The Forex (FX) or Foreign Exchange market is a very dynamic one, with over $5 Trillion changing hands every day. To put that into perspective, the US stock market daily volume amounts to a few hundred billion dollars.
With so many dollars changing hands on a day-to-day basis, the FX market creates a lot of opportunity for your everyday retail trader, which is why it has attracted so many traders in recent years.
What is the FX market exactly?
It is a global currencies market, in which two currencies are paired together, creating an exchange rate. Have you ever traveled to another country? If so, it is likely that the currency from your local country was not accepted in the foreign country you were traveling to.
So, in order to buy goods and services in the foreign country, you had to convert your local currency into the foreign nation’s currency (often done with a bank). This conversion or exchange of currencies takes place in the foreign exchange market.
The conversion or exchange rate that you receive depends upon the value of the exchange rate in the FX market at that current point in time. For instance, if you were living in the United States and traveling to Canada, you would need to convert your US dollars into Canadian dollars.
The US and Canada exchange rate is listed as USD/CAD (more on this later). Let’s say the exchange rate is currently 1.20. That would mean that 1 USD is worth $1.20 CAD. Or looked at from the other way, 1 CAD is worth $0.80 USD. As you can see, the US dollar is worth more than the Canadian dollar. So, for every one USD that you convert, you would get back $1.20 Canadian dollars.
When it’s time to leave Canada and you have extra Canadian dollars, you could convert them back into US dollars. Now, the USD/CAD exchange rate may have changed by this point, because the value of exchange rates fluctuate every single day, just like the value of a stock would.
Unlike the stock market that moves in pennies, the Forex market moves in fractions of a penny, in what is known as a “pip” or “percentage in point”. Just 1 pip is 1/100th of a penny.
So, if the USD/CAD changed value from 1.2000 to 1.2001, that would mean the USD has gained in value against the CAD by 1 pip. There are 100 pips in a penny. So, if the USD/CAD went from 1.2000, up to 1.2100 then the currency pair moved 100 pips or 1 penny.
Now, it may sound impossible to be able to make money considering each currency pair is moving in such small increments, but that is not the case. In Forex you are given a lot of leverage. If you want to trade Forex you need to open up a brokerage account with a Forex broker.
Each Forex broker offers you a certain amount of leverage (often depending on the country it operates in). In the US that leverage is capped at 50:1. In other countries you can get 100:1, 200:1 or even more.
What that means is, if a broker is offering you say, 100:1 leverage, that means for every 1 dollar you put up, your broker gives you 100 dollars to trade with. So, if you put $1,000 into a Forex account, you would have $100,000 to trade with. Despite the small incremental movements, leverage is how you can make money in the Forex market as a retail trader.
Hours and Liquidity
The Forex market is a 24 hour market. It opens up Sunday at 10pm GMT and closes on Friday at 10pm GMT.
There are three major sessions globally in FX: European, North American, and Asian session. The London market is the largest FX market in the world, followed by New York, and lastly Tokyo.
The European session begins at 7am (Frankfurt opens at 7am and London at 8am) and closes at 4pm GMT. North America opens at 1pm GMT and closes at 10pm GMT. Asia opens up at 11pm GMT and closes at 7am GMT.
A couple of important things to note here; there are overlaps of the three different sessions which can create added volatility in the market. Simply put volatility is how far and fast prices fluctuate. Volatility is a good thing, it means prices are moving and you need that as a trader in order to make money.
But too much volatility can create poor trading conditions because it often means increased risk, which is not what we want as traders or risk managers.
Also note, that from 10pm – 11pm GMT the FX market is still open but there is no major session that is open. Meaning, there are no major banks (banks are the big players in FX) open and this creates extremely poor trading conditions because liquidity is low.
This is important because you want to trade when there is volume or liquidity in the market. Liquidity simply determines how quickly you can get in and out of the market and at what price.
When you buy a currency pair, commodity, stock, etc, someone is on the other side of that trade, selling to you. And when you go to sell, someone needs to be on the other side buying from you, otherwise you won’t be able to get out of your position when and/or at the price you want.
