Important Terminology a New or Intending Forex Trader Must Know
Forex, also known as FX or currency trading, is a marketplace where people from every part of the world buy, sell and exchange different currencies. The market consists of central banks, commercial banks and companies, investment management firms, hedge funds, retail Forex brokers and investors.
Over the years, it has been regarded as a gold mine by people who want a legitimate career which can be operated with phones and computer devices from the comfort of their homes.
Before you begin trading on Forex, there are some terms you need to understand as they could impact how you fare in the marketplace.
The Japanese candlestick is the visual representation of a market signal which represents the battle between the buyers (bulls) and sellers (bear) over a specific period of time. It is essential for every trader to fully grasp this concept because it enables them understand the market and plan an entry and exit strategy which will result in optimal profits.
The candlesticks can be divided into two: The Hollow (Light) Candlesticks which means that the close price is greater than the open price, and
The Filled (Dark) Candlestick which states that ‘the close price is lesser than the open price; indicating the seller’s pressure.
Bullish & Bearish Candlestick
Bullish is a hollow or light candlestick which indicates that there is an upward movement of trends in the market and the trader is expected to buy. This leads to an increment in the price value, while the bearish is the filled or dark candlestick that shows the downward movement of trends in the market. In this case, the trader is advised to sell as this causes a decline in the price value. In a nutshell the bullish candlestick is an indicator which tells you when to buy while the bearish candlestick indicates the best time to sell.
This extremely sought-after technique was developed by technical trader John Bollinger in the 1980s to enable traders determine price volatility. It is a statistical chart which indicates the volatility of the market. It simply informs the trader of the market status (if it’s loud or quiet). Governed by twenty two set of rules, the band increases when the market is loud and decreases when it’s quiet.
Characterised by the Upper and Lower bands, many traders believe that when the price gets closer to the lower band, it’s overbought and when the price gets closer to the upper band then it’s oversold.
Relative Strength Index (RSI)
- Welles Wilder created RSI in his 1978 book titled “New Concepts in Technical Trading Systems“. This indicator assesses the speed and change of price and examines it in relation to the market being overbought or oversold. RSI regulates between zero to 100 and Wilder considered that when the RSL is above 70 it’s overbought and when it’s below 30 it indicates the market is oversold. It is important to know that a great extent of price movement false signals can be developed and due to this fact, most traders use extreme value readings to discover if the market is overbought or oversold (above 80 and below 20, respectively).
RSI has a relatively simple calculation which can be solved using the formula below:
RSI = 100 – [100 / (1 + (Average of Upward Price Change / Average of Downward Price Change)]
The RSI is divided into three components, which are RS, Average Gain and Average Loss. RS is the average gain in the up period or the average loss of a down period, set in specific time duration.
When buying or selling, currencies are exchanged for a product or service. In the world of Forex, currencies are exchanged through a broker and it is usually done in pairs. Currency pairs represent the buying and selling process in the Forex market, using two currencies, for example, trading the US Dollar and British Pound Sterling USD/GBP or Euro and Japanese Yen EUR/JPY.
Good currency pairs are characterised by high liquidity, great movement, a minimum spread (ideally 3pips) and a great extent of trading volume.
The US Dollar dominates the market with 85% of usability in transactions, this is followed by the Euro with 39%, Japanese Yen has a 19% market share while British Pounds has 13%, Australian Dollars has 8%, Swiss CHF has 6% and Canadian Dollars has 5% market share.
This is one of the most popular indicators in the trading world. Its foundation is rooted in past price action and because it’s a lagging indicator it should never be moved alone, it should be used with signals and price action patterns.
There are two types of moving averages; The Simple Moving Average (SMA), which is the average of currency movement over time, while in Exponential Moving Average (EMA) price actions are weighed using a more recent time. The most sought-after moving averages by traders are 10, 20, 50, 100 and 200.
Although there are many ways to use a moving average, these three have been proven to be highly effective.
Trend analysis is the most common way simple moving average and exponential moving average are used as indicators and although it’s not completely reliable, the analyses of trends are easier because of them.
Moving average can be used as support and resistance. This works in conjunction with identifying over extended markets.
One of the challenges new traders face is not knowing when to buy and sell, and if the market has been over extended, hence making buying a bad move for the trader. The moving average helps traders to know when the market is overextended.
Price Interest Points
The Price Interest Point (PIP) is the fundamental unit of measurement in the Forex market. It is the smallest point which brings a change to the currency pairs. In essence, PIP is used by traders to calculate its profit and loss.
For example if a trader states that he made 15 pips after a trade, it simply means that he made 15 pips profit.
PIP measures the movement that occurs in the exchange rates and due to the fact that a majority of the currency pairs are priced to four decimal places, the smallest change that takes place in the last decimal is equal to 1/100 of 1%. The value of a pip can be calculated using the formula below.
1/10,000 or 0.0001 by the exchange rate.