Basic Terms You Need To Know about Forex!
Foreign Exchange, also known as (Forex):
Forex, also known as foreign exchange, FX or currency trading, is a decentralized global market where all the world’s currencies are traded. The Forex market is the largest of all financial markets and most liquid market in the world with an average daily trading volume exceeding $5 trillion USD.
Facts and History cont.
Compare the FX market to other
major Financial markets.
In 2010, Retail trading represented only about
$1.49 trillion of $4 trillion and to date this
numbers have increased significantly.
Forex was once only for the elite
Once was only for the few such as:
- Large Banks
- Large Institutions
Now available to the masses.
Thanks to the fast and stable internet we have today! ☺
Forex trading for the rest of us
Retail trading is just that, retail.
- A consumer product for the masses
- Only three things are required to trade
- Credit card
- Internet connection
1. Retail FX is growing
Just less than 2,000 platforms worldwide
- Generating $1.49 Trillion a day in volume
- Vast majority of volumes being generated from lessthan 20% of the platforms
- 20% growth over year
- Been around since the early 2000’s but exploded worldwide around 2006
- Been in Cyprus since the beginning
- First platforms were here from the start
2. Retail FX is serious (just how serious)
Lets look at the numbers (blue book)
- Some of the largest are in Cyprus
- Some of the smallest are in Cyprus
- Some of the medium ones are in Cyprus
- All Types of Brokers are in Cyprus
- Over 140 or so brokers so far with more being added each day
3. Why Cyprus?
Rule of four:
- Regulatory environment favorable to
- Tax (10%)
- Cost of a license
- Highly educated employee base
4. What it isn’t?
Things you should know more about Forex,
- It isn’t gambling
- It isn’t money laundering
- It isn’t without risk
Matter of fact… 95% loose their initial capital
over the life cycle of trading.
How does it compare to stocks Structure
Unlike stocks or futures, there is no centralized
exchange and there is not just one price
dictated by one exchange. Quotes from
brokers vary and one can always shop around
for the best rate.
FX advantages over stocks:
- No commissions, no clearing fees, no exchange fees, no government fees,
no brokerage fees.
- No middlemen, trade directly with the market responsible for the pricing
on a particular currency pair.
- Leveraged accounts, allows traders to participate with accounts as small as $25.
- A 24-hour market, no waiting for the opening bell. From Australia to New York.
- No one can corner the market, its so huge and has so many participants that no single entity (not even a central bank) can control the market price for an extended period of time.
Foreign Exchange Basics
Trading foreign exchange on the currency market, also called trading forex, can be a thrilling hobby and a great source of income. To put it into perspective, the securities market trades about $22.4 billion per day; the forex market trades about $5 trillion/day.
Market Size and Liquidity
- Unlike stocks or bonds, its very easy for anyone to buy and sell currencies due to its liquidity. A trade can be made up or down. Hard to sell a stock and make a profit on a down slide.
- Liquidity is also very important because it determines how easily price can change over a given time period. A liquid market environment like forex enables huge trading volumes to happen with very little effect on price, or price action.
Forex Basics again:
- Originally it was just currency assets but most platforms now offer other types of assets to trade.
- Buying and selling currency assets… but not really. Traders aren’t actually buying actual hard assets. Traders are taking advantage of the volatility of exchange rates between two currencies and fluctuating rates.
- Currencies are traded through a broker or dealer, and are traded in pairs; for example the euro and the U.S. dollar (EUR/USD).
- Ultimate goal is to profit from the rise in one currency from the other.
Forex Basics pairs, buy/sell, rates:
This is how it works:
- Currencies are always traded in pairs.
- It’s a simultaneous trade of buy and sell and there is always a buy price and a sell price.
- Its all about the exchange rate: the ratio of one currency valued against another. For example, the EUR/USD exchange rate indicates how many Euros can purchase one US Dollar, or how many US Dollars you need to buy one Euro.
The PIP (percentage in point):
EUR/USD = 1.2535
The unit of measurement to express the change in value between two currencies is called a “Pip.” If EUR/USD moves from 1.2535 to 1.2536, that .0001 USD rise in value is ONE PIP. A pip is usually the last decimal place of a quotation. Most pairs go out to 4 decimal places, but there are some exceptions like Japanese Yen pairs which go out to two decimal places and fractional pips which add 5 and 3 decimal places.
Simply put: It’s the last digit on any quoted price.
FX in the simplest way:
Let’s break it down
EUR/USD = 1.2535
- Base currency (always to the left).
- Quote currency (always on the right)
- When buying you have to pay 1.2535 USD to buy 1 Euro.
- When selling you will receive 1.2535 USD when you sell 1 Euro.
- The base currency is the “basis” for the buy or the sell. If you buy EUR/USD you are buying the base currency and simultaneously selling the quote currency.
- Buy the pair if you believe the base currency (EUR on the left) will go up against the quote currency (USD on the right).
- Sell the pair if you think the base currency (EUR on the left) will go down against the quote currency (USD on the right).
