Guide to Forex Trading
Introduction to the foreign exchange market
The Foreign Exchange Market, i.e. FOREX or FX for short, is one of the most lucrative markets in the world. Over $5 trillion USD is traded in a single day… Compare that to the world’s largest stock exchange (The New York Stock Exchange, NYSE) which trades roughly $169 billion USD a day. You can see by those numbers how highly liquid The Foreign Exchange Market is. Therefore, providing an immense amount of opportunities for investors and traders alike.
The FX Market is open 24 hours a day, five days a week, spanning across three major time zones: Asian Session (Tokyo Exchange), European Session (London Exchange), North American Session (New York Exchange).
Apart from significant bank holidays (Christmas/Thanksgiving) and other institutional breaks, respective of each county, it is rare for The Forex Market to be closed.
What exactly is Forex?
Established approximately 500 years ago in Amsterdam, The Foreign Exchange Market is a decentralized market for buying and selling international currencies arranged and traded in pairs.
What are ‘pairs’?
Since FX is the simultaneous act of buying and selling currencies, two separate currencies are needed to place a trade. 8 major currencies take up a majority of today’s market, due to extensive international use and relative strength:
1) United States Dollar, USD
2) European Union Euro, EUR
3) Japanese Yen, JPY
4) Great Britain Pound, GBP
5) Australia Dollar, AUD
6) Canadian Dollar, CAD
7) Swiss Franc, CHF
8) New Zealand Dollar, NZD
The Major Pairs:
In Forex, a currency is the abbreviation of the country’s name and currency designation. Combined in pairs it is written, for example, as EUR/USD (European Union Euro/ United States Dollar).
4 of the most popularly traded pairs are:
Commodity (minor) Pairs:
Commodity Pairs/Commodity Currencies include the USD and are heavily correlated by the fluctuations in goods, particularly that of gold (AUD and NZD) and crude oil (CAD). Although highly watched as well, these ‘minor’ commodity pairs are:
1) AUD/USD (gold)
2) USD/CAD (oil)
3) NZD/USD (gold)
In total, these seven pairs accumulate for over 70% of the market volume with EUR/USD being the most actively traded.
Historically, if a trader in Britain wanted to trade the Japanese Yen, or GBP/JPY, a conversion to USD and back into GBP would have to occur. After World War II, with the rise of Western economies and advancement in trading technology, the need to incorporate USD in every trade was not required.
A cross-currency pair is where the American Dollar is not involved. For example, GBP/JPY can be traded directly without having to convert to USD. Other examples may include EUR/GBP, EUR/JPY, EUR/CHF, etc.
With 180 individual currencies, it can become overwhelming, which is why many traders stick to the “major 8”. Unlike the majors, ‘minor’ commodities or cross-currency pairs, exotic currencies are those of emerging markets – countries that have characteristics of a “developed” market but do not meet the standards of one. (https://en.wikipedia.org/wiki/Emerging_markets)
If you’re feeling a little adventurous and want to trade USD/GEL (Georgian Lari), potential risks to the tune of higher fees, less liquidity, limited trading, and inconsistency in market behavior are a few reasons to trade more favoured pairs. Sticking to the major and minor pairs are advantageous to any new (and experienced) FX trader. (https://www.oanda.com/currency/help/exotic-currencies)
ANATOMY OF A TRADE:
The left side of a pair is the BASE currency, always equal to 1, which the trader plans to sell or buy, while the right side of the pair is the QUOTE or counter currency.
Being that EUR/USD is the most widely traded pair, let’s use this major as our example. EUR is the base currency. USD is the quote currency.
For the sake of illustration, let’s say: EUR/USD = 1.4444
1 EUR is equal to having 1.4444 USD.
If we need to exchange (or buy) $1000 US Dollars for a trip, it would only require 692.52 Euros. We are technically selling Euros and buying US dollars which happens simultaneously in the FX market.
The act of buying is to LONG a trade.
If the market reveals strength in EUR/USD and price has room to move up, then there is a bullish bias. Multiple moves upward would consider the pair to be in an overall Bull market.
The act of selling is to SHORT a trade.
If the market reveals weakness in EUR/USD and price has room to move down, then there is a bearish bias. Multiple moves downward would consider the pair to be in an overall Bear market.
To expand, if we sell EUR/USD at 1.4444 and price drops to 1.4400 upon the exit of the trade, there is a 44 PIP difference. The difference occurred in our favor resulting in a profit for this specific example of 44 PIPs.
What is a PIP?
PIP means price-in-percentage. Traders make or lose money based on pip differential after closing out a trade. It is the most basic unit of measurement to convey the change of value in a pair.
