How does Forex work?
This section was made especially for beginners in the financial markets. Trying to find any useful information, the novice trader faces too much information. In order to save time for traders, we have identified the most basic learning strategies for beginners.
Forex is the largest and most liquid market in the world today. Here you can make a profit using the fluctuations of different rates: shares, currencies, indices, and other financial units. This market is one of the youngest trading platforms. It appeared in the 70’s of the XX century when it was decided to refuse binding to exchange rates. Since then, millions of traders around the world have earned on the currency rate fluctuations. By the way, now the Forex market volume exceeds 5 trillion US dollars.
At the stage of initial training, it is important to note that the Forex market is a free world market, i.e.without a certain location in contrast to the exchanges. The market has a huge number of participants who sell and buy currencies from each other.
Various geopolitical events, key decisions of central banks on interest profit margins, other macroeconomic information that can reflect the economy state of a country – all these factors play the most important role in the market fluctuations. Success of your training in Forex trading will determine the correct assessment of the influence of these factors on currencies.
Basic concepts and terms in the Forex market
For example: exchange rate for a pair Euro/USD – EUR/USD = 1.07602
The “base” in the pair is the first currency, while the second is known as “counter” or “quoted currency”.
The base currency on Forex is the basis for the sale or purchase.
Based on the exchange rate, we see that 1.07 US Dollars can buy 1 Euro. Buying EUR/USD means that you sell dollars and buy Euros. In case you sell EUR/USD, you buy dollars and sell Euros.
Long and short positions on Forex
In the trading terminal you will see two main buttons – Sell and Buy. “Buy” means that you will buy at cheaper price and sell at higher price. Your profit is the difference in price. Another term is “Going long”.
“Sell” means that you sell a pair expecting its falling. The expressions “Short” or “Going short” on Forex means sale.
Below we will review the pair EURUSD, which is the most popular on Forex. The first currency is called “basic” and the second one is “quoted”. Operation “Buy” means that you bought cheaper and sell more expensive. Your profit is the difference in price. “Sell” means that you sell a pair expecting its falling. This means that trading in the currency market is possible both on the fall and on the growth of currencies, which is important to remember when studying trading peculiarities for beginners.
If you put an order to sell the pair, it means that you sell Euro and buy USD, and in case if the order is placed for purchase, then you buy Euro and sell USD.
Spread or Bid/Ask
“Bid” and “Ask” are two different prices displayed in the platform terminal for each currency pair.
- “Ask” is the price, at which the currency pair is bought.
- “Bid” is the price, at which the currency pair is sold.
The difference between the above two prices is called the spread, which serves as the basis for earning of a forex broker.
It is quite an important instrument for both experienced and novice Forex traders, which allows to set an order in a trading terminal for sale or purchase of currency at a certain price, which is not present at the moment, but is expected in the future. This order will be automatically executed by the trading terminal, even if you are not at the computer.
Pending orders can be both for purchase and sale:
- Purchase order “Buy Limit” is set by you in case you want to buy a pair at a price that is lower than the current price. Otherwise, you should use the “Buy Stop” order.
- We have 2 types of pending orders when a pair goes downwards, for example, EURUSD: “Sell Limit” – the pair moves upward. Used in the case of selling the pair at a price higher than the current price. “Sell Stop” order is used for sale at the lower price.
What is Stop Loss and Take Profit?
These, extremely useful trading operations, are not used in case of training a novice trader only, but also for those having sufficient experience to make the trade more comfortable.
“Stop Loss” is a protective stop used to limit the amount of the probable loss in case the price goes against you. In other words, this is the price, at reaching which your position is automatically closed.
Take Pprofit is an internal transaction with the opposite effect, it allows locking the profit if you have correctly calculated the market moves and the price is moving in your direction.
It is necessary to remember that the Trade Point means changing the quote by one point. For example, EURUSD – if the current price is $1.1196 and the next $1.1216, it means that the price changed by 20 points. Changes indicate the strength of movement on the pair. Average variation on a pair is 100-140 points per day.
