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Basic Introduction to Forex Trading

With a daily turnover of over US $4 trillion, there is no other market that even comes close to rivaling the forex market in size or liquidity.

The foreign exchange market goes by many names and these include the forex market, fx market, currency exchange, and currency market.

Its popularity is widely due to the high liquidity, low entry barriers, low transaction costs, and the fact that it is a 24-hour market.

Here is a description of some of the basics of the forex market:

  1. Nature of the Forex Market

The fx exchange market has no clearing house for matching orders, neither does it have a central exchange or trading floor. It is an Over-The-Counter (OTC) market with different access levels where currencies are exchanged in different market makers.

The Inter-Bank Market enables large financial institutions to trade with each other through the Electronic Brokerage System (EBS). This market is not open directly to retail or individual traders. The financial institutions make quotes within this market and the quotes are only available to those financial institutions that they trade with.

The Online Market is accessible to retail traders over internet platforms set up by brokers who have a working relationship with the financial institutions that are part of the EBS. The larger the volume traded by these brokers, the more the relationships it is likely to have with the financial institutions on the EBS.

  1. History and Recent Trends of the Forex Market

Man has been using different forms of paper money since the middle ages and the values were set against the values of gold, silver, and other valuable items. The gold standard was a relatively stable way for determining worth and value across many different currencies.

However, the industrial revolution brought about heightened volatility and this in part led to the Great Depression. From 1931, world leaders began redefining monetary policy and forex trade. After the Second World War, the leaders established the Bretton Woods Agreement which later became unstable.

In 1971, President Richard Nixon took the dollar off the gold standard, delivering what is known as “The Nixon Shock”. This resulted in most major countries becoming free floating and subject to market forces.

The forex market became largely a preserve of governments, large financial institutions, and extremely wealthy individuals.

Finally in the late 1990’s, technological advancements opened up the market making it accessible to retail traders at low cost with no barriers.

With the evolution of the internet, high speed connectivity, interactive user interfaces, and the advent of online trading platforms, currency market is now accessible to anyone who wants to participate in it.  And, this site, www.forextradingbig.com has been created to help those who want to reap big profits from this highly advancing market.

Basic Introduction to Forex Trading

  1. Comparison of Forex Market with Other Markets

The forex market shares a lot of similarities with the other financial markets. It also has many distinctive differences with other financial markets and this can be best illustrated by comparing it with the two other major markets – futures and equities.

Structure: Forex and equities are OTC markets while futures are traded on the floor.

Trading hours: Forex can be traded 24 hours a day while futures and equities are traded typically between 9:30 a.m. and 4 p.m. for equities and 9 a.m. to 3 p.m. for futures.

Market Size: Equities have an estimated daily turnover of U.S. $ 100 – 200 billion, futures are estimated at $300 – 500 billion, and forex is estimated to be in excess of $4 trillion daily.

Transaction costs: Both futures and equities charge commissions in addition to spreads while forex traders only incur spreads costs.

Spreads: The spreads in futures and equities fluctuate while forex online market makers typically have fixed spreads.

  1. Forex Traders

Traders in the fx market can be divided into two groups.

Hedgers: These include governments, importers, and exporters. The fluctuation between their domestic currency and the foreign currency of the country they trade with affects their profits and losses.

Speculators: These include banks, funds, companies, and retail traders. They create artificial currency rate exposures with an aim of profiting from any price variations.

  1. Currency Pairs

Forex involves exchanging one currency for another. Therefore, all trades are typically an exchange of two currencies which form a currency pair. Each country’s currency is identified by a 3-letter code.

For example, the American dollar is the USD, the euro is the EUR, the Japanese yen is JPY, the British sterling pound is the GBP, the Swiss Franc is the CHF, the Australian dollar is the AUD, and the Canadian dollar is the CAD. The currencies mentioned above are also known as the majors.

Since currencies are traded in pairs, they are quoted as such with a base currency and a secondary currency separated by a slash e.g. EUR/USD 1.2929, which means to purchase one euro you would require 1.2929 US dollars.

  1. Calculating Forex Profit and Loss

A forex trader enters a trade at one price and exits the trade at a different price. To illustrate, take the example of trading EUR/USD.

The trader may use €100,000 to purchase dollars at 1.2929 and later buys €100,000 at 1.2804. The trader’s net position is zero for the euro, but s/he has made dollar profits. The difference is calculated thus:

Profit   = (100,000 x 1.2929) – (100,000 x 1.2804)

= $1250

  1. Forex Pips

In the above example, the euro moved from a dollar value of 1.2929 to 1.2804. This represents a 0.0125 price movement. One pip is equal to a 0.0001 change in currency value, so in our example the euro gained 125 pips.

  1. Forex Spreads

In forex trading, a retail trader can buy a currency at one price of another currency from the broker or executing company and can only buy the same currency at a different, higher price from the same broker.

These prices are referred to as the “bid” price for buying and the “ask” price for selling. The executing firms quote the bid and ask prices in the following manner; EUR/USD 1.2929/1.2932.

The spread is the difference between the bid price and the ask price and in our case that is 1.2932 – 1.2929 = 0.0003.

The spread is the cost of the trade incurred by the trader.

  1. Types of Forex Orders

Trading in the forex market involves the trader making some orders to be executed by the broker. A few of the most common orders are:

Market Orders: These are buy or sell orders which require the broker to buy or sell on behalf of the trader at the best available current prices.

Entry Orders: This is a trader’s request for the broker to purchase or sell a defined amount of certain currency at a specified price. The transaction is made when the currency hits that specified price.

Stop Loss Orders: These are orders placed to close a position once the currency reaches a particular price. The exit price will be lower than the entry price and will end up in a loss for the trader. The order is placed to avoid incurring further losses.

Take Profit Orders: These are orders placed to close a position once the price hits a predetermined level. This order is placed so as to lock in profits and prevent losses in case of a price movement reversal.

Good Until Cancelled (GTC): Almost very order in fx trading is a GTC order, meaning the executing firm will go ahead with the placed order unless the trader revokes it.

  1. Forex Market Analysis

For consistent success in forex trade, a trader should be able to analyze the market. There are three major approaches to analyzing the market which can be used exclusively or in combination.

Sentiment Analysis: This involves analyzing the predominant views and opinions of forex traders and then making trade decisions that are contrary to expectations.

These decisions are based on the premise that if there is an overwhelming movement in one side, a trend reversal is inevitable in the near future.

Fundamental Analysis: This market analysis approach uses economic data and political events to gauge the future direction of currency prices.

Technical Analysis: This market analysis approach uses technical tools such as historical data, charts, and indicators to predict future price movements.

 

Photo Credit: Focusoft

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