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INTRODUCTION TO THE FOREX MARKET ...................................................................................................................................................................................................2 HOW IS FOREIGN EXCHANGE TRADED? .....................................................................................................................................................................................................3 ADVANTAGES OF TRADING IN THE FOREX MARKET ...................................................................................................................................................................................5 HIGH LEVERAGE .................................................................................................................................................................................................................................................... 5 LOW MARGIN ...................................................................................................................................................................................................................................................... 5 24 HOUR TRADING ............................................................................................................................................................................................................................................... 5 TRADE BOTH SIDES OF THE MARKET ........................................................................................................................................................................................................................ 5 LOW TRADING COSTS ............................................................................................................................................................................................................................................ 5 CURRENCY PAIRS ......................................................................................................................................................................................................................................6 THE SIGNIFICANCE OF CURRENCY PAIRS .................................................................................................................................................................................................................... 6 WHEN TO BUY A PAIR ........................................................................................................................................................................................................................................... 6 WHEN TO SELL A PAIR ........................................................................................................................................................................................................................................... 6 THE CONCEPT OF LEVERAGE......................................................................................................................................................................................................................7 WHAT IS LEVERAGE? ............................................................................................................................................................................................................................................. 7 WHAT IS MARGIN? ............................................................................................................................................................................................................................................... 7 HOW ARE LEVERAGE AND MARGIN RELATED? ........................................................................................................................................................................................................... 7 TRADING COSTS ........................................................................................................................................................................................................................................8 HOW MUCH DOES IT COST TO MAKE A TRADE? ........................................................................................................................................................................................................... 8 BELOW ARE SOME EXAMPLES OF CURRENCY PAIRS: ..................................................................................................................................................................................................... 8 FUNDAMENTAL ANALYSIS.........................................................................................................................................................................................................................9 WHAT INFLUENCES PRICES IN THE FOREX MARKET? ..................................................................................................................................................................................................... 9 FUNDAMENTAL ANALYSIS TECHNIQUES .................................................................................................................................................................................................................... 9 TECHNICAL ANALYSIS .............................................................................................................................................................................................................................. 12 WHAT IS SO GREAT ABOUT TECHNICAL ANALYSIS? .................................................................................................................................................................................................... 12 FOREIGN EXCHANGE MARKET - THE BEST MARKET TO USE TECHNICAL ANALYSIS? ........................................................................................................................................................ 12 SUPPORT AND RESISTANCE ................................................................................................................................................................................................................................... 13 SUPPORT AND RESISTANCE IN A RANGE - TRADING MARKETS ..................................................................................................................................................................................... 13 THE DISADVANTAGES OF RANGE-TRADING ............................................................................................................................................................................................................. 13 SUPPORT AND RESISTANCE IN MOMENTUM MARKETS .............................................................................................................................................................................................. 14 TOOLS IN TECHNICAL ANALYSIS ............................................................................................................................................................................................................................. 14 RISK MANAGEMENT ............................................................................................................................................................................................................................... 16 THREE BASIC QUESTIONS FOR EVERY TRADER .......................................................................................................................................................................................................... 16 PSYCHOLOGY OF THE TRADER ................................................................................................................................................................................................................. 17 WHAT SHOULD THE PSYCHOLOGY OF THE TRADER BE? ............................................................................................................................................................................................... 17 HOW TO AVOID FALLING IN A TRAP ....................................................................................................................................................................................................................... 17 CONTACT US ........................................................................................................................................................................................................................................... 18
The first currency listed in a pair is known as the base currency, while the second currency is called the counter or quote currency. The base currency is the "basis" for the Bid price (the cost of selling the base currency) or the Ask price (the cost of buying the base currency). For example, if you Ask EUR/USD you have bought Euros (and simultaneously sold Dollars). You would do this if you expected that the Euro would rise in value against the US Dollar. If the EUR/USD is quoted at 1.2755, this means that one Euro is currently worth just over $1.27. If the market moves from 1.2755 up to 1.2756, that represents a move of one pip. A pip is the smallest increment of a currency pair and it is one ten thousandth of a Euro, Dollar or Pound and one hundredth of a Yen. Forex is traditionally traded in lots, which represent 100,000 units of the base currency although much smaller lot sizes are available today. In the case of the EUR/USD currency pair, a pip is worth $10 in one lot and is $1 in a 10,000 EUR/USD position; so a movement of one pip would be worth $10 on a 100,000 position and $1 on a 10,000 position.
