Part 1: The Foundation
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Global currency market facilitates the buying and selling of various currencies. It operates without any central exchange or control yet accounts for trillions of dollars in cross-border transactions that makes it the largest financial market in the world.
Unlike any other market, where people trade money for goods and services, in the Forex market, money is traded against money. To be precise, one fiat currency, issued by a central bank of a country, is traded against another.
When you buy a Pencil and pay money, you know the price of the pencil in Dollars or Yen. But when you buy Dollars by exchanging Yen, you are buying one currency with another currency and that’s what is called a currency pair. Here, it would be USD/JPY.
Over $5 trillion worth of currencies are traded in the global Forex market on average per day. Compared to equity markets, the Forex market is almost 25 times larger in size.
The Forex market is open 24 hours a day and people can trade anytime they want. However, liquidity in the market remains high during banking hours in major financial centers around the world like Tokyo, London, and New York.
The most popular way to trade in the Forex market is buying and selling currencies Over the Counter (OTC), which is known as the spot market. Besides spot trading, traders also participate in the Forex market through currency futures, various options, and investing in exchange-traded funds (ETFs).
Making profits in the Forex market is similar to buying things at a cheaper price and selling it back at a higher price. Instead of buying a “thing,” or commodity, here, people buy and sell one currency for another.
Value is always subjective, and the market price of a currency pair is the collective, aggregate, subjective value determined by supply and demand. Learning to forecast which currency’s demand will go up or down requires knowledge about economics as well as socio-political issues. However, to forecast the movement of a currency pair in the short-term, traders often rely on intuitive chart reading.
A pip is a unit of measurement. Depending on the currency pair, the value of a pip will vary. For example, if the GBP/USD goes up from 1.1100 to 1.1101, then the price of the pair would go up by 1 pip. But, if USD/JPY goes up from 120.0100 to 120.0200, it would be considered to have risen by 1 pip as well.
Currencies are bought and sold in chunks in the interbank market. That’s why traders cannot simply buy 1 USD worth of currency pairs. Usually, banks and large traders buy and sell standard lots, which is equivalent to 100,000 units of a given currency. Smaller retail traders often trade mini lots worth 10,000 units. However, some brokers offer even smaller lot sizes like Micro and Nano lots, worth 1,000 and 100 units of currencies, respectively.
Besides placing market orders, Forex brokers often allow a range of different orders to suit the need of different types of traders. While there are over 20 types of different orders, the most common are pending limit and stop orders. With limit orders, you can enter the market at a price lower than the current market price. By contrast, a stop order lets you enter the market when price moves up and reach a certain level. While stop-loss orders are called stop orders, these are usually limit orders at which you liquidate your positions.
The idea behind demo trading is that practice makes perfect. Before risking your hard-earned trading capital, you should always paper trade the Forex market with a demo account and get yourself familiarized with fast-moving price action. Moreover, you should practice trading with a set strategy to become a more disciplined trader before risking your own money.
The good news is that most Forex brokers offer free demo accounts and you can demo trade as long as you need to feel confident. However, it is usually advised that you do not demo trade for a prolonged period as it might create a psychological hindrance when you actually trade real money later.
Yes, theoretically the Forex market is open 24/7, including the weekend because there is no central exchange that facilitates trade, and anyone can trade with anyone. However, liquidity in the market remains high only when major financial centers are operating.
These are called trading sessions.
The first major Forex session to open in a day would be Tokyo, Japan, as it is located in the Far East in a time zone ahead of other major financial centers. After Tokyo, trading begins in Kuala Lumpur and Singapore and that’s why some traders also call it the Asian session.
As the Tokyo session is about to end, the next time zone to wake up is in Europe. First, it would be Frankfurt in Germany. However, since London, United Kingdom is one of the largest financial capital in the world, the European session is termed as London session.
New York is the Easternmost financial hub in the United States, and it is also one of the largest centers of commerce as the famous financial center, Wall Street, is located there.
The answer depends on which time horizon you are trading. If you are trading on the 24-hour (daily) chart, it will hardly matter when you place your order. But, if you are trading by pursuing a day trading strategy, it would be best to trade only when market volatility is high as it will provide you with more trading opportunities. Let’s be honest, nobody wants to stay awake at midnight after New York session closes and wait for a trade when the market is moving 2 pips per hour.
That’s why the best time to day trade would be the beginning of the New York session. Because, when the market in New York opens, it also merges with the last several hours of the trading session in London. Hence, the volatility is often very high during the opening hours of the New York session and with the right strategy, you can find a lot of short-term trades.
