NEW TO FOREX
Knowledge is the key to success.
Trading in financial markets can be profitable but risky. Is it very difficult to make money in the Forex market? Definitely not, provided you know all about Forex and currency trading. It is very important to know everything you can about Forex and currency trading before you start trading. For those of you who are new to Forex, the information given in this section covers the basics of currency trading. I recommend you read it carefully and open a demo account before you start trading on a live account.
In this website, you will find articles on trading, written by experts. More detailed information on Forex and CFD is given here also.
Trading successfully in the Forex market is not an easy task. However, knowing a lot about Forex and currency trading you can make it possible.
By the way, WHAT IS FOREX?
Foreign Exchange Market (Forex) is the arena where a nation's currency is exchanged for that of another at a mutually agreed rate. It was created in the 70's when international trade transitioned from fixed to floating exchange rates, and nowadays is considered to be the largest financial market in the world because of its tremendous turnover.
Probability of earning on Forex is based on the fact that every national currency is a good, as well as wheat or sugar, and a medium of exchange, as gold or silver. As the world is changing so fast, economic conditions of every country
(Production, inflation, unemployment etc) are getting more and more dependent on each other, as a result, the rate of a currency changes against other currencies. This is the main reason of the process of rate fluctuations.
Why FOREX?
Nowadays Foreign Exchange Market (FOREX) is the most profitable sector for your investments.
Unlike other financial markets the Forex market has no physical location, like stock exchange, for example. It operates through the electronic network of banks, computer terminals or just by phone. The lack of physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one zone to another across the major financial centers (Sydney, Tokyo, HonKong,
Frankfurt, London, New York etc). In every financial center there are a lot of dealers, who buy and sell currencies 24 hours a day during the whole business week.
Here the most important reasons why Forex is so popular nowadays:
• Liquidity. Forex is the largest financial market in the world, with the equivalent of over 3-4 trillion changing hands daily when the volume on the stock markets is only 500 billions of dollars.
• Flexibility. Because of 24-hour trading participants of the foreign exchange market would not wait to react on some events, as this happens on other markets (for example: stock markets). On other markets you simply can be late if you have to wait till morning to show your reaction, as in the morning the event will be already in the price, greatly differ from the desired level.
• Lower transaction costs. Traditionally the Forex market has no commissions, except spread, the difference between ask and bid prices.
• Price stability. High liquidity helps ensure price stability, when unlimited contract size can be executed at a fair price. It helps to avoid the problem of instability, as it happens in the stock market and other exchange-traded markets because of the lower trade volume, where at one price only limited number of contracts can be executed.
• Margin. Margin size for trading on Forex is defined in the contract entered between a client and a bank or a brokerage company, which gives the opportunity to enter the market for the individuals and usually it is 1:100. So, the collateral of 1000 US dollars allows a trader to make deals on $100.000.
Such high leverage combining with the rapid rates fluctuation make this market profitable but at the same time extremely risky.
FOREX may be classified by several features: Type of transactions; For example, there is an international conversion market
(Conversion transactions such as US Dollar / Japanese Yen or US Dollar / Canadian Dollar etc.). Geographic feature; Unlike other financial markets the Forex market has no physical location, like stock exchange, for example. It operates through the electronic network of banks, computer terminals or just by phone. The lack of physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one zone to another across the major financial centers (Sydney,
Tokyo, Hong Kong, Frankfurt, London, New York etc). In every financial center there are a lot of dealers, who buy and sell currencies 24 hours a day during the whole business week. Trading session starts in Far East, in New
Zealand (Wellington), then Sydney, Tokyo, Hong Kong, Singapore, Moscow, Frankfurt-on-Maine, London and ends in New York and Los Angeles.
Main FOREX Participants
Let’s consider the main FX participants
• Commercial banks
They execute the main volume of currency operations. Other market participants hold their accounts in banks and make necessary conversional, depositary and credit transactions on them. Banks cumulate (through operations with clients) market requirements of currency conversions and funds attraction/depositing and refer with them to other banks. Besides filling clients’ requests banks can make transactions independently at own their expenses.
