Forex Trading Primer

The Basics of FOREX Trading

FOREX trading, in simple terms, involves the buying and selling of international currencies.

Previously, only major banking and trading institutions had access to the FOREX market.

However, advancements in technology have now made it possible for smaller companies and even individuals to engage in online currency trading.

Unlike fixed currency rates, the world’s currency rates follow a floating exchange rate system and are traded in pairs such as EuroDollar, Dollar/Yen, and others.

The majority of international transactions involve the major currencies.

The major currency pairs in the FOREX market include Euro v. US dollar, US dollar v. Japanese yen, British pound v. US dollar, and US dollar v. Swiss franc.

These pairs are considered major due to their high trading volume.

In the FOREX market, these pairs are abbreviated as EUR/USD, USD/JPY, GBP/USD, and USD/CHF.

They can also be written without the slash as EURUSD, USDJPY, GBPUSD, and USDCHF.

The following chart illustrates the relationship between these four currency pairs.

Major Currency Pairs

Figure 1.0: Daily Data of Major Currency Pairs

It is important to note that currencies do not pay dividends.

In FOREX trading, traders speculate whether one currency’s value will appreciate against another currency and exchange the latter for the former.

The aim is to exchange the first currency back for the other at a later time and make a profit from the trade.

Typically, FOREX transactions are carried out by professionals at major banks and brokerage firms.

The FOREX market has always been a significant aspect of the international market, with brokers trading currencies around the world at all hours of the day.

In fact, the FOREX market operates 24 hours a day and five days a week, with traders at international banking institutions working in different shifts.

Unlike the stock market, the FOREX market experiences smoother price shifts without significant gaps.

Each day, trillions of dollars are traded in the FOREX market, allowing for easy entry and exit from positions.

It is a dynamic and continuous system that remains active at all times, even during major events like September 11, 2001.

Also known as FX or the foreign exchange market, FOREX is the oldest and most extensive financial market globally.

In comparison, the currency futures market is only a fraction of the size of the FOREX market.

Trades in the FOREX market occur between major banking groups worldwide, spanning America, Australia, Asia, Europe, and the U.S.

Previously, the financial requirements and high minimum transaction amounts made the FOREX market inaccessible to small traders.

However, things have changed now, as FOREX market dealers allow smaller corporations and individuals to trade smaller units.

The market has evolved significantly, thanks to high-speed internet connections and advanced online trading platforms, enabling individual traders to participate and potentially succeed in FOREX trading.

This guide serves as the first step towards a prosperous future in the highly profitable FOREX market.

Reasons To Trade In The FOREX Market

If you were to inquire Forex traders about the primary reason they engage in Forex trading, most of them would mention the potential for profit.

US/GBP Trades

The provided chart (Figure 1.1) displays the daily data for the GBPUSD currency pair.

The arrow represents the “BUY” entry point where a Forex trading system made a purchase.

This particular trade has yielded a profit of approximately $24,000 per Forex contract. Such opportunities for profit exist across all Forex currency pairs.

The cash/spot Forex market offers a unique and highly lucrative opportunity, irrespective of market conditions.

The advantages of Forex trading include:

1. Around-the-clock market:

Forex operates 24 hours a day, allowing traders to participate whenever they deem market conditions favorable.

This flexibility is particularly advantageous for part-time traders who can easily find suitable trading hours that align with their work schedule.

2. Easy entry and exit:

Traders can enter or exit the market with great ease, as Forex offers high liquidity and minimal execution barriers.

Unlike other markets, there are no limits on daily trading activities.

Moreover, the leverage available in Forex is significantly higher compared to equity markets, reaching up to 400:1 as opposed to 2:1.

While increased leverage entails higher risks, it also presents profit potential.

3. Low transaction costs:

The Forex market boasts some of the lowest transaction costs in comparison to other markets.

4. Profit opportunities always available:

Forex trading involves buying or selling one currency against another, ensuring that there is always a chance for profit within different currency pairs.

5. Global market:

Forex trading is facilitated through electronic communication and telephones, as there are no organized exchanges like the New York Stock Exchange.

6. No market monopoly:

Due to the vast size of the Forex market, no single trader or bank can control prices for an extended period.

Attempts by banks to manipulate prices have proven ineffective and diminished in impact.

Forex trading offers numerous advantages over futures or stocks, including:

1. Lower margin requirements:

Forex traders can control a substantial amount of currency with a small account deposit.

