The word “Forex” is an abbreviation for the words “Foreign Exchange” and it’s the relative value of one currency versus another currency. The foreign Exchange market is the biggest market in the world with daily turnover (buying and selling) of up to 5 trillion dollars!

A lot of different organisations including banks, large companies, trading companies, investors and speculators all take part in the Forex market for many different reasons. Whilst a speculator may buy and sell positions looking to make money trading Forex by fast moves in the market, large companies could be exchanging large quantities of currency for clients that need their money converted into another currency.

The Forex market is the biggest in the world and turns over up to $5 trillion per day. There is no other market in the world that even comes close to having this sort of trading volume during a 24 hour period.

The Forex market for traders is a market where they can make profit by either buying low and selling high or by selling high and buying low.

Trading Forex for retail speculative traders has not always been available, it was not until around 1996 that retail traders have been able to trade. Before this, Forex was only the domain of either large companies, or the super rich.

With the invention of new technology and the internet, Forex has opened up to all sorts of traders with the smallest traders now being able to trade only cents at a time.

 

Key Features of the Forex Market

– The Forex market is a 24-hour market. Currencies are traded all around the world

– Big financial centers include New York, Tokyo and London

– Forex market is a very liquid market. Liquidity is the ability to get very quickly in and out of the market at the fair market price.

– The Forex market is a fast moving market, which means that exchange rates can react very quickly to key pieces of data.

– Unlike trading shares, the Forex market is at best a zero-sum game meaning that your