Forex is the most exciting markets for investors. The main participants in the forex market are large banks and other institutional investors, but with technological innovation in the last 20 years, the market became accessible for smaller retail investors as well.
Today, all you need to participate in this exciting market brimming with money making opportunities is a computer with internet access, a broker account which you open online, and this forex tutorial, which will cover all the basics to start trading.
Major World Currency Pairs
As you probably already assumed from the name, the foreign exchange market is where traders go to trade the world’s currencies. There are many currencies around, but just a few are considered the major currencies. Namely, there are eight most traded currencies in the forex market. These are:
- U.S. dollar (USD)
- British pound (GBP)
- Euro (EUR)
- Japanese yen (JPY)
- Swiss franc (CHF)
- Australian dollar (AUD)
- New Zealand dollar (NZD)
- Canadian dollar (CAD)
As you can notice, all the listed currencies are from developed economies, as they make up the highest share of the world trade, which makes their currencies the most traded in the world.
The Structure of the Forex Market
- Buyers > Highest Person (Controller) < Sellers
- The stock market is a monopolistic place to be in, and there is actually only one entity. This is one specialist who controls all of the prices, which is the middle person in the graph above. All of the trades made in the area have to go through this one person. These prices can then be altered to benefit the specialist in the position and actually hurt the traders in the end. This is something that almost always happens.
- The specialist in this position is forced to fulfill all of the orders that come from the clients. If the number of sellers was more than the number of buyers, then the specialist, who is forced to fulfill the client’s needs, has to leave a bunch of stock to the sellers that he cannot sell off to the buyers that are in this trade.
- If you want to prevent the specialist from doing this, then the specialist can simply widen the spread that everyone is using or even increase the cost of transaction to prevent any of the sellers in the market from entering this specific trade. This actually allows the specialist to manipulate the quotes and the figures to fit everyone’s tastes, if they so choose to do so.
Decentralized the Trading Spot for Forex
- You do not actually need to go through a centralized exchange like the Stock Exchange in New York using just one flat price each time. In the Forex field of the market, there is nothing stating that there is a single price for any given currency at any time. This allows you to have the idea that quotes differ from dealers and prices will vary from day to day.
- This is something that many people find a lot to handle since there are many different components within the graph. This is what makes the Forex market what it is, however. This is because you want the largeness of the market each time you trade for the competition, that the dealers put off, giving you the best deal that you can get each time.
- You are able to do Forex trading wherever you would like, which means no crazy loud stock market to run to every day. It is done just like if you were to trade cards of a favorite sport.
Learning More about the Forex Ladder
The Forex market is a decentralized area, and the people in the market can be categorized through a series of ladders. You can find out for yourself where each person and company fits on the ladders below:
The top of the market ladder in the Forex industry is the interbank market. This is one of the largest banks in the world and also includes the smaller banks who participate with the larger bank. They also trade directly to and from each other, and electronically through EBS systems. They can also use the Reuters Dealing 3000 Spot matching to do the job, and do it right.
The competition between the EBS and Reuters Dealing 3000 Spot Matching is tough and tight. They each want to make it out the best, yet the competition is tough. They are always battling over clients and want the higher of the market share in the end. They both offer a number of currency pairs, although some of the currency pairs are more liquid than the others that they offer.
In the EBS system, EUR/USD, USD/JPY, EUR/JPY, USD/CHF, and EUR/CHF are more liquid than any others. For the Reuters system that is used, it is a bit different coming in as GBP/USD, EUR/GBP, USD/CAD, NZD/USD, and AUD/USD are the more liquid of the group.
All of the banks that are within this group at the interbank market can see each of the rates that are offered, yet not all of them can make deals on the prices at hand. The credit relationship between the two parties is dependent on the rates and vice versa. The better the credit standing, the better the reputation with them and you will have the better interest rates with the largest loan that you can get.
The hedge funds, retail market makers, and corporations of retail ECNs in the ladder. Since these institutions do not have a tight credit ratings and relationships with the participants of the interbank market. These markets have a higher transaction via commercial banks. Their rates are slightly higher than the people in the interbank market and can be more expensive in the end.
The bottom of the ladder holds the retail traders of the market. These people are at the bottom because it is very hard for them to engage in the market. Now that times have changed however, the internet allows the little people to trade and enter the Forex trading barrier that once stopped them.
The Evolution of the Forex Trader
Exchange rates fixed, and placed the U.S. dollar as the de facto world reserve currency backed by gold. Even today, the dollar remains world’s most trusted reserve currency.
The agreement also established two important international finance institutions:
- The International Monetary Fund, with the role to monitor the fixes exchange rate regimes, and to lend reserve currencies to countries.
- The World Bank, which helped in reconstruction of countries devastated by the consequences of World Wars I and II.
