE to confirm a trend line.

 

The STEEPER the trend line you draw, the less reliable it is going to be and the more likely it will break.

Like horizontal support and resistance levels, trend lines become stronger the more times they are tested.

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what is Support and Resistance?

Strangely enough, everyone seems to have their own idea of how you should measure support and resistance.

Let’s take a look at the basics first.

Forex Support and Resistance Explained

Look at the diagram above. As you can see, this zigzag pattern is making its way up (a “bull market”).

 

When the price moves up and then pulls back, the highest point reached before it pulled back is now resistance.

 

Resistance levels indicate where there will be a surplus of sellers.

When the price continues up again, the lowest point reached before it started back is now support.

Support levels indicate where there will be a surplus of buyers.

In this way, resistance and support are continually formed as the price moves up and down over time.

The reverse is true during a downtrend.

In the most basic way, this is how support and resistance are normally traded:

Trade the “Bounce”

  • Buy when the price falls towards support.
  • Sell when the price rises towards resistance.

Trade the “Break”

  • Buy when the price breaks up through resistance.
  • Sell when the price breaks down through support.

A “bounce” and “break”? Say what? If you’re a little bit confused, no need to worry as we will cover these concepts in more detail later.

Plotting Support and Resistance Levels

One thing to remember is that support and resistance levels are not exact numbers.

 

Often times you will see a support or resistance level that appears broken, but soon after find out that the market was just testing it.

 

With candlestick charts, these “tests” of support and resistance are usually represented by the candlestick shadows.

Forex Support and Resistance | Support holding at 1.4700

Notice how the shadows of the candles tested the 1.4700 support level.

At those times it seemed like the price was “breaking” support.

In hindsight, we can see that the price was merely testing that level.

So how do we truly know if support and resistance were broken?

There is no definite answer to this question. Some argue that a support or resistance level is broken if the price can actually close past that level. However, you will find that this is not always the case.

Let’s take our same example from above and see what happened when the price actually closed past the 1.4700 support level.

Forex Support and Resistance | Support holds at 1.4700

In this case, the price had closed below the 1.4700 support level but ended up rising back up above it.

If you had believed that this was a real breakout and sold this pair, you would’ve been seriously hurtin’!

Looking at the chart now, you can visually see and come to the conclusion that the support was not actually broken; it is still very much intact and now even stronger.

Support was “breached” but only temporarily.

To help you filter out these false breakouts, you should think of support and resistance more as “zones” rather than concrete numbers.

One way to help you find these zones is to plot support and resistance on a line chart rather than a candlestick chart.

 

The reason is that line charts only show you the closing price while candlesticks add the extreme highs and lows to the picture.

These highs and lows can be misleading because oftentimes they are just the “knee-jerk” reactions of the market.

It’s like when someone is doing something really strange, but when asked about it, he or she simply replies, “Sorry, it’s just a reflex.”

When plotting support and resistance, you don’t want the reflexes of the market. You only want to plot its intentional movements.

Looking at the line chart, you want to plot your support and resistance lines around areas where you can see the price forming several peaks or valleys.

Line chart showing forex support and resistance zones

Other interesting tidbits about support and resistance:

  • When the price passes through resistance, that resistance could potentially become support.
  • The more often price tests a level of resistance or support without breaking it, the stronger the area of resistance or support is.
  • When a support or resistance level breaks, the strength of the follow-through move depends on how strongly the broken support or resistance had been holding.

Examples of forex support and resistance

With a little practice, you’ll be able to spot potential forex support and resistance areas easily.

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3 Types of Forex Charts and How to Read Them

n order to study how the price of a currency pair moves, you need some sort of way to look at its historical and current price behavior.

A chart, or more specifically, a price chart, happens to be the first tool that every trader using technical analysis needs to learn.

A chart is simply a visual representation of a currency pair’s price over a set period of time.

It visualizes the trading activity that takes place during a single trading period (whether it’s 10 minutes, 4 hours, one day, or one week).

