A Beginner’s Guide to Forex Trading
Welcome to the exciting world of Forex trading. In this guide, you will be introduced to all the basic techniques in currency market. This beginner’s guide will also cover common forex terms and ISO codes for trading in currencies. Including the common terms used by traders and brokers, and ISO codes for each traded currency. This guide will familiarize you with the history of forex, currency standards, charting basics and the difference in forex trading platforms. By the end of the guide, you will be ready to open your demo account, and begin learning how to trade.
What is Forex?
Forex, or Foreign Exchange simply refers to the transaction involved in converting one form of currency into another. While a lot of foreign exchange transactions is done for practical purposes, a larger majority of the transactions is done with the aim of making profit. The forex market is the largest financial market in the world with a daily trading volume in excess of $5 trillion.
A brief history of Forex
Even though some form of foreign exchange transactions has been in existence long before, the Forex Market as we know it can be traced to sometime in 1971. After the Second World War, England and other Europeans countries faced great instability while the American currency and economy remained strong. This brought about the Bretton Woods Conference of 1944 where the international standard for currency was tied to the US Dollar. The Bretton woods conference agreement lasted until 1971 when the US Dollar was once again allowed to float. This paved the way for Forex trading as we know it today. In this system, the strength of a country’s currency is tied to the economy of the country, their political stability and a wide range of other economic indices. As any of these factors change, so will the value of the country’s currency when measured against that of other countries.
Forex Charting Basics
Reading and understanding a forex chart can be said to be a form of science, this is because they look complicated at a first glance. But once you get used to it, it can be quite easy. Using forex charts for your trading strategy means using technical analysis. A forex chart can normally display in three formats. It can be displayed as a line chart, it can be displayed as a bar chart and it can be set to display as a candlestick chart.
Line Chart: Line charts are a good way to show a simple display of the price. The line chart will show you the closing price for each period by drawing a line from one closing price to the next. When put together, these lines show the general price movement of a particular currency pair over a period of time.
Bar Charts: A bar chart is a bit more complex than a line chart. A bar chart shows where the price opened at the start of trade, the high points and low points and where the price closed.
At the bottom of the vertical bar is where the lowest traded price for that time period is indicated, while the top of the bar the highest price paid is indicated.
Bar charts are usually called “OHLC” charts, because they show the Open, High, Low, and Close for a particular currency.
How it is interpreted:
- Open: The little horizontal line on the left is the opening price
- High: The top of the vertical line indicated the highest price of the time period specified
- Low: The bottom of the vertical line indicates the lowest price of the time period specified
- Close: The little horizontal line on the right is the closing price
Candle Sticks: Candlestick charts are the most commonly used method for displaying the price on a Forex chart. Some technical analysts argue that a candle stick chart can be used to make a near exact prediction on the market. Candlestick charts show the information as a bar chart, but the display comes in a more graphic format. A candlestick chart still indicates the high and low price range with a vertical line, however, the larger block in the middle of the chart indicates the range between the opening and closing prices within the specified time period.
Forex Trading Standards
Gold Standard: The gold standard is a system where the value country’s currency has a direct link to the value of gold. Countries that used gold standard will set a fixed price for the value of gold. This fixed price is used to determine the value of the currency and the country cannot issue out currency that is in excess of the gold it has in its reserves. From the mid 1940s to the early 1971, gold determined the value of most major currencies in the world as a result of the Bretton Woods agreement. This gold system or standard was completely abandoned in 1971 after then US president Nixon ordered the U.S. Dollar completely removed from the gold standard.
Floating Standard: A floating system of currency exchange rate is a system where the price of a country’s currency in the forex market is based upon the demand and supply of the currency compared with others. What this means is that if the demand of the Japanese Yen is lower than the demand for the US Dollar, then the price of the Japanese Yen will be lower than the price of the US Dollar. Since the collapse of the Bretton Woods agreement in 1971, the majority of the world’s currencies is based on the floating standard.
In this monetary system, central banks buy and sell their country’s currencies to adjust the exchange rate value or to cause an effect in the foreign exchange market.
Currency Trading Codes
Currency codes are symbolic codes used to identify currencies as defined by the ISO 4217 international standard. There is a three digit code for every national currency.