Eventually, the dollar overvaluation led to the collapse of the agreement in 1973, and foreign countries chose to let currencies float, which is one of the most important events in the history of forex.
Before the fall of the Bretton Woods agreement, large institutional investors were the exclusive participants in the foreign exchange market. Small investors couldn’t invest in the market. But, with the rapid technological development and the Internet boom in the 1990s, the forex market became accessible to smaller investors as well and thus, retail foreign exchange trading was born.
The retail forex market is where you and I can trade. This segment of the global forex market has approximately 5% of the share, which still represents over $280 billion in daily trading turnover. With the development of internet, trading software and the availability of trading on margin (that is, opening larger positions with only a percentage of your available balance), the retail forex market started growing. The following chart shows the growth rate of daily trading volume since 1989:
Most forex brokers are so-called market makers. A market maker buys and sells the currencies from its clients, making profit on the small price differential called a spread. When you exchanged currencies for a holiday trip to Europe, maybe you noticed the “bid” and “ask” price of a foreign currency in the bank. These are the prices at which banks (and market makers) buy and sell the currency from you, making a profit from the difference in the price.
On the other hand, an ECN broker uses electronic communication networks (ECNs) to give clients direct access to other market participants, like banks. This means that ECN forex brokers have tighter spreads than other retail forex brokers, but usually require a higher minimum deposit to start trading.
Who Trades the Forex Market
news that big banks and institutions have.
Some traders think they can’t compete with the “big players” in the forex market: the large banks, large commercial companies, governments, central banks, insurance funds etc. The truth is, you don’t have to compete with these giants. Instead of trying to be ahead of them, you can trade along with them. The market is large enough that no individual bank or company can influence it and most of the time, the “big players” are hit by the same breaking news or volatile market movements as an independent trader would be.
Interest rate changes, inflation and employment reports, natural disasters, almost all news is immediately available to both the “big players” and independent traders. Instead of fearing these large investors, you should read their analysis and forecasts, and try to jump in the same trades as they do. That being said, their forecasts can also be wrong from time-to-time. Let’s take a closer look at the “big players” in forex.
The Super Banks
The big banks account for the majority of the transacted volume. The amounts they transact between each other are huge, often hundreds of millions of dollars. The biggest players include Deutsche Bank, UBS, Citi, HSBC, Goldman Sachs and others. Unlike other market participants, banks have the little advantage that they can track their clients’ orders and determine possible buying and selling pressures on specific currencies.
But, due to the size of the forex market ($5 trillion a day), one single bank can’t move the market and influence the prices. They have the same goal of making profit, just like a retail investor. The following chart shows the largest players in forex among banks:
Large Commercial Companies
· Large companies also participate in the foreign exchange market. From small businesses to large multinational corporations, many companies need to exchange currencies from time to time. Unlike the other participants in the forex, the intention of companies is not directly to make a profit trading currencies. Rather, the nature of their core business makes them buy and sell currencies.
· For example, a cheese producer from France selling his products in the United Kingdom, will receive British pounds for the sales. He will exchange the pounds to euros in France, not with the intention to profit on the currency moves. Indeed, large companies want to offset the risk from currency fluctuations, making their profit in overseas markets more predictable. To do so, they will hedge their receivables or fix the exchange rate with currency forward agreements.
Governments and Central Banks
· The role of governments and their central banks is an important one in the forex market. Central banks don’t trade currencies to make profits, but to facilitate their government’s monetary policies. The role of central banks in developed countries is usually to maintain a stable exchange rate through eliminating excess supply and demand for their national currency, and to target specific inflation rates and low unemployment rates.
· To achieve their goals, central banks hold reserve currencies which they buy or sell on the market to stabilize the national currency’s exchange rate, or they can change the key interest rates and influence supply and demand for the local currency. Central banks usually hold dollars as the reserve currency, but recently other currencies like euros or Japanese yens are also becoming increasingly popular. Traders should closely monitor any activities of central banks as they can have a large and long-lasting impact on the value of currencies.
· Governments play an indirect role in the forex market, mainly by the sheer volume of money that they are able to invest through public spending and investing. Government debts also play an important role for the value of national currencies, with higher debts usually having a negative impact on the currency.
Individual Retail Traders
· The forex market, combined with some knowledge and experience, can be very profitable for the individual retail trader. Many retail traders don’t even have a finance background, and are self-taught in forex. Many people with a technical background, like engineers, find forex exciting as they can establish their own strict rules and analyze the market from a technical perspective. To start trading forex, you don’t even need to make large initial deposits. The availability of trading on margin makes it possible to start trading with as little as $50, but opening much larger positions.
Why Traders Love the Forex Market
Whatever your approach to trading is, it is possible to implement it in forex. If you are a day-trader and find it exciting to follow the markets all day round, you can do it. Looking at the charts and following forex-related news from all over the world is the best way to gain experience and learn trading. If you have a day job and want to analyze the market in the evening, to place a trade and let it open a few days, that is also possible.