Any financial asset with price data over a period of time can be used to form a chart for analysis.

Price changes are a series of mostly random events, so our job as traders is to manage risk and assess probability and that’s where charting can help.

Charts are user-friendly since it’s pretty easy to understand how price movements are presented over time since it’s sooooo visual.

With a chart, it is easy to identify and analyze a currency pair’s movements, patterns, and tendencies.

On the chart, the y-axis (vertical axis) represents the price scale and the x-axis (horizontal axis) represents the time scale.

Prices are plotted from left to right across the x-axis.

The most recent price is plotted furthest to the right.

Back in the day, charts were drawn by HAND!

Fortunately for us, Bill Gates and Steve Jobs were born and made computers accessible to the masses, so charts are now magically drawn by software.

What does a price chart represent?

A price chart depicts changes in supply and demand.

A chart aggregates every buy and sell transaction of that financial instrument (in our case, currency pairs) at any given moment.

A chart incorporates all known news, as well as traders’ current expectations of future news.

When the future arrives and the reality is different from these expectations, prices shift again.

The “future news’ is now “known news”, and with this new information, traders adjust their expectations on future news. And the cycle repeats.

Charts blend all activity from the millions of market participants, whether they’re humans or algos.

Whether the transaction occurred by the actions of an exporter, a currency intervention from a central bank, trades made by an AI from a hedge fund, or discretionary trades from retail traders, a chart blends ALL this information together in a visual format technical traders can study and analyze.

Types of Price Charts

Let’s take a look at the three most popular types of price charts:

  1. Line chart
  2. Bar chart
  3. Candlestick chart

Now, we’ll explain each of the forex charts, and let you know what you should know about each of them.

 

Line Chart

A simple line chart draws a line from one closing price to the next closing price.

When strung together with a line, we can see the general price movement of a currency pair over a period of time.

Line Chart Example

It’s simple to follow, but the line chart may not provide the trader with much detail about price behavior within the period.

All you know is that price closed at X at the end of the period. You have no clue what else happened.

But it does help the trader see trends more easily and visually compare the closing price from one period to the next.

This type of chart is usually used to get a “big picture” view of price movements.

The line chart also shows trends the best, which is simply the slope of the line.

Some traders consider the closing level to be more important than the open, high, or low. By paying attention to only the close, price fluctuations within a trading session are ignored.

Here is an example of a line chart for EUR/USD:

Line Chart - Type of Forex Chart

Bar Chart

Unfortunately, this is not a chart at a bar.

A bar chart is a little more complex. It shows the opening and closing prices, as well as the highs and lows.

Bar charts help a trader see the price range of each period.

OLHC Price Bar - Forex Chart

Bars may increase or decrease in size from one bar to the next, or over a range of bars.

 

The bottom of the vertical bar indicates the lowest traded price for that time period, while the top of the bar indicates the highest price paid.

 

The vertical bar itself indicates the currency pair’s trading range as a whole.

As the price fluctuations become increasingly volatile, the bars become larger. As the price fluctuations become quieter, the bars become smaller.

The fluctuation in bar size is because of the way each bar is constructed. The vertical height of the bar reflects the range between the high and the low price of the bar period.

The price bar also records the period’s opening and closing prices with attached horizontal lines.

The horizontal hash on the left side of the bar is the opening price, and the horizontal hash on the right side is the closing price.

Here is an example of a bar chart for EUR/USD:

OLHC Chart - Type of Forex Chart

Take note, throughout our lessons, you will see the word “bar” in reference to a single piece of data on a chart.

A bar is simply one segment of time, whether it is one day, one week, or one hour.

When you see the word ‘bar’ going forward, be sure to understand what time frame it is referencing.

Bar charts are also called “OHLC” charts because they indicate the Open, the High, the Low, and the Close for that particular currency pair.

A big difference between a line chart and an OHLC (open, high, low, and close) chart is that the OHLC chart can show volatility.

