What is Forex
Forex (Foreign Exchange) market is a place where you buy or sell currencies. It is also known as FX market or currency market. It is the largest and most liquid market in the world, many times larger than stock market. Daily trading turnover is about 4 trillion USD compared to stock market of 300 billion USD.
It is interesting to note that forex market is open 24 hours a day and 5 days a week. This mean that anyone from any part of the world can be trading forex at any time of the day. The markets open with Sydney, followed by Tokyo, London and New York.
Although the market open 24 hours, the New York market close mark the end of one day trading.
See Forex Trading Session below.
How Trading Is Conducted
Forex market is different from stocks market. Stocks market has a central marketplace like NYSE (New York Stock Exchange) whereas forex has no marketplace. Forex bid and ask price are quoted by the world major banks. That is the reason the price differs from each forex broker to the others.
Currencies are always quoted in pairs, e.g. EUR/USD or GBP/USD or USD/CAD. It is quoted in this manner because for every currency you buy, you are selling another.
The expectation is that the currency you buy or sell is appreciated or depreciated respectively against another currency. An example: you buy EURO, you are at the same time selling US Dollar. This trade term is called Long on EUR/USD. When the EURO currency appreciate, you will make profit selling US Dollar. Likewise, if US Dollar appreciated, then you will sell at a loss.
Refer illustration above, EUR (Euro) is the base currency and USD (US Dollar) is the quote currency.
When you want to trade ‘Long’ or buy EUR/USD, the exchange rate tells you how much you will have to pay in units of the quote currency to buy one unit of the base currency. In this case, you will have to pay 1.2292 US Dollars to buy 1 British Pound.
If you choose to trade ‘Short’ or sell EUR/USD, the exchange rate tells you how many units of the quote currency you get when you sell one unit of the base currency. In this case, you will get 1.2290 US Dollars when you sell 1 British Pound.
What Is A Spread?
A spread is the difference between the bid and the ask price. So the spread for the EUR/USD as per above illustration is 2 pips (1.2292 – 1.2290). The 2 pips is the brokerage commission. This is where the broker makes his money.
What Is The Value Of A Pip?
A PIP (point in percentage), is a measurement of the smallest amount of change in the exchange rate for a currency pair. For example, when a currency pair (e.g. EUR/USD) move from 1.2292 to 1.2294, a trader is deemed to have gained 2 PIPs.
If it moves from 1.2292 to 1.2304, the gain is 12 PIPs.
If it moves from 1.2292 to 1.2394, the gain is 102 PIPs.
However, do not confuse with the measurement of PIP for Japanese Yen pairs. For example, when USD/JPY (US Dollar / Japanese Yen) move from 108.52 to 108.54, a trader is deemed to have gained 2 PIPs.
If it moves from 108.52 to 108.64, the gain is 12 PIPs.
If it moves from 108.52 to 109.64, the gain is 102 PIPs.
Now you know what is a PIP and how to calculate it, so what is the monetary value of a PIP.
The monetary value of a PIP will depend on:
- Currency pair traded ( e.g. EUR/USD)
- The size of trade you placed (e.g. $100,000)
- The exchange rate (e.g. EUR/USD 1.2292)
Example 1: Assuming you placed a trade on EUR/USD for $100,000. The exchange rate was 1.2292.
- Determine the value of quote currency (USD) — multiply the amount traded ($100,000) by 1 pip. 100,000 X 0.0001 = 10 USD per pip. If your trading account is in USD, stop here.
- Determine the value of base currency (EUR) — divide the amount of pip per USD (10USD) by the closing exchange rate (1.2292). 10 / 1.2292 = 8.14 EUR per pip.
Example 2: Assuming you placed a trade on USD/CAD for $100,000. The exchange rate was 1.2649.
- Determine the value of quote currency (CAD) — 100,000 x 0.0001 = 10 CAD per pip.
- Determine the value of base currency (USD) — 10 / 1.2649 = 7.90 USD per pip.
To make money in trading forex, you must not speculate. You must develop or follow some trading strategy developed by someone. Base on your strategy and analysis, you will then place a trade of high probability that it will move in your intended direction.
There are many trading strategies available out there. Some traders follow strategies based on technical analysis. Technical analysis track historical prices and volume traded. Traders used these information to plot it on to the chart to determine the market trend and identify repeating patterns. This analysis will provide signal for future trade entry. Some popular strategies are:
- Moving averages crossing
- Price Action
Of course there are traders who used strategies based on fundamental analysis. It is the study of news events and economic statistics to determine trading opportunities. Traders will be looking out for news on:
- Bank interest rates
- Employment reports
- Other economic indicators.
In my opinion and opinions of many traders, is to base your trading strategy on both technical and fundamental analysis. It is popularly quoted that “fundamental analysis tells you what to trade, and technical analysis tell you when to trade it”.
When To Buy?
You would buy, if you have reason to believe that the base currency will appreciate against the quote or counter currency.
When To Sell?
You would sell, if you have reason to believe that the base currency will depreciate against the quote or counter currency.
Protect Your Money
It has been quoted by some forex brokers that 95% of the forex traders loss their money in trading. Only 5% are making money.
In order to make money you must protect your money that you invested into the trade.
How Much To Risk Per Trade
It is highly recommended that you risk 1 – 2% of your capital in each trade. It means for a $10,000 you invested, you only risk $100 – $200 (maximum) per trade. It will ensure that even if you lose 10 trades in a row, you will still have capital to continue to trade.
How to Protect Your Loses
Every time you enter a trade, either buy or sell the currency pair, you must place your stop loss order. This is to ensure that your trade will be stop and closed when the currency pair moves opposite to your desired direction.
Establish Risk Reward Ratio
It should be in your trading strategy that you establish a risk reward ratio. The more common one is 1:2 or 1:3.
What it means is that for every $100 you risk in the trade, you expect a return of $200 or $300. So if your winning rate is 60%, you are making money.
Forex trading is very high risk and you will lose your money if you are not able to manage your risk well.
The advantage of forex trading is that most brokers allow you to open a demo account. Use this account to practice your strategy for a few months. If you are profitable with a demo account then you are ready to migrate to a live trading account.
Remember that forex trading is not a Get Rich Quick scheme. You have to spend sometime to learn and practice on trading platform. Most popular platform is MT4 (MetaTraders 4).
Alternative from self trading will be, you can join companies or brokers (forexsignals – currently tracking their performance) that provide managed forex trading or you may want to join broker that provide auto trade through its trade copying service.
To subscribe to auto trade, you need to sign up with brokers (ICMarkets — I am using this broker for live trading) that support auto trading.
Should you have any questions or comments with regard to this post or any subject matter on investing, please input it in the comment section below. I will respond as soon as humanly possible.
Risk Disclaimer: Foreign exchange trading carries a high level of risk that may not be suitable for all investors. Leverage creates additional risk and loss exposure. Before you decide to trade foreign exchange, carefully consider your investment objectives, experience level, and risk tolerance. You could lose some or all of your initial investment; do not invest money that you cannot afford to lose. Educate yourself on the risks associated with foreign exchange trading, and seek advice from an independent financial or tax adviser if you have any questions. Any data and information is provided ‘as is’ solely for informational purposes, and is not intended for trading purposes or advice.