What is forex?

What is forex? Why trade forex? 

 

The foreign exchange market – or forex for short – is the buying and selling of currencies, and it’s one of the fastest growing markets in the world. From 2007 to 2010, forex market activity increased by 20%, with average daily turnover reaching nearly $4 trillion in April of 2010.

 

 

Forex trading works much like it does with stocks, you buy low and you sell high. The benefit of trading forex is that you don’t have to choose from thousands of companies or sectors. Plus, you can make things even simpler than choosing which company to buy.

For example, most people, even those that are new to forex, have an opinion on the US dollar and the US economy. They can easily take their opinions and translate them into a forex trade. Buying or selling US Dollars as simple as they buying or selling a company’s stock.

Also, another advantage of the FX market is that it doesn’t begin at 9AM and end at 4PM. Trading takes place 24 hours a day, 5 days a week. For most people 24 hour trading means they can trade before or after work. Plus, you have the flexibility to make your trades online.

 

 

Plus, you can buy and sell at any time, in up trends (also called bull markets) and in down trends (also called bear markets).

Forex Trading, Not Using Money Management

 Money Management (MM) is one of the essential parts of trading. The main purpose of MM is to avoid the risk of ruin. The lack of using MM is one of the reasons most traders lose their trading accounts.

MM basically answers the next question: how much to risk on each individual trade? It should not be confused with risk and trade management (pyramiding, scaling out, trailing stops, where to place stops, etc.) MM tells you how big or what size the next trade should be. 

Most traders just focus on the profit side of each trade and totally forget about the risk side. In other words, they think the trade is a winner before placing it, and therefore they do not pay any attention to the consequences a losing trade could produce on your trading account. But remember, every trade is statistically independent from each other. Although the outcome of a series of trades is predictable, there is no possible way to forecast the outcome of each individual trade.

The best systems available are only right around 60 or 70% of the time. For every 10 trades, there is a possibility to have 3 or 4 losing trades. If we don't pay attention to these 3 or 4 trades, we could end up losing month after month, or worse yet, blowing up (losing) our entire account.

We will never know which trade will be a winner and which one a loser, never. So MM should be applied in every single trade, regardless of what you think the outcome of the trade will be.

Even with a system that is right 90% of the time, you could end up broke if you do not apply a sound money management technique.

MM also helps us in the winning side of every trade, when applying MM techniques we could benefit from the geometric growth of our trading account. As your account grows, you will trade larger amounts according to the MM technique applied.

FACT - If you do not have a system that is right 100% of the time you should us Money Management (meaning you should use it because such a system does not exist), regardless of how big or small your trading account is. We will never know the outcome of the next trade, and this one trade could be the last one if you do not apply MM. using MM is not an option, it is a must if you want to achieve your trading goals. You need to do whatever you need to do to be able to trade the next day, week, or year.

If you want to be in this business for the long haul, apply proper trading sizing techniques.

Success in Forex = Learning + Practicing + Update Knowledge

How To Be Successful Forex Trader - Looking for Excitement

 Some other traders are attracted to the Forex market or any other financial market because of the excitement that is to be and be named a trader. And to tell you the truth, it is very exciting. But if this is the main reason you were attracted to the Forex market, or more precisely, this is the reason you are still trading or interested in trading the Forex market, sooner or later you will discover the most expensive adventure you have ever known.

At first, it is all excitement, but as the time goes by, and traders get more involved in the trading process, they realize it is not as easy they thought it would be. All the excitement calms down, and it becomes an obsession. At this phase, only the 5% of all traders, the ones that are consistent profitable, still think it is exciting.

Believe me, there is nothing less exciting than losing money month after month. This happens to around 90% of all traders.

I am aware most of us think trading is exciting, and there is nothing wrong with that, as long as it is not the main reason you are still trading or intend to trade.

There are many other exciting adventures that are way cheaper than trading. Analyze it, because trading, if treated this way, could be a very expensive adventure.

FACT - Yes, trading is exciting, but this should not be the main reason you are trading or intend to trade. Do some thinking on it, otherwise, you will find out the hard way as many have done.

Success in Forex = Learning + Practicing + Update Knowledge

What moves the Forex Market?

Currency movements, as in any other market, are driven by two main forces: supply and demand.