Here’s an example of a price bar again:

OLHC Price Bar - Forex ChartOpen: The little horizontal line on the left is the opening price

High: The top of the vertical line defines the highest price of the time period

Low: The bottom of the vertical line defines the lowest price of the time period

Close: The little horizontal line on the right is the closing price

Candlesticks Charts

The candlestick chart is a variation of the bar chart.

Candlestick charts show the same price information as a bar chart but in a prettier, graphic format.

Many traders like this chart because not only is it prettier, but it’s easier to read.

Candlestick

Candlestick bars still indicate the high-to-low range with a vertical line.

However, in candlestick charting, the larger block (or body) in the middle indicates the range between the opening and closing prices.

Candlesticks help visualize bullish or bearish sentiment by displaying “bodies” using different colors.

Traditionally, if the block in the middle is filled or colored in, then the currency pair closed LOWER than it opened.

In the following example, the ‘filled color’ is black. For our ‘filled’ blocks, the top of the block is the opening price, and the bottom of the block is the closing price.

If the closing price is higher than the opening price, then the block in the middle will be “white” or hollow or unfilled.

Candlestick Price Bar - Forex Chart

Here at BabyPips.com, we don’t like to use traditional black and white candlesticks. They just look so unappealing.

And since we spend so much time looking at charts, we feel it’s easier to look at a chart that’s colored.

Color television is much better than a black and white television, so why not splash some color on those candlestick charts?

 

We simply substituted green instead of white, and red instead of black. This means that if the price closed higher than it opened, the candlestick would be green.

 

If the price closed lower than it opened, the candlestick would be red.

In our later lessons, you will see how using green and red candles will allow you to “see” things on the charts much faster, such as uptrend/downtrends and possible reversal points.

For now, just remember that on forex charts, we use red and green candlesticks instead of black and white and we will be using these colors from now on.

Check out these candlesticks…BabyPips.com style! Awww yeeaaah! You know you like that!

Colored Candlestick Price Bar - Forex Chart

Here is an example of a candlestick chart for EUR/USD. Isn’t it pretty?

Candlestick Chart - Type of Forex Chart

The purpose of candlestick charting is strictly to serve as a visual aid since the exact same information appears on an OHLC bar chart.

The advantages of candlestick charting are:

  • Candlesticks are easy to interpret and are a good place for beginners to start figuring out chart analysis.
  • Candlesticks are easy to use! Your eyes adapt almost immediately to the information in the bar notation. Plus, research shows that visuals help with studying, so it might help with trading as well!
  • Candlesticks and candlestick patterns have cool names such as the “shooting star,” which helps you to remember what the pattern means.
  • Candlesticks are good at identifying market turning points – trend reversals from an uptrend to a downtrend or a downtrend to an uptrend. You will learn more about this later.

There are many different types of charts available, and one is not necessarily better than the other.

The data may be the same to create the chart but the way that data is presented and interpreted will vary.

Each chart will have its own advantages and disadvantages. You can choose any type or use multiple types of charts for technical analysis. It all depends on your personal preference.

Now that you know why candlesticks are so cool, it’s time to let you know that we will be using candlestick forex charts for most, if not all of forex chart examples on this site.

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what is Sentiment Analysis?

Earlier, we said that price action should theoretically reflect all available market information. Unfortunately for us forex traders, it isn’t that simple.

The forex markets do not simply reflect all of the information out there because traders will all just act the same way. Of course, that isn’t how things work.

 

This is why sentiment analysis is important. Each trader has his or her own opinion of why the market is acting the way it does and whether to trade in the same direction of the market or against it.

 

The market is just like Facebook – it’s a complex network made up of individuals who want to spam our news feeds.

 

Kidding aside, the market basically represents what all traders – you, Warren Buffet, or Celine from the donut shop – feel about the market.

Each trader’s thoughts and opinions, which are expressed through whatever position they take, helps form the overall sentiment of the market regardless of what information is out there.

