Forex Essentials

FOREX

Forex and FX are both abbreviations for “Foreign Exchange”; it may also be called the currency market, the foreign currency market, the currency trading market and etc. The Forex market is where banks, international corporates / organizations, governments, investors and traders come to exchange and speculate on currencies. Forex is considered as the world largest and most liquid-able market in the world with an average daily turnover of over USD $3.98 trillion dollar as the business days continues.

As we understand that Forex market is the origin market places for all activities that involves currency transaction, it is also commonly understood that there will be no central marketplace for the Forex Market; trading is instead said to be conducted “over the counter” unlike other investment such as stocks where there is a central marketplace with all orders processed like NYSE.

All Forex currency pricing are all quoted by all the major banks and not all banks will have the exact same price. The brokers shall be taking the average feeds from all the banks or liquidity provider.

As the business transactions from all levels organizations from each country, currencies will be bought and sold just like any other commodities and its value shall increases and decreases depending on the economics movement of each nation; this is where Forex comes into place as the fluctuation of currencies price will be the main target for Forex investor, traders or fund manager to focus on for their investment as they place their trades between the currencies and gain their respective profits.

How to make profit with Forex?

Many traders would have the wrong understanding on how to make money with Forex on the moment they open their real trading account. Making money in Forex does not solely depending on the purchase of some sounding Automated Trading Robots or Expert Advisor (EA) as the reality might be different from the expectation of all beginner traders.

There is not free money or easy money in this world especially in Forex as everyone commonly understands that there will be no free lunch unless one was born with golden spoon. Surely it is very likely to make consistent money or profit in the forex market, and it can be a relatively easy way to augment the monthly income if a trader uses the right approach and with the right mindset. The first thing that each trader must embed in their mind is to make profit or money in Forex with consistent paste instead of always aiming for huge gains followed by huge losses. Traders will need to be always be aware of their emotions and make sure their trading routine is consistent and that it reflects their consistent mindset (*Emotional Control in Investment). The reason is because it will be easier for them to diagnose their mistake and to find out the next best approach to be able to continuously making profit and covering losses.

In order for a trader to learn to make money in Forex, he must also learn how to trade effectively and must learn an effective trading strategy that isn’t too complicated. Once he does this, he will have to actually learn to manage himself in a responsible manner in the markets. This means constantly being aware of his emotions and actions, and making a Forex trading plan and keeping a Forex trading journal. Traders who don’t do these things are typically going to lose money, sooner or later. The best way to learn how to trade the markets is to obtain training and guidance from an experienced and successful Forex trading mentor, just as learning any any other skills or profession is best learned from a mentor as well.

What is Foreign Exchange?

Why would I trade Forex?

Trading Forex Has Many Purposes

There are many levels traded which impact on you that you would not even be aware of. For every purchase you make, the contents, ingredients, by-products, parts or materials may not necessarily all be from a domestic source. Many elements could have been bought internationally, and as such, the exchange of foreign currency would have had to have taken place.

Financial Perspective

From a financial perspective, some people may trade the Forex market for profit. By taking a cross currency pair, they may exchange currency to a foreign designation hoping for domestic currency values to depreciate, thus when you convert it back you will receive more than you initially started with.

Goods and Services

For international importers or exporters of goods and services, there are great opportunities available through having access to the international market. However, with fluctuating international currency rates, payment can sometimes be difficult. Initially companies make a sale for an agreed price, then on the day of payment the agreed value is significantly less than agreed to, due to a currency fluctuation known as “foreign exchange risk”.

Types of Businesses

You will find all types of businesses, from large financial institutions to small retail freight forwarders will practice foreign exchange hedging. Simply put, these companies will put in place measure to ensure that their agreed payment value will represent the same value at the day of payment, regardless of currency value fluctuations.

The 8 Major Currencies

Internationally, there are 8 currencies that are traded more than other currencies. These are often referred to as “Majors”. These currencies are as follows:
USD
Unites States Dollar
JPY
Japanese Yen
GBP
British Pound
CAD
Canadian Dollar
EUR
The Euro
chf
Switzerland Dollar
AUD
Australian Dollar
NZD
New Zealand Dollar

What is a Pip?

A pip is a small measurement of change in the underlying currency. Generally, it is the forth (0.0001) decimal place of a currency price, except with the Japanese Yen, where they have no denomination for cents in their currency (in the Japanese Yen, the pip is the second decimal place). Shown below is an image representing an order window reflecting the price of the GBP/USD.

The fourth decimal place is marked red to show which decimal the pip is in reference to. If the price 1.35361 moves to 1.35371 then there was a 1 pip movement.

A pip is a good reference measure to how much a trader can make based on the volume of their trades. For example, if a trader purchases 1 standard contract of GBP/USD, the value of potential return and risk is $10 profit or loss (of the counter currency in a pair) per pip movement. You can follow the table below as a reference to potential risk or return:

Quite often, the annotation used to measure how well a trader is doing is to mention how many “pips” they have gained in a set time period.