Finally, Forex represents a market of interbank transactions, and under currency and interest rates fluctuations we should consider interbank foreign exchange market.
Large international banks, daily operation volumes of which reach 1 billion dollars, have the most important impact on the world exchange markets. These are such banks as Deutsche Bank, Barclays Bank, Union Bank of Switzerland, Citibank, Chase Manhattan Bank, Standard Chartered Bank and others. Large transaction volumes that may cause significant changes in quotations or currency prize are the most evident distinction of these banks. Large players are usually divided into bulls and bears. Bulls are the market participants who play for the currency prize increasing; bears are the market participants who play for the currency prize decreasing. The market is usually in balance between bulls and bears, and the difference in currency quotations usually fluctuates in quite a narrow range. Although when bulls or bears overpower, currency rates quotations fluctuate quite sharply and significantly.
• Firms that realize foreign trade operations
Companies that take part in the international trading have a great demand on the foreign currency (with regard to importers) and offer of the foreign currency
(With regard to exporters), and also deposit and attract free currency remains.
As a rule, these organizations have no direct access to Forex and make conversional and deposit transactions via commercial banks.
• Companies that realize depositing of foreign assets (Investment Funds, Money Market Funds, International Corporations)
These companies represent different international investment funds. They realize policy of diversifying management of assets portfolio, depositing funds in securities of governments and corporations of different countries. They are called just funds in slang of dealers. The most popular funds are «Quantum» of George Soros and «Dean Witter».
Large international corporations also refer to this kind of firms. They realize foreign industrial investments: affiliates and joint enterprises foundation, such as Xerox, Nestle, General Motors, British Petroleum, etc.
• Central banks
Currency regulation on the foreign market is the main duty of the central banks, particularly, prevention from national currency sharp bounces in order to avoid economical crises, support balance between exports and imports etc. Central banks have a direct influence on Forex. Their influence may be both: direct – currency intervention, and indirect – money funds and interest rates regulating.
They can’t be referred to bulls or bears, as they may play both for rising and falling depending on concrete tasks they have currently. Central banks may act alone on the market to influence on the national currency, or they may act together with the other central banks to conduct the collective currency policy on the international market or for collective interventions.
The following banks have the greatest influence on the world currency market: the US Central bank — US Federal Reserve (FED), German Central bank —
Deutsche Bundesbank and GB Central bank — Bank of England (Old Lady).
• Foreign exchanges
In some countries with transition economy currency markets operate. They realize currency exchange for entities and formation of the market currency rate. The State usually regulates the exchange rate, making use of currency markets compactness.
• Currency brokerage firms
Their function is to bring together a buyer and a seller of the foreign currency and to accomplish conversional or loan-depositary operation between them.
Broker firms take broker commission in the form of percent from the transaction charge.
• Physical bodies
Physical bodies make a great deal of noncommercial transactions as related to traveling abroad, wages, and pension and earned income transfer, foreign exchange cash buying and selling. In 1986 due to margin introduction physical bodies got an opportunity to invest free cash on Forex to take profit.
The main volume (90-95%) on Forex is earned by the largest world commercial banks by making conversional transactions both in clients’ interests and by their own expense. Nevertheless, advance in computer technologies let to find field of application for funds of private and retail investors. More and more brokerage firms and banks give access for private investors to Forex via Internet.
Mini Forex
Work on mini-forex means work with contracts less than $100 000. Mini-forex offers an opportunity to receive the services equal to those that traders who work with several thousands/tens of thousands dollars deposits receive, but depositing only $100.
When trading on mini-forex a trader just makes less than 1.0 lot deals. Till 2003 there was difference between mini-forex and forex in trading terms. Till 2003 $3 commission was charged for each transaction on mini-forex without reference to the transaction volume.
Forex is an interbank market with the minimal transaction size $1 milion.