Simply put: Buy if you think the left is going to go up against the right. Sell if you think the left is going to go down against the right.
The spread makes the broker money
All forex quotes are quoted with two prices: the bid and ask.
The bid is the price at which a broker is willing to buy the base currency.
The ask is the price at which a broker will sell the base currency.
The difference between the two is the spread.
This is where brokers gain a head start in the market.
The rates are going to padded a bit as compared to the real market rates.
The more spread, the harder it is for a trader to make profits on low volatility.
Leverage… good and bad
Currencies are measured in pips the smallest increment of that currency. To take advantage of these tiny increments, you need leverage or large amounts of money to see any significant profit or loss.
Brokers offer leverage which makes a small investment act like a large investment. Small changes in the price can mean big changes in profit and loss.
Several choices are available depending on the broker. 500:1, 400:1, 200:1, 100:1
Simply put: 100:1 leverage allows a $1,000 investment to act like $100,000.
Fun fact: leverage is all “funny” money. The broker doesn’t actually loan the trader $99k.
Leverage again as its important!
It’s critical that you know exactly how leverage works and how a client should use it.
Leverage can be a trader’s best friend when used carefully, and his/her worst enemy when used recklessly. It is a great tool for increasing profits, higher the leverage, the higher the risk.
When the market moves against him/her it eats away at clients investment very quickly.
1:100 leverage would require the market to move 100 pips against you for your position to be wiped out.
1:400 leverage would require the market to move 25 points against you for your position to be wiped out.
Currency symbols always have three letters, where the first two letters identify the name of the country and the third letter identifies the name of that country’s currency.
The Majors: all contain the U.S. dollar (USD) on one side and are the most frequently traded currency pairs and the most liquid.
Minor and cross pairs:
Currency pairs that don’t contain the U.S. dollar (USD) are known as the “crosses.”
Major crosses are known as “minors.” The most actively traded crosses are derived from the three major non-USD currencies: EUR, JPY, and GBP.
Exotic pairs are made up of one major currency paired with the currency of an emerging economy, such as Brazil or Mexico.
The USD is king:
The US dollar is the most traded currency
- 85% of all transactions
- The euro’s share comes in second at 39%
- The Yen rounds out third at 19%.
The USD is one half of every major
currency pair, and the majors
comprise 75% of all trades.
Almost everyone owns USD
The U.S. dollar comprises almost 62% of the world’s official foreign exchange reserves! Almost every investor, business, and central bank own it. Pay attention to the U.S. dollar.
- LARGEST economy in the world. Largest and most liquid financial markets in the world.
- Stable political system and a military superpower.
- U.S. dollar is the medium of exchange for many cross-border transactions. Oil is priced in U.S. dollars. If Mexico wants to buy oil from Saudi Arabia, it can only be bought with U.S. dollar. If Mexico doesn’t have any dollars, it has to sell its pesos first and buy U.S. dollars.
Three ways to trade FX:
There are three ways to analyze and develop ideas to trade.
- Technical Analysis
- Fundamental Analysis
- Sentiment Analysis
As to which analysis is better, your guess is as good as mine but a good trader knows to look at each independently and comprehensively.
The framework in which traders study price movement. The theory is that a person can look at historical price movements and determine the current trading conditions and potential price movement.
“History tends to repeat itself”
“It’s all about the charts”
Technical analysts look for similar patterns that have formed in the past, and will form trade ideas believing that price will act the same way
All about the charts:
In the world of trading, when someone says technical analysis, the first thing that comes to mind is a chart. Technical analysts use charts because they are the easiest way to visualize historical data!
Fun Fact: as more traders rely on technical analysis, the signals tend to become self-fulfilling. As more and more traders look for certain price levels and chart patterns, the more likely that these patterns will manifest themselves in the markets.
Analyzing economic, social, and political forces that affects the supply and demand of an asset.
Using supply and demand as an indicator of where price could be headed is easy. The hard part is analyzing all the factors that affect supply and demand. You have to understand the reasons of why and how certain events like an increase in unemployment affect a country’s economy, and ultimately, the level of demand for its currency.
The idea is that if a country’s current or future economic outlook is good, their currency should strengthen. The better shape a country’s economy is, the more foreign businesses and investors will invest in that country. This results in the need to purchase that country’s currency to obtain those assets.
Macro economics and the news:
Let’s say that the U.S. dollar has been gaining strength because the U.S. economy is improving. As the economy gets better, raising interest rates may be needed to control growth and inflation.
Higher interest rates make dollar-denominated financial assets more attractive. In order to purchase these US assets, traders and investors have to buy some USD first. As a result, the value of the dollar will increase.
Its all about feelings. You already know the terms, Bull(ish) or Bear(ish).
If a trader chooses to ignore market sentiment, it’s almost always a certain fail. No matter how clear that chart looks and how good that news is coming out of Reuters. If the market is Bearish the rate won’t move that drastically upward.
Fun fact: a bull’s horns go up when charging so to say bullish it means the markets are up. A bear’s claws go down when charging so to say bearish it means the markets are down.