Volatility is a significant movement and change by several figures per day (figure is 100 points) of a pair, which happens when the news of high importance become known, like decisions of major central banks on monetary policy, presidential election or data on U.S. employment outside the agricultural sector.
There is an opinion that volatility can both increase risks on Forex trading and increase profit in case when direction is chosen correctly.
Popular types of analyses
When learning how to trade in the Forex market, you will need to analyze the charts in your trading platforms. Technical and fundamental types of analyses will effectively help you in making trading decisions.
Novices in Forex often think that staying outside the market on Forex is the easiest way, and real trading is associated with either sale or purchase of an asset. However, to stay out of the market is a complicated skill and similar to Zen meditation, although sometimes it is the only possible correct solution.
There are various types of analyses, from which the most popular can be distinguished:
- Wave analysis (Elliott waves);
- Technical analysis;
- Fundamental analysis;
- Candlestick analysis (Japanese candles).
One of the most significant parts in the technical study of Forex trading is technical analysis. Candlestick and wave analysis can also be considered as part of technical analysis.
In fact, it is a prediction of a possible price change that is based on regularities in the form of similar prices in earlier similar circumstances.
Technical analysis does not cover the reasons why prices have changed. It analyzes only the price, implying that the various factors influencing the price (psychological, political, or economic) have been already taken into account by the market and included in it. It follows that the technical analysis is based on 3 postulates:
- History is repeated;
- Market moves are subordinate to the trend;
- Market moves take into account everything.
Today, by virtue of IT development, it has become possible to analyze a huge amount of information, and technical analysis is a very popular tool. Based on this type of analysis, you can find charts in any trading platform.
In terms of technical analysis, the following skills will help achieve success:
- Analyzing prices;
- Identifying the trend and trading according to it;
- Using graphic models that are repetitive over time.
A part of the technical analysis is a wave analysis that analyzes the fact instead of the reasons for the price change.
A part of the technical analysis is a wave analysis that analyzes the fact instead of the reasons for the price change. Versatility is one of its main advantages, as this analysis method can be applied to any liquid market. It can provide forecasts for both months and years. None of the other types has such a unique characteristic. There is a critical level showing the trader where to set the Take Profit and Stop Loss levels.
Candlestick analysis is also popular among many traders in the financial markets. The main advantage of this analysis is the provision of the full amount of information reflected on the candlestick chart. It allows generating predictions quite accurately, and is easy enough to use.
The “candle” consists of a white or black body and a lower or upper shadow. The lower and upper borders of the shadow show the minimum and maximum prices during the bidding. At the same time, the body borders indicate the closing and opening prices. Thanks to the Japanese candlesticks you can visually assess the balance of forces between the traders.
Fundamental analysis is based on issued daily macroeconomic indicators that have an impact on the levels of exchange rates and market participants. It also includes information about the government’s economic policy, GDP assessment, inflation, parliamentary or presidential elections, central bank interest rates, trade balance, confidence in the world’s national currency, etc.
Strategies in trading
Forex training involves choosing by a trader its position in the market depending on the term, for which it plans to make transactions:
- Scalping is making profit on small price fluctuations in a short period of time. Scalper can make more than 100 transactions per day.
- Position trading is trading in the long term based on the leading trends on the charts with long intervals (from one month to several years).
- Trading on the news – as the name suggests, it refers to expectation of particularly important news, which will cause volatility in the markets.
- Day trading – as the name suggests, this trade is limited to one-day period. Trade is conducted on the basis of any important news, which may influence the market fluctuations. “Day traders” use this opportunity immediately in order to get a small profit in the shortest possible time. This includes trading on news and scalping.
The main feature of the method is the closing of all transactions at the end of the day.
When viewing graphs in the terminal, one may think that this method is only for men in expensive suits from Wall Street. However, most traders go deeper in a fascinating world of price movements, news and quotes. Becoming a trader is possible!