A market is always open somewhere – be it in Tokyo and Sydney or Frankfurt and London. This is a very effective approach, as it prevents overtrading if you stick all day in front of a trading platform. Forex offers something for every type of trader, be it a day trader, a swing trader, position trader or scalper. We will touch later the different types of traders and their characteristics.
Unlike a traditional stock broker, a forex broker has no commissions, no middleman, no fixed lot size and low transaction costs. As we already said, a forex broker makes his profit from the difference between the bid and ask price of a currency quote. The spread is very tight on the major currency pairs like EUR/USD, GBP/USD or USD/JPY, often as low as 1-2 pips (a pip is the smallest increment a currency pair fluctuates, if EUR/USD goes from 1.1245 to 1.1246, it changed one pip).
The value of a pip varies with the size of your position, ranging from just a few cents for a small position to a few dollars for a large position. You can open positions of any size you want, if you have sufficient margin to finance the position. There is no fixed lot size in forex.
The volatility in forex can be very high, especially in periods of important news-releases. In these circumstances, currency pairs can move easily a few hundred pips in a short time. Combined with the high liquidity that forex offers, and the trading sessions which are open around the clock, there will always be an opportunity to place a trade and make a profit in forex. When compared to stock- or futures markets, this makes the currency market one of the most profitable financial markets out there. The following table shows the average daily range for some of the forex pairs.
The pair GBP/JPY (British pound/Japanese yen), has traditionally the highest volatility when compared to the other pairs. As you can see, there is no lack of excitement in forex!
Why Traders Choose Forex Over Stocks
York Stock Exchange alone! All these stocks are influenced by various factors, like earnings reports, rumors about mergers and acquisitions, and even resignations of CEOs. Multiply this with hundreds or thousands of stocks, and you will pretty soon realize the amount of work and time needed to catch up with all of this.
Now, let’s compare this with the forex market. I have made some bullet points to make it easier to follow:
The Only Eight Major Currencies in Forex
As mentioned earlier, eight currencies make up the majority of the daily turnover in the foreign exchange market. These are:
- U.S. dollar (USD)
- British pound (GBP)
- euro (EUR)
- Japanese yen (JPY)
- Swiss franc (CHF)
- Australian dollar (AUD)
- New Zealand dollar (NZD
- Canadian dollar (CAD)
The major currency pairs, (which consist of the U.S. dollar and one of the other seven currencies), have a market share of 72% in forex. You can check the share of total volume by currency pair on the next chart. Let’s stop here for a minute and compare this to the stock market. Eight currencies far easier to follow than thousands of stocks, do you agree?
Most traders focus only on one or a few of the major currency pairs, like EUR/USD, USD/JPY and GBP/USD. Following three charts and four currencies, which I can trade all day long, compared to the limited trading hours and big number of stocks is something that attracted me to the forex market in the first place.
The Forex Market is Open All Day Long, 24/6
Forex is a decentralized market which trades at large financial centers around the world. The largest of them are: New York (U.S. session), London and Frankfurt (European session), and Tokyo and Sydney (Asia-Pacific session). Recently, Hong Kong and Singapore have become large forex centers as well. With the closing of the U.S. session, the Asian session opens, followed by the European session. Notice the overlap in active market hours between London (European session) and New York (U.S. session), this is the most volatile period of the day with the majority of daily volume taking place. Compared to the stock market, the advantage of forex is obvious in this case.
Forex Has No Middleman
Being a decentralized market, forex has no middleman in the usual sense. Forex brokers do have a similar role as stockbrokers on the stock market, but they only charge a small fee in the form of a spread. There is no commission in forex. With the advantage of technology and straight through processing (STP) brokers, which provide direct access to the market, the need for a middleman disappeared.
Forex is Much Harder to Influence than Other Markets
Forex is the largest financial market in the world, with participants including large banks, hedge funds, multinational corporations, investors, to central banks and governments. The size of the market makes it impossible that one single market participant influences the value of a currency in noticeable amount. Compare this with the stock market, where analysts’ discussions or rumors can have a big impact on the price of stocks. In the long run many investors believe this helps to make the analysis of currencies much easier and more predictable than stocks.
Why Traders Choose Forex Over Futures
The same advantages of forex over the stock market, applies to the futures market as well. As noted earlier, forex is always alive. It’s a truly 24-hour market which can be traded almost every day, and dwarfs the $30 billion daily turnover of the futures market. Even on Sunday, you can place trades when the Asian session opens at 5:00 PM in Sydney, and 7:00 PM in Tokyo. Compared to the limited trading-hours of the futures market, this means that trading opportunities in forex exist around the clock.
