Forex or foreign exchange is the trading on currency prices. An investor will determine which currency pair is going to offer the largest profit, and within that pair, which currency will increase, and which currency will decrease in value.
Investors trade currency pairs, such as GBP/USD or EUR/USD. Each currency pair has a base currency and a quote currency. The base currency is the first in the pair. It may be the USD, EUR, or a different currency depending on the quote currency. The quote currency is the one investors purchase based on one unit of the base currency.
The way currency pairs are listed is called the ISO currency code, which uses the three-letter alphabet to denominate, which currency is being discussed. When you trade, remember to assess the pairs based on the base currency equalling one and double check that the broker has the proper ISO listing for the currency code.
Trading requires you to either bid or ask for a currency pair. The bid is the buy price, which represents the amount you need to pay for the quote currency. The ask or sell price shows how much you sell the quote currency for to buy one unit of base currency.
Forex charts help investors trade currency based on patterns. There are three main types of charts; investors can use to determine how a currency pair is moving and what it might do next. Within the different types of charts, investors will discover various “symbols” that denote how a pair might move. For example, a head and shoulders appearance on a line chart has a short peak, a higher peak, and a short peak again, so that it appears like the head and shoulders of a person. Investors need to learn the indicators as much as the different charts.
A line chart is the simplest type of forex chart an investor can use to determine the changes in the currency pair. Line charts are the best option to monitor the support and resistance trends of a currency pair. In trading, the support line is the lowest point a currency pair may reach before it turns back towards an increase. The resistance line is where the currency pair will top out. It is the point where you would want to sell and take your earnings from the currency pair. People trade on the support and resistance line, by buying when the trend is increasing, and selling when the trend is decreasing. The difference between when you purchase or sell is how you make money.
A bar chart depicts closing and opening prices. The right side of the bar indicates the closing price, while the left is the opening price. The top of the vertical line on a bar shows the highest price a currency made it to for the day, while the bottom of the bar is the lowest price.
A single bar is designed to represent a specific unit of time, typically, a day of trading. However, some bar charts can be used to show minutes, hours, or even weeks of trading.
Candlestick charts were created by Japanese rice merchants and traders. The idea, in the beginning, was to track the market price and the daily changes in their rice trade. After hundreds of years of being used in the rice industry, some entrepreneur in the United States felt candlestick charts could be used in multiple trading arenas, including forex.
The candlestick is like a bar and is considered the body of the chart. The closing price and opening price are also depicted by the colour of the candlestick. Depending on the company producing the chart you may see black or red if the price closed lower than it opened. A white or green candlestick indicates a currency pair closed higher than the opening price.
The shape of the candlestick also determines the high, low, opening, closing, and trends for the day. The candle wick may be shorter or longer than the candle body depending on how the currency pair traded for the day. A long black or red candlestick shows high selling, while a long white candle is more of a support level for the price.
Use of Demo Accounts
Learning how to trade forex is challenging, even for trading experts. There are a lot of pieces to the puzzle that can cost investors their hard-earned money. For the very reason that forex is challenging, investors should begin with a demo account.
Demo accounts provide you with news, forex charts, indicators, and support from staff members. You can use demo accounts to test out theories and learn how to trade.
Investors are never going to have 100% successful trades; however, by learning how to trade first, testing out different strategies, and checking your knowledge—you can have a better return on your investment than you would if you go in blind.
Using a demo account, you want to reach a point where you have at least 60/40 on your return on investment. It is better to have a higher percentage, but as a beginner, you can settle for earning 60 percent more than you lose.
Demo accounts also help you practice strategies you may be uncomfortable with. For example, if you have yet to master reading bar charts or candlestick charts, a demo account is the way to determine if you are reading things correctly.
The pressure is also off when a person trades with “paper money” instead of their investment funds. You have the option of trying various trades over again until you feel confident.
The one caution regarding demo accounts is to know when you are ready to trade so that you do not lose your nerve. For some traders, it is easy to get lost in attempting to learn how to trade instead of jumping into the market.