A pip is a small measurement of change in the underlying currency. Generally, it is the forth (0.0001) decimal place of a currency price, except with the Japanese Yen, where they have no denomination for cents in their currency (in the Japanese Yen, the pip is the second decimal place). Shown below is an image representing an order window reflecting the price of the GBP/USD.

The fourth decimal place is marked red to show which decimal the pip is in reference to. If the price 1.35361 moves to 1.35371 then there was a 1 pip movement.

A pip is a good reference measure to how much a trader can make based on the volume of their trades. For example, if a trader purchases 1 standard contract of GBP/USD, the value of potential return and risk is $10 profit or loss (of the counter currency in a pair) per pip movement. You can follow the table below as a reference to potential risk or return:

Quite often, the annotation used to measure how well a trader is doing is to mention how many “pips” they have gained in a set time period.

Bid, Ask and Spread

Leverage

Borrowing Based on the Deposit

Leverage is the amount that you are borrowing based on the deposit in your account. Default leverage is set at 100:1, meaning that for every $1 you have in your account, you have a buying power of $100. If you have $1,000 in your account, you have buying power of $100,000.

Base Currency

Something to remember is 1 standard contract is $100,000 of the base currency. If you wanted to trade a full contract and you had leverage of 500:1, then you could take this position with only $200 in your account ($200 x 500 = $100,000). High leverage can help you take larger positions based on smaller capital in your account, but it is not without its pit falls. Larger positions result in larger dollar movements per pip and, as such, can wipe out smaller capital amounts in a short period of time.

Taking Your First Step

  • The first time logging in to the MetaTrader 4 platform can be overwhelming. However take the time to have a look at the data available. The market watch window shows current prices for the currency pairs available and the charts give you a timeline based representation of the prices.
  • Now focus on one particular currency pair. Make a choice, a random one is perfectly fine. Say for example, you have selected the AUD/USD pair. Open an order and you will be presented with the option to “buy” or “sell”. We want to make a random trade now, so execute an order to “buy” or “sell” at market.
  • You have now placed your first trade on the MetaTrader 4 platform.
  • You will now see that you have executed a trade. Take a moment to watch how it performs.
  • After a break, you will notice that your trade has now either taken a profit, or taken a loss.
  • Regardless of the position of this random trade, you now know how you can make money and, also potentially, how to lose it. Don’t worry if your trade took a loss, this was a random trade and the exercise was to place a trade. Choosing the right directions of trading will come later in developing a strategy.
  • Having executed this exercise you have completed the first steps towards learning how to trade. You can close this trade if you wish, or you can keep it open and continue to watch it.

Basic Chart Types

If you can’t read the charts, then you won’t make sense of any of the data, with which to form your strategy. The charts can be placed into three different categories:
line-bar

Line Bar Charts

The easiest to read of the charts is the Line Bar Chart. It simply shows a line graph of time vs. price.

Bar Charts

The next chart to decipher is the Bar Chart. Bar charts not only show price, but also show the entry price per period, the exit price at the end of the period and the high and low of that period. Each horizontal line represents one time period. The period is selected by you to represent 1 minute, 5 minutes, 15 minutes, 30 minutes, 1 hour, 4 hours, a day, a week or a month.

Candlestick Charts

Candlestick charts are similar to bar chart but with additional information of each bar being hollow or coloured. This is done to allow a trader to easily visualise a period bar to have moved in a positive or negative direction from its entry price.

As shown in the image above, the hollow bars are bars that have moved up. Coloured or filled bars are bars that have gone down. The lines that you see above each bar represent the high and lows.

Interpretation of Charts

Now you know what line charts, bar charts and candlestick charts look like, how do you interpret them?

Firstly, you have to understand that these individual bars or candlesticks only represent one-time frame. Have a look at the following image to see that each bar represents one hour.


The x -axis represents a time interval and the y-axis represents the currency pair price. Each single bar represents the high and low of that one- hour period, the open price and the close price at the end of the hour. Each bar can be represented in all sizes and lengths.
  • Longer bars indicate there were big differences between the high and low.
  • Short bars indicate not much movement in the market.

When accessing the types of bars or candlesticks, “shadows” is the term given for the portion of the bar or candlesticks where they have reached a high or low, but have not ended the period at the high or low. You will be able to see the shadows of each bar or candlestick where there were highs or lows for that period.

By being able to see the shadows, it gives an indication that the market at that time period may have reached a high, but the market retracted and closed at a lower point. This may show that when the underlying asset (the currency pair) reached a certain point where there was resistance by other market participants in offering a higher price than the high shown.

On the other side, it can be said that there was support in pushing the price in the other direction if you see several shadows in one direction, ie. several consecutive bars or candlesticks with shadows in one direction.

As you can see in the image above, in the filled candlesticks, there are a lot of consecutive shadows going downward. This shows that there are many market participants seeking a lower price.

It shows support for a downward trend for this particular case, however many counter tails in the opposite direction can set up a reversal so care is needed in thinking whether lower tails always equal lower prices.


The bars reach a certain high, but seem to struggle to beat a price mark. The horizontal line indicates that there is an imaginary level where market participants feel that they should not push the currency past. This is known as resistance.