The problem is that as retail traders, no matter how strongly you feel about a certain trade, you can’t move the forex markets in your favor.

 

Even if you truly believe that the dollar is going to go up, but everyone else is bearish on it, there’s nothing much you can do about it (unless you’re one of the GSs – George Soros or Goldman Sachs!).

 

As a trader, you have to take all this into consideration. You need to perform sentiment analysis.

It’s up to you to gauge how the market is feeling, whether it is bullish or bearish.

If you choose to simply ignore market sentiment, that’s your choice. But hey, we’re telling you now, it’s your loss!

 

Sentiment analysis is often used as a contrarian indicator.

There are a couple of ideas why this is.

One idea behind this is if EVERYONE (or almost everyone) shares the SAME sentiment, then it’s time to go hipster and trade against the popular sentiment.

For example, if everyone and their mamas are bullish EUR/USD, then it might be time to go short.

Why? Unfortunately, you’ll have to go further down the School to find out! Ha!

Another idea is that most retail forex traders (unfortunately) suck. Depending on where you find statistics, between 70-80% of retail traders lose money.

So if you know that these all these unprofitable traders who are usually wrong are all currently long EUR/USD….well, theeeeeen. 🤔

It might be a good idea to do the opposite of what they do!

Being able to gauge market sentiment aka sentiment analysis can be an important tool in your toolbox.

Later on in school, we’ll teach you how to analyze market sentiment and use it to your advantage, like Jedi mind tricks.

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what is Fundamental Analysis?

Whereas technical analysis involves poring over charts to identify patterns or trends, fundamental analysis involves poring over economic data reports and news headlines. (And even random tweets from a certain world leader before he was banned.)

Fundamental analysis is a way of looking at the forex market by analyzing economic, social, and political forces that may affect currency prices.

If you think about it, this makes a whole lot of sense! Just like in your Economics 101 class, it is supply and demand that determines price, or in our case, the currency exchange rate.

 

Using supply and demand as an indicator of where price could be headed is easy. The hard part is analyzing all of the factors that affect supply and demand.

 

In other words, you have to look at different factors to determine whose economy is rockin’ like a BLACKPINK song, and whose economy sucks.

You have to understand the reasons why and how certain events like an increase in the unemployment rate affect a country’s economy and monetary policy which ultimately, affects the level of demand for its currency.

The idea behind this type of analysis is that if a country’s current or future economic outlook is good, its currency should strengthen.

The better shape a country’s economy is, the more foreign businesses and investors will invest in that country. This results in the need to purchase that country’s currency to obtain those assets.

In a nutshell, this is what fundamental analysis is:

Forex Fundamental Analysis
For example, let’s say that the U.S. dollar has been gaining strength because the U.S. economy is improving.

 

As the economy gets better, raising interest rates may be needed to control growth and inflation.

 

Higher interest rates make dollar-denominated financial assets more attractive.

In order to get their hands on these lovely assets, traders and investors have to buy some U.S. dollars first. This increases demand for the currency.

As a result, the value of the U.S. dollar will likely increase against other currencies with lesser demand.

Later on in the course, you will learn which economic data points tend to drive currency prices, and why they do so.

 

 

To be able to use fundamental analysis, it is essential to understand how economic, financial, and political news will impact currency exchange rates.

This requires a good understanding of macroeconomics and geopolitics.

 

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What is Technical Analysis?

The theory is that a person can look at historical price movements and determine the current trading conditions and potential price movement.

Someone who uses technical analysis is called a technical analyst. Traders who use technical analysis are known as technical traders.

 

The main evidence for using technical analysis is that, theoretically, all current market information is reflected in the price.

 

Technical traders generally ascribe to the belief that “It’s all in the charts!”

This simply means that all known fundamental information is priced into the current market price.

If price reflects all the information that is out there, then price action is all one would really need to make a trade.

Technical analysis looks at the rhythm, flow, and trends in price action.

Now, have you ever heard the old adage, “History tends to repeat itself“?

