Introduction to Forex by TradersAsset
The Foreign Exchange market is the largest financial market in the world. Foreign Exchange transactions range from personal transactions, such as a tourist exchanging currency at a Bank, to the multi-billion dollar transactions made by large corporate entities and governments for overseas trade and commerce. Forex or FX, as it’s more commonly referred to, are simply the abbreviations for “Foreign Exchange”.
The underlying asset class that this applies to are referred to as “Currencies”. The evolution and availability of online trading technology and global connectivity mean that it’s not just money managers and large institutions that can trade Forex.
Online trading has been available to the public from the late 1990’s, and is commonly referred to as “Retail Forex”. Retail Forex is a purely speculative market where individuals speculate on the interest rates between currencies. No physical transactions actually take place, but the outcomes are very real.
Top 20 Forex Brokers
As global trade increases, so do the number of Forex transactions carried out each day. An example of this is the trading volume within the Forex marketplace, currently reported to be in excess of $4trillion per day. Similarly, the retail markets enjoy a daily trading turnover of up to $100billion each day. This global marketplace for trading currencies is in high demand and operates 24 hours a day, and almost seven days a week. This is made possible due to it being a global electronic communication network (ECN), and not a physical exchange with opening and closing times. The global Forex marketplace can be split into three main regions; North America, Europe and Australasia. Trading begins each week in New Zealand, followed by Sydney, Tokyo, London and finally in New York. There are some overlapping times between territories, and these provide Forex traders with a highly active trading window in which to trade.
The Forex market is open to everyone through the numerous online forex brokers offering access to this global marketplace. All you need to qualify is be over the age of 18, and have the means to make a valid deposit. It’s important at this stage to warn potential traders that there are risks associated with trading in the Forex Markets. You must never risk capital that you cannot afford to lose and you must focus on your trading education to be a successful day trader. Get your strategies right however, and you can make substantial gains, a unique and inspiring example of which is George Soros, famed for making a billion dollars in a single day.
Understanding Forex Trading
Forex can be briefly defined as the exchange or trading of currencies. It is presented in multiple currency pairs such as EUR/USD (Euro/US Dollars). At the heart of currency trading is the exchange rate of each currency. The exchange rate establishes the value of a currency against another, and is determined by numerous macroeconomic variables such as interest rates and national productivity. The continuous fluctuation between the values of currencies is important on retail Forex, as this effects the speculative pricing of each currency pair. Correctly predicting the difference in value between two chosen currencies and then “going long” (buying) or “going short” (selling), is how Forex traders make a profit. Please see below for more definitions to help you understand the terminology used in Forex trading.
Leverage – Leverage within Forex can be defined simply as borrowed funds or a loan provided to traders by their brokers, and is expressed as a ratio. A ratio of 50:1, for example, will signify that you will be able to trade with $50 for every $1 you put up. Forex is a margined product and trading is offered in 100,000 units of a currency (also known as Pips). A trader need only put up a small percentage of the full value of a position to place a trade and benefit from a high leverage. Please note that leverages can amplify both profits and losses and can be risky, however, the risk is significantly reduced with the uses of stop and limit orders. It’s also worth mentioning that currency pricing usually changes by less than 1% within each trading day. We encourage traders to understand how to place risk management orders before they take advantage of the high leverages offered by most Forex brokers.
Pips and Points – Forex pricing and profits are usually referred to in pips. This is an acronym of the term Percentage In Point. A Point is the smallest possible change on the left side of the decimal in a price, for example, in a price of 1.3574, a point is the ‘1’. The value of currency pairing is usually represented with a number to four decimal places. A pip is the smallest movement in that value, or a change of $0.0001 for U.S.-dollar related currency pairs. This is also referred to as 1/100th of 1% or “one basis point”. For example, if the EUR/USD exchange rate is 1.3574, but then moves up to 1.3575 – the value of the pair has climbed by one pip. The exception to this rule is the Yen (¥), which is displayed to two decimal places and the smallest changes will be an increment of 0.01.
Pricing – Each global currency has a three-letter code assigned to it. The first two letters usually depict its country of origin and the third letter usually represents the domestic name of the currency. Examples of this are the GBP for Great British Pound, and AUD for Australian Dollar. All currencies can be paired together, and with the advent of digital currencies, many online brokers provide even more trading possibilities by offering their customers the ability of pairing with Bitcoin (current code: XBT, previously: BTC).