Some of the most common are:
|Hong Kong Dollar||HKD||344|
|New Zealand Dollar||NZD||554|
|United States Dollar||USD||840|
Common Forex Terms
It is important to know the terms and meanings of any business you want to get involved in, the same applies to forex trading. Here are some common forex terminologies and their meaning.
- Cross rate – The exchange rate between two currencies
- Exchange Rate – The value of one currency in terms of another. For example, if EUR/USD is 1.2300, 1 Euro is worth US$1.2300.
- Pip – The smallest movement in price a currency can make
- Leverage – Leverage is the ability to trade with a larger amount of money than you have in your total account margin.
- Margin – The deposit required to open or maintain a trade.
- Spread – The difference between the bid and offer price. For example, if USD/JPY quotes read 1.3200/03, the spread is the difference between 1.3200 and 1.3203, or 3 pips.
- Currency Pair - The currencies currently involved in your forex transaction for instance EUR/USD
- Base currency - The first currency in a currency pair.
- Quote currency - The second currency in a currency pair.
Forex Trading Platforms
One of the first steps every forex trader must make before he or she can begin to trade is to decide on a choice of trading platform. There are many different types of trading platforms of brokers, but they all fall into two broad categories. Dealing Desk and Non Dealing Desk Platforms.
Dealing Desk Broker
A dealing desk platform or broker refers to a broker who takes the other side of a client’s trade by setting the deal and ask price and waiting for another trader to take advantage of the terms. For instance, you place a buy order for USD/JPY for 10000 units, your dealing desk broker will first try to find a similar sell order from its other clients, and if none is available, pass your trades on to its liquidity provider.
Non Dealing Desk Broker
As the name suggests, a non dealing desk broker does not pass your trade through a dealing desk, they simply link buy and sell clients together.
How is the Forex Market Regulated
The Forex market is the single largest financial market in the world with more than $5 trillion traded daily. To meet this trade demand, hundreds of forex brokers carry our services all over the world. Despite this huge size, the forex market is relatively unregulated as there is no single global body or association to watch over foreign exchange market activities. Nevertheless, at individual country level, there exist a number of bodies and policies that oversee and regulate the forex market operations in their country. These agencies handle cases that involve fraud and breach of their rules.
Do you fancy yourself as a forex trader? Then you must have a lot of questions on your mind. We've compiled a list of possible questions on forex trading that you might have and concise answers. This guide is perfect for beginners(and experienced traders) and will help you better understand forex trading and decide if it is right for you.
What Are The Benefits Of Forex?
There are many benefits of forex trading. It is a great way to supplement your income. It is also open 24 hours a day for five days a week, so that means that you can trade currency when you want. It doesn't matter if you are on holiday or it is the middle of the night. Your mobile phone or laptop is all you require as an investor to trade forex. The prices in the forex market are relatively stable compared to the stock or equity markets. The forex market also has high liquidity levels. This is because of the large sums of money available for forex trading; about $1.9 trillion is traded every day.
How Can I Trade Forex?
The basic principle of forex trading is the buying and selling of another currency and waiting till you are in a profitable position before you exit. This is a huge advantage for entry-level traders because you can completely focus on two currencies as opposed to being overwhelmed by all the options available on the stock markets.
I Know nothing About How To Trade Forex, How Do I Get Started?
Getting started with forex trading is as simple as opening an account on an online trading platform. Fill out the information required on the platform form, wait for verification; your trading account is ready to soon as it is open. You will need to credit your account to begin trading, of course.
Please note, it doesn't matter how small or large your trading capital is, always put a trading plan in place before you trade.
What Is Forex?
Forex, (the short form for 'Foreign Exchange Markets') is a term that used to describe the international trading market for selling and buying different currencies.
Forex trading has grown over the years and has a total value of over $1.9 trillion. For seasoned investors, the opportunity to get a piece of the largest trading market in the world is something not to be missed.
Entry-level traders also love the fact that they are not required to pay a commission on the trade profits. And as a bonus, you can access the market from wherever you are in the world.
What Are The Risks Involved With Forex Trading?
As with other types of investment and stock trading, Forex trading comes with its own set of risks; especially when you are starting out. It is often considered more risky than conventional investment and trading options because it is leveraged trading. What this means is that you can use more money to trade than is available in your account.
Why Should I Trade Forex Instead Of Stocks Or Commodities?