Another major disadvantage of the futures market over forex are the commissions. In the forex market, brokers only charge a small fee which is called the “spread” – the difference between the bid and ask price for a specific currency pair. Many brokers offer spreads as low as 1 pip on the major currency pairs like EUR/USD, and under normal market conditions. This is the only cost you will have when opening a position in the forex market.
Compare this with the average volatility of currency pairs during the main trading sessions in the next article, and you will see that the spread can be earned back in a matter of seconds if you are on the right side of the price movement. With an increase in market liquidity during some trading sessions, the spread becomes even tighter as there is heavy supply and demand in the market. Trading sessions will be covered in the coming few articles.
When opening a position with a forex broker, you will get fast trade execution and price certainty under normal trading conditions, thanks to the deep liquidity of the market. On the stock and futures market the opposite is true – the price the broker shows for a specific stock or futures contract is the last price at which the instrument has traded, and not necessarily the price at which your order will be opened. This creates price uncertainty which can affect your bottom line.
In the forex market, you can also always have a known risk/reward ratio, thanks to the various types of market orders and guaranteed limited risk. For example, you can open a buy position on GBP/USD with a take-profit level of 100 pips above the current price, and a stop-loss level of 50 pips below the current price. This gives you an exact risk to reward ratio of 1:2. As most traders trade with leverage on forex, this means that a specific amount of trading capital needs to be “locked” while opening a position. This is called the margin. If you trade with a 1:50 leverage, the required margin for opening a position will be 2% of your position size.
A margin call happens when your position goes against you to such an extent that your available margin becomes zero (that is, the free funds which are not locked in your margin). With a margin call, you can’t lose more than your required margin for opening the position in the first place.
Forex Market Sessions and Trading Times
If you are a beginner, this could look unimportant to you – but you should learn the different characteristics of the major market sessions as early as possible, because it can make a real difference to your learning curve.
The best time to trade is when the market is most active and volatile – this is when you will find the most trading opportunities. If there is not much movement in the market and it’s calm, you could waste your time waiting for a trade setup. There are other tips that you could implement depending on the trading sessions that you are trading, and we’ll get into those in just a bit.
The Four Major Trading Sessions
· What you need to know from the get-go is there are four major trading sessions – the New York session, the London session, the Tokyo session and the Sydney Session. The following table shows the open market hours for each of the sessions, including the difference between summer and winter times.
· The Asia-Pacific trading sessions, which include Tokyo and Sydney, are the markets that open the forex trading day. They usually offer lower volatility compared to the London and New York sessions, and are more suitable to risk-averse traders as the lower volatility also decrease the associated risk.
· Risk-tolerant traders, on the other hand, are better suited with the US and European sessions, especially during their overlap, which creates the most volatile trading hours of the day and offers plenty of day-trading opportunities. These traders also use the Asia-Pacific session to get a feeling about the market momentum, so they can prepare their trading strategies before London and New York opens.
· As you can see from the table above, there are certain times during the day when sessions overlap. The most significant is the overlap of the New York and London trading sessions, between 8:00 AM and 12:00 PM EST. This is the time when most of the daily trading volume occurs, as companies and banks start their day and daily operations. The volatility during these few hours of overlap rises significantly, and this is the time when you will find the most trading opportunities – especially if you are a day-trader or scalper.
· Around 85% of all trades involve the U.S. Dollar, and these pairs are especially volatile during the New York and London overlap. Another minor overlap happens between 3:00 AM and 4:00 AM, when the European and Asian sessions overlap. However, the market volatility during this overlap is far lower than during the New York and London overlap, and offers only a smaller number of trading opportunities.
· Disclaimer: The pip values were calculated using past averages and are not absolute values. These values can vary depending on volatility and liquidity
· Now that you have a basic understanding of what forex trading sessions are, what their opening and closing times are and which are more suitable according to your risk profile, let’s explain each of the sessions in more detail. We will start with the opening of the trading day in the Land of the Rising Sun – the Asian/Tokyo session.
The Asian/Tokyo Trading Session
the third largest forex trading center, after London and New York. Since the Japanese economy is heavily based on exports, it’s no surprise that the Japanese yen is the third most traded currency in forex. Other important financial centers in Asia include Singapore and Hong Kong, and around 20% of all forex transactions take place during the Asian session.
The Asian session is the first major market to open, and many traders around the world use it as a benchmark for the upcoming trading day. The following table tabulates the average pip ranges for the major currency pairs during the Asian session.
Disclaimer: The pip values were calculated using past averages and are not absolute values. These values can vary depending on volatility and liquidity
The EUR/JPY, GBP/JPY, AUD/JPY and GBP/USD are among the most volatile currency pairs during the Asian session. These are the pair on which risk-tolerant traders should keep an eye on during the Asian session. Japanese exporters are known to participate in the forex market during this session to repatriate their overseas earnings from Europe, USA and Australia, creating high pressures on the mentioned currencies. Australia is also a key importer of ore to Japan, and American investment banks use the Tokyo trading hours to enter into the Japanese equity and bond market.
