Forex, sometimes called FX, is an international market where many of the world’s currencies float in value against each other. This means that their values go up and down against each other in response to market conditions.
Perhaps you are familiar with trading stocks, but don’t know much about Forex. What is Forex trading and how does it differ from the stock, commodities or futures markets? What makes Forex so special?
What is Forex Trading?
Forex trading is the act of trading a position in the market, that is buying or selling one currency in opposition to another currency. On the Forex market, the financial instruments you will be buying and selling are currency pairs. For example, if you believed that the Euro (EUR) would rise in value in relation to the U.S. Dollar (USD), then you would want to make a buy order on the pair EUR/USD.
While the stock market is open a few hours a day, the Forex market is open from late afternoon Sunday to Friday afternoon (U.S. Eastern time), making it open 24 hours a day, five days a week. Since Forex is an international market, orders are routed on a rolling basis across the world. So, even if you were located in the U.S. and the New York office was closed, your order would be routed through Tokyo, London or some other office throughout the world.
Unlike the stock market, with its thousands of options, the FX market has much fewer financial instruments to choose from. This allows you to focus on fewer instruments, and makes it easier to keep up with what would otherwise be a bewildering set of news items.
Forex Market Business Hours
As a 24 hour, 5 day a week market, what happens on the weekend during those two days when the Forex market is closed. It is even possible with some brokers to contact the trading desk on the weekends and execute emergency trades. It may be surprising to learn that although the Forex market is not open on the weekends, the prices are in fact changing during that time. Some experienced Forex traders try to avoid keeping trades open over the weekend for this very reason.
So, when the Forex market re-opens on Sunday afternoon, you may notice a gap between the closing price from Friday and the opening price on Sunday.
While regulation of the Forex market is greater than ever before, it is still much freer than that of the stock, commodities and futures markets. It is much more common to have access to margin with a Forex trading account than with a stock trading account and much easier to obtain. This credit provided by your broker magnifies your trading power by several multiples.
Another way that Forex is freer than the stock market is that its much easier to trade short. Since all of the currency pairs in the Forex market are pitted against each other, it is only natural and inherent to the market that you can trade short. For example, to reference our earlier example, if you feel that USD was going to rise against the EUR, you would simply do the reverse and sell EUR/USD instead of buying it.
Forex Training and Education
Training and education are a big part of Forex trading, with almost every Forex broker providing a demo account. Demo accounts mimic the platform and tools available on the real account. Videos, tutorials and in-depth articles are all widely available to help you learn Forex investment strategies. It is possible to use these resources to educate yourself and be able to successfully trade on the Forex market.
How to start Forex trading?
As mentioned above, the currencies in the Forex market trade in pairs. The vast majority of the trading in the market is made up of the U.S. dollar (USD) paired with the Euro (EUR), Japanese Yen (JPY), British pound (GBP), Australian dollar (AUD), Swiss franc (CHF), New Zealand dollar (NZD) and the Canadian dollar (CAD), respectively. These pairs are EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF, NZD/USD and CAD/USD.
Consider, for example, that the price of EUR/USD is 1.1107. What this means is that it costs 1.1107 USD to buy 1 EUR. In order to calculate how many Euros it would take to buy 1 USD, it would be the reciprocal of this, or 1 divided by 1.1107 – which yields 0.9003 EUR to buy 1 USD.
The smallest quantity of a Forex currency pair is called a pip. The pip is the fourth decimal place on a Forex pair or the second decimal place when JPY is the base currency of the pair. Sometimes, you will hear or read about a 50-pip move or a 100-pip move. In terms of EUR/USD or any other pair for which USD is the base currency, this represents a move of 0.0050 USD. For a pair like USD/JPY, a 50-pip move represents a change of 0.50 JPY.
Forex brokers let you trade currencies in order sizes called lots. Historically, this meant 100,000 units (known as a standard lot). Eventually, Forex brokers came to support a 10,000-unit lot size (known as a mini lot). Some now support a 1,000-lot size (known as a micro lot) or even smaller. Many now also support odd lots, which means you can buy whatever quantity you want. But you will see these historical lot sizes referenced in examples and learning materials, so it is good to be familiar with them.