The forex market is the largest and most liquid financial market in the world. It has a daily trading volume of about $5.3 trillion. The fx market is also the only market that is open 24 hours a day. There are over 870 currencies to trade, which makes it 12 times larger than the futures market and 27 times larger than the equities and stock markets.
What Is Leveraged Trading?
With leveraged trading, you can borrow the money you intend to trade with from your broker. You only have to deposit an upfront security fee just in case you incur any loss. What this means is that traders can invest small amounts but stake on bigger trades using the limited capital.
How Do I Know When To Enter And Exit The Market?
This is probably one of the most important skills a forex trader needs. Making the decision to exit or enter a market must be arrived at with objectivity; devoid of emotion. A good way to do this is to consider price levels or the technical formations on your chart before making your decision.
You can also plan out your entry and exit strategy/ plan in advance. For beginners, it is always advisable to keep your trades small and increase your trade volume gradually or commit to a trade volume little at a time for the duration of a particular period. If you do this, you can mitigate your risk and the losses you might incur from a bad exit or entry position.
What Is Market Spread?
A market spread in the forex market is the difference between the bid price and the asking price in a currency pair . This difference is calculated in pips and is used by brokers to determine the profit margins for a particular transaction.
How Do I Know Which Currencies To Trade?
You shouldn't only trade using the most popular pairs but carefully research currency pairs and only trade using the ones that you are most familiar with.
Are there forex trading headquarters, like the stock in exchange and if there are, when are the trading hours?
There is no brick and mortar location for the forex trading market. However, the largest trading centres can be found in London, Singapore , Tokyo, Hong Kong, and New York. Forex trading happens through electronic systems or over-the-counter markets where banks, licensed brokers and traders are connected.
This is why forex trading takes place 24/7 (Monday to Friday), because a forex market centre is always open somewhere.
When Can I Start Forex Trading?
There is no better time than now! Unlike conventional stock and equity markets, the forex trading market is open for 24 hours a day (five days a week). So you can begin trading at any time of the day or night from your mobile phone or laptop.
This is made possible because of the different time zones in different countries. The perfect trading time varies from currency pairs, so you are not limited by the traditional 9-to-5 schedule of the DFW or NASDAQ exchanges. Which makes forex trading ideal for anyone even those who work a 9-to-5 office job and cannot run trades during work hours or a parent who can only trade when the children fall asleep.
What Is Pip?
A pip is the unit used by forex traders to measure the movement of currency when trading. For example, for EUR/USD, one pip is 0.0001.
What's A Stop Loss And How Do I use It?
Stop Loss is a trader management technique that is used to forecast the ideal time for you to exit a losing trade so you do not incur more losses. While losses are a natural occurrence in Forex trading, stop loss allows you to control the situation by providing you with the opportunity to make a quick decision about what to do when you are losing.
You can set parameters for your stop-loss plan by setting a limit of the amount you are willing to lose on your accounts. Or you can use visible volatility, prevailing market conditions, resistance and support levels on charts, or a time limit.
If you are a beginner in Forex trading, we recommend that you get professional training and advice before including a stop-loss strategy in your plan.
What Are Binary Options And How Are They Different From Forex Trading?
Binary options are fixed rewards and loss contracts in which the trader predicts when a currency will rise or fall within a practical timeframe. So you're totally aware of how much money you get back if your prediction pans out or how much you'd lose if your prediction doesn't.
Forex trading and binary options are similar because they can be started with a small capital and trades can be done online. The major difference between them is in how much profit you can get over time.
Trading with the binary options would require very accurate predictions in order for you to make a significant amount of profits. Binary options are also expensive in the long run. Forex trading, however, gives you the freedom to determine your stop-loss orders and profit targets. What this means is that you can still earn a profit even when most of your predictions are apparently incorrect.
What's The Difference Between Spot Trading and CFDs?
A contract for difference (CFD) is a contract agreement is where you are paid for every pip that the currency you are trading has moved in your favour. If this doesn't happen, then you would have to pay.
The are so named because every time you close on a position, the profits you acquire is the difference between your opening and closing price. This difference will then be added or subtracted from your trading account. Please remember, you do not really own the currency you buy physically or virtually so you do not have to deliver the currency that you trade.
Spot trading, however, requires the actual exchange of currencies by an electronic system or physically. What this means is if you buy or borrow a currency you would either receive interest or be required to pay via real currency notes.
What Is Technical Analysis?
