Information About Forex Trading

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Foreign exchange market

The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is by far the largest market in the world, in terms of cash value traded, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The trade happening in the forex markets across the globe exceeds $1.9 trillion/day ( on an average ) presently. Retail traders (small speculators) are a small part of this market.

Market size and liquidity

The foreign exchange market is unique because of:

·         its trading volume,

·         the extreme liquidity of the market,

·         the large number of, and variety of, traders in the market,

·         its geographical dispersion,

·         its long trading hours - 24 hours a day (except on weekends).

·         the variety of factors that affect exchange rates,

Average daily international foreign exchange trading volume was $1.9 trillion in April 2004 according to the BIS study Triennial Central Bank Survey 2004

% of overall volume, May 2005

Top 10 Currency Traders

Rank

Name

% of volume

1

Deutsche Bank

17.0

2

UBS

12.5

3

Citigroup

7.5

4

HSBC

6.4

5

Barclays

5.9

6

Merrill Lynch

5.7

7

J.P. Morgan Chase

5.3

8

Goldman Sachs

4.4

9

ABN AMRO

4.2

10

Morgan Stanley

3.9

Exchange-traded forex futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts. Forex futures volume has grown rapidly in recent years, but only accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).

The ten most active traders account for almost 73% of trading volume, according to The Wall Street Journal Europe, (2/9/06 p. 20). These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually only 1-3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203. Minimum trading size for most deals is usually $100,000.

These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100 / 1.2300 for transfers, or say 1.2000 / 1.2400 for banknotes or travelers' cheques. Spot prices at market makers vary, but on EUR/USD are usually no more than 5 pips wide (i.e. 0.0005). Competition has greatly increased with pip spreads shrinking on the majors to as little as 1 to 1.5 pips

Trading characteristics

There is no single unified foreign exchange market. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currency instruments are traded. This implies that there is no such thing as a single dollar rate - but rather a number of different rates (prices), depending on what bank or market maker is trading. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs.

Top 6 Most Traded Currencies

Rank

Currency

ISO 4217 Code

Symbol

1

United States dollar

USD

$

2

Eurozone euro

EUR

3

Japanese yen

JPY

¥

4

British pound sterling

GBP

£

5-6

Swiss franc

CHF

-

5-6

Australian dollar

AUD

$

The main trading centers are in London, New York, and Tokyo, but banks throughout the world participate. As the Asian trading session ends, the European session begins, then the US session, and then the Asian begin in their turns. Traders can react to news when it breaks, rather than waiting for the market to open.

There is little or no 'inside information' in the foreign exchange markets. Exchange rate fluctuations are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in GDP growth, inflation, interest rates, budget and trade deficits or surpluses, and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow.

Currencies are traded against one another. Each pair of currencies thus constitutes an individual product and is traditionally noted XXX/YYY, where YYY is the ISO 4217 international three-letter code of the currency into which the price of one unit of XXX is expressed. For instance, EUR/USD is the price of the euro expressed in US dollars, as in 1 euro = 1.2045 dollar.

On the spot market, according to the BIS study, the most heavily traded products were:

  • EUR/USD - 28 %
  • USD/JPY - 18 %
  • GBP/USD (also called sterling or cable) - 14 %

and the US currency was involved in 89% of transactions, followed by the euro (37%), the yen (20%) and sterling (17%). (Note that volume percentages should add up to 200% - 100% for all the sellers, and 100% for all the buyers).

Although trading in the euro has grown considerably since the currency's creation in January 1999, the foreign exchange market is thus still largely dollar-centered. For instance, trading the euro versus a non-European currency ZZZ will usually involve two trades: EUR/USD and USD/ZZZ. The only exception to this is EUR/JPY, which is an established traded currency pair in the interbank spot market.

Basic Guidelines to know more abt FOREX

.1. What is Foreign Exchange?

Foreign exchange is the simultaneous buying of one currency and selling of another. The world's currencies are on a floating exchange rate and are always traded in pairs, for example Euro / Dollar or Dollar / Yen. With a daily average turnover of approximately $1.4 trillion, the foreign exchange market, also known as the "Forex" or "FX" market, is the largest financial market in the world.

