Trading the Market Sentiment – Forex Trading Strategy
Lesson 1 – Forex Trading Strategy Guide – Introduction
- Searching for an efficient way to invest your money rather than letting it rest and lose value?
- Looking for a way to really leverage your money?
- Looking for higher returns on your investments?
- Starting a part or full-time career in finance?
- Looking for an extremely dynamic market?
Introduction to the global Forex market
The Forex market is a worldwide market of currencies (also called instruments). It measures the value of a currency in terms of another currency’s value (e.g. $1 = £0.66).
Nowadays our world is a single, large global market. Different currencies change hands any time, any place – for trading purposes, investments, loans, and partnerships. You can think of the globe as an enormous market where the forces of supply and demand are constantly changing due to a vast range of events taking place each and every day.
Did you know that almost everyone has taken part in Forex activities? For example, by changing currency when flying to a foreign country for a holiday or business trip, giving a quote to a client, or even by chatting with friends or colleagues about the dollar, euro, or other currencies.
The Forex market is the most traded market in the world, larger by far than any other market. Daily trading volume amounts to approximately 5 trillion dollars!! Just for comparison, the biggest stock market, the NYSE (New York Stock Exchange), has a daily turnover of around 50 billion dollars (which is 100 times less than Forex). Amazing, right! There is no other market which can equal the Forex market.
So what is Forex? Let’s go back to the holiday example. Say you are on a short vacation trip from your home in New York to Rome, Italy. When landing at the airport and changing dollars into euros you participate in a Forex transaction. A few days later, after flying back from Rome to N.Y., you change the euros you have left back into dollars, but at a slightly different price. In the second action you executed an opposite transaction to the first, closing a circle of buying and selling one currency for another.
So far so good? Great!
History of Forex Trading Market
Until the 1970s the Forex market did not act like an enhanced, modern market, reacting to changes in supply and demand. From the 1970s onwards, this all changed. The market became global and rates fluctuated, moving in response to market forces. Over the years the Forex market got bigger and bigger until it reached its current size.
Nowadays, the Forex market is so huge that no one can move it by themselves, no matter how much volume they are trading. Even the large institutions – such as investment banks and hedge funds – do not affect Forex market. Even central banks have a hard time shifting their currencies.
In the past, the only real forces in the market were big commercial ones such as banks and big firms trading according to their business needs (for example, a company would hold Japanese yen if they had business activity in Japan). Today things are different: Forex is now extremely popular with private traders, large and small. Since the late 1990s, the rules of the game have changed, thanks to the Internet revolution. Banks, forex brokers and financial companies now offer comfortable, simple, online forex trading platforms, which let ordinary people (medium and small players) trade the Forex market for themselves.
What do we trade?
First, get used to the fact that in Forex we trade currencies, not physical goods. Currencies are goods like any other, but when you trade forex online you don’t get to see or touch the money until you withdraw the profit from your account. The idea behind buying currency is actually very simple. If you believe that a currency’s value will rise you buy it with another currency, and hold it until you no longer believe it will rise further. If you think a currency’s value will fall, you sell it. Whether you buy or sell you are actually exchanging currencies – buying one currency and selling another (e.g. buying the dollar and selling the euro).
When you buy a forex pair you always buy the first currency alongside the second one. This means that you are selling the second currency. For instance, if you buy USD/JPY you are buying the dollar and selling the Yen. It is the same when you sell a forex pair; you always sell the first currency and buy the second.
Currency instruments are always traded in pairs. Imagine a currency pair as a couple of boxers in the ring, caught up in an endless struggle over who is stronger. During the match, each has his stronger and weaker moments, their ups and downs. Sometimes they rest and sometimes they attack.
Symbols – Each instrument is indicated by 3 letters (the first 2 are the country and represent the base country for that currency, the third is the name of the currency). For example, USD = U.S Dollar.
There are 3 main pair categories:
Majors – The 8 most traded pairs in the world, for example, GBP/USD (British pounds/US dollar), USD/JPY (US dollar/Japanese yen), EUR/USD (euro/US dollar). In the next lesson, we will look at all 8.
Cross Currency Pairs (or Crosses) – All pairs that do not include the US dollar. For example, EUR Crosses are all pairs that include the euro, except for EUR/USD (which is a Major).