One more thing to consider is that Japan and China are the largest owners of US treasuries, whose central banks create heavy supply and demand of the USD/JPY pair through their open market operations. Large banks and hedge funds are also known to use the Tokyo open to trigger their stop orders. The mentioned currency pairs thus provide the most trading opportunities, but due to their volatility they are also the riskiest to trade. However, liquidity during the Asian session can sometimes be very thin.
Other currency pairs that include EUR, GBP and CHF are also volatile during the Asian session, as the big players in Europe are preparing for the opening of the London session and position themselves according to the Asian session’s momentum. For traders that are more risk-averse, USD/JPY and USD/CHF are appropriate to trade as their relative lower volatility offer traders the opportunity to implement long-term trading strategies.
The European/London Trading Session
· With the large number of banks and trading firms located in London, this session makes up 30% of all forex transactions.
· Most day-trends also start with the London session, and they usually last until the opening of the New York session. Trends that form during this session can sometimes reverse with the trading day in London approaching its end, as the market participants lock in profits and close their positions. The following table shows the average pip ranges during the London session:
· Disclaimer: The pip values were calculated using past averages and are not absolute values. These values can vary depending on volatility and liquidity.
· As the table shows, even 9-out-of-12 pairs have an average range of above 80 pips during the London session. The most volatile among them are GBP/JPY, EUR/JPY and GBP/USD. These are pairs for the risk-tolerant traders, as their high volatility offer plenty of trading opportunities and large profit potential in a short period of time.
· EUR/USD, EUR/CHF, AUD/JPY and USD/CHF are other pairs with an average range of above 100 pips. As you can notice, there are almost no currency pairs that can’t be traded during the London session. Additionally, the high liquidity decreases the broker’s spread on major pairs, making opening positions less costly than during other market hours. Lower spreads make trading some cross-pairs also more profitable than during other trading sessions.
· While the London session is at its peak of trading volume, the opening of the New York session at 8 AM marks the overlap between these two sessions. The overlap lasts until the market in London closes at 12 PM EDT. These four hours are the most active hours in the forex market, and constitute about 70% of the total average range for all currency pairs during the London session, and 80% of the total average range during the New York session. These numbers alone tell that if you are really after the most volatile trading hours but can’t sit in front of the screen all day long, this is the time to trade the forex market.
· The London session also offers another overlap – with the late Asian session. When the London session opens at 3 AM, the Asian session is almost over and closes one hour later – at 4 AM. Although, this small overlap is by far not as important as the New York overlap. Traders who want action in the market are better to stay away during these calm market hours.
The US/New York Trading Session
The majority of trades in the New York session are executed in the morning session between 8:00 AM and noon, when the European markets are still open. It is also important to note that most economic indicators and reports are published just before the opening of this session, and thus have a great impact on the U.S. Dollar which is involved in about 85% of all forex trades.
The volatility tends to wind down after the London session closes at 12:00 PM. This is especially true on Fridays, when it’s common that markets make a small reversal as U.S. traders close their positions and lock in profits ahead of the weekend. The following table tabulates the average pip ranges of currency pairs during the New York session.
Disclaimer: The pip values were calculated using past averages and are not absolute values. These values can vary depending on volatility and liquidity
For traders who are more risk-tolerant, EUR/USD, GBP/USD, USD/CAD, EUR/JPY and GBP/JPY are pairs to consider as most of them have average daily ranges of above 100 pips. Any pairs involving the U.S Dollar are volatile during the New York session, as foreign investors need to exchange their domestic currency for U.S. dollars to participate in the U.S. bond and equity market.
As with the London session, GBP/JPY is the most volatile currency pair in the New York session while it overlaps with the London trading hours. Although trading currency pairs with high volatility is lucrative, traders need also to pay attention to the increased risk while doing so.
Cross-pairs that don’t directly involve the U.S Dollar are also affected by the New York session. The reason for this is that these pairs usually involve two transactions to be performed to execute a trade. For example, to open a short position on AUD/JPY, this will involve both AUD/USD and USD/JPY. First, Australian dollars need to be exchanged to dollars, which are then used to buy Japanese yen. This is why the New York session has an indirect impact on cross-pairs as well, increasing their volatility.
For more risk-averse traders, EUR/GBP, USD/JPY, AUD/USD and NZD/USD have comparably lower volatility but are still pretty active during the New York session. Traders can also use the lower volatility to concentrate on more long-term trading strategies that involve macro and fundamental trading.
How to Make Money Trading Forex
· Imagine that the EUR/USD pair is trading at 1.0950 in the forex market, which means if you sell 1 euro you will get 1.0950 USD in return. Since the price of currencies always fluctuates, a trader’s goal is to anticipate the market movement and make money.