1.2. Where is the central location of the forex market?

Unlike the stock and futures markets, forex trading is not centralized on an exchange. Due to the fact that transactions are conducted between two counterparts over the telephone or via an electronic network, the forex market is considered an "Over the Counter" (OTC) or "Interbank" market.

1.3. Who are the participants in the forex market?

The reason that the forex market is referred to as an interbank market is due to the fact that historically it has been dominated by banks, including central banks, commercial banks, and investment banks. However, the percentage of other market participants is rapidly growing, and now includes large multinational corporations, global money managers, registered dealers, international money brokers, futures and options traders, and private speculators.

1.4. When is the forex market open for trading?

Forex is a true 24-hour market and trading begins each day in Sydney, and then moves around the globe as the business day begins in each financial center - first to Tokyo, then London, and finally New York. Unlike any other financial market, investors can respond to currency fluctuations caused by economic, social, and political events at the time they occur - day or night.

1.5. What are the most commonly traded currencies in the forex markets?

The most frequently traded or "liquid" currencies are those of countries with stable governments, respected central banks, and low inflation. Nowadays, over 85% of all daily transactions involve trading of the major currencies, which include the U.S. Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and the Australian Dollar.

1.6. Is forex trading capital intensive?

Most forex brokers require a minimum deposit of just $3,000 for opening a regular forex trading account, and only $1,000 for opening a mini account. Forex brokers enable currency trading to be conducted on a highly leveraged basis. You are able to select the degree of leverage or gearing that you wish to employ in trading. However, it is important to remember that while this type of leverage allows investors to maximize their profit potential, the potential for loss is equally great.

Trading Fundamentals

2.1. What is Margin?

Margin is a performance bond, or good faith deposit, to ensure against trading losses. The margin requirement allows you to hold a position much larger than your actual account value. Most forex brokers' online trading platforms perform automatic pre-trade checks for margin availability, and will only execute the trade if you have sufficient margin funds in your account. These systems also calculate the funds needed for current positions and displays this information to you in real time. In the event that funds in your account fall below margin requirements, some or all of your open positions will be closed. This prevents your account from ever falling below the available equity even in a highly volatile, fast moving market.

2.2. What does it mean have a "long" or "short" position?

A long position is simply one in which a trader buys a currency at one price and aims to sell it later at a higher price. In this scenario, the investor benefits from a rising market. A short position is one in which the trader sells a currency in anticipation that it will depreciate. In this scenario, the investor benefits from a declining market. However, it is important to remember that every forex position requires an investor to go long in one currency and short the other.

2.3. What is the difference between an "intraday" and "overnight position"?

Intraday positions are all positions opened and closed before 17:00 Eastern Time (the end of the international trading day). Overnight positions are positions that are held through 17:00 Eastern Time

2.4. How are currency prices determined?

Currency prices are affected by a variety of economic and political conditions, but probably the most important are interest rates, inflation and political stability. Sometimes governments actually participate in the forex market to influence the value of their currencies, either by flooding the market with their domestic currency in an attempt to lower the price, or conversely buying in order to raise the price. This is known as Central Bank intervention. Any of these factors, as well as large market orders, can cause high volatility in currency prices. However, the size and volume of the forex market makes it impossible for any one entity to "drive" the market for any length of time.

2.5. How does the Margin Call work?

If the equity balance in your account falls below the margin requirement, a margin call will be generated. In the event that an account exceeds its maximum allowable leverage, some or all open positions will be liquidated immediately.

3.1. How do I manage risk?

The limit order and the stop loss order are the most common risk management tools in forex trading. A limit order places restriction on the maximum price to be paid or the minimum price to be received. A stop loss order ensures a particular position is automatically liquidated at a predetermined price in order to limit potential losses should the market move against an investor's position. The liquidity of the forex market ensures that limit order and stop loss orders can be easily executed.

3.2. What kind of trading strategy should I use?

Currency traders make decisions using both technical factors and economic fundamentals. Technical traders use charts, trend lines, support and resistance levels, and numerous patterns and mathematical analyses to identify trading opportunities, whereas fundamentalists predict price movements by interpreting a wide variety of economic information, including news, government-issued indicators and reports, and even rumors. The most dramatic price movements, however, occur when unexpected events happen. The event can range from a Central Bank raising domestic interest rates to the outcome of a political election or even an act of war. Nonetheless, more often it is the expectation of an event that drives the market rather than the event itself.