Exotic Currency Pairs – Pairs built of one major currency and one “weaker” currency (from a developing market). These pairs are usually traded in much lower volumes. Commissions on exotic pairs, asked by the brokerages, are relatively high. For example, GBP/THB (British pound/Thai Baht).
Forex Market Structure and Size
The Forex market does not have a “rooftop structure” (A single supervising body and trading limitations). It is the most popular and most traded market in the world, with private groups, small and medium-sized traders, commercial and public companies, banks and governments all involved. Trading is electronic and online and takes place simultaneously around the globe, 24 hours a day.
The most traded currencies are the US dollar, which accounts for a bit more than 85% of the total traded currencies around the world; the Euro with almost 40% and the Yen with 18%. We are already at more than 140%. Confused? Remember that total percentage in Forex is 200%. Why? Because the market is composed of pairs so there are 2 currencies in each trade. The U.S. holds the largest and most stable economy in the world, which is why the US Dollar constitutes 62% of the total currencies reserves worldwide.
Other instruments we should note as we progress are those of the developing markets, such as Brazil, Turkey, and Eastern Europe republics.
Here you can take a look at the distribution of currencies in the Forex market (total = 200%!)
Trades take place in real time, around the clock. The market is highly dynamic and very volatile, with outstanding profit possibilities and nonstop information about it available at all times of day. Anyone can easily trade: it doesn’t matter whether you are a “heavy trader” or a “small trader”, trading from your own home.
Advantages of Forex Trading
There are many advantages in trading currencies:
- The market is open for business 24 hours a day, five days a week, anywhere in the world. It starts Monday morning in Australia in the east and ends Friday afternoon N.Y. time in the west.
- There are no commissions for opening and closing accounts. There are no taxes either. You are your own master, trading positions and executing actions by yourself; without needing anyone to do the work for you.
- Its enormous size brings endless opportunities, with millions of winners every day.
- You can start trading with almost any amount! Even with 25 dollars.
- The market is so comprehensive: there is no force in the world powerful enough to control and manipulate it. Unlike other markets, where the banks and financial firms can control the prices that their clients pay, the Forex market is absolutely clean of price manipulation.
- Huge liquidity: you can always buy or sell any currency you want.
- Profit potential is massive, even for traders who trade with small amounts. There are endless options for grabbing earnings, even in low volume trading. We will delve deeper into this subject later on!
Currencies vs. Stocks:
Let’s take a look at the advantages of the Forex market, compared to stock markets:
- Note the enormous difference between Forex and stock market volumes. While the media prefers to cover stock markets such as NASDAQ and NYSE, rather than Forex, in fact these markets are tiny when compared to the Forex market (which is 10 times larger than all the stock markets in the world put together)!
- Think for a moment about stocks and goods: let’s assume you decided on trading stocks. The variety of stocks is so ridiculously large – on the NASDAQ alone there are almost 4,000 companies registered; on the LSE (London Stock Exchange) there are another 2,000 companies! How do you figure out which stock to choose? You can get a headache even thinking about it! Forex is much simpler – there’s just a handful of the main currency pairs to choose from.
- Whereas stock markets close down every afternoon, the Forex market is open 24/5. There are many advantages to this, such as immediate order execution. The Forex market is also much more reactive to dramatic events than stock markets because continuous trading hours allow traders to respond instantly. There is no room for surprises or massive reactions following dramatic events taking place outside trading hours (as can be the case with stocks). Reactions are always in real time, live.
- No force can manipulate the market. Brokers and financial companies cannot control the market by raising and reducing the commissions we have to pay in order to activate our positions. Bottom line – traders do not pay fees.
- As opposed to stocks, in Forex you can also earn money in falling markets. In fact, it is very simple – whenever the value of one currency in a pair goes down, the value of the second currency goes up! To be precise, it is also possible to make profits out of impairments in the stock market by selling and buying “Shorts” (used to capitalize on an expected decline in the security’s price), but we relate to natural market conditions, without manipulations. Remember, there is a constant “struggle” between the 2 currencies making up the pair. Selling one instrument means buying the other.