The foreign exchange market presents two currencies against one another, such as EUR/USD for example. The first currency in the pair is known as the Base Currency. This is also known as the Primary Currency, or more commonly as the Bid. The second currency in the pair is known as the Quote Currency. This is also known as the Counter Currency, or more commonly referred to as the Ask. The bid price is the highest price a buyer is willing to pay, and the ask price is the lowest price a seller is willing to accept. The difference between the bid and ask prices is called a Spread, for example if the EUR/USD is dealing at 1.35460/1.35468, the spread is 0.8 pips or 0.00008. The exception to this would be any currencies paired with JPY (Japanese Yen), as they are quoted at just two decimal places. For example, a USD/JPY price of 101.80/101.83 would display a 3 pip spread.
The value of the first currency is always assumed at 1 and the price quoted for the second currency in the pair is the price listed at four or five decimal places. The EUR/USD currency pair with a quoted price of 1.35745 for example, will mean that €1.00 Euro (the base currency), can be purchased for $1.36 USD (the quote currency).
Placing Forex Trades Online
The basic mechanism of a Forex trade is simple. You “Buy” a currency pairing if you believe the base currency will increase in value against the counter currency (ie: when the quote price goes down). Alternatively, you would sell a currency pair if you felt that the base currency would weaken against the counter currency (ie: when the quote price goes up). Forex Trading is a simple way of profiting when the value of currency fluctuates, which it does at every second of the trading day.
There are a multitude of tools, techniques and strategies to consider as a trader. There are also numerous blogs, social media sources and books available to guide and help traders understand how the financial markets work. However, it’s vitally important to understand and conduct a detailed Technical and Fundamental Analysis before you place any Forex trades. Some key factors that influence Forex are political and economic stability, monetary policy, currency intervention and natural disasters. The fundamental analysis will help highlight these and help with both short and long term trading strategies.
Technical Analysis – A technical analysis is a method of forecasting the direction of pricing by using historical market data on price and volume. There are numerous technical analysis charting systems used to spot price trends, such as the Candlestick Technique, Dow Theory or Point and Figures (P&F).
Fundamental Analysis – A fundamental analysis by comparison is very complex and uses multiple economic announcements to gain insight into a currency. These include macroeconomic indicators such as unemployment figures, the Consumer Pricing Index (CPI), the Purchasing Managers Index (PMI), sales on Durable Goods and Retail Sales, to name a few. Forex is a high liquidity marketplace, therefore prices can change rapidly in response to news and short-term events. Forex traders can use these indicators to evaluate countries, and consequently the value of their currencies to help place successful trades.
Key terms to understand when trading Forex:
- Paper Trading – This refers to virtual or simulated trading, usually used for practise purposes. Many Forex brokers offer free demo accounts where new traders can buy and sell currency for a pre-agreed sum of demo funds. The platform will be identical to one a real-money trader will use, but the positions traded are hypothetical and simply keep track of your theoretical trading progress. It is crucial that new traders request demo accounts and practice before risking their own capital. This will provide real-world experience in trading and give you a feel for the features and functionality of broker platform before you deposit real money.
- Price Action – Understanding Price Action is the foundation of every successful trader. This is a highly subjective process, which is why it seems elusive to most traders. It is very simply any movement made by a currency pair and can be analysed by using the Candlestick analysis tools on a chart. It encourages traders to be proactive instead of reactive, and helps them recognise patterns from past trends to apply on future trades.
- Backtesting – Price Action forms the basis of any trading strategy, and is therefore a vital part of becoming an effective trader. Observing successful strategies will provide you with the basis required to create more advanced trading systems and strategies of your own. It is risky to run new trading strategies in real-time. This is where Backtesting comes in, by providing a trader with the opportunity to run simulations of his or her trading strategies on past data. This will help a trader gauge the effectiveness of a strategy, which can then be applied in real-time.
- Stop Loss and Profit Target Orders – Profit Targets and Stop Losses are part of a wider risk management strategy to ensure a trader can maintain a profitable position. A profit target is a predetermined point at which a trader will exit their profitable trade to remain profitable. This can normally be set as a dollar or percentage amount. A stop loss order is the opposite of a profit target order. Whereas the profit loss order ensures that a traders exit whilst still profitable, a stop loss order will automatically exit a trader from a trade that has reached a predetermined level of losses.
Money management is vital to ensure a successful trading career. Making a trade without an exit strategy is highly likely to lead to running losses. Make your first investment, an investment in your own education. Understand and apply these risk management strategies when making trades to keep your trading career consistent and profitable.