· For instance, if you think that the price of the euro will go up, then and you would open a long position on EUR/USD. If the next day the currency pair trades at 1.1000, by closing the long position you would make 50 pips in profit. What a pip is and how to calculate the dollar value of pips will be discussed later.
By using concepts like trading on margin and leverage, you could open a much larger position than the size of your trading account. Compared to your investment, the profit potential is extremely high in this industry, but beware. that using a higher leverage also increases the risk of losses.
· Currencies are always traded in pairs. A currency pair consists of the base currency, and the quote (or counter) currency. Let’s explain this with an example:
· The USD/JPY is trading at 110.20. This is a classic example of forex quotes. The base currency is on left-hand side of the slash, in this case the U.S. dollar, while on the right-hand side you will find the counter currency, Japanese yen. This means for 1 USD (base currency) you are going to get 110.20 Japanese yen in the foreign exchange market. (You probably also noted that most of the time the short names of the currencies are used to express their quotes.)
· In order to make a profit, traders buy or sell certain currency pairs. To make a profit from the market volatility, traders have to successfully anticipate the market’s next movement. To do so, traders have various tools at their disposal, the most important of which are fundamental and technical analysis. The characteristics of both fundamental and technical analysis will be covered later.
· If your analysis shows that the price of EUR/USD pair will go up, then you would open a long position. On the contrary, if your analysis suggests that the price of EUR/USD will go down then you would open a short position.
Bid and Ask Price
· The bid and ask prices are prices at which the market buys the currency from you (bid price), and sells the currency to you (ask price). Let’s show this with an example:
· EUR/USD is trading at 1.0950/53. The bid price, or price at which the market buys one euro from you, is $1.0950. The ask price, or price at which the market is willing to sell you a euro, is $1.0953. The following picture shows how bid and ask prices are usually presented by brokers.
· Did you notice the gap between the Bid and Ask price? This is the spread charged by your broker. Competitive brokers will offer you tight spreads which will cut down your trading cost significantly. Spreads on majors are usually very low, just a few pips, but can increase significantly in times of higher volatility and important news announcements.
Deciding When to Buy or Sell
a few examples to show you how the market should be analyzed to make a sound decision whether to buy or sell a currency pair.
Nothing moves the currency market more than the labour reports. This a leading indicator of the economy, as companies will be reluctant to add new payrolls if they think there will be no increase in demand for their goods or services in the future. Similarly, companies will hire new workforce if they assume the demand will pick-up in the near future.
On the employee side, nothing deteriorates personal consumption more than becoming unemployed – and personal consumption also has the biggest share in a country’s GDP. Simply said, a falling unemployment rate gives solid indication that the economy is doing well and that future GDP may increase.
The U.S. non-farm payroll report, published on the first Friday each month, is a major report that every trader should watch. If you believe the U.S. will add more payrolls than expected, this will be bullish for the U.S. dollar. In this case, you would consider buying the USD pairs where the USD is the base currency, or selling pairs where USD is the counter currency. Both would be sound trading decisions.
Interest Rate Hikes
Central banks often hike interest rates when the economy is doing well, and to dampen inflationary pressures. A key thing to consider is whether such interest rate hikes are already anticipated by investors, and thus already priced into the market. There are many signs that hint interest rate hikes: a falling unemployment rate, a rising inflation rate above the central bank’s target, rising retail sales, growing GDP quarter over quarter, and countless others.
All these signs are bullish for the domestic currency. On top of that, an interest rate hike would attract foreign capital inside the country, which additionally spurs demand for that currency making it appreciate.If you believe the European economy is doing well, and an interest rate hike is around the corner, you would buy currency pairs where EUR is the base currency (like EUR/USD), in the expectation that EUR will rise against the U.S. dollar.
A Rising Price in Commodities
Major commodity producers tend to experience their currencies rising or falling with changes in the commodity prices. Think of the Canadian dollar, which is closely related to oil prices, or the Australian and New Zealand dollars which are linked to gold. Canada is a major exporter of oil, exporting around 2 million barrels per day to the United States. A rising oil price will be beneficial to the Canadian economy, making the CAD appreciate. You would like to sell currency pairs where CAD is not the base currency, like USD/CAD to take advantage of the rising oil prices.
Australia and New Zealand are both large exporters of gold, and rising gold prices tend to have positive impact on their currencies. You could buy currency pairs like AUD/USD or NZD/USD in this case. While the Australian and New Zealand dollars are rising, the US dollar usually falls with rising gold prices as investors sell dollars to buy the precious metal.
Trading on Margin
A margin is a part of your trading account, which is used as collateral to open much larger positions than your trading account would otherwise allow. Many traders new to the markets think about margin as a “transaction cost”, but this is far from true. A margin is just a part of your trading account which is “locked” until your position is open. The margin still belongs to you.
