Traders' views - Forex

A practical understanding of the forex markets

By Sam Evans, 31 May 2012

Sam Evans, UK education director and instructor at Online Trading Academy, walks through the basics of foreign exchange markets and forex trading

Having been an instructor with the globally recognized Online Trading Academy for around five years, I meet many traders with a keen interest in the worldwide foreign exchange markets, also known as forex or FX. With a huge variety different information sources available to us, it can often be challenging for newer traders and investors to decide which of these is best to trust.

Personally, I have always been a technical trader, choosing to focus on price for my entries and exits. For some, this can be a challenge as there is so much fundamental news coming out each and every day related to FX, that we often feel that we need to use it to make our trading and investing decisions.

When I am teaching a class, I try to keep things as simple as possible for my students, illustrating to them that prices in all FX markets (and any other markets) around the world, change as a result of the changes in supply and demand at any given time. If you know what you are looking for, this can be seen on a price chart but firstly we need to understand what these changes are like on a fundamental level.

The foreign currency market is where global exchange rates are derived for everyone including market speculators and end users of currency. People and companies buy and sell currency much like you would buy and sell anything else.

Strong economies have strong currencies. When we trade the forex markets, we are trading economies. Therefore, supply and demand for currency depends on the current and expected perceived health of a country’s economy.

A brief history

Forex trading traces its history centuries back before the Babylonians. While they were the ones credited with the first use of paper notes and receipts, forms of currency had existed for quite some time already.

In the beginning, the value of goods and services was expressed in terms of other goods and services, also called "the barter system." Limitations of this system were the catalyst for establishing more generally accepted mediums of exchange.

In the early days, primitive economies used items such as teeth, feathers, and stones as means of payment. In time, a more structured value system using gold and silver was created. After this, came government paper money like we use today.

Over the past few decades, forex has developed into the world’s largest global market. Restrictions on capital flows have been removed in most countries, leaving the market forces free to adjust foreign exchange rates according to their perceived values based on pure supply and demand for currency.

Why trade forex?

Leverage – Low capital requirements. Forex traders can start with much smaller amounts of money than you need for day trading equities.

Time – Forex traders can trade when they have time. The forex market is open and moving 24 hours a day, five and a half days a week. Trading occurs in all time zones in the world and can be a part-time or full-time occupation.

Opportunity – The FX markets are fantastic trending markets. They are also made up of markets that are not moving in the same direction. This provides rare non–correlated opportunity. Also, traders can profit in up and down trends by buying long or selling short. There are no short-selling rules.

How does a trade work?

First off, a "pip" means Percentage In Points. For example, a move in the Australian dollar vs US dollar from 0.9050 to 0.9051 = 1 pip.

At $10.00 a pip, let’s calculate a trade setup much like we do in our Extended Learning Track (XLT) forex class. Trading a 1 lot, if we have a protective stop loss that is 15 pips away from entry and a target for profit that is 80 pips away from entry, we would be risking $150 to make $800, 15 pips to make 80, or just over a 1:5 reward to risk ratio. See the chart below:

We can look for a setup based on identifying where the biggest imbalances in supply and demand reside in the market by objectively analysing the price to look for the lowest risk, highest reward trades the chart provides. A disciplined trader or investor knows that prices have to rally when demand exceeds supply and that they must fall when supply exceeds demand.

The key to getting involved in forex trading is to first get educated and keep things simple. Next, trade a demo account until your numbers suggest you should trade real money.

Once that is accomplished, you can trade mini spot forex at $1.00 a pip. Once your numbers suggest you are doing well, which means you are consistently making at least two or three times what you are losing on each trade along with a decent win/loss ratio, then go to the $10.00 a pip market and trade your successful plan.

Never put your hard-earned money at risk until you are quite certain you have a plan that leads to consistent profits. You will only know this after your education leads to a trading plan that leads to consistent demo and mini spot forex trading. From my experience in the trading and trading education world, those who don’t think this way typically lose their accounts to those who do.

Join me next time for a deeper look into the powerful dynamic of supply and demand and how a simple understanding of this concept can form a rule-based core strategy which can be used to identify the lowest risk and highest reward trades in the markets.

 

Warning: Remember, particularly if you are new to trading in the stock market and in forex, that the prices of shares and other investments can fall fast and you may not get back the money you originally invested. The material here is for general information only and is not intended to be relied upon for individual investment decisions. Take independent advice before making such decisions. Also, the BullBearings free stock exchange simulation portfolios are a good way to practice trading techniques.

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