Similar to futures trading, Forex requires only around 1% margin compared to the 5% margin in futures.

Essentially, Forex allows traders to control five times as much with their money compared to futures trading and fifty times more than stock trading.

It is crucial to understand the high risks associated with trading on margin and to review the margin agreement with the clearing firm.

Regularly monitoring the margin balance and utilizing stop-loss orders can help mitigate risks and protect capital.

2. No exchange fees or commissions:

Unlike the futures market, Forex trading is commission-free with most Forex brokers.

While there are no direct fees, the spread (difference between the asking and bidding price) in Forex is generally higher than in futures trading.

3. Risk limitation through guaranteed stops:

Although it is believed that Forex offers guaranteed stops to limit risk, this is not entirely accurate.

During periods of extreme volatility, stops in the Forex market can be “run,” similar to other markets.

Instances have been reported where stops were exceeded by over 140 pips per contract, leaving traders unable to exit positions as prices moved against them.

Planning ahead can help limit risks in the FOREX trading market, such as potential losses caused by events like Mad Cow Disease in the futures market.

One important aspect of FOREX trading is the need to rollover each trade every two days to maintain your position.

Unlike futures, where you have to anticipate and plan for contract expiration.

While the futures market restricts trading to specific time windows, the FOREX market operates around the clock, five days a week.

This global accessibility allows traders to respond to current events and exit positions whenever necessary, without being limited by market opening hours.

The foreign exchange market is a massive $1.4 trillion market that continues to grow.

It surpasses the combined size of all futures markets, making it a focal point for governments worldwide as they strive to regulate their own currencies amidst the vast number of people engaging in FOREX trading.

FOREX trading presents a compelling alternative to futures and commodities trading, offering great opportunities.

However, it is crucial to acknowledge the inherent risks. To mitigate these risks, seeking the guidance and expertise of a broker is highly recommended.

This comprehensive guide will equip you with the necessary knowledge and skills to succeed in the FOREX market. Let’s begin this exciting journey!

Getting Started In The Exciting World Of Forex Trading

Trading with Forex doesn’t have to be overly complicated, but there are important factors to keep in mind and guidelines to follow.

Before you start trading, it’s crucial to find a reliable broker to execute your trades. Just like in other professions, there are numerous Forex brokers to choose from.

Here are some key considerations to help you select the right broker:

1. Minimal Spreads:

Unlike traditional stock trading brokers, Forex brokers don’t charge commissions on trades.

Instead, they earn through spreads, which is the difference between the buy and sell prices of currency at a specific time.

When researching brokers, inquire about their spreads. Opt for a broker with lower spreads to minimize your trading costs and maximize your profits.

2. Compliance and Reputation:

While stock trading brokers usually operate through their own brokerage houses, Forex brokers are often affiliated with large banks or financial institutions due to the significant capital requirements.

It’s essential to verify that your chosen Forex broker is licensed and registered.

Look for registration with the Futures Commission Merchant (FCM) and regulation by the Commodity Futures Trading Commission (CFTC).

You can confirm this information on the CFTC website. It’s crucial to trade with a broker affiliated with a reputable institution.

3. Available Research Tools and Information:

Just like traditional brokers, Forex brokers offer various websites, trading platforms, and research portals.

These platforms should provide real-time information, current charts, technical analysis, comparison tools, and other relevant data.

A reliable Forex broker should also offer the ability to trade on different systems. Request free trials to evaluate the broker’s trading platforms.

Additionally, ensure that the broker provides a wide range of information, tools, and support functions to assist your trading success.

4. A Variety of Leverage Options:

Leverage is crucial in Forex trading as it allows you to magnify your trades using borrowed capital from the broker.

This enables you to profit from small price fluctuations.

For example, a leverage ratio of 100:1 means that for every dollar you trade, you are borrowing 100 dollars from the broker.

Most brokers offer leverage ratios of up to 250:1. However, it’s important to consider the associated risks.

Higher leverage ratios mean increased borrowing and potential losses if the market moves against you.

Your risk tolerance and available capital should guide your choice of leverage.

Even with ample capital, it’s prudent to consider lower leverage during volatile market conditions, such as with exotic currency pairs.

Remember, finding a broker that offers the necessary tools, services, and leverage options is crucial for your trading success.

When it comes to trading, you will need to open an account with a broker. There are different types of accounts available, each with its own requirements and benefits.

The smallest type of account is called a mini account, which has a low minimum opening balance of around $300.