A Trade Example: You think that the Euro will rise against the Dollar so you Ask the EUR-USD currency pair. You are correct, the price rises and you close the trade. The EUR/USD was trading at 1.2750 when you asked (bought) it. The EUR/USD was trading at 1.2890 when you bid (sold) it. You bought at 1.2750 and sold at 1.2890 for a profit of 0.0140 or 140 pips. If your trade had been worth $100,000 each pip would have been worth $10. On 140 pips x $10 you would make a $1,400 profit.
In Forex, you also have the opportunity to short sell (Bid first) a currency pair if you think it will fall in price. Another Trade Example: If you had thought that the Euro was going to fall relative to the U.S. Dollar, you would have Bid on the EUR-USD currency pair. Again, you were correct and you closed your position for a profit. The EUR/USD was trading at 1.2760 when you bid it. The EUR/USD was trading at 1.2610 when you sold it. You sold at 1.2760 and closed your position at 1.2610 for a profit of 0.0150 or 150 pips. Again your position was $100,000 making each pip worth $10. 150 pips x $10 = $1,500 profit.
Remember that these are profitable examples. Always evaluate your positions carefully; ending up on the wrong side of a trade can be very expensive.
CURRENCY PAIRS
What is the Significance of Currency Pairs? A currency pair represents the exchange rate between two currencies. For example, the rate at which the EUR/USD is trading represents the number of US Dollars one Euro can purchase. The first currency listed is always the base currency. When to Buy a Pair If, for example, a trader believed that the Bank of Japan was likely to intervene to cause a decrease in the Yen against the US Dollar, then the trader would Buy USD-JPY (Ask the US Dollar/Bid the Yen) expecting that the price of the USD-JPY would rise. When to Sell a Pair If a trader believed, for example, that Japanese investors were losing faith in the United States' economy and were pulling money out of the US into Japan, then the trader would Sell USD-JPY (Bid the US Dollar/Ask the Yen) expecting that the price of the USD-JPY would fall. Below is an example of how currency pairs are listed on the Trader24 trading platform. The currency pairs are listed on the left side of the screen. The Bid price is the level at which a trader Bids the currency pair and the Ask price is the level at which a trader Asks the currency pair.
TRADING COSTS
How much does it Cost for a Trader to Make a Trade? Traders do not take positions on a currency pair at the exact rate at which the currencies are trading. Instead, they are offered two rates for the currency pair: the bid rate and the ask rate. The bid rate is the price at which traders can Sell the pair. The ask rate is the price at which traders can Buy the pair.
The ask (Buy) rate is always higher than the bid (Sell) rate and the spread on the EUR/USD is 3 pips, meaning that if a trader Asks this pair, then the Bid rate of this pair will have to go up 3 pips in order for the trader to break even. The difference between the bid rate and the ask rate is the spread. The spread is an automatic adjustment that is made to the trader's account when making the trade. Because of this spread, traders will begin every position they assume with a small loss and will need to gain some profit in order to break even. For example, if a trader Asks into a position at the ask rate, and then immediately closes the position at the bid rate, the trader will have a loss on their account that is equal to the spread. These spreads are seen in every kind of market. However, it can be difficult to identify the spread cost in the equities and futures markets due to the broker-based system they use.