Technical analysis is a technique that requires the use of charts as a tool for generating informed trading decisions. By analysing the volume and price movements provided by this chart, forex traders can predict how weak or strong a particular currency is and prepare for future or movements.
Where Can I Get Help To Improve My Forex Trading?
There are a lot of useful learning materials that are available online and most of them are free. You also have access to current real-time market information from sources such as Daily Effects or Bloomberg.
While basic information on forex trading or even technical analysis techniques and advanced advice is readily available, please check to ensure that the source of this information can be trusted. If it comes from a financial service provider, then check to see if they are licensed.
You can also get familiar with the trading process and techniques that work by practising with play money in the demo accounts offered by some trading platforms. This would help build your skills and confidence before you attempt to take real money. This way you will not be you will avoid all the learning pitfalls and will be better equipped to wade through this new territory.
Another alternative would be for you to get training from experts traders with a proven track record of market successes and years of experience.
What is Forex Commission?
With conventional stock and equity markets, most investors who trade in futures and stock options would require a broker to act as an agent in the transaction. The broker is taxed with taking the order to an exchange and executing it according to the customers' requirements. They then pay the broker a commission for buying and selling the trades on behalf of the customer.
Forex trading market however doesn't have commissions because most investors do the trading by themselves. As FX is a principal only market, Forex trading companies are dealers not brokers. Dealers offset the market risk by serving as a third party to the investor's trade. They do not require a commission but make their money through the market spread.
With FX, the investor cannot attempt to sell or buy in on an existing bid as is commonplace in most exchange-based markets. There is also no additional fee or commission to be paid by the investor once the spread is cleared. So every single profit acquired goes to the investor.
Dealers are required to match and surpass the market spread and this makes gulping difficult in Forex trading.
How Do I know When My Trading Plan is Working And When To Change Strategies?
Like with most plans, results are key performance indicators for determining the effectiveness of your Forex trading plan. To guarantee long-term success, these results must be significant and consistent for a long period. Please note, a strategy that has only worked a couple of times is not foolproof.
How Does Forex Compared To Other Markets?
Forex trading doesn't take place in regulated markets as opposed to futures stock or option currency trading. It is also doesn't have a central governing body. Therefore, there are no guarantees on trades and it has no panel registered to adjudicate disputes. All trades by members are made on credit agreements. What this means is that business in Forex trading is physically conducted over are a handshake.
For new investors who are used to the structure of exchanges like the Chicago Mercantile Exchange (CME) or the New York Stock Exchange (NYSE), the arrangement in the forex trading market is weird. But you can be assured that this arrangement works.
Self-regulation has proven to be an effective tool to control the markets. This is because participants in the FX trading markets are forced to cooperate and compete at the same time . As an added bonus, reputable retail FX dealers in the United States are members of the National Futures Association (NFA) and are bound by an arbitration agreement in the event of disputes. If you intend to trade currencies using a retail FX dealer then you should only use member firms that are reputable.
Another unique feature of the forex trading market is the ability to shut down a pair that is on a downward spiral at will. There are no opt-out rules in Forex trading because there is no stock. You are also not limited by size as in futures. So you could hypothetically trade or sell a $100 billion dollars' worth of currency if you have the prerequisite capital.
A trader is also free to act on information in any way they deem fit and we would not consider this insider trading like in most conventional mark trading markets. For instance, if a trader finds out from a client that knows the governor of the bank of Japan, that the BOJ's intends to raise its rates in the next meeting, the trader can buy as much yen as he wants.
In fact, because there is no such thing as insider trading in the FX market, European economic statistics like the German employment figures are often leaked days before the official release date and traders act on this information without being sanctioned.
This doesn't mean that the forex trading market is the jungle of the finance world but it is the most fluid and liquid market in the world (24 hours a day) and rarely has gaps in price.
Because of its sheer share size from North America, Europe and Asia, it is also the most accessible currency market in the world. Therefore, it produces substantial data that can predict future price movements.
What Are You Really Trading?
Simply put, nothing. The retail Forex trading market is speculative. There is no physical exchange of currencies. All trades exist as computer entries and are paid out based on market price. For instance, if it is a dollar-denominated accounts then loss or profit is calculated and accounted in dollars on the trader's accounts.
