What is FOREX?

What is FOREX?

Foreign Exchange is the simultaneous buying of one currency and selling of another. The foreign exchange market (FOREX) is the largest financial market in the world, with a volume of over $1.5 trillion daily; more than three times the aggregate amount of the US Equity and Treasury markets combined. Unlike other financial markets, the Forex market has no physical location, no central exchange.

 It operates through an electronic network of banks, corporations and individuals trading one currency for another. The lack of a physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one zone to another across the major financial centers.

FOREX Advantages

    •   24-hour market - A trader may take advantage of profitable market conditions at any time. There is no waiting for the opening bell.

    •   High liquidity - The Forex market has an average trading volume of over $1.5 trillion per day. It is the most liquid market in the world. This means that a trader can enter or exit the market at will in almost any market condition with minimal execution risk.

    •   Low transaction cost - The retail transaction cost (the bid/ask spread) is typically less than 0.1% (10 pips or points) under normal market conditions. At larger dealers, the spread could be 3-4 pips. 

    • Uncorrelated to the stock market - A trade in the Forex market involves selling or buying one currency against another. There is limited correlation between the foreign currency market and the stock market. A bull market or a bear market for a currency is defined in terms of the outlook for its relative value against other currencies. If the outlook is positive, we have a bull market in which a trader profits by buying that currency against other currencies. Conversely, if the outlook is pessimistic, we have a bear market for that currency and traders may profit by selling the currency against other currencies. In either case, there is always a good trading opportunity for a trader.

    •   Inter-bank market - The backbone of the Forex market consists of a global network of dealers. They are mainly major commercial banks that communicate and trade with one another and with their clients through electronic networks and telephones. There are no organized exchanges to serve as a central location to facilitate transactions the way the New York Stock Exchange serves the equity markets. The Forex market operates in a manner similar to the way the NASDAQ market in the United States operates; thus it is also referred to as an over the counter (OTC) market.

    •    No one can corner the market - The Forex market is so vast 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. As the market has grown even central bank interventions have become increasingly ineffectual and short lived as a tool for controlling the value of a particular currency.

Symbol Terminology - "Currency Pairs"
In the Forex market, trading is always in currency pairs, such as EUR/USD or USD/JPY. 

The base currency-the first currency listed in the currency pair-is the basis for the buy or the sell. As an example, the US Dollar is the base currency for USD/JPY (US Dollar/Japanese Yen). The current bid/ask price for USD/JPY could be 107.20/107.23, which means you could buy $1 US for 107.23 Japanese Yen, or sell $1 US for 107.20 Japanese Yen.
 

Spread Terminology - "Pip"
The term used in currency market to represent the smallest incremental move an exchange rate can make. Depending on context normally one basis point (0.0001 in the case of EUR/USD, GBP/USD, USD/CHF and 0.01 in the case of USD/JPY). 

Risk Management
Trading foreign currencies is a challenging and potentially profitable opportunity for educated and experienced investors. However, before deciding to participate in the Forex market, you should carefully consider your investment objectives, level of experience and risk appetite. Most importantly, do not invest money you cannot afford to lose. 

There is considerable exposure to risk in any foreign exchange transaction. Any transaction involving currencies involves risks including, but not limited to, the potential for changing political and/or economic conditions that may substantially affect the price or liquidity of a currency. Moreover, the leveraged nature of FX trading means that any market movement will have an effect on your deposited funds proportionally equal to the leverage factor. This may work against you as well as for you. The possibility exists that you could sustain a total loss of initial margin funds and be required to deposit additional funds to maintain your position. If you fail to meet any margin call within the time prescribed, your position will be liquidated and you will be responsible for any resulting losses. Investors may lower their exposure to risk by employing risk-reducing strategies such as 'stop-loss' or 'limit' orders. 

There are also risks associated with utilizing an internet-based deal execution software application including, but not limited, to the failure of hardware and software and communications difficulties.

The Forex Market is the largest and most liquid financial market in the world. Since macroeconomic forces are one of the main drivers of the value of currencies in the global economy, currencies tend to have the most identifiable trend patterns. Therefore, the Forex market is a very attractive market for active traders, and presumably where they should be the most successful. However, success has been limited mainly for the following reasons:

Many traders come with false expectations of the profit potential, and lack the discipline required for trading. Short term trading is not an amateur's game and is not the way most people will achieve quick riches. Simply because Forex trading may seem exotic or less familiar then traditional markets (i.e. equities, futures, etc.), it does not mean that the rules of finance and simple logic are suspended. One cannot hope to make extraordinary gains without taking extraordinary risks, and that means suffering inconsistent trading performance that often leads to large losses. Trading currencies is not easy, and many traders with years of experience still incur periodic losses. One must realize that trading takes time to master and there are absolutely no short cuts to this process. 

The most enticing aspect of trading Forex is the high degree of leverage used. Leverage seems very attractive to those who are expecting to turn small amounts of money into large amounts in a short period of time. However, leverage is a double-edged sword. Just because one lot ($10,000) of currency only requires $100 as a minimum margin deposit, it does not mean that a trader with $1,000 in his account should be easily able to trade 10 lots. One lot is $10,000 and should be treated as a $100,000 investment and not the $1000 put up as margin. Most traders analyze the charts correctly and place sensible trades, yet they tend to over leverage themselves (get in with a position that is too big for their portfolio), and as a consequence, often end up forced to exit a position at the wrong time. 

For example, if your account value is $10,000 and you place a trade for 1 lot, you are in effect, leveraging yourself 10 to 1, which is a very significant level of leverage. Most professional money managers will leverage no more then 3 or 4 times. Trading in small increments with protective stops on your positions will allow one the opportunity to be successful in Forex trading. 
 

Currency Trade Profit/Loss Calculation Example
The current bid/ask price for USD/CHF is 1.6322/1.6327, meaning you can buy $1 US for 1.6327 Swiss Francs or sell $1 US for 1.6322.

Suppose you decide that the US Dollar (USD) is undervalued against the Swiss Franc (CHF). To execute this strategy, you would buy Dollars (simultaneously selling Francs), and then wait for the exchange rate to rise.

So you make the trade: purchasing US$100,000 and selling 163,270 Francs. (Remember, at 1% margin, your initial margin deposit would be $1,000.) 

As you expected, USD/CHF rises to 1.6435/40. You can now sell $1 US for 1.6435 Francs or buy $1 US for 1.6440 Francs.

Since you're long dollars (and are short francs), you must now sell dollars and buy back the francs to realize any profit. 

You sell US$100,000 at the current USD/CHF rate of 1.6435, and receive 164,350 CHF. Since you originally sold (paid) 163,270 CHF, your profit is 1080 CHF. 
To calculate your P&L in terms of US dollars, simply divide 1080 by the current USD/CHF rate of 1.6435. Total profit = US $657.13  
 

Setting your goals.
1. Initially set a goal of 20 pips a day
2. Use MACD: divergence; otherwise, it just  confirms the trend.
3. 20-30 pip stop losses - but on the other side of event that caused you to take action.  
4. Specialize in one currency pair. I love the Euro
5. Keep a log.
6. Sit on your hands unless you "SEE" something  concrete to do.
7. Don't scalp. Ride the trend! Currencies trend well.
8. Calculate Pivots at midnight ET. 
9. Don't buy too soon in a downtrend; don't sell too soon  in an uptrend; currencies trend well.
10. Average trading range (ATR) usually fulfilled starting at 3 am ET.
11. Forget trading retrenchments when you catch the main trend.
12. Four things to watch out for. To be discussed later.
13. Single versus multiple lots.
14. NO MAN'S LAND - except where you see ironclad  signals like bar/candle/chart patterns, multiple bottom/top,  MACD divergence, trend line break.
15. You don't need to draw pivot points.  If you do, they don't  have to be exact.
16. Green lights.
17. Learn, paper trade, demo, live.
18. Look at lower-level chart when price is at a pivot point and moving fast.
19. Automated systems kick in at pivot points; therefore,  lots of follow-through.
20. Shades of gray. Trading is not a science.
21. M1/M3 and M2/M4 - like early warning radar, but not cast  in stone; S can become R, and R can become S.
22. Buying below the central pivot point and selling above the central pivot point can be influenced by signals like bar/candle/chart  patterns, multiple bottom/top, MACD divergence, trend line break.
23. If bias is to be short, think short - not long; if bias is to be long, think long; go one way or the other, but not both. Try hedging.
24. Use standard default settings for indicators.  
 25. Do not trade holidays, Mondays, month-end, quarter-end,  year-end.
26. Repeat after me, "The trend is your friend."  If the trend line holds, buy the dips in an uptrend, and sell the rallies in a downtrend. Currencies trend WELL!  In an uptrend, don't look to go short; in a downtrend, don't look to go long.
27. No volume figures; but, a very liquid market.
28. Take your signals off higher-level charts, unless you see something concrete at the lower level.  Remember, the five minute chart is your 'trim tab.' It is not to be used for scalping! Use the 5 min to spot price reversal situations, where price is on a tear, and/or where price is moving quickly in and around a pivot point. You won't know what hit you on the 15 min in such situations.
29. Any one indicator like a hammer or spinning top  may not be enough ammo to pull the trigger.  Look around for more evidence of an impending shift in price direction.

For more details please visit: Forex Basic Learning Center.

To Your Success,
SelTrading Realty