3.3. How long are positions maintained?

As a general rule, a position is kept open until one of the following occurs: 1) realization of sufficient profits from a position; 2) the specified stop-loss is triggered; 3) another position that has a better potential appears and you need these funds.

Common Guidelines

Plan your trade and trade your plan: You must have a trading plan to succeed. A trading plan should consist of a position, why you enter, stop loss point, profit taking level, plus a sound money management strategy. A good plan will remove all the emotions from your trades.

The trend is your friend: Do not buck the trend. When the market is bullish, go long. On the reverse, if the market is bearish, you short. Never go against the trend.

Focus on capital preservation: This is the most important step that you must take when you deal with your trading capital. You main goal is to preserve the capital. Do not trade more than 10% of your deposit in a single trade. For example, if your total deposit is $10,000, every trade should limit to $1000. If you don't do this, you'll be out of the market very soon.

Know when to cut loss: If a trade goes against you, sell it and let go. Do not hold on to a bad trade hoping that the price will go up. Most likely, you end up losing more money. Before you enter a trade, decide your stop loss price, a price where you must sell when the trade turns sour. It depends on your risk profile as of how much you should set for the stop loss.

Take profit when the trade is good: Before entering a trade, decide how much profit you are willing to take. When a trade turns out to be good, take the profit. You can take profit all at one go, or take profit in stages. When you've recovered your trading cost, you have nothing to lose. Sit tight and watch the profit run.

Be emotionless: Two biggest emotions in trading: greed and fear. Do not let greed and fear influence your trade. Trading is a mechanical process and it's not for the emotional ones. As Dr. Alexander Elder said in his book "Trading For A Living", if you sit in front of a successful trader and observe how he trades, you might not be able to tell whether he is making or losing money. That's how emotionally stable a successful trader is.

Do not trade based on a tip from a friend or broker: Trade only when you have done your own research and analysis. Be an informed trader.

Keep a trading journal: When you buy a currency or stock, write down the reasons why you buy, and your feelings at that time. You do the same when you sell. Analyze and write down the mistakes you've made, as well as things that you've done right. By referring to your trading journal, you learn from your past mistakes. Improve on your mistakes, keep learning and keep improving.

When in doubt, stay out: When you have doubt and not sure where the market or stock is going, stay on the sideline. Sometimes, doing nothing is the best thing to do.

Do not overtrade: Ideally you should have 3-5 positions at a time. No more than that. If you have too many positions, you tend to be out of control and make emotional decisions when there is a change in market. Do not trade for the sake of trading.

Forex Market

Forex (Foreign Exchange) is the name given to the "direct access" trading of foreign currencies. With an average daily volume of $1.4 trillion, forex is 46 times larger than all the futures markets combined and, for that reason, is the world's most liquid market. In the past, forex trading was limited largely to enormous money center banks and other institutional traders. But in just the past few years, technological innovations and the development of online trading platforms allow small traders to take advantage of the significant benefits of trading foreign currencies with forex.

In contrast to the world's stock markets, foreign exchange is traded without the constraints of a central physical exchange. Transactions are instead conducted via telephone or online. With this transaction structure as its foundation, the Foreign Exchange Market has become by far the largest marketplace in the world.

Buying and Selling

In the forex market, currencies are always priced and traded in pairs. You simultaneously buy one currency and sell another, but you can determine which pair of currencies you wish to trade. For example, if you believe the value of the euro is going to increase vis-á-vis the U.S. Dollar, then you would go long on EUR/USD instrument (currency pair). Obviously, the objective of forex currency trading is to exchange one currency for another in the expectation that the market rate or price will change so that the currency you bought has increased its value relative to the one you sold. If you have bought a currency and the price appreciates in value, then you must sell the currency back in order to lock in the profit. An open trade or position is one in which a trader has either bought / sold one currency pair and has not sold / bought back the equivalent amount to effectively close the position.

Calculating Profit

The objective of forex currency trading is to exchange one currency for another in the expectation that the market rate or price will change so that the currency you bought has increased its value relative to the one you sold. If you have bought a currency and the price appreciates in value, then you must sell the currency back in order to lock in the profit.