Just like sessions, the best day to trade Forex will depend on your trading strategy and timeframe you are trading. Having said that, if you are a news trader, then checking an economic calendar to see which day of the week will have the highest number of high impact news releases may be a good idea.
After the Second World War, the Bretton Woods system basically fixed exchange rates. However, after U.S. President Richard Nixon pulled the country out of the gold standard, the dollar became a fiat currency and exchange rates were left to the mercy of the market’s supply and demand. In the early days of floating exchange rate, only large banks and institutional traders had to resources to invest and speculate in the Forex market.
In the new millennium, the advent of the Internet made it easier for brokers to allow trading online and reach potential customers. Retail trading became popular among professionals and people with ample disposable income as speculating in the currency market offered an extraordinary return on investments compared to other financial markets.
The Forex market has no central structure. Hence, it is common sense that large financial institutions who make billions of dollars’ worth of transactions every day will be the major player. In fact, large banks like the Citi Group, JPMorgan, UBS, and HSBC are the key players in the market.
Not everyone trading Forex is speculating. Large companies like General Electric or Toyota need to buy and sell currencies to pay for export and import bills. Hence, these large multinationals tend to dominate the price movement.
Government and non-profit sector are the third-largest players in the global currency market despite the fact that they may not actively trade! Nonetheless, central banks around the world determine the interest rate and that alone can cause huge price swings.
Last but not least, the large-scale hedge funds with speculative exposure in the Forex market often move markets to find better rates to scale in or scale out of positions.
All markets offer some benefits and drawbacks. As a trader, it is up to you to decide which types of markets you want to trade. However, objectively, there are some key advantages to trading Forex compared to trading stocks or futures.
Trading Forex requires hardly any major commitments or long learning period. While fundamental analysis requires some knowledge of macroeconomics, the premises of the efficient market hypothesis suggests trading based on chart reading with the aid of technical analysis is almost sufficient.
There are well-regulated Forex brokers who welcome clients from all over the world and allow opening live accounts with less than $50, where you can trade nano lots to start the ball rolling. Moreover, most Forex brokers offer much higher levels of leverage and no-commission trading environment that stocks brokers cannot due to the structure of the market.
Besides low barriers to entry, the Forex market offers higher volatility and liquidity. Furthermore, it is open 24/7, meaning anyone can trade at any time without being chained to regular banking hours when the market is open during the day.
Stocks are basically representing pieces of a company and a lot of people think this is something tangible and traders should stick to trading stocks than currencies. The problem is, you cannot go to a company and buy a few shares from their reception. Stocks are traded in large exchanges like the NASDAQ or NYSE, which means every transaction has to go through a central authority.
When a market is controlled by any central authority, it opens up various possibilities of tempering and outside influence, which the Forex market is immune to. On top, often large hedge funds can manipulate the price of stocks by buying and selling simultaneously. Being a decentralized large market, it is virtually impossible for even central banks to corner the Forex market due to the sheer size of it.
Moreover, to trade stocks, you need to pay commissions to your stockbroker. There are low-cost discount brokers, sure. However, it does not change the fact that you are relying on middlemen who have the capability to benefit from your trades with front-running.
The main advantage of trading Forex compared to stocks is the existence of electronic communications networks (ECNs)brokers that enable traders’ direct access to the interbank currency market. With an ECN broker, traders can trade directly with other traders and there are absolutely no middlemen in the process. Since there is no reason for an ECN broker to care about your profits or losses, as opposed to a bucket shop broker, it is much safer to trade Forex compared to stocks.
Margin is the concept of trading larger sums in your open positions than the amount of money you have deposited in your account. Margin trading enables you to deposit $2,000 and trade 2 full lots worth $200,000 if your broker’s margin requirement is only 1%.
Keep in mind that the concept of margin is slightly different than leverage and we will discuss it below. For now, just keep in mind that the size of your positions will always depend on the relationship between offered leverage and margin requirement of your broker.
When you finally open a live account and deposit any money, it reflects your balance. The balance in your live account is the cash amount reflecting all closed positions.
Once the market starts to move in the direction of your trade, you will start seeing profits accumulating in the unrealized profit column in your Forex brokerage account. The problem is, the trade is still open, and your profits can go up or go down, even the open trade can turn into a loss. Unless you have closed the position and “locked” your profits, it will not affect your “balance.” So, that’s unrealized profit.
However, once you have closed a trade with either profit or loss, it will affect your account balance in a positive or negative way, which will be then your realized profit or loss.