You will want to work on how to determine when you are ready to trade. For example, do you remain calm during losses and decent earnings? If you still get too excited and jump back in and make a mistake—you are not ready to leave the demo account.
Spread, Swap and Market Hours
The forex market is desirable because of the market hours. As a decentralized market that operates around the world on banking hours, it is possible to trade nearly 24/7. Investors can trade during the day or go home and trade because another country is still up and awake. The biggest time zones for trading are New York, Tokyo, Sydney, and London. Based on eastern standard time the market is open in New York from 8 am to 5 pm, Tokyo 7 pm to 4 am, Sydney 5 pm to 2 am, and London 3 am to noon. London and New York are the busiest times in the forex market. However, you can trade or set up trades during other hours.
The spread is the difference between the bid and ask price, regarding a currency pair. As you learned in the introduction, you have a buy and sell price, based on a currency pair, such as the GBP/USD. The spread is denoted by pips. A pip is a percentage point, which is shown in the currency quotation with four decimal places. For example, if you trade one GBP, the USD price may be around 1.2878. If the price changes by 0.0061, it has changed by 61 pips.
There are fixed, and variable spreads. The fixed spread is set by the company, where you may have a five-pip difference between the ask and bid price. The difference is how the forex trading company makes their money. The variable spread correlates to the market conditions. It is how the amount will change based on how the currency pair is being bought or sold.
A swap is when one investor borrows one currency from another party, while also lending currency to a party.
In forex, there are different types of currency pairs, major, cross, and exotic. Major currency pairs are the major world currencies that are traded on the market. These include the currency pairs with the USD. For example, EUR/USD, USD/JPY, GBP/USD, and USD/CHF are considered the top four major currency pairs. There are more than four, including the CAD and USD, AUD and USD, and NZD and USD pairs. These major currency pairs help determine the rest of the market and are often the most stable. Exotic currency pairs tend to be volatile. Cross currency pairs do not include the USD. The most common cross currency pairs include the Japanese yen and euro.
Leverage is Key
Leverage is an amount of money required to invest in the forex market. Forex is the most significant industry where leverage is used; however, it is also used in the stock market and commodities trading. Forex trading has high leverage based on the initial margin requirement because it takes more funds to create decent earnings from forex investments.
A trader must determine what they are willing to invest regarding units, and then the amount that is leveraged is created. For example, regular trading uses 100,000 units of currency to trade. If an investor chooses 100,000 units as a regular “lot,” the leverage either needs to be 50:1 or 100:1. When a person decides $50,000 or less as the trading size, the leverage increases to 200:1. If you invest $50,000, then the forex broker will help you leverage that money by purchasing 200:1, so that you have a more significant margin to earn money.
As discussed, a pip is a unit of measure to determine the change in price between a currency pair. One pip is equal to 0.0001. If the EUR/USD goes from 1.1060 to 1.1061, the move was one pip.
The key is understanding the value of that pip. Let’s say you have 1 USD to 1.0300 CAD.
If you want to know the value of the pip, you must use a pip 0.0001 cad times 1 USD divided by 1.0300 CAD, or 0.0001 divided by 1.0300 x 1 equals 0.000097. If you trade 10,000 units of USD/CAD, then a pip change would equal 0.97 because 10,000 times 0.000097 is 0.97.
Let’s look at a different example to determine the price of a pip. If you traded GBP/JPY and earned 0.813 GBP, but your currency is USD, you need to figure out what GBP/USD would value. We will say the exchange rate is 1.5590. So, 0.813 GBP per pip divided by 1 GBP divided by 1.5590 USD would come out to 1.2674 USD per pip move. The idea in this example is a lot size of 10,000 units.
Pips are essential to forex traders to help understand the actual value of the transaction based on the number of units you invest, the currency, and the change in value, which is denoted by the pips. The more change in pips, the more you earn when you trade unless you chose the opposite position from the way the currency pair moved in the market.