Let’s summarise the major advantages the Forex market has over the Stock market:
|Hard to follow (complicated rules)||Easy to understand|
|Open during working hours||Open 24/5|
|Open to manipulations||Huge earnings potential|
|Transaction Fees||Free of charge|
Key Forex Trading Players Reviewed
We have already said that the Forex market is simple to understand. It is really no problem to get oriented. A large number of major players make up this market. It is a decentralized market, not controlled by any single source. Yet there is order. Here are the key players influencing the Forex market:
Central banks: Each operates for its own country, according to the needs of the respective economy and government. Central banks play a major role in the Forex market, determining national interest rates, levels of inflation and more. Central banks also have an influence on exchange rates. If the exchange rate is too high or too low, the central bank starts buying or selling very large quantities of currency in exchange for other currencies. Their influence on economies and currencies is critical. In times of crisis, such as for instance the global crisis of 2008, the central bank lowers interest rates in order to help the economy get back on track. The impact it has on the supply and demand for the currency is tremendous.
More on this can be found in our Fundamental Forex Trading Strategies page.
Benchmark Interest Rates
Examples of interest rates in the major markets (accurate as at 8/2011):
Commercial banks: The biggest and most significant group in this category is the commercial banks. These banks set the tone in the Forex market. The amounts of capital switching hands inside the banking system (called Interbank) are astronomical! They set the exchange rates for market’s supply and demand. Examples are Citigroup, Barclays, JP Morgan, UBS, Deutsche Bank and BofA.
Commercial companies: All large companies trade Forex and exchange currencies according to their changing needs. Usually, their activity relates to their business environment. Let’s take Samsung for example: when starting a business partnership with new electronic suppliers from Germany, Samsung will consider holding more euros in its inventory. Now, assume there are other corporations and large firms that tighten their collaboration with German suppliers (or other European suppliers) – the demand for the euro will rise, strengthening it. These companies also buy option contracts to exchange their currency for Euros at the current exchange rate when they need to in the future. This also affects the actual and the future rate. Experienced traders who track these changes can make a fortune with this data!
Hedge funds: These trade currencies in order to keep their clients’ investments profitable through skillful leveraging. We call it “letting your money work smart”. Their clients are companies with wide inventories of capital.
Retail Forex brokers: All the Forex trading companies offering trading platforms to the small-medium traders around the world. They are called brokerages. There are hundreds of regulated Forex brokers, offering the possibility to trade with almost any amount of capital, anywhere on the globe (as long as you have an Internet connection), without having to use the services of the banks.
Retail Traders: Privates investor like you, trading Forex to create profits and a second income for themselves. This way they can increase their capital. They take advantage of the fact that they can trade Forex anytime, even during or after work, and from anywhere.
Opening a Free Forex Trading Practice Account
Most of our recommended trading platforms allow new traders to open a ‘Practice Account’ (also called ‘Demo Account’), free of charge. In your practice account, you can use virtual money to trade on live market rates. Practice accounts allow you to warm up and study the platform, before opening a real trading account and jumping in at the deep end. The only difference from a real account is that you cannot make or lose real money.
Remember: Demo trading holds zero trading risks!
We recommend you open a demo account with one of our recommended brokers and use it to practice everything you learn throughout the course, before depositing your own money. Try to see it like learning to drive a car: it is nice to have a good instructor, but until you take the wheel and practice for yourself you still don’t know how to drive…
We recommend a selection of the best, most popular brokers in the world, brokers who will allow you to open practice accounts on their platforms free of charge. We will also guide you on how to do this.
Once you feel ready, you will be able to open a proper account and start trading for real. Trust us, there is nothing more fun and exciting than using your new knowledge to make money out of good investments! Forex offers the highest money-making potential in the world. You just need to learn how to put it into action, and that is why we are here!
Important: Take a couple of minutes and open a practice account. It will be very helpful along the way. Remember that the effort you put in now will translate into potential profits later!
How to open a free practice account
The account you are about to open will serve you for training purposes. Each and every method learned can be tested on the platform. Then, you will feel ready to trade for real because you will be in a strong position, understanding the market’s secrets and rules.
Opening demo accounts on these platforms is a simple process, and their practice accounts provide the friendliest, most intuitive trading platforms for beginner Forex traders.
When you click on your chosen broker you will be asked to register for a trading account and once you have finished this process you will have your very own account to practice with.
Ready to choose a broker? Click here to learn how to choose a recommended brokers.
You are in the right place – the Forex market!
In Chapter 2 – First Steps in Forex Trading we will elaborate more on “Choosing the right broker”. There you will get a detailed explanation of how to choose the right broker for your own needs, plus additional tips and recommendations. But there’s no rush! There’s still a lot of ground to cover before you open a real account.