Trend lines are lines that are usually drawn on charts to determine a direction the market is moving. A person sitting in front of a chart will physically draw a line from one point to another point to determine the general direction the market is moving.

Trend lines are useful to help determine current market direction. To have a confirmed trend support or resistance you need two points to make it a line.


Channel lines are drawn to show the general direction taking into consideration also any bar “shadows” containing support and resistance.

Drawing channels clearly show the channels that trading generally trades between. This is particularly useful when using the “ranging strategy” and also for assessing opportunities for “break out strategies”.

Forex Strategies

Having placed some random trades, you would have figured out that when you place an order to buy or sell, you could potentially earn or lose money. The theory is quite simple, pick the right direction and you will make money. The important question is “how do I pick the right direction?”

The simple truth is that if there was a way to know exactly when to buy and sell, everyone would be rich. Simply put, there is no guaranteed way to always pick the right direction the market moves. However, there are a number of tried and tested strategies that you can base your decision on which can increase your chances of a profitable trade.

Strategies are a systematic and planned course of action based on existing information you know of the market. There are a multitude of strategies for Forex trading. A lot are available to learn for free by doing an internet search. There are also books available and people that will teach these strategies for a fee. Around the world, professional traders and recreational traders alike will always hold at least one trading strategy to heart and will attribute their success in trading to following that one or many trading strategies. The following section covers some popular strategies that are used by many traders.

The Trending Strategy

The trending strategy is to follow the market in the direction that it is clearly following over an extended period of time. Currency pairs often take either “bullish” (up) or “bearish” (down) trend.

By following the trend of a particular currency pair, you are banking on the fact that the currency continues its existing direction and you are taking in a profit by following the market direction. This strategy is by far the most popular strategy method for trading currency.

Trends can be long or they can be short, meaning that there are short term trends and there are long-term trends. An example would be that during a 6-month period, there was a bullish trend for the AUD/USD, however, in between this 6-month period there were 2 short periods where it took a bearish trend. The following is a graphical representation of the example.

  • The trending strategy is to follow the market in the direction that it is clearly following over an extended period of time. Currency pairs often take either “bullish” (up) or “bearish” (down) trend.
  • By following the trend of a particular currency pair, you are banking on the fact that the currency continues its existing direction and you are taking in a profit by following the market direction. This strategy is by far the most popular strategy method for trading currency.
  • Trends can be long or they can be short, meaning that there are short term trends and there are long-term trends. An example would be that during a 6-month period, there was a bullish trend for the AUD/USD, however, in between this 6-month period there were 2 short periods where it took a bearish trend. The following is a graphical representation of the example.

News Release Trading Strategy

News traders trade off economic news release. The Forex market is particularly reactive to economic news, in particular, interest rate news from the G8 countries, as well as unemployment news for each corresponding country.

News traders will have to bear in mind that the Forex market movements have already taken in to consideration existing and expected economic news. The sharp movements you see due to economic news are corrections due to unexpected news, either better than expected or worse than expected.

Another consideration to take to heart for potential news traders is that during negative sentiment news reports, currency movements generally head towards lower yielding and perceived ‘safer’ currencies; USD and JPY in particular.

A good grasp of economics is generally recommended for traders wishing to start news releasing trading.

An economic news calendar is highly recommended. Forex Economic calendars show the release date for important economic news such as “non-farm payroll”, GDP figures and interest rate news. Above image is an example of what an economic calendar shows.

Forex calendars will show what forecasted data should be and what it was previously. If at the news release the actual data released was worse than expected, you can expect the underlying currency of that country to react negatively.

Managing Risk

Trading the Forex market can be profitable, however, it can be just as costly without the proper management over your capital. Generally with each trade, stop losses are placed to ensure that a trade that goes against you does not completely devour your invested capital.

A stop loss is a preset target where your trade will close out. Setting proper stop losses are important to ensure that your losses are minimised. For traders that don’t want to sit in front of their computer every minute they have positions opened, stop losses are your best friend.

Setting the amount you are willing to lose per trade is subjective. Generally, risk levels are set at between 1% and 5% of your trading accounts total balance. This means at a risk level of 5%, you can place 20 losing trades before you lose all your funds. If you find that you often incur losses, you may wish to review your strategy.

Say for example, you deposited an initial amount of $1,000. To risk 2% per trade would be to set a stop loss which will close the trade for you should a single trade lose $20 ($1,000 x 2% = $20).

Make sure that you manage your risk, as this is one of the pivotal aspects in long-term trading success.

Managing your Emotions

Quite often, the greatest opponent you have while trading is not the market but yourself. When trading, greed and fear often limits the potential returns from profiting trades and on the opposite side of the spectrum can result in greater losses than necessary or turn potentially profitable trades into losing trades.

All traders (successful and unsuccessful) can attest to holding on to losing trades for far too long for no other reason than the “hope” that they become positive again. This is otherwise known as being too greedy.

Alternatively, the fear of taking profits too early or closing at a small loss when they can potentially be profitable is also another emotional response that needs to be adjusted. Good traders strictly follow a complete trading plan that incorporates money and risk management, entry, exit rules and do not let emotions influence their trading.

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