The margin requirement is basically the percentage of collateral a broker need to let you open a position. Every Forex broker has different margin requirements. In fact, a single broker can have different margin requirement for different currency pairs. For example, the margin requirement for EUR/USD might be 1%, GBP/USD might be 2%, but USD/TRY might be 25%.
First, find out what is the margin requirement for the currency pairs you are trading or have open positions. If your broker’s margin requirement for USD/CHF is 5%, and you want to open a position worth 1 mini lot or $10,000, then your margin requirement would be (10,000 x .05) $500.
Continuing with the example above, let’s say you have a $1,000 balance in your account. Once you have opened a single mini lot of USD/CHF, and you have used half of your margin allowance and at this point, and you can only open another $10,000 worth of the USD / CHF position.
In a nutshell, just deduct the used margin from your account’s current equity to figure out your free margin. The good news is most reputable Forex brokers will display you how much free margin you have left in real-time in your account.
The formula for margin level is the following:
Margin Level = (Remaining Equity ÷ Already Used Margin) x 100%
So, the margin level shown in your account represents the percentage of equity versus already used margin. By knowing your margin level, you can remain informed about how much of your equity is available for new positions.
Your equity is the real-time amount you have left in your account that reflects all your closed and open positions. Let’s say your account balance is $10,000 but you have an open position with USD/CHF that is currently in $300 profit. So, your equity would be $10,300.
In a simplistic way, the margin is like collateral your broker needs to let you trade. Once your open losses reach below 100% margin level your broker will probably give you a warning that your account is trading with less than 100% margin. It is a sign that you are at risk of a margin call and your open positions will be automatically closed.
Your broker’s margin call level could be 100% or 50%. Once your margin level falls below the margin call level, your positions will be stopped out. Depending on the policy of your broker, all of your open positions could be closed at once. Or, your broker may close one of your positions then wait for existing positions cause your equity to fall below the margin call level to close more positions.
The best way to avoid a margin call is to have a clear money management strategy that clarifies when to get out of a position without letting the situation escalate too much that the equity in your brokerage account falls below the margin call level.
The worst thing that can happen to your Forex trading career is being stopped out. When the equity in your account falls below the margin call level, your broker will forcefully close your positions. Or, you might have a stop-loss order placed with your broker and when the price of a currency pair goes against your trade’s direction, and reach this stop-loss level, your broker will close your position to protect your account. At this point, your unrealized losses will become realized losses.
To not get stopped out, you should reassess the situation in the market periodically and see if your open trades are performing as planned and close trades accordingly. Remember, if you do not take small losses, you will end up accepting larger losses.
Your broker’s margin calls level and the stop out level could be the same or different.
Let’s say the margin call level is 100%, but the stop out level is at 30%. Once your margin drops below 100%, someone from your Forex broker might call you or you might get an email that your equity has dropped below margin call. But, once your equity reaches the 30% stop out level, only then your positions will be forced to be closed.
The leverage offered by your broker is completely different than the margin requirement. However, there is a close and an inverse relationship between these two concepts.
The maximum leverage offered by your broker is expressed in X:1. It could be 100:1, where you might need a minimum 1% margin to open a position for EUR/USD. But, with the same 100:1 leverage in your account, the margin requirement for USD/CHF might be 5%. So, the maximum effective leverage you can use for USD/CHF would be 20:1.
Hence, with the same leverage in your account, your actual allowed leverage could be different depending on the currency pair you want to trade.
To make buying or selling decisions, traders can use various methods and tools to analyse price movements in the price charts and stock prices.
A distinction is made between the fundamental data trader, who makes trading decisions based on company or economic data, and the so-called technical trader, who only analyses share prices and focuses on specific patterns and price formations.
It is difficult to generalise that one decision-making process or analysis approach is superior to the other. Rather, it is important that the individual trader chooses the type of trading that suits him/her better.
2. Short-term vs. Long-term
The investment horizon is an important topic that fundamentally determines the type of trading. We normally distinguish between two groups: day trading and swing trading.
In case of short-term trading, the trader opens and closes his/her individual trades within a few minutes or hours. Since the speculative period is usually limited to one day, these trades are called day trading.
If the holding period of a position is a few days to weeks or even months, it is called swing trading.
The application possibilities of these two trading types and the respective requirements for traders are fundamentally different.
Day trading is often less suitable for employed people due to time constraints, since it is often necessary to keep an eye on price charts throughout the opening hours of the market. When the Frankfurt Stock Exchange opens at 9.00 AM, most people in Germany are probably at work and cannot follow the price movements actively. However, a German day trader could alternatively switch to other stock markets and actively trade on the American or Asian stock exchanges after his/her working hours.
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