WHAT IS FOREX?
Forex is a commonly used abbreviation for “foreign exchange”. It typically describes the buying and selling of currency in the foreign exchange market, especially by investors and speculators. The familiar expression, “buy low and sell high,” certainly applies to currency trading. A forex trader purchases currencies that are undervalued and sells currencies that are overvalued; just as a stock trader purchases stock that is undervalued and sells stock that is overvalued.
For example, imagine a situation where the U.S. dollar is expected to weaken in value relative to the euro. A forex trader in this situation will sell dollars and buy euros. If the euro strengthens, the purchasing power to buy dollars has now increased. The trader can now buy back more dollars than they had to begin with, making a profit.
This is similar to stock trading. A stock trader will buy a stock if they think its price will rise in the future and sell a stock if they think its price will fall in the future. Similarly, a forex trader will buy a currency pair if they expect its exchange rate will rise in the future and sell a currency pair if they expect its exchange rate will fall in the future.
WHAT IS AN EXCHANGE RATE?
The foreign exchange market is a global decentralized marketplace that determines the relative values of different currencies. Unlike other markets, there is no centralized depository or exchange where transactions are conducted. Instead, these transactions are conducted by several market participants in several locations. It is rare that any two currencies will be identical to one another in value, and it’s also rare that any two currencies will maintain the same relative value for more than a short period of time. In forex, the exchange rate between two currencies constantly changes.
For example, on January 3, 2011, one euro was worth about $1.33. By May 3, 2011, one euro was worth about $1.48. The euro increased in value by about 10% relative to the U.S. dollar during this time.
WHY DO EXCHANGE RATES CHANGE?
Currencies trade on an open market, just like stocks, bonds, computers, cars, and many other goods and services. A currency’s value fluctuates as its supply and demand fluctuates, just like anything else.
- An increase in supply or a decrease in demand for a currency can cause the value of that currency to fall.
- A decrease in the supply or an increase in demand for a currency can cause the value of that currency to rise.
A big benefit to forex trading is that you can buy or sell any currency pair, at any time subject to available liquidity. So if you think the Eurozone is going to break apart, you can sell the euro and buy the dollar (sell EUR/USD). If you think the price of gold is going to go up, based on historical correlation patterns you can buy the Australian dollar and sell the U.S. dollar (buy AUD/USD).
This also means that there really is no such thing as a “bear market,” in the traditional sense. You can make (or lose) money when the market is trending up or down.
Online forex trading has become very popular in the past decade because it offers traders several advantages:
FOREX NEVER SLEEPS
Trading goes on all around the world during different countries’ business hours. You can, therefore, trade major currencies at any time, 24 hours per day. Since there are no set exchange hours, it means that there is also something happening at almost any time of the day or night.1
GO LONG OR SHORT
Unlike many other financial markets, where it can be difficult to sell short, there are no limitations on shorting currencies. If you think a currency will go up, buy it. If you think it will fall, sell it. This means there is no such thing as a “bear market” in forex – you can make (or lose) money any time.
LOW TRADING COSTS
Most forex accounts trade without a commission and there are no expensive exchange fees or data licenses. The cost of trading is the spread between the buy price and the sell price, which is always displayed on your trading screen.
Because forex is a $5.3 trillion-a-day market, with most trading concentrated in only a few currencies, there are always a lot of people trading. This makes it typically very easy to get into and out of trades at any time, even in large sizes.
Because of the deep liquidity available in the forex market, you can trade forex with considerable leverage (typically 200:1). This can allow you to take advantage of even the smallest moves in the market. Leverage is a double-edged sword, of course, as it can significantly increase your losses as well as your gains.
As the world becomes more and more global, investors hunt for opportunities anywhere they can. If you want to take a broad opinion and invest in another country (or sell it short!), forex is an easy way to gain exposure while avoiding vagaries such as foreign securities laws and financial statements in other languages.
HOW DO YOU READ A QUOTE?
Because you are always comparing one currency to another, forex is quoted in pairs. This may seem confusing at first, but it is actually pretty straightforward. For example, the EUR/USD at 1.4022 shows how much one euro (EUR) is worth in us dollars (USD).
WHAT IS A LOT?
A lot is the smallest trade size available. FXCM accounts have a standard lot size of 1,000 units of currency. Account holders can however place trades of different sizes, so long as they are in increments of 1,000 units like, 2,000, 3,000, 15,000, 112,000 etc.
WHAT IS A PIP?