This table shows the required margin as part of your trading account to open positions on different leverage ratios. The higher the leverage you use, the smaller the required margin is, but keep in mind that higher leverage increases both your risk, as well as profit potential.
Rollover Interest Rates
Rollover interest rates offered by brokers are interest rates paid or earned for holding a position overnight. The current interest rates for the major currencies are presented in the following table:
If you opened a buy position on NZD/USD, you would earn a positive interest rate return equal to the difference between the NZD interest rate (bought currency) and USD interest rate (sold currency). Similarly, a short position on USD/CAD will have a negative rollover interest rate, as the Canadian dollar has a smaller interest rate return than the U.S. dollar.
Pips and Profits: How do They Work Together?
0.0001. It’s the fourth decimal of a currency quote. A simple example will make the concept of pip crystal clear to you.
Let’s say the EUR/USD pair is trading at 1.0955. After one hour, the price has changed and is now equal to 1.0985. The EUR/USD pair just rose 30 pips, from 1.0955 to 1.0985.
However, in brokers that use 5-digit pricing quotes on their platform, the last digit is called a pipette and it is often referred as the fractional value of the pip, but where exactly did pips come from?
A percentage in point, or pip, is the unit of change of a currency pair in the forex market. Under the Bretton Woods system, established after World War II with the aim to govern monetary policies among countries, all currencies were pegged to the U.S. dollar and gold. As there was no volatility in exchange rates, some currencies didn’t even use pips, (i.e. the fourth decimal to quote against the U.S. dollar).
For example, the Japanese yen was pegged at a rate of exactly 270 yen per dollar in 1948, and 360 in 1949. The German Mark was pegged at 4.20 Marks per dollar in 1949, and revalued to exactly 4 Marks per dollar in 1961.
It is with the fall of the Bretton Woods system in 1971-73, that the newly unpegged currencies started to quote in much greater precision, making the concept of pips important. Today, currencies can even be quoted in pipettes, the fifth decimal in the exchange rate. Pipettes are even more precise than pips, as 10 pipettes equal one pip.
Lot Size vs. Pips
The number of pips a trader can make is the amount of money he can expect from trading. But the value of a pip also depends on your position size.For instance, if you trade with 1 standard lot (100,000 units) then one pip will be around $10, while trading a mini lot (10,000 units) will make a pip worth around $1. How the value of a pip is calculated is presented in the next article.
The Value of a Pip: Trading Different Lot Sizes
The lot size represents the size of your position in the market. Your profit factor in forex is directly related to your lot size since the value of each pip will depend on it. There are 4 major lot sizes in retail forex trading. If you buy 1 standard lot of EUR/USD then you are actually buying 100,000 euros in the market. Let’s see how different lot sizes affect the pip value in forex trading. The following table gives an overview of the difference in pip values for different position sizes.
Let’s say the EUR/USD pair is trading at 1.1235. So, if you open a trade with 1 standard lot, then your pip value will be calculated the following way:
· EURUSD 1.1235 = (0.0001 / 1.1235) X 100,000 units =8.9 USD or 9 USD per pip
· USD/JPY at 110.45: (.01 / 110.45) x 100,000 ) = $9.05 per pip
As you can see, the formulas are slightly different depending if the U.S. dollar is the base currency or the counter currency. With currency pairs like the USD/JPY, we also use .01 instead of .0001 to account for the difference in the decimal place of the pip.
But when you trade with a mini lot (10,000 units) then your new pip value will be calculated as:
· EUR/USD 1.1235 = (0.0001 / 1.1235) X 10,000 units =0.9 USD or 0.9 USD per pip
Now, you know that with 1 standard lot your pip value is 9 USD, and for opening one standard lot you will need around 1.1235 x 100,000 (1 standard lot) = 112,350 USD.
Pretty high, right! This is where leverage comes into action. In order to open 1 standard lot, you will require only $1,123 with a 100:1 leverage. With leverage, you can open a much larger position than your initial trading account size. If you have deposited 2000 USD, with a 100:1 leverage you actually have 2000 USD x 100 Leverage = 200,000 USD available to trade. Still, opening such a large position would take all of your account as margin, and the associated risk would be huge.
Though high-leverage trading account provides an extreme level of profit potential, traders should know that it might act as a double-edged sword. You should always follow proper risk management and never risk more than 2% of your account capital in a single trade.
Basic Forex Order Types
your order, it will open the position based on the information provided in the order. Now that you know what an order is, let’s cover the main order types, and a few other less-known order types.
The five main order types are:
- Market orders
- Limit orders
- Stop orders
- Take profit orders
- Stop loss orders.