The more market participants (the more buying/selling taking place), the more volume or liquidity there is going to be in the market, which means the easier it is going to be for you to get in and out of the market.
This is what you want as a trader, to trade during high volume or liquidity times. Europe has the most volume, followed by NY and then Asia. Between 10pm and 11pm when no major market is open, known as the “dead zone”, liquidity is very low making trading very risky, and because of that it should be completely avoided when trading.
What are Currency Pairs and the Different Types
When trading the FX market, you are trading pairs of currencies. It is always one currency against another. These pairs, make up exchange rates. For instance, USD/CAD, EUR/GBP (Euro vs the British pound), AUD/CHF (Aussie vs the Swiss franc), and so on.
These pairs are only listed one way. You will never see the USD/CAD listed as CAD/USD. It would simply be the complete opposite of the USD/CAD.
So, for simplicity, exchange rates are only listed one way. The first currency is known as the “base” currency and the second currency is known as the “quote” currency. In the example of the USD/CAD, the USD is the base and the CAD the quote.
To interpret these currency pairs, you ask yourself, how much is the first currency pair worth if converted into the second currency pair. For example, if the EUR/USD exchange rate is 1.15, that would mean 1 Euro is worth $1.15 USD. Since you are trading pairs of currencies, it makes FX a relative game – the value of one currency is only relative to that of another currency.
We do not just trade the Euro, we trade the Euro versus another currency, making the Euro’s value only relative to whatever currency it is paired against.
Because of this, the Euro could be rising in value against the USD, but at the same time falling in value against the GBP (Great British pound).
When you execute a trade in a currency pair, you are buying one currency and simultaneously selling the other currency. Whatever action you take, whether it’s buy or sell, that action is always on the first currency, and the opposing action would be on the second currency.
For instance, let’s say you think the Euro is going to rise in value against the USD, you would then want to buy the EUR/USD currency pair. In this case you would be buying the Euro and at the same time selling the USD. Now, if you believed the opposite to be true, that the USD would rise in value against the Euro, then you would sell the EUR/USD currency pair.
This time, you would be selling the Euro and buying the USD. In the former case you would make money when the EUR/USD value rises and, in the latter, when it falls.
Which Currencies to Trade
There are 8 major currencies: USD, Euro, CAD, GBP, AUD (Aussie), NZD (New Zealand), CHF (Swiss franc), and the JPY (Japanese yen). About 70% of all the liquidity in the Forex market is in just these 8 currencies, and when combined make up 28 different currency pairs.
I would recommend finding the pairs you like to trade within the majors, strictly because of the liquidity.
Now, there are three different types of currency pairs: “majors”, “crosses” and “exotics”. The majors all include the USD, because it is the most liquid, and most widely traded currency.
The cross pairs or minors, include any combination of the 8 major currencies, excluding the USD.
Exotic currencies are generally emerging market currencies, like the Brazalian real, Hong Kong dollar, Turkish lira, Mexican peso, etc. Exotic currency pairs are an exotic currency paired with one of the 8 majors, for instance the USD/BRL (Brazilian real) or USD/HKD (Hong Kong dollar). Unless you have a lot of experience, I would stay away from the exotics because they have less liquidity, plus more volatility, which equates to increased risk.
As I mentioned earlier, that in order to trade Forex you need an account with a Forex broker. Each broker will provide you with a software or platform so you can trade any currency pair.
Most traders like to analyze a currency pair on a chart, usually a candlestick chart. These charts allow you to see not just the current value of a specific currency pair, but past values as well.
These charts show you exactly where price “traded” in the past. It depicts all the past movements right in front of you, and these past movements are what is known as price action. It’s through a currency pair’s past price action, combined with its current price value, that information can be gathered to make an informed decision on where price could likely be headed next.
Successful Forex traders use not just charts to trade, but they have a system – a set of rules telling them when and where to enter and exit, as well as how to properly manage their risk. Without a proven system, any success in the FX market will be short-lived.
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