Well, that’s basically what technical analysis is all about!

If a certain price held as a major support or resistance level in the past, forex traders will keep an eye out for it and base their trades around that historical price level.

Technical analysts look for similar patterns that have formed in the past and will form trade ideas believing that price could possibly act the same way that it did before.

Technical analysis is NOT so much about prediction as it is about PROBABILITY. 

Technical analysis is the study of historical price action in order to identify patterns and determine probabilities of the future direction of price.

Technical analysis: Price unable to break support and resistance levels

So how the heck does one “study historical price action“?

In the world of trading, when someone says “technical analysis”, the first thing that comes to mind is a chart.

 

Technical analysts use charts because they are the easiest way to visualize historical data!

 

Technical analysts live, eat, and breathe charts which is why they are often called chartists.

You can look at past data to help you spot trends and patterns which could help you find some great trading opportunities.

What’s more is that with all the traders who rely on technical analysis out there, these price patterns and indicator signals tend to become self-fulfilling.

As more and more forex traders look for certain price levels and chart patterns, the more likely it that these patterns will manifest themselves in the markets.

You should know though that technical analysis is VERY subjective.

Just because Michelangelo, Donatello, Leonardo, and Raphael are looking at the exact same chart setup or indicators doesn’t mean that they will come up with the same idea of where price may be headed.

 

The important thing is that you understand the concepts under technical analysis so you won’t get nosebleeds whenever somebody starts talking about Fibonacci, Bollinger Bands, or pivot points.

Now we know you’re thinking to yourself, “Geez, these guys are smart. They use crazy words like ‘Fibonacci’ and ‘Bollinger’. I can never learn this stuff!”

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3 Types of Forex Market Analysis

There are three types of market analysis:

 

  1. Technical Analysis
  2. Fundamental Analysis
  3. Sentiment Analysis

There has always been a constant debate as to which analysis is better, but to tell you the truth, you need to know all three.

Three types of forex market analysis

It’s kind of like standing on a three-legged stool.

If one of the legs is weak, the stool will break under your weight and you’ll fall flat on your face.

The same holds true in trading.

Oh, wait. Since the stool is supposed to represent how a trader goes about thinking and analyzing the market, it’s missing a brain.

But wait! The stool needs more brains!

There technically should be three brains….to represent the three different types of thought process…

Three Typess to Analyze Markets

Ahhh. There we go.

You need to have three “brains” when thinking about the market.

If your analysis on any of the three types of analysis is weak and you ignore it, there’s a good chance that it will cause you to lose out on your trade!

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What is a Spread in Forex Trading?

,

The difference between these two prices is known as the spread.

Also known as the “bid/ask spread“.

The spread is how “no commission” brokers make their money.

Instead of charging a separate fee for making a trade, the cost is built into the buy and sell price of the currency pair you want to trade.

From a business standpoint, this makes sense. The broker provides a service and has to make money somehow.

  • They make money by selling the currency to you for more than they paid to buy it.
  • And they also make money by buying the currency from you for less than they will receive when they sell it.
  • This difference is called the spread.

It’s just like if you were trying to sell your old iPhone to a store that buys used iPhones. (A smartphone with only two rear cameras? Yuck!)

Price Spread

In order to make a profit, it will need to buy your iPhone at a price lower than the price it’ll sell it for.

If it can sell the iPhone for $500, then if it wants to make any money, the most it can buy from you is $499.

That difference of $1 is the spread.

So when a broker claims “zero commissions” or “no commission”, it’s misleading because while there is no separate commission fee, you still pay a commission.

It’s just built into the bid/ask spread!

How is the Spread in Forex Trading Measured?

The spread is usually measured in pips, which is the smallest unit of the price movement of a currency pair.

For most currency pairs, one pip is equal to 0.0001.

An example of a 2 pip spread for EUR/USD would be 1.1051/1.1053.