Think for instance of the car selling business in a small village. At first there will be just a few car vendors. As the village grows, more and more people will need cars to satisfy their needs, pushing up the demand for cars. At this point the demand for cars is greater than the quantity supplied, pushing prices up. As people realize selling cars is such a great business opportunity, more people will be attracted the car business and will start selling cars. As this happens, more and more cars will be available, pushing up the supply of cars. At some point, the supply will be greater than the demand of cars. If car vendors don't lower their prices, they won’t be able to sell their cars, so they are forced to lower them.

The same goes for currencies, when a currency increases its value, the demand is greater than its supply. When a currency decreases its value, its supply is greater than its demand.

What factors influence the supply and demand of one currency?

The two main factors that influence the movements in one exchange rate are:

1. The capital flows

2. The trade flows

These two components constitute what economics call balance of payments. The main purpose of the balance of payments is to quantify the demand and supply for a currency of one country, over a period of time.

Balance of Payments = Capital Flows + Trade Flows

A negative balance of payments indicates that the capital leaving the country is greater than the capital entering the country (not much demand)

A positive balance of payments means that the capital entering the economy is greater than the capital leaving the economy (increasing demand of the domestic currency)

Theoretically, a balance of payments equal to zero indicates the right value of one currency.

Capital Flows

Capital flows is the net quantity of currency traded (bought or sold) through capital investments.

The capital flow can be divided into: physical flows and portfolio investments.

Physical Flows - They happen when foreign entities sell their local currency and buy foreign currency to make foreign direct investments (for joint ventures, acquisitions, etc.) When the volume of this kind of investment increases, it reflects the good shape and health of the economy where it is invested.

Portfolio investments - These are investments made on global markets, variable and fixed income market investments (Forex, stocks, T-bills, etc.) An example of portfolio investments is when a hedge fund in Japan invests in the US equity markets.

Trade Flows

Trade flows measure the net exports and imports of a given country. These two components (exports and imports) constitute what economists call the current account.

Countries that have a positive current account (exports greater than imports) are more likely to depreciate their currency; this way the consumer abroad will perceive the foreign currency to be cheaper (and can purchase more goods and services). A good example is Japan.

On the other hand, countries that have a negative current account (imports greater than exports) are more likely to appreciate their currency since they need to sell the local currency and buy foreign currency in order to purchase goods and services. United States is an example of a net importer country.

Purchasing Power Parity (PPP)

This theory states that exchange rates are determined by the relative prices of a similar basket of goods in different countries. In other words, the ratio of prices of a basket with similar goods of two countries should be similar to the exchange rate.

If a Personal Computer in Australia costs AU$1,500, and the same PC in United States costs US$1,200. According to the PPP, the exchange rate AUD/USD would be 1.2500 (1,500/1,200).

If the exchange rate was at 1.3000 (or above 1.2500) it states that in the long run it will decrease its value until 1.2500 is reached. On the other hand, if the exchange rate was at 1.0500 (or below 1.2500) the exchange rate in the long run will increase its value until 1.2500 is reached.

This example is just illustrative, in the real world it is not just one good, but a basket of goods.

The major weakness of this theory is that it assumes that there are no costs related to the trade of goods (tariffs, taxes, etc). Another weakness is that it does not consider other factors that might influence the exchange rate (i.e. interest rates etc)

Modern monetary theories include the capital markets to the PPP theory arguing that capital markets have less costs of trading.

Interest Rate Theory

This theory states that interest rates differentials neutralize the increase or decrease of any currency against another currency. Therefore there are no arbitrage opportunities.

For instance if the interest rate of Australia is 6.25% and the interest rate of United States is 3.5%, then the AUD should depreciate against the USD, so that there are no arbitrage opportunities.

There are also other theories that try to explain the value of a currency pair. But as with every theory, they are based on assumptions that may or may not be present in the real world.

The Psychology of Forex Trading(1)

The Psychology of Forex Trading

 

I have been a trader long enough to know a thing or two about how most people think while trading the market. You see, most people experience similar thinking patterns and emotions as they trade the markets, and we can learn many important things from the differences in the way losing traders think and the way winning traders think.
I would be lying to you if I said that success in the Forex markets depends entirely on the system or strategy you use, because it doesn’t, it actually depends mostly on your mindset and on how you think about and react to the markets. However, most Forex websites trying to sell some indicator or robot-based trading system won’t tell you this, because they want you to believe that you can make money in the markets simply by buying their trading product. I prefer to tell people the truth, and the truth is that having an effective and non-confusing trading strategy is very important, but it’s only one piece of the pie. The bigger portion of the pie is managing your trades correctly and managing your emotions correctly, if you do not do these two things you will never make money in the markets over the long-term.
• Why most traders lose money
You have probably heard that most people who attempt Forex trading end up losing money. There’s a good reason for this, and the reason is primarily that most people think about trading in the wrong light. Most people come into the markets with unrealistic expectations, such as thinking they are going to quit their jobs after a month of trading or thinking they are going to turn $1,000 into $100,000 in a few months. These unrealistic expectations work to foster an account-destroying trading mindset in most traders because they feel too much pressure or “need” to make money in the markets. When you begin trading with this “need” or pressure to make money, you enviably end up trading emotionally, which is the fastest way to lose your money.