A pip is the unit you count profit or loss in. Most currency pairs, except Japanese yen pairs, are quoted to four decimal places. This fourth spot after the decimal point (at one 100th of a cent) is typically what one watches to count “pips”. Every point that place in the quote moves is 1 pip of movement. For example, if the EUR/USD rises from 1.4022 to 1.4027, the EUR/USD has risen 5 pips.
WHAT IS LEVERAGE/MARGIN?
As mentioned before, all trades are executed using borrowed money. This allows you to take advantage of leverage. Leverage of 400:1 allows you to trade with $1,000 in the market by setting aside only $2.50 as a security deposit. This means that you can take advantage of even the smallest movements in currencies by controlling more money in the market than you have in your account. On the other hand, leverage can significantly increase your losses. Trading foreign exchange with any level of leverage may not be suitable for all investors.
The specific amount that you are required to put aside to hold a position is referred to as your margin requirement. Margin can be thought of as a good faith deposit required to maintain open positions. This is not a fee or a transaction cost, it is simply a portion of your account equity set aside and allocated as a margin deposit.
HOW TO READ A CHART
Forex traders have developed several methods for attempting to figure out the direction of a currency pair. Fundamental traders may read news sources such as DailyFX.com to see how interest rates, economic growth, employment, inflation, and political risk affect the supply and demand for currencies. Technical traders use charting tools and indicators to identify trends and important price points of where to enter and exit the market.
But no matter what type of trader you are, you’ll need to learn how to read forex charts…
OPENING A PRICE CHART
To get started, click on the ‘create marketshot’ button at the top of the trading station. Next, you need to pick a currency pair, select the period, and specify the data range.
The period is the time interval that the chart updates. For example, a period set to one day (d1) means that each point on the chart represents one trading day of data. A period set to five minutes (m5) means that each point on the chart represents five minutes of data. The data range is the amount of data you want the chart to populate. If you want to look at a full year of data, you’d set the data range to one year.
USING CANDLESTICK CHARTS
The default chart type is called a ‘candlestick’ chart. This chart type is used frequently in the forex market. A bar on a candlestick chart shows the open, close, high and low prices for the selected period. The body of the candle shows the open and close prices where the wicks show the high and low prices.
If the closing price is higher than the opening price of the previous candle, then the candlestick will be blue. If instead the closing price is lower than the opening price of the previous candle, then the candlestick will be red. Candlesticks simply make it easier to see if the trading period ended up or down.
ADDING AN INDICATOR
Just looking at forex charts can be helpful in making a trading decision, but many traders also use technical indicators to help them make more informed trading decisions. These tools help a trader locate price trends and predict future price movements. The trading station is equipped with over thirty popular pre-loaded indicators. Over six hundred popular and custom indicators are downloadable online. To add an indicator to a chart, right click on the chart and select ‘add indicator.’
DRAWING A TREND LINE
Prices trend in one of three ways: up (bull market), down (bear market) or sideways (range bound market). A trend line is used to help a trader visually recognize which trend direction is in place. Until the trend is “broken,” a trader can reasonably expect the trend to continue. Trend lines are drawn with the ‘pencil’ tool. Typically, when you draw a trend line, you want to connect two or more extreme high or low prices that define the trend. Here are a few examples:
How to Place Trades
The FXCM Trading Station platform is where you buy and sell currencies, manage your account and directly connect to the forex market. But first, you have to learn how to trade forex.
PLACING YOUR FIRST TRADE
Placing a trade is simple. All you need to do is click on the Sell or Buy price for the currency pair you want to trade from the Dealing Rates window. Then simply click OK to confirm the order details.
- Step 1: Click Buy or Sell
- Step 2: Confirm Order and Click OK
MONITORING YOUR LIVE TRADES
With live trades in the market, you want to know if you’re making money or losing money. To do this, look in the Summary window to see your live trades.
SUMMARY OF WINDOW DEFINITIONS
|Symbol:||the traded currency pair|
|Amt:||the total amount of all positions|
|S/B:||the trade type: S/sell, B/buy|
|Avg Open:||the average rate value|
|Close:||the current market rate to close|
|Gross P/L:||the profit/loss of all open positions|
|Net P/L:||the Gross P/L with commissions and interest included|
|Net Stop:||the net position stop|
|Net Stop Move:||the amount of pips until the net stop moves|
|Net Limit:||the net position limit.|
CLOSING YOUR LIVE TRADES
When you’re ready to close a live trade, simply click on the appropriate price in the Close Sell or Close Buy column in the Summary window. Next, confirm the order details and click OK. Once the trade closes, your profit or loss on that trade is booked, and your account balance updates in the Accounts window. Remember, your balance reflects realized profits and losses; your equity is balance plus any profits or losses from open trades.