FUNDAMENTAL ANALYSIS
What Influences Prices in the Forex Market? Prices in the currencies market are affected by macroeconomic factors, such as inflation, unemployment and industrial production. Information on events such as these is easy to find. Fundamental analysis is based on the analysis of economic data; traders try to use this information to take positions in the market in order to make profit. There are three main macroeconomic factors a trader should focus on when analysing foreign exchange rates: a. Interest Rates: Each currency has an overnight lending rate. This is determined by a countrys central bank. Lower interest rates usually lead to the value of the country's currency declining. This is largely due to traders who execute carry-trades. A carry-trade is a trade where a currency with a low interest rate is sold and a currency with a high interest rate is bought. This is based on the idea that currencies with higher interest rates will generally rise in value and will rollover - and allow traders to earn interest on a daily basis. b. Employment: The unemployment rate is a key indicator of a countrys economic strength. If a country has a high unemployment rate, it means its economy is not strong enough to provide people with jobs - and this leads to a decline in the currency value. c. Geopolitical Events: Key international political events affect not only the foreign exchange market, but all other markets as well. Fundamental Analysis Techniques How does Fundamental Analysis explain Long Term Trends? Fundamental analysis is very useful for determining long term trends within a currency pair. By focusing on long term economic factors that affect countries, fundamental analysis predicts long term trends.
Examples of how to use Fundamental Analysis with the Major Currency Pairs: 1) EUR/USD When the dollar weakens the EUR/USD will rise and if the USD recovers then a strong foreign demand will send the EUR/USD lower. If you think the U.S. economy will become weaker and hurt the US Dollar, you can ASK the EUR/USD. If you think that there will be increased foreign demand for US financial instruments such as equities and treasuries, that benefit the US dollar, you can BID EUR/USD as you are expecting the euro to lose value against the dollar.
2) USD/JPY Japanese government intervention to weaken their currency sends the USD/JPY higher; and gains in the Nikkei and demand for Japanese assets drive the USD/JPY down. If you think that the Japanese government will continue to weaken the Yen in order to help its export industry, you would click on ASK, expecting the U.S. Dollar to increase in value against the yen. If you think that Japanese investors are pulling money out of U.S. financial markets and repatriating funds back into the Japanese asset markets, such as the Nikkei, you would click on BID. This means that you expect the Yen to strengthen against the U.S. Dollar as Japanese investors Bid their assets and convert their dollars back into yen.
3) GBP/USD High Yield and attractive growth in the UK drives the GBP/USD higher. Speculation about the UK adopting the Euro will send the GBP/USD lower. If you think the British economy will benefit from high yield and attractive growth in the future, you would click ASK, which means that you expect the British Pound to strengthen against the U.S. Dollar. If you believe the British are about to commit themselves to adopting the Euro, you would click BID, expecting the Pound to weaken against the Dollar as the British devalue their currency in anticipation of merging with the Euro.
4) USD/CHF Global stability and global recovery send the USD/CHF higher. The USD/CHF weakens on geopolitical instability. If you think that the market is headed towards a period of global stability and economic recovery, meaning that investors no longer need to park their money in a safe haven currency such as the Swiss Franc, you would click ASK, expecting the U.S. Dollar to strengthen against the Swiss Franc. If you believe that due to instability in the Middle East and in U.S. financial markets, the Dollar will continue to weaken, you would click BID, expecting the Swiss Franc to strengthen against the Dollar.
5) EUR/CHF The Swiss government uses verbal intervention to weaken the Franc, sending the EUR/CHF higher. If inflation took off in Germany and France it could drive the EUR/CHF lower. If you think the Swiss government wishes to devalue the currency to help exports in Europe, you would click ASK, expecting the Euro to increase in value against the Swiss Franc. If inflation started taking off in Germany and France, you would click BID expecting the Swiss Franc to increase in value against a devalued euro.
6) AUD/USD Rising commodity prices send the AUD/USD higher. Droughts hurt the Australian economy and the AUD/USD. If you think that commodity prices are going to rise dramatically, thus benefiting the Australian Dollar, you would click ASK, expecting the Australian Dollar to strengthen against the U.S. dollar due to Australia's status as one of the world's leading commodity exporters. If you believe that Australia will face another drought, hurting the domestic economy, you would click BID, expecting the U.S. dollar to strengthen against the Australian dollar.