The main purpose of the FX market is to provide a channel for the exchange of one currency into another for large enterprises that require continuous currency trades (for payment of goods and services from vendors to acquisitions and mergers). This transaction however only comprises about 20% of the entire Forex trading markets volume.
The other 80% of trades are speculated and conducted by multibillion-dollar hedge funds, large financial institutions and individuals who want to speculate on the geopolitical and economic events that day.
Currencies are always in pairs, what this means during the trade is that a trader is always long in one currency and shorts in the other. For example, if a trader sells standard lots (800,000 units ) of EUR/USD, they would have exchanged euros for dollars and would now be short Euros and long dollars.
To better explain how this works, if an individual buys a computer from a store for $1,000 and then exchanges dollars for a computer; the individual is short $1000 but long by one computer. And the store would be a $1000 long and short one computer. This same principle applies in the FX market; the only difference is that there is no physical exchange. And all transactions are input by computer however, the consequences are very real.
What Is Currency Carry Trade?
Currency carry trading is one of the most popular trades in the FX markets. It is practised by both small retail speculators and large hedge funds. The carry trade is based on the associated interest that every currency in the world has. This interest rates are short-term and are set by the central banks of these countries; the Bank of England in the United Kingdom, the bank of Japan in Japan, and the federal reserve in the United States.
The carry trade concept is simple. A trader will go long on a high interest rate currency, making a purchase using a currency with low interest rate.
For example, in 2005, the NZD/JPY cross was a great pairing. New Zealand saw an influx of commodity demand from China and an increase in its housing market rate; this directly translated to an increase of its rates on the FX markets to 7. 25% and it stayed at that point while Japanese rate was at a steady 0%.
A trader who went long on the NZD/JPY would have gained 25 base points in profits alone. On a 10:1 leverage base, it would have produced a 7 to 2.5% annual return of interest rate differentials on the carry trade of the NZ/JPY with no appreciation from capital.
This example paints a better picture of why the carry trade is very popular in the FX market. Please be advised, the carry trade isn't stable and is susceptible to a sudden downward spiral. We know this in the FX market as currency carry trade liquidation.
It happens when many speculators decided that a particular carry trade no longer has any future potential. Thus, every trader would seeks to exit their position immediately and once there are no longer bids, the profits on industry interest rate differentials are not enough to offset capital losses.
This doesn't mean that you shouldn't run a carry trade but it is always best to position yourself at the beginning of the cycle, this would allow you ride the movements of interest rates differentials.
What Currencies Trade In Forex?
The major liquid currency pairs that delist trade in scratch that there are seven liquid currency pairs that are used by major treaty of dealers in trade. It is divided into four majors and three commodity pairs.
The majors include
USD/JPY (Dollar/Japanese Yen)
USD/CHF (Dollars/Swiss francs) and
GBP/USD (British pounds/Dollar)
The commodity pairs include
NZD/USD (New Zealand dollar/United States dollar)
AUD/USD (Australian dollar/United States dollar)
USD/CAD (United States dollar/Canadian dollar)
These currency pairs account for over 95% of speculative trading in the Forex market alongside currency pairs such as GBP/JPY, EUR/JPY, EUR/GBP and so on.
Given the limited number of trading tools, there are only 18 pairs and crosses that are actively traded. This makes the Forex market more concentrated than the conventional stock market.
Other Forex Terms
Every market has its peculiar terms and the FX market is not different. Below are some terms that an experienced forex trader should know and understand
Yard: 1 billion units, that is "I sold a couple of yards of sterling"
Cable, pound, sterling: nicknames for the GBP
Figure :Forex term that connotes a round figure such as one points 20000
Buck, Greenback: nicknames for the US dollar
The little dollar, Loonie; nicknames for the Canadian dollar
Swissie: nicknames for this Swiss Franc
Kiwi: nicknames for the New Zealand dollar
Aussie: nicknames for the Australian dollar.
After completing this guide, your next step will be to open a demo account. A demo account is an account where you practice trading with the full features and conditions of a forex trade without committing your money.
Forex is an exciting platform for individuals and corporations to try their hand at foreign exchange and in the process make a profit. It also carries with it an element of risk, just like any other business. Forex is very profitable but it is also volatile markets to trade in for both experienced and inexperienced traders. While access to the market through a broker is easier now than it was before, the answers provided to the questions will serve as a valuable resource for anyone who wants to take on Forex trading themselves.