Forex trading mistakes and traps(5-Trading real money too soon or gambling it)

The urge to jump into the market and start trading real money is often too much for most traders to withstand. However, the truth is that until you have mastered an effective Forex trading strategy like price action trading, you really should not be trading real money. By “mastering” the strategy, I mean you should be consistently successful with it on a demo account for a period of 3 to 6 months or more, prior to going live. However, you don’t want to use demo account trading as a crutch…trading a real account is different due to the real emotions involved, so just be sure you switch to real-money trading after you have achieved success on demo…don’t be afraid of trading real money, because eventually you will need to make the switch to real money trading.
Also, be sure you are not just gambling your money away. Doing the things we discussed above; over-trading, over-leveraging, not having a trading plan, etc, these are all things that gambling traders do. Traders who don’t gamble in the markets are calm and calculating…they have a trading plan, a trading journal, and they know exactly what their trading edge is and when to trade it.

Forex trading mistakes and traps(3-Not applying risk reward and money management correctly)

Risk management is critical to achieving success in the markets. Risk management involves controlling your risk per trade to a level that is tolerable for you. Most traders ignore the fact that they COULD lose on ANY TRADE. If you know and accept that you could lose on any trade…why would you EVER risk more than you were comfortable with losing??? Yet traders make this mistake time and time again…the mistake of risking too much money per trade. It only takes one over-leveraged trade that goes against you to set off a chain of emotional trading errors that wipes out your trading account a lot faster than you think. Check out this cool article on Forex money management for more.

The myth of automated Forex trading systems

While we are talking about different ways of trading the Forex market, I want to touch on what I feel is a widely believed “myth” regarding automated robot and indicator-based trading systems…

You are probably going to come across many Forex website selling Forex software that they claim will fully mechanize the process of trading, so that all you have to do is click your mouse when the software tells you to and then rake in the profits. You need to constantly keep in mind the old saying “If it sounds too good to be true it probably is…” when you are learning to trade Forex. Like I said before, you are probably going to come across a lot of these robot websites if you have not already. You are best served by ignoring them all together.
You will probably see track records that they claim are “indisputable” evidence of the robots performance in the markets…what they don’t tell you is that this track record is simply a display of a “perfect” set of data that the software was back-tested on. The point is that trading software cannot work over the long-term because the market is constantly changing and as such, it takes the discerning discretion of the human brain to effectively trade the markets over the long-term. I am not saying that computer software has no place in trading, but it cannot be the only thing you rely on, and it certainly should not be used in attempt to fully-automate the trading process. The ability to read the raw price action of a market and grow and evolve with the ever-changing conditions of the market is how I personally trade and how I teach my students to trade.

Price Action Trading Analysis

 What is Price Action Analysis?

My definition of Price Action Analysis: Price action analysis is the analysis of the price movement of a market over time. By learning to read the price action of a market, we can determine a market’s directional bias as well as trade from reoccurring price action patterns or price action setups that reflect changes or continuations in market sentiment.

In simpler terms: Price action analysis is the use of the natural or “raw” price movement of a market to analyze and trade it. This means, you are making all of your trading decisions based purely on the price bars on a “naked” or indicator-free price chart.
All economic variables create price movement which can be easily seen on a market’s price chart. Whether an economic variable is filtered down through a human trader or a computer trader, the movement that it creates in the market will be easily visible on a price chart. Therefore, instead of trying to analyze a million economic variables each day (this is impossible obviously), you can simply learn to trade from price action analysis because this style of trading allows you to easily analyze and make use of all market variables by simply reading and trading off of the price action created by said market variables.