7) USD/CAD Canadian economic underperformance against the US sends the USD/CAD higher. Higher interest rates and a rebounding labour market in Canada will help to drive the USD/CAD lower. If you think that the U.S. economy is going to rebound while the Canadian economy goes into recession, you would click ASK, expecting the U.S. Dollar to strengthen against the Canadian Dollar. If you believe that the higher yields and rebounding labour market in Canada warrants a higher valuation for the Canadian Dollar against the U.S. Dollar, you would click BID, expecting the Canadian Dollar to strengthen against the U.S. Dollar.
8) NZD/USD Bad weather in the US, increasing demand for foreign wheat, would send the NZD/USD higher. The expectation that New Zealand Interest rates will decrease would send the NZD/USD lower. If you think that Hurricane damage in the US will lead to an increase in wheat imports from foreign nations, such as New Zealand, you would click ASK, expecting the New Zealand Dollar to strengthen in value against the U.S. Dollar. If you felt that interest rates in New Zealand will fall in the future while interest rates in the US will continue to rise, you would click BID expecting the New Zealand Dollar to drop in value against the U.S. Dollar.
TECHNICAL ANALYSIS
What is so great about Technical Analysis? Once a trader masters technical analysis, it can be easily applied to any currency or time frame. Technical analysis allows the user to figure out, in a relatively short time, where trends are going. Because of the short time it takes to study price curves, technical analysts are able to follow many currencies at the same time; whereas fundamental analysts usually focus on one or two pairs of currencies, because there is so much information in the market for them to analyse. Technical analysis offers many different ways for traders to analyse market information. Traders who use fundamental analysis can sometimes run into trouble because the sheer amount of data they are attempting to organize can be overwhelming. This can lead to misdirection, misunderstanding and ultimately, loss of money. On the other hand, technical analysis can be much more straightforward. Many traders even consider it to be self-fulfilling, meaning that it works well because so many traders use it. This is an important aspect of technical analysis because if many traders are basing their decisions on technical indicators, then the indicators must be watched since they reflect the sentiment of the market and the majority of the traders. Why is the Foreign Exchange Market the Best Market to use Technical Analysis? The foundation behind using technical analysis is to find trends when they first develop, which allows the trader to follow the trend until it ends. The foreign exchange market is typically composed of trends and is, therefore, a place where technical analysis can be effective. Traders are able to speculate on both up and down trends in the foreign exchange market because it is possible to Ask a currency and Bid against another currency. This aspect of currency trading works well with technical analysis, because technical analysis helps determine where the trends are and which way they are going, thus giving the trader a chance of profiting from the market, regardless of its direction. In comparison to the equities and futures markets, technical analysis is much more common and popular within the foreign exchange markets, which causes the traders to pay attention. The market partly moves because of all the technical analysis performed. For example, according to technical analysis, if a currency pair decreases, then the majority of traders will Bid the pair, causing it to drop further.