Market orders are the most common type of orders in the forex market. These are instant-execution orders, which means that you are buying or selling a currency instantly at the best available price. For example, let’s say that EUR/USD is trading at 1.0950/53.
With a buy market order, you would buy euros at the ask price of $1.0953, and with a sell market order, you would sell euros at the bid price of $1.0950. These orders are usually instantly filled, but in periods of high market volatility your market order can be filled with a different price than you indicated in the order.
Unlike market orders, limit orders become active only if certain conditions are met. A similarity with market orders is that limit orders can also be both buy limit order and sell limit orders. Generally, if you’d like to buy below the current market price, or sell above the current market price, a limit order would be the type of order to use.
For example, if USD/JPY is trading at 110.30 at the moment, and you think that it will rise further to 110.80 but then fall in price, you would use a sell limit order placed at 110.80. After the price reaches 110.80, the sell limit order becomes a usual sell market order and executes the short position. The main advantage of limit orders over market orders, is that you don’t have to wait for the price action to happen to place a market order. The limit order will do the waiting for you.
Just like limit orders, stop orders also become market orders once certain conditions are fulfilled. You’d use stop orders to buy above the market, or sell below the market.
Taking the previous example with USD/JPY trading currently at 110.30 – if you believe that the pair will break 110.80 (this could be a major resistance level) and target 111.20 afterwards, you would place a buy stop order at 110.80. Once the pair reaches 110.80, the buy stop order will become a buy market order. Just place a buy stop order and you don’t have to wait in front of the screen for the price to reach 110.80.
Take Profit Orders
A take profit order automatically closes your position when the target price is reached. You can specify take profit orders inside any other types of orders, like market orders. For example, you placed a market order on GBP/USD at $1.2500, and specified a take profit level of $1.2600. The market order becomes instantly active, and will remain active until the price reaches $1.2600. Here the take profit order will kick in and automatically close your position with a 100-pips profit. Nice, isn’t it?
Stop Loss Orders
Stop loss orders are similar to take profit orders, with the difference that they are used to limit your loss. Once the market goes against you and hits the stop loss price, the position will be automatically closed to prevent further losses. Let’s say that in the previous example your analysis was wrong, and GBP/USD fell from $1.2500 to $1.2400. By using a stop loss at $1.2450, the position would be closed leaving you with a loss of 50 pips instead of 100 pips or more.
There are also a few less-known market orders, which will be covered next.
Good ‘Til Canceled Orders
A good ‘til canceled (GTC) order is similar to a limit order in its nature. As the name suggests, a GTC order remains active until it is either executed, cancelled by the trader, or expired. The expiration of GTC orders is usually set from 30 to 90 days after the trade is entered, but can be specified for any period of time.
Good For the Day Orders
A good for the day order, also called day order, automatically expires by the end of the day if the conditions of the underlying limit or stop order are not met. In this regard, it’s a GTC order with an expiration by the end of the day.
Also called an OCO order, a one-cancels-the-other order is a combination of a limit and stop order previously discussed. The main point here, is that once either the limit order target, or the stop order target is reached, the remaining order is cancelled leaving only one open position.
These are the main order types you will encounter while trading forex. Each of them offer specific advantages, and you should become familiar with them to know under which market conditions they are appropriate to use.
Why Demo Trading is Crucial for Every Trader
What is a Demo Trading Account?
A demo trading account is exactly similar to your real trading account with only one exception. Instead of real money, your broker will give a virtual money to learn the skills neccessary to successfully trade on the forex market. The best thing about using a demo account is that you will never lose a single penny in the market. And just like with real accounts, you will have access to the currency market and real-time quotes, where you can place your trades and practice trading.
Key Benefits of Using Demo Trading
Many professional traders have started with demo trading before they opened real trading accounts. As a new trader, you can easily develop your trading strategy in the demo environment and place as many trades as you want. You can easily assess your trading performance and based on that you can develop your own trading strategy.
This will help you to build-up your confidence and allow you to avoid the most frequent mistakes when trading with real money. Demo accounts will give you a perfect risk-free trading environment where you can develop yourself to an expert trader.
Tips and Tricks for Demo Trading
There are some certain techniques which you can follow while using your demo account. As a new trader, you should open a demo trading account with the same amount of money which you would deposit in your real trading account. Always treat your virtual dollars like real dollar and try to trade with rational logic. When you face losing trades don’t get frustrated, but make extensive market analysis and find the exact reason for your loss.
Make sure that you know how much profit you can generate monthly in terms of percentage. Once you start making consistent profit in your demo trading account, you are ready to switch to a real trading account and trade with the same principles that you used as a demo-trader.
Trading is all about strict discipline. If you truly want to consider trading as your full-time profession than make sure that you develop yourself as a stable trader, by using a demo account first. Always follow proper risk management while placing the trades. Once you feel confident, you can move to a real account.