Let us assume that you open a long position by buying USD/JPY for 107.58 (quantity of 100000) and few hours after that, you close the position by selling USD/JPY for 107.74 (quantity of 100000). These two trades would bring you profit of (107.74 - 107.58) * 100000 = JPY 16000 (JPY is the counter or quote currency in the USD/JPY pair). You can than convert the profit to a currency you like, for example JPY 16000 = 16000 / 107.74 = USD 148.51.

We can also say that these two trades would bring you 16 "pips" profit. A "pip" is the smallest increment in any instrument. For asset types other than forex, the smallest increment is often called "tick". In EUR/USD one pip is 0.0001, in USD/JPY one pip is 0.01. Expressing position profits in pips is often very useful for quick calculations and estimates.

One pip, from the example above, would bring you 0.01 * 100000 = JPY 1000 profit, or JPY 1000 = 1000 / 107.74 = USD 9.28.

Orders and Positions

When you want to open a position you need to place an "entry" order. If and when the entry order executes, the position becomes "open" and starts its life on the market. At one point in time, you will place an "exit" order to "close" the position. A position can be "long" (entry order is to buy and exit order is to sell an instrument) or "short" (entry order is to sell and exit order is to buy an instrument).

At the point when you place your entry order, you need to define price level at which you want to buy or sell certain instrument. You also need to specify type of the order and quantity of the instrument you want to trade. There are 3 order types:

Market Order

Placing a market order means that you will buy at your broker's current "ask" (or "offer") price, or sell at your broker's current "bid" price, whatever that price currently is. For example, suppose you are buying EUR/USD. The current market, as quoted by your broker is 1.2934 / 1.2938. This means that your broker is willing to buy EUR/USD from you at 1.2934, and sell it to you at 1.2938.

Stop Order

Initiating a trade with a stop order means that you will only open a position if the market moves in the direction you are anticipating. For example, if USD/JPY is currently 108.72 and you believe it will move higher, you could place a stop order to buy at 108.82. This means that the order will only be executed if the market moves up to 108.82. The advantage is that if you are wrong and the market moves straight down, you will not have bought (because 108.82 will never have been reached). The disadvantage is that 108.82 is clearly a less attractive rate at which to buy than 108.72. Opening a position with a stop order is usually appropriate if you wish to trade only with strong market momentum in a particular direction.

Limit Order

A limit order is an order to buy below the current price, or sell above the current price. For example, if EUR/USD is trading at 1.2952 / 56 and you believe the market will rise, you could place a limit order to buy at 1.2945. If executed, this will give you a long position in EUR/USD at 1.2945, which is 11 pips better than if you had just bought EUR/USD with a market order. The disadvantage of the limit order is that if EUR/USD moves straight up from 1.2952 / 56, your limit at 1.2945 will never be filled and you will miss out on the profit opportunity even though your view on the direction of EUR/USD was correct. Opening a position with a limit order is usually appropriate if you believe that the market will remain in a range before moving in your anticipated direction, allowing the order to be filled first.

For both entry and exits orders you can specify price levels at which you want them to be executed. You have to specify entry levels when you place you entry order, while most

Market Conventions

Market conventions are rules and standards imposed by a governing body. In case of decentralized forex market these conventions might differ due to many national regulators (FSA, FSC, CFTC, NFA, BCSC, etc.). Since there is no central governing body that sets forex market rules and standards, we will reference only these that are universal.

Quoting Conventions

The first currency in the pair is referred to as the base currency, and the second currency is the counter or quote currency. The U.S Dollar is usually the base currency for quotes, and includes USD/JPY, USD/CHF, and USD/CAD. The exceptions are the Euro (EUR), Great Britain Pound (GBP), and Australian Dollar (AUD). As with all financial products, forex quotes include a "bid" and "ask", which is more often called "offer" in the forex market. The bid is the price at which a forex market maker is willing to buy (and you can sell) the base currency in exchange for the counter currency. The offer is the price at which a forex market maker will sell (and you can buy) the base currency in exchange for the counter currency. The difference between the bid and the offer price is referred to as the spread.

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