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2011-11-25 10:49:34
Posted: Oct 4, 2009
Because forex (FX) is a decentralized market in which dealers disseminate their
own price feeds through proprietary trading platforms, it is crucial to learn
the features and idiosyncrasies of each type of trading software before
committing real funds to an account. Fortunately, in retail, FX traders can
test out each platform using demo dollars. Every reputable dealer in FX allows
potential customers to download a free demo version of its software. This is
critical if the customer is to become acquainted with the platform's layout and
the means of order entry. Here we'll discuss the importance of demo trading and
let you know what you should look out for when trying different platforms. (If
this seems a little over your head, check out our Forex Walkthrough Charts,
Economics, Trading, or you could start at Beginner.)
Basic vs. Integrated Platforms
Looking at the following screen images, you can see how some platforms
integrate everything from charting to news, while others have very simple
layouts that focus only on price quotes, order entry and reporting.
Figure 1 - A very straightforward platform from FXCM. The primary focus is on
execution - quotes, positions and account balances are all clearly marked and
visible.
Figure 2 - A more integrated platform from Oanda that tries to combine quotes,
charts and account balances all on one screen.
Figure 3 - Another integrated platform, this time from FX Solutions, that
squeezes a trade summary, quotes and market news headlines all into one screen.
Placing Orders
As a trader, you should always try out dealer demos before trading live - it's
the only way to become familiar with the different features of various
platforms. For example, some platforms simply use pop-up tickets, while others
actually mark the order location on the chart. Typically, to buy a currency
pair, you simply click on the offer part of the quote (the ask), and to sell,
you click on the bid part. Some platforms allow you to choose market or limit
orders after the quote window pops up, while others force you to make your
selection beforehand. (For more information on placing orders, see The Basics
Of Order Entry.)
It's a good idea to place at least 20 demo trades on each platform before
trading actual money, just so you can master the specifics of order entry on
each platform. A trader should never trade live unless he or she can
confidently answer all of the following questions:
How do I place a limit order?
How do I set a stop?
Can I set a limit and a stop at the time of entry?
Are the spreads on the platform fixed or variable?
What is the lot size that I can trade (1,000 units, 10,000 units, 100,000
units)?
Can I mix and match the lot sizes?
Can I call the dealing room directly if my internet connection goes down?
Figure 4 - A simple market order ticket on the FX Solutions platform that
clearly shows that the user is selling 1 lot of GBP/USD.
Figure 5 - An example of an order ticket on the FXCM platform that allows the
trader to attach stop and limit parameters to a market buy order of EUR/USD.
Figure 6 - From the Oanda platform, a limit order in EUR/USD that quotes all
the way to five decimal places (i.e. 1/1000th of a penny!) and automatically
makes the order good for a week.
The Taxman Cometh
One function that most new FX traders overlook is tax reporting. Because FX is
a global, unregulated market, dealers as a general rule do not provide any
documentation to the tax authorities in the trader's country of residence. Tax
reporting is solely the responsibility of the trader. Dealers simply produce
detailed transaction histories - in an electronic format - from which the
traders must then compile their own tax reports. Such an arrangement clearly
calls for a trading platform with highly organized and flexible reporting
functions. But reporting quality varies greatly from dealer to dealer: all
dealers will provide you with a full transaction report, but how those
transactions are laid out could mean the difference between spending hundreds
of hours on reconciliation or taking one minute to print out a final report to
present to your accountant. Note the different approaches to reporting in the
following platforms:
Figures 7 and 8 - Note how the FXCM platform elegantly separates closed trades,
outstanding orders and floating positions and then tidily summarizes all the
key activity in an account summary.
Figure 9 - The Oanda platform requires the trader to do his/her own trade
reconciliation.
Some FX traders may generate as many as 1,000 trades in a year. A platform that
reconciles all those trades into an easy-to-understand, end-of-year income
statement, breaking down all profits and expenses, can be invaluable.
Reporting, though hardly the glamorous part of FX trading, is a crucial part of
a trader's personal record keeping and can have significant tax ramifications.
Tax treatment of currency trading is very much dependent on the individual's
tax status. Most dealers will not advise you regarding tax matters, nor should
you take their advice if they do, because they lack the expertise to deal with
the multitude of tax authorities around the world. You should always consult
with a tax professional before choosing a course of action.
A final note on taxes and reporting: as you try out the various dealers'
platforms, you will find that certain functions are common across most
software. The devil is in the details, which can determine the difference
between profits and losses.
Trade Like It's Real
Once you have mastered the mechanics, you can use the demo platform to
experiment with various trade sizes and styles and determine your trading
personality. Are you a short-term momentum trader who likes high leverage and
tries to capture 20-30 point intraday moves? Or do you prefer using smaller
sizes to hold longer-term positions that could potentially yield hundreds of
points? Demo trading can help you discover what type of trading suits you best.
Always remember, however, that demo trading is in no way similar to trading
real money. You may be perfectly calm about sustaining a $10-million loss with
fake money, but might become completely unhinged over a $100 loss in your real
account. To make demo trading as productive as possible, you need to trade the
demo account as though the money were real. For example, if you plan on funding
your real account with $5,000, don't trade a demo account that has $100,000.
The thrill of a $1-million trade can give you a temporary high, but it will
only hurt when you have to transition to a real account, because you will have
no sense of proportion and will likely make drastic errors in judgment.
Conclusion
Even after you decide to trade live, demo trading can be very valuable. Many
successful traders will test strategies and set-ups on practice accounts before
they try them out with real money. Although demo trading will not guarantee you
profits in real life, almost all traders agree that if you cannot first achieve
success on a demo, you are almost certain to fail in your live account. This is
why demo trading is vital to the growth and development of all FX traders.
For further reading, take a look at our Forex Walkthrough.
by Boris Schlossberg