When you do start to trade, one of the most important Forex basics is to be able to figure out the price per pip. Some trading clients calculate this for you, but being able to do it yourself can also give you some useful background understand into all the moving parts involved. This price will be the amount by which you gain or lose when the price of the currency pair you bought or sold changes by 1 pip. This makes it easy to understand what a 10-pip move would mean for you in a particular trade.
Choosing a online Broker
Choosing a broker is an important decision that can affect your trading success. Some of the things you will want to look out for are low spreads, good execution and an easy-to-use trading platform. There are generally two categories of trading account offered on Forex exchanges. These are a standard account with no commissions and low spreads, and an account that does charge a commission but has no spreads. The account with a commission is for advanced traders, who would benefit more from paying commission than paying a spread on their high volume of trades. So, as a beginner, you will want to look for the standard account.
Spreads in Forex Trading
You can think of spreads as a type of fee for each trade. It is an additional cost built into the price of the trading pair. These spreads vary according to the pair in question and the market conditions at that particular time. If the liquidity on a given pair is low, the spread can be quite significant. Even on the most heavily traded pair in the world – EUR/USD – the spread can rise dramatically in times of high volume, like during news events and economic reports. If you stick to the major pairs – as a beginner should definitely do – and avoid trading on news events (which even some experiences traders do), you can avoid excessively high spreads. Once you choose a broker you will want to sign up for a demo account and get familiar with the trading platform. Trade the demo account like a real account and build your experience buying and selling currency pairs.
Paradigms for Analyzing Markets
There are three paradigms for making sense of the price movements that drive the Forex market. These three are fundamental analysis, technical analysis and sentimental analysis.If you like this article, you might also be interested in this Forex Compounding Calculator
Fundamental analysis in the Forex market and other markets is the study of supply, demand and the effect these two have on price in order to make trading decisions. Some examples of this would be a interest rate increase by the U.S. Federal Reserve. If the Federal Reserve raised the interest rate, it would mean that the cost of borrowing money is going up. There will be less money borrowed and consequently less money will be printed. Assuming all other factors are equal, fewer dollars means that those dollars will go up (less supply increases price, assuming demand remains constant). This means that assuming factors driving the price of the Euro remain constant, the price of USD would rise in relation to EUR. Since the USD is on the bottom of the EUR/USD pair, this would mean that EUR/USD would generally fall on this news.
In terms of sudden price movement in relation to news events, this would only happen if it was an unexpected surprise. If the interest rate hike is revealed beforehand or expected over a long period of time, then the actual announcement of it may not have much of noticeable effect at all. Some central banks even occasionally leak the news ahead of time for this every reason. When an economic report announces the results that were expected by the market consensus, the price is already baked-in, or already taking these results into account.
Much of the time, there is not a great deal of news to go on in the Forex market and one must use what other means are available to try to determine what is happening. The study of price history as a means of determining future price is known as technical analysis. To those who are not familiar with it, technical analysis appears to be some kind of fortune telling. But, in fact, price action in all markets creates regular patterns in market charts – and chart patterns along with previous price history can give traders an edge in trading markets.
This is simply a fancy way of saying that one makes an analysis based on what other people think will happen with the market. If you decide it is a good time to EUR/USD because many people you trust think it will, this is an example of sentimental analysis.
Which method is the best?
The best method of these three is to combine them all into one so that you take the benefits of all three without being exposed to the weaknesses that come with relying on them exclusively. For example, if you operate strictly by fundamental analysis, you may know where the market will go, but you may not buy at exactly the right time. You may buy at the top of a wave, when it would have been better to wait for the bottom.
If you relied on technical analysis exclusively, you would see the forces of the fundamentals at play in the price, but may not understand it in light of the fundamentals or you may notice it too late to properly take advantage.
Think of these three paradigms as a three-legged step stool with each leg relying on the other two. This perspective will give you a balanced approach that will serve you for many years to come.