Despite its small size, a mini account offers a high leverage ratio, allowing you to trade larger sums with a small amount of capital.

Another option is a standard account, which offers various leverage ratios but requires a higher minimum balance of approximately $2000.

For those looking for more advanced features and services, brokers also offer premium accounts, which have higher minimums to open.

These accounts provide multiple leverage options and access to additional platforms and tools.

It’s important to choose a broker that offers the right mix of accounts, leverage, and services based on your financial circumstances and requirements.

In the trading industry, it’s crucial to steer clear of disreputable brokers who prioritize their own profits over their clients’ best interests.

These brokers engage in unethical practices such as buying or selling prematurely to increase their own gains.

They may manipulate trades to their advantage, even if it means taking a fraction of a penny from each of your trades.

While brokers won’t openly admit to such behavior, there are ways to identify these disreputable brokers.

Seek advice from other brokers and inquire about their opinion on the ones you are considering.

You can also search online forums or discussion boards to uncover any information about brokers and their trading activities, although there is no official organization monitoring such practices.

Understanding margin calls and requirements is crucial when leveraging your trades with borrowed money from a broker.

It’s important to have a clear understanding of the risk your broker is willing to allow you to take.

This involves discussing price differentials and fluctuations to determine the best buying and selling opportunities.

However, there is a potential downside to this arrangement.

If your positions experience a significant drop before eventually rebounding, your broker may decide to trade out your position to mitigate their risk and potential loss.

Unfortunately, this could result in a margin call for you, making you liable for substantial amounts of money, even if the price eventually recovers after your position is liquidated.

When opening a Forex account, whether it’s a mini, standard, or premium account, it is akin to obtaining a revolving equity loan or maintaining an equity account.

The key difference is that a Forex account requires you to enter into a margin agreement with your broker.

This agreement acknowledges that you are trading with borrowed money and grants the broker the authority to intervene in your trades to manage their risk and protect their interests.

It also outlines your liability in case of any losses.

Once you have executed the agreement and deposited the initial capital into your account, you are ready to start trading.

Overview of Basic FOREX Strategy

Technical analysis and fundamental analysis are the two primary forms of analysis used in both the FOREX market and equity markets.

However, many FOREX traders prefer to utilize technical analysis for their trading strategies.

Let’s provide a brief overview of both types of analysis and their application in FOREX trading.

Fundamental Analysis:

Implementing fundamental analysis in the FOREX market can be challenging and is typically used to predict long-term trends.

Although some traders base their short-term trades solely on current news releases.

There are several fundamental indicators of currency values that are released at different times. Here are a few examples:

– Non-farm Payrolls
– Purchasing Managers Index (PMI)
– Consumer Price Index (CPI)
– Retail Sales
– Durable Goods

These indicators are not exhaustive, and there are additional meetings that can provide valuable information affecting the market.

These meetings often focus on factors like interest rates, inflation, and other causes of currency value fluctuations.

Sometimes, even the wording of issues, such as the Federal Reserve chairman’s discussion on interest rates, can cause volatility in the market.

The most important meetings to be aware of are the Federal Open Market Committee and Humphrey Hawkins Hearings.

Analyzing the commentary from these meetings can assist both long-term and short-term traders in understanding market trends and capitalizing on market movements.

If you choose to adopt a fundamental strategy, it is essential to have an economic calendar on hand to keep track of when these reports are released.

Your broker should also be able to provide you with up-to-date information.

Technical Analysis:

Technical analysis helps FOREX traders analyze price trends, similar to equity market traders. The only difference is that the FOREX market operates 24 hours a day.

To accommodate this continuous trading, certain types of technical analysis may need to be adjusted or modified.

Here is a list of commonly used technical analysis tools in the FOREX market:

– Moving Averages
– Stochastic Oscillator
– Channel Breakout
– MACD (Moving Average Convergence Divergence)
– Candlestick charts
– Elliott Waves
– Fibonacci Studies
– Parabolic SAR
– Pivot Points

Introduction to Forex Charts:

A crucial aspect of technical analysis is understanding Forex chart basics. Let’s begin with the “bar” chart, named for its bar-like shape.

A typical bar on a bar chart consists of four components:

– Open: The opening price of the selected time period
– High: The highest price reached during the selected time period
– Low: The lowest price reached during the selected time period
– Close: The final price at the end of the selected time period

The bar chart is just one type of Forex chart.

Bar Chart