As an example, 1 pip is the 4th decimal place for most major pairs. In the above EUR/USD example we have mentioned a drop from 1.4444 to 1.4400, that’s a 44 PIP difference.
What is a spread?
The spread is the difference between the ask and bid price.
The ASK price is the number which you can buy the base currency (EUR). Simply, the price a broker is willing to sell the base currency (EUR) for the quote currency (USD). In our EUR/USD example, a broker would sell 1 EUR for 1.4444 USD.
The BID price is the number at which you can sell the base currency (EUR). Simply, the price a broker is willing to purchase the quote currency (USD). In our EUR/USD example, it would be the amount of USD you can buy when selling 1 EUR.
Brokers will often increase the spread based on the liquidity of a pair. Referring back to the previous point of exotic pairs, the spread can be incredibly high. The smaller the spread, the better. These spreads (difference in ASK/BID price) also account for what the broker takes as commision.
What are commissions/fees?
When any trade is initially entered there is a small portion that is taken out for ‘services’ – handling the account and doing calculations when placing a trade. It is a transaction fee charged by the broker. These fees/commission a broker receives, vary. Depending on account size, position, and company with whom you do business, some may charge a flat rate while other brokers may charge a dynamic rate.
What is lot size?
In reference to a trade position in the FX market, a LOT is how much of the base currency in units you are exchanging. There are three different lot sizes:
Standard – equal to 100,000 units of the base currency.
Mini – equal to 10,000 units of the base currency
Micro – equal to 1,000 units of the base currency.
What is leverage?
In FX leverage is used because price moves in very small increments. Therefore, in order to be profitable, one needs to use leverage to place a larger position. Think decimal points here, if you place a position at 1.2828 and it moves to 1.2900 that could be considered a micro-movement. However, currency pairs tend to move exactly like that (in small increments). So leverage is used to actually make money on these small movements.
Leverage for Forex can be offered anywhere between 30:1 – 200:1 (sometimes higher) depending on your specific broker and your country of residence. This means that for every $1000.00, you are placing a $30,000.00 position (based on leverage of 30:1).
Utilizing leverage can allow for more vulnerability to inexperienced traders, as one can risk much more than they can afford to lose, and when not consistent, large over-leveraged positions can wipe out an entire account (hence why trading education is so crucial). It’s very important to be mindful of leverage, as a few mismanaged losses with high leverage has the potential to be catastrophic to a new trader. To be successful, it comes down to elimination of risk while still capturing consistent profits.
Day Trading Vs. Swing Trading
Day Trading: Traders who prefer quick in and out positions. Typically, a trade is executed and closed within a 24hr period – however, it can occasionally run for a couple of days and may even turn into a long-term position if the market presents itself accordingly. In essence, Day Traders capture short-term movements.
Swing Trading: Traders who prefer holding positions for greater periods of time – multiple days, weeks, or months. With this style of trading, more focus is given to the higher time frames (i.e. Daily, Weekly, Monthly etc). In essence, Swing Traders capture long-term movements.
Picking between these two significant styles of trading is up to the trader and the lifestyle they desire. While some like to place a position and simply let it run (swing trading), there are also those who prefer analyzing lower time frames, such as the 4 hour or 1 hour, to capitalize on the daily movements (day trading).
FUNDAMENTAL vs. TECHNICAL Analysis
Fundamental: In regards to stocks, an example of fundamental analysis is that of examining a company’s earnings report or calculating whether a CEO’s public decisions for the company is beneficial or detrimental to overall value. In Forex, Fundamentals may refer to reports of a country’s growth, economic stability, political climate and or a catastrophic event that impacts a currency’s value, to name a few.
As an economic leader, the U.S. NFP is the most notable fundamental impact on the forex market. Delivered once a month, it is a report by the U.S. Bureau of Labor Statistics of employment changes inside the United States.
Be an informed trader: It is wise to understand the risks of trading through high-impact announcements. It is a common practice to consider closing a running position or staying out of the FX market until NFP clears, because it can cause quick, massive spikes in price, making a trade vulnerable to being stopped out before moving in the predicted direction.
Technical: Although both types of analysis (fundamental and technical) can mesh into a single strategy, for new traders, it can be beneficial to begin with technical analysis, which is covered in-depth in Trading MasterClass. Technical analysis at its core is based on price action, candlestick formation, and geometric patterns such as triangles and wedges. Regardless of news, proper technicals can form on any time frame during a trading session and on any currency pair.
Because the FX market is available year round, 24 hours a day, 5 days a week, it offers endless opportunities. It allows traders and investors the ability to work from anywhere in the world with access to a plethora of currencies.