• How do you apply price action analysis to the Forex market?
First, I want to say that price action analysis can be used to trade any financial market, since it simply makes use of the “core” price data of the market. However, my personal favorite market to trade is the Forex market, mainly due to its deep liquidity which makes it easy to enter and exit the market, and also because the Forex market tends to have better trending conditions as well as more volatility which makes for better directional trading and allows price action trading to really shine.
My own personal approach to trading and teaching price action trading is that you can trade effectively from a few time-tested price action setups. There really is no need to try and trade from 25 different price patterns, the Forex market moves in a relatively predictable fashion most of the time, so all we need is a handful of effective price action entry setups to give us a good chance at finding and entering high-probability trades.
The first thing you need to do to apply price action to the Forex market, is to strip your charts of all indicators and get a “clean” price chart with only the price bars in a color you like. I choose simple black and white or blue and red for my colors, but you can pick whichever colors you like (Part 7 will cover an introduction to charting). Here’s an example of my daily chart setup on the EURUSD:
Now, let’s look at an example of a clean and simple price chart next to a price chart covered with some of the most popular indicators that many traders use. I want you to look at these two charts and think about which one seems easier and more logical to trade off of:
From looking at the two charts above, you will probably agree that it seems a little silly to hide the natural price action of a market with messy and confusing indicators. All indicators are derived from price movement anyways, so if we have a solid method to trade based only on price movement (price action analysis), it only makes sense that we would use that instead of trying to analyze messy secondary data.

The Basics of How Money is Made Trading Forex

Trading currency in the Forex market centers around the basic concepts of buying and selling.

Let's take the idea of buying first. What if you bought something (it could literally be almost anything...a house, a piece of jewelry or a stock) and it went up in value. If you sold it at that point, you would have made a profit...the difference between what you paid originally and the greater value that the item is worth now.

Currency trading is the same way...

Let's say you want to buy the AUDUSD currency pair. If the AUD goes up in value relative to the USD and then you sell it, you will have made a profit. A trader in this example would be buying the AUD and selling the USD at the same time.

For example if the AUDUSD pair was bought at 1.0615 and the pair moved up to 1.0700 at the time that the trade was closed/exited, the profit on the trade would have been 85 pips. (See the chart below…)

Had the pair moved down to 1.0600 before the trade was closed, the loss on the trade would have been 40 pips.

Also, it makes no difference which currency pair you are trading. If the price of the currency you are buying goes up from the time you bought it, you will have made a profit.

Here is another example using the AUD. In this case we still want to buy the AUD but let’s do this with the EURAUD currency pair. In this instance we would sell the pair. We would be selling the EUR and buying the AUD simultaneously. Should the AUD go up relative to the EUR we would profit as we bought the AUD.

In this example if we sold the EURAUD pair at 1.2320 and the price moved down to 1.2250 when we closed the position, we would have made a profit of 70 pips. Had the pair moved up instead and we closed out the position at 1.2360 we would have had a loss of 40 pips on the trade.

Remember, we are always buying or selling the currency on the left side of the pair. If we buy the currency on the left side, which is called the base currency, we are selling the one on the right side which is called the cross or counter currency. The opposite would be true if we were selling the currency on the left side.

Now let's take a look at how a trader can make a profit by selling a currency pair. This concept is a little trickier to understand than buying. It is based on the idea of selling something that you borrowed as opposed to selling something that you own.

In the case of currency trading, when taking a sell position you would borrow the currency in the pair that you were selling from your broker (this all takes place seamlessly within the trading station when the trade is executed) and if the price went down, you would then sell it back to the broker at the lower price. The difference between the price at which you borrowed it (the higher price) and the price at which you sold it back to them (the lower price) would be your profit.

For example, let’s say a trader believes that the USD will go down relative to the JPY. In this case the trader would want to sell the USDJPY pair. They would be selling the USD and buying the JPY at the same time. The trader would be borrowing the USD from their broker when they execute the trade. If the trade moved in their favor the JPY would increase in value and the USD would decrease. At the point where they closed out the trade, their profits from the JPY increasing in value would be used to pay back the broker for the borrowed USD at the now lower price. After paying back the broker, the remainder would be their profit on the trade.

For example, let’s say the trader shorted the USDJPY pair at 76.28. If the pair did in fact move down and the trader closed/exited the position at 75.81, the profit on the trade would be 47 pips.

On the other hand, if the pair was shorted at 76.28 and the pair did not move down but rather it moved up to 76.50 when the position was closed, there would be a loss on the trade of 22 pips.

In a nutshell, this how you can make a profit from selling something that you do not own.

In wrapping up, if you buy a currency pair and it moves up, that trade would show a profit. If you sell a currency pair and it moves down, that trade would show a profit.