Bid, Ask and Spread Example

Currency pairs involving the Japanese yen are quoted to only 2 decimal places (unless there are fractional pips, then it’s 3 decimals).

For example, USD/JPY would be 110.00/110.04. This quote indicates a spread of 4 pips.

What Types of Spreads are in Forex?

The type of spreads that you’ll see on a trading platform depends on the forex broker and how they make money.

There are two types of spreads:

  1. Fixed
  2. Variable (also known as “floating”)

Fixed vs. Variable Spreads

Fixed spreads are usually offered by brokers that operate as a market maker or “dealing desk” model while variable spreads are offered by brokers operating a “non-dealing desk” model.

What are Fixed Spreads in Forex?

Fixed spreads stay the same regardless of what market conditions are at any given time. In other words, whether the market is volatile like Kanye’s moods or quiet as a mouse,  the spread is not affected. It stays the same.

 

Fixed spreads are offered by brokers that operate as a market maker or “dealing desk” model.

 

Using a dealing desk, the broker buys large positions from their liquidity provider(s) and offers these positions in smaller sizes to traders.

This means that the broker acts as the counterparty to their clients’ trades.

By having a dealing desk, this allows the forex broker to offer fixed spreads because they are able to control the prices they display to their clients.

What are the Advantages of Trading With Fixed Spreads?

Fixed spreads have smaller capital requirements, so trading with fixed spreads offer a cheaper alternative for traders who don’t have a lot of money to start trading with.

Trading with fixed spreads also makes calculating transaction costs more predictable. Since spreads never change, you’re always sure of what you can expect to pay when you open a trade.

What are the Disadvantages of Trading With Fixed Spreads?

Requotes can occur frequently when trading with fixed spreads since pricing is coming from just one source (your broker).

And by frequently, we mean almost as frequently as Instagram posts from Kardashian sisters!

 

There will be times when the forex market is volatile and prices are rapidly changing. Since spreads are fixed, the broker won’t be able to widen the spread to adjust for current market conditions.

 

So if you try to enter a trade at a specific price, the broker will “block” the trade and ask you to accept a new price. You will be “re-quoted” with a new price.

The requote message will appear on your trading platform letting you know that price has moved and asks you whether or not you are willing to accept that price. It’s almost always a price that is worse than the one you ordered.

Slippage is another problem. When prices are moving fast, the broker is unable to consistently maintain a fixed spread and the price that you finally end up after entering a trade will be totally different than the intended entry price.

Slippage is similar to when you swipe right on Tinder and agree to meet up with that hot gal or guy for coffee and realize the actual person in front of you looks nothing like the photo.

What are Variable Spreads in Forex?

As the name suggests, variable spreads are always changing. With variable spreads, the difference between the bid and ask prices of currency pairs are constantly changing.

 

Variable spreads are offered by non-dealing desk brokers. Non-dealing desk brokers get their pricing of currency pairs from multiple liquidity providers and pass on these prices to the trader without the intervention of a dealing desk.

 

This means they have no control over the spreads. And spreads will widen or tighten based on the supply and demand of currencies and the overall market volatility.

Typically, spreads widen during economic data releases as well as other periods when the liquidity in the market decreases (like during holidays and when the zombie apocalypse begins).

Wide Forex Broker Spread

For example, you may want to buy EURUSD with a spread of 2 pips, but just when you’re about to click buy, the U.S. unemployment report is released and the spread rapidly widens to 20 pips!

Oh, and spreads may also widen when Trump randomly tweets about the U.S. dollar when he was still the President.

What are the Advantages of Trading With Variable Spreads?

Variable spreads eliminate experiencing requotes. This is because the variation in the spread factors in changes in price due to market conditions.

(But just because you won’t get requoted doesn’t mean you won’t experience slippage.)

Trading forex with variable spreads also provides more transparent pricing, especially when you consider that having access to prices from multiple liquidity providers usually means better pricing due to competition.

What are the Disadvantages of Trading With Variable Spreads?

Variable spreads aren’t ideal for scalpers. The widened spreads can quickly eat into any profits that the scalper makes.

Variable spreads are just as bad for news traders. Spread may widen so much that what looks like a profitable can turn into an unprofitable within a blink of an eye.

Fixed vs Variable Spreads: Which is Better?

The question of which is a better option between fixed and variable spreads depends on the need of the trader.

There are traders who may find fixed spreads better than using variable spread brokers. The reverse may also be true for other traders.

Generally speaking, traders with smaller accounts and who trade less frequently will benefit from fixed spread pricing.

And traders with larger accounts who trade frequently during peak market hours (when spreads are the tightest) will benefit from variable spreads.

Traders who want fast trade execution and need to avoid requotes will want to trade with variable spreads.

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How to Avoid a Margin Call

If you fail to understand the concept of margin or not knowing what to do when faced with a margin call from your broker, you will definitely experience the shock of your trading account blow up.

Here are five ways to avoid a margin call.

1. Know WTF a margin call is.

Understanding what margin call is and how it works is the first step in knowing how to avoid one.

 

Most new traders want to focus on other details of trading such as technical indicators or chart patterns, but little thought is given to the other important elements such as margin requirements, equity, used margin, free margin, and margin levels.

 

If you’re hit with a margin call out of the blue, this usually means you have no clue what causes a margin call and are opening trades without considering margin requirements.

If this is you, you are doomed to fail as a trader. Guaranteed.

A margin call occurs when your account’s Margin Level has fallen below the required minimum level. At this point, your broker will notify you and demand that you deposit more money in your account to meet the minimum margin requirements.

Nowadays, this process is automated so your broker will probably notify you by email or text rather than receiving an actual phone call.

2. Know what the margin requirements are even before you place ANY order.

Knowing the margin requirements BEFORE you open a trade is crucial.

 

The concept of margin call isn’t thought about much by most traders, especially when they are placing pending orders with their broker.

 

Typically, traders tend to place an order with their broker and it remains open until the limit price is reached or until the pending order expires.

When you place a pending order, your trading account is not affected because margin is not applied to pending orders.

However, this exposes you to the risk of the pending order being automatically filled.

 

If you’re not properly monitoring your margin level, when this order gets filled, it could result in a margin call.

 

In order to avoid such a situation, you need to consider margin requirements before placing an order.

You have to account for the margin amount that will be deducted from your free margin, as well as having some additional margin so your trade will have some breathing room.

When you have multiple pending orders open, it can get quite confusing and if you’re not careful, these orders could result in a margin call.

To avoid such a tragedy, it’s crucial that you understand the margin requirements for each position you plan to enter.

3. Use stop loss orders or trailing stops to avoid margin calls.

If you don’t know what a stop loss order is, you’re on your way to losing a lot of money.

As a refresher though, a stop loss order is basically a stop order sent to the broker as a pending order. This order is triggered when the price moves against your trade.

 

For example, if you were long 1 mini lot on USD/JPY at 110.50, and you set your stop loss at 109.50.

 

This means that when USD/JPY falls to 109.50, your stop order is triggered and your long position is closed for a loss of 100 pips or $100.

If you traded WITHOUT a stop loss order and USDJPY continued to fall, at some point, depending on how much money you have in your account, you would trigger a margin call.

A stop loss order or a trailing stop order prevents you from taking on further losses, which helps prevent getting a margin call.

4. Scale in positions rather than entering all at once.

Another reason why some traders end up with a margin call is that they misjudge price movement.

For example, you think GBP/USD has gone up way too high and too fast and you believe that there is no way price can go higher, so you open a HUGE short position.

This type of overconfident trading increases the probability of triggering a margin call.

To avoid this, one approach is to build a trade position, also known as “scaling in”.

Instead of trading with 4 mini lots right off the bat, start off with 1 mini lot. Then add or “scale in” to the position as the price moves in your favor.

