Tag: stock options

Forex Trading; Constructing a Spread position

 

WHATS KILLING MY PROFITS?   There are many things that eat away at investors profits.  Most all of them are avoidable.  Of course we cannot control the markets movements, neither its direction nor how far it moves, but we dont have to.  We know the market moves.  For the most part a currency pair will constantly be moving up and down, unless there is a huge national event in a country.  Even then, the currency will move back the other way again.

     One of the biggest killers of profits that I have seen is the use of “strategies” when investing in Forex.  I have an entire article on strategies, so this one will focus on the use of spreads.  Many times investors will attempt to use strategies from other investment vehicles (i.e. stocks, options, futures, etc.) in the Forex market.  Although these can be adapted to work they often are not.  Most investors simply take a proven formula for trading from one investment vehicle to another and they lose money.  

     Spreads are no different.  

WHAT IS A SPREAD?  The concept is easy, the definition of a spread is:  Options spreads are the basic building blocks of many options trading strategies. A spread position is entered by buying and selling equal number of options of the same class on the same underlying security but with different strike prices or expiration dates.

 

 

     Many Forex traders have never traded options and dont truly understand how they work.  A spread in an option position means that you bet on two sides, up and down.  This strategy depends on only one thing to win, volatility.  When the market moves a good amount in either direction the option holder can make money.  This is a Very simple definition of a quite complex trading strategy.

     When you apply a spread to Forex you get a buy and sell on the same currency pair.  So you would place a buy and a sell order on the same currency pair, hoping for volatility, the price to fluctuate up and down.  This typically happens every trading day on many different currency pairs.  So why do so many investors lose money with this strategy?  Because they dont adjust the “buy in” position rules to fit Forex trading.   Meaning, they enter the trade in the wrong way, incorrectly constructing a spread for Forex.

     HOW TO CONSTRUCT A SPREAD;  A very simple example is this:  when you construct a spread position on a stock option you will enter a buy and sell order, and those will typically be at different strike prices (target price).  When you apply that same principle to a currency pair the entire dynamic is changed!  Because there is a whole other element that needs considered that you Don’t have with an Option spread, and that is entry price.  I am trying to keep this very simple while explaining very complex actions.  You see, when you sell an option contract (as when building a spread position) you actually Recieve money in your account (because it not only represents your short,bearish, belief of the underlying asset (same as the forex sell),  you Actually literally sell something).  In Forex you do Not get a payment for a “selling” a currency pair.

When you sell an option, you will actually instantly receive the limit price in your account.  

 

That would be buying abc/def currency pair at 107.468 and selling at at 107.348 as an example.  The one part we havnt considered yet is where we buy in at.  This one simple piece can make all the difference in you loosing or making moneu on a trade.  

WHERE DO YOU BUY IN AT?  The key to making money on these swing trades is to buy in right. In the Forex world buying “in the money” on a spread means to overlap the prices where you buy and sell your opening position.  Here below you see an example to make it clear.

 

 

So as you can see from the real spread position above, I entered the spread trade “in the money”, meaning I constructed my spread for optimal profit and probability of profit.  

IN THE MONEY;  In Forex entering a position in the money means buying at a higher price than your selling price.  As you see in the screenshot above, I bought a currency pair, and sold the same currency pair, “in the money”.  You can see that an in the money spread is truly in the money, meaning in the profit at the same time!  Both the buy and sell orders are Both in the profit at the same time.  This is a proper Spread.  Of course the further in the money you enter, the safer and more profitable it will be.  This can be easily done by using “limit” buy and sell orders.