A logical question occurs – How transactions of $10,000 size, made on miniforex, get into the interbank market? Broker is clients’ counterparty for such transactions. If a broker has a lot of clients who trade on mini-forex he can transfer a joint client position to Forex. If a company works for a long time and has thousands/tens of thousands clients (both on Forex and mini-forex), then as a rule the joint client position is transferred to Forex and a broker isn’t interested in his clients to lose. Every client’s transaction (without reference to its financial result) brings 1-2 pips to broker. The more successful a client is the more transactions he/she will make and the more profit a broker will take.
So, work on mini-forex in large companies doesn’t differ from work on Forex.
Forex Glossary
In banking practice there are special code abbreviations: for example, the exchange rate for dollar against yen refers to USD/JPY, British pound against US Dollar to GBP/USD. The first currency is referred to as the base currency and the second as quote currency:
USD / JPY = 120.25
Base currency Quote currency Rate
This abbreviation specifies how much you have to pay in quote currency to obtain one unit of the base currency (in this example, 120.25 Japanese Yen for one US Dollar). The minimum rate fluctuation is called points or pips.
Most currencies except USD/JPY, EUR/JPY and GBP/JPY where pip is 0.01 have 4th decimal system as 0.0001.
The currency pairs on Forex are quoted as bid and ask (or offer) prices:
Bid Ask
USD / JPY = 120.25 / 120.30
Bid is the rate at which you can sell the base currency, in our case it is dollar, and buy the quote currency, i.e. Japanese Yen.
Ask (or offer) is the rate at which you can buy the base currency, in our case dollars, and sell the quote currency, i.e. Japanese Yen.
Spread is the difference between the bid and the ask price.
Margin trading assumes that Forex dealing is based on the margin, the collateral, and the provided leverage.
This means that a client places minimal cash deposit, much smaller than the underlying value of the contract, but can operate with larger amounts sufficient to enter the real market. Such credits are provided by the brokerage companies besides their informational services and make it possible for a trader to enter into positions larger than his/her account balance. This collateral is typically referred to as margin.
Leverage is the term used to describe margin requirements: the ratio between the collateral and borrowed funds 1:20, 1:40, 1:50, 1:100. Leverage 1:100 means then when you wish to open a new position, then you must have 100 times less than the contract size.
Currency Rate is the ratio of one currency valued against another value of a currency of one country. It whether depends on the demand and supply on free market or restricted by a government or by central bank.
Lot is a fixed standard currency amount for trading provided on the collateral
— margin. Sometimes it is called the contract size. The 1.0 lot contract size for each currency pair is listed in Contract Specification.
Storage is the charge to rollover the position overnight. It can be both positive (Credited to your account balance!) or negative (debited from your account balance) depending on the interests rate in the countries which currencies you trade.
Trader's Textbook
For profitable work on the financial markets a trader should follow the principles specified below.
Forecast which way a market is expected to trend (Analysis).
There is a wide range of methods of analysis: Fundamental Analysis, Technical
Analysis, Elliott Wave Analysis, Candlesticks, Tomas Demark Theory, Chaos Theory or any other. With the help of these methods a trader can forecast prices behavior in the future.
Choose a right moment to open or close a position (Trading Strategy).
Trend identification is not enough for profitable trading. It is essential to choose the right moment to enter the market. E.g. if having identified the bullish trend you enter the market before a retreat starts, this retreat may cancel your stop order. Your position is closed. You lose money and the market reverses and goes in the direction you’ve identified.
Follow the rules of money management (Money Management).
It will decrease the risks of your financial operations. Your money management system will allow you to make deals only with the minimal risk.
Do not allow your emotions to operate your account (Psychological Peculiarities of Trading). When making a decision emotions should be kept under control. Emotions are the first enemies of a trader.
Fundamental Analysis
Introduction to the fundamental analysis
The most important and complicated component of the currency dealing is ability to analyze the tendency of market changes and therefore to forecast which factors will influence on the currency rate and how. The probability of a quick profit taking and quick losses is included in the price trend. Thus, correct forecast of the market trend, estimation of different events, correct reaction to the speculations and expectations àre the necessary component of traders’ successful work. There is a great deal of factors which influence on the whole market as well as on the separate instruments (currencies, shares, futures).
There are two main methods of the market analysis — fundamental and technical. The fundamental analysis estimates the market situation in the context of political, economical, financial and credit aspects. The technical analysis is based on the methods of graphical research and mathematical analysis.
In the context of the fundamental analysis monetary, political and economic events in the world are studied. These events may influence on the market development. The most important here is information about economic indicators of the countries, work of exchanges and large companies such as market-makers, interest rates of the central banks, government's economic rate, probable changes in the country's political situation, various speculations and expectations. The fundamental analysis is the most complicated and important part of the work at the Forex market. To perform the fundamental analysis is much more difficult than any other, as the same factors have different influence on the market in different situations and important factors may shift to the insignificant ones. Except some more formal rules experience of work at the market is needed here.
Fundamental factors are usually estimated from two points of view:
Influence on the interest rate; State of the country’s national economy.
Data of Economic Development of a Country
The principle of this sub-group impact is based on the axiomatic statement that the rate of any currency is the derivative of this country economic development.
Stability of economic development specifies foreign investors interest in the capital expenditures to the country and, correspondingly, demand on the national currency. The data of economic development of a country include such key indicators as balance of trade and balance of payment, inflationary rates, unemployment rate, GDP etc.
In the Forex market a unified system of currencies quotation through the US dollar was elaborated. Thus, the US economic development and the dollar rate are the key factors, which specify market movement, common to the main currencies. That is why the US dollar and its behavior are in the limelight, as they trigger some specific reaction of other currencies. Frankly speaking, it doesn't eliminate other factors impact, such as policy of the national banks or influence of the related markets, which will be described briefly a bit later. In the USA the main indicators of economic development are released monthly or quarterly.
Trade negotiations
Trade negotiations are the important part of economic policy of any country. In particular, such the important economic indicator as trade balance represents the difference between export and import. In case the sum of exported goods and services exceeds the price of imported ones Trade Balance is positive
(Surplus), in case import surpasses export it is negative (deficit). The trade deficit is the main problem for the USA within the last years. It is one of the reasons of the dollar fall against the major European currencies. Results of trade negotiations have an immediate impact on the market.
Technical Analysis
Technical analysis is market dynamics research, mostly by means of charts, to forecast future prices movement.
There are three principles of technical analysis:
Price discounts everything
Price is affected by economic, political and other fundamental factors.
Some of them push the price up and others down price and factors influencing it.
All this information is reflected in prices. Technical analysis utilizes the information captured by the price to interpret what the market is saying with the purpose of forming a view on the future.
Price movements are not totally random, or prices trend
Trend is the main direction of the price. The main purpose of the charts is to define a trend at an early stage and to trade in accordance with its direction.
There are three types of a trend
Trend Analysis
Trend is a general direction of the price.
There are three types of trends:
• Uptrend (or bullish). Prices rise.
• Downtrend (or bearish). Prices fall.
• Flat or Range. Though any price movement cannot be linear. Any trend consists of the periods when the price moves in the direction of the main trend (Impulsive movement) and periods of retracement (Correction). The market moves in the wave mode. As the result tops and bottoms form on the price charts.
Support/Resistance Levels
Looking at the charts you can notice that tops and bottoms of the market can be almost on the same inclined (sometimes horizontal) line. Such lines are called support / resistance levels.
Resistance: lines are drawn between the significant top points. The more tops confirm the line the stronger it becomes. That is the market shows that the price level, specified by the resistance line, is very important and the market, having reached its saturation, bounces back from it.
Support: lines are drawn between the significant bottom points.
Once the support level is broken downwards it becomes the resistance level.
Once the resistance level is broken upwards it becomes the support level.
Channel Lines Often prices fluctuate between support / resistance levels. Such a movement is called a Chanel. In case the channel lines diverge this is an expanding channel, if they converge, then it is contracting.