 

While you continue adding new positions, you can also start moving the stop losses on the previous positions to reduce potential losses or even lock in profits.

Position scaling can help you magnify your profits while trading risk-free when you combine all the positions.

While this usually means that you’ll have to allocate more capital towards the larger margin requirement, scaling in positions at different price levels and using different stop loss levels means that your risk of losses on the trade is spread out which lowers the probability of a margin call (when compared to opening one big position size all at once).

5. Know WTH you are doing as a trader.

It’s not uncommon to hear about noob traders who are hit with a margin call and don’t know what the hell happened.

These traders are the types of traders who are just focused on how much money they can make and don’t know what the hell they are doing and don’t fully understand the risks of trading.

Don’t be that trader.

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The Relationship Between Margin and Leverage

What is the relationship between Margin and Leverage?

You use margin to create leverage.

Leverage is the increased “trading power” that is available when using a margin account.

Leverage allows you to trade positions LARGER than the amount of money in your trading account.

Leverage is expressed as a ratio.

Leverage is the ratio between the amount of money you really have and the amount of money you can trade.

It is usually expressed with an “X:1” format.

For example, if you wanted to trade 1 standard lot of USD/JPY without margin, you would need $100,000 in your account.

But with a Margin Requirement of just 1%, you would only have to deposit $1,000 in your account.

The leverage provided for this trade would be 100:1.

Here are examples of Leverage Ratios depending on the Margin Requirement:

Currency Pair Margin Requirement Leverage Ratio
EUR/USD 2% 50:1
GBP/USD 5% 20:1
USD/JPY 4% 25:1
EUR/AUD 3% 33:1

Here’s how to calculate Leverage:

Leverage = 1 / Margin Requirement

For example, if the Margin Requirement is 2%, here’s how to calculate leverage:

50 = 1 / .02

The leverage is 50, which is expressed as a ratio, 50:1

Here’s how to calculate the Margin Requirement based on the Leverage Ratio:

Margin Requirement = 1 / Leverage Ratio

For example, if the Leverage Ratio is 100:1, here’s how to calculate the Margin Requirement.

0.01 = 1 / 100

The Margin Requirement is 0.01 or 1%.

As you can see, leverage has an inverse relationship to margin.

“Leverage” and “margin” refer to the same concept, just from a slightly different angle.

 

When a trader opens a position, they are required to put up a fraction of that position’s value “in good faith”. In this case, the trader is said to be “leveraged”.

 

The “fraction” part which is expressed in percentage terms is known as the “Margin Requirement”. For example, 2%.

The actual amount that is required to be put up is known as the “Required Margin”.

For example, 2% of a $100,000 position size would be $2,000.

The $2,000 is the Required Margin to open this specific position.

Since you are able to trade a $100,000 position size with just $2,000, your leverage ratio is 50:1.

Leverage = 1 /Margin Requirement

50 = 1 / 0.02

Margin vs. Leverage

Forex Margin vs. Securities Margin

Forex margin and securities margin are two very different things. Understanding the difference is important.

In the securities world, margin is the money you borrow as a partial down payment, usually up to 50% of the purchase price, to buy and own a stock, bond, or ETF.

This practice is often referred to as “buying on margin”.

So if you’re trading stocks on margin, you’re borrowing money from your stock broker to purchase stock. Basically, a loan from the brokerage firm.

In the forex market, margin is the amount of money that you must deposit and keep on hand with your trading platform when you open a position.

It is NOT a down payment and you do NOT own the underlying currency pair.

Margin can be looked at as a good faith deposit or collateral that’s used to ensure each party (buyer and seller) can meet their obligations of the agreement.

Unlike margin in stock trading, margin in forex trading is not borrowed money.

When trading forex, nothing is actually being bought or sold, only the agreement (or contract) to buy or sell are exchanged, so borrowing is not needed.

The term “margin” is used across multiple financial markets. However, there is a difference between how margin is used when trading securities versus when trading forex. Understanding this difference is essential prior to trading forex.

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