Support and Resistance At the core of all technical analysis theory are two very simple concepts: support and resistance. Support can be defined as a floor through which the currency pair has trouble falling below. There is no scientific formula for calculating support; it is something that is typically eyeballed by traders, and which has a subjective element, as a result. Resistance, on the other hand, is simply the opposite: it is the upper boundary through which a currency pair has trouble breaking. Similar to support, resistance levels are somewhat subjective. Generally, if the market reaches a price level a certain number of times and cannot sustain a break above that level; it can be identified as resistance. The reason why price has trouble breaking these levels is the presence of actual orders around these levels. A support level is simply a price area where Ask orders tend to be, so it takes more than normal Biding pressure to break that level. Similarly, a resistance level is a price area where Bid orders tend to be, so it takes more than normal Asking pressure to break that level. Support and Resistance in a Range - Trading Markets One simple way to use support and resistance in trading is to simply trade the range: in other words, traders can simply Ask at support levels and Bid at resistance levels. The Forex market is range-bound a majority of the time, making this a simple and attractive strategy for many market conditions. The Disadvantages of Range-Trading Trading in a range generally does not result in substantial gains on a per-trade basis. Generally, when the market breaks out of the range, it will make big moves. As a result, traders trading with range strategies can suffer big losses when the market breaks out of the range. The chart below illustrates the concept of range-bound trading:
Support and Resistance in Momentum Markets Another way to use support and resistance is to trade outside of the range; in other words, to anticipate a breakout. This involves placing orders to Ask above resistance and to Bid below support. The rationale is that the market will gain momentum once it breaks out of the range, thus by placing orders just below or above of support or resistance, traders may be able to profit if the market continues to move out of the range and they are on the right side of the market. Momentum trading is a bit counter-intuitive, as it involves Asking at a higher price and Biding at a lower price. Below is a chart that illustrates the concept of momentum trading:
Tools in Technical Analysis Oscillators Oscillators are a type of mechanical trading tool that are used to indicate when a currency pair is overbought or oversold. A popular oscillator is the Relative Strength Index.
Relative Strength Index The relative strength index (RSI) measures a currency pair's strength relative to its recent past performance. As the indicator is front-weighted (more importance is given to the most recent data), it usually provides a better velocity reading than other oscillators. RSI is less affected by sharp movements and filters out a lot of "noise" in the Forex market. Many traders also use this indicator as a substitute for volume confirmation, since the huge amount of traders in the Forex market - from all over the world - make real-time volume reporting impossible. RSI levels are between 0 and 100. Most traders use 30 as an oversold condition and 70 as an overbought condition, although some traders may use 20 and 80. When choosing the settings for RSI, traders should typically use the default time period of 14, since that is what the market as whole tends to look at.
In general RSI is used in Five Different Ways: Top and Bottoms - Overbought and Oversold conditions are usually signalled at 30 and 70. Divergences - When a pair makes new highs (lows) but RSI does not, this usually indicates that a reversal in price is coming. Support and Resistance - RSI may show levels of support and resistance, sometimes more clearly than the price chart itself. Chart Formations - Patterns such as double tops and head and shoulder may be more visible on RSI rather than on the price charts. Failure Swings - When RSI breaks out (surpasses previous highs or lows), this may indicate that a breakout in price is coming.
RSI was useful in detecting this USD/JPY short after a crossover of the 70 "overbought" level materialized on the daily. Following the clear Bid signals, the pair moved down 450 pips over the next 30 days.
RISK MANAGEMENT
There are Three Basic Questions that every Trader should Answer BEFORE Entering any Trade: How much do I believe the market will move and where do I want to take my profit? Limit Orders allow traders to exit the market at profit targets. If you are short (sold), the system will only allow you to place a Limit Order below the current market price because this is the profit zone. Similarly, if you are long (bought), the system will only allow you to place a limit order above the current market price. Limit orders help create a disciplined trading methodology and enables traders to walk away from the computer without constantly monitoring the market. How much am I willing to lose before I exit the position? A Stop Loss order allows traders to set an exit point for a losing trade. If you are short on a currency pair, the stop loss order should be placed above the current market price. If you are long on the currency pair, the stop loss order should be placed below the current market price. Stop Loss orders help traders control risk by capping losses. Stop Loss orders are counter-intuitive because you do not want them to be hit; however, in the long-run you will always be happy that you placed them! Where should I place my stop loss and take profit? As a general rule of thumb traders should set Stop Loss orders closer to the opening price than take profit. If this rule is followed, a trader needs to be right less than 50% of the time to be profitable. For example, a trader that uses a 30 pip Stop/Loss and 100 pip take profit needs only to be right 1/3 of the time to make a profit. Where the trader places the stop and limit will depend on how risk-adverse he/she is. Stop Loss orders should not be so tight that normal market volatility knocks the position out. Similarly, take profit should reflect realistic expectations of gains, given the markets trading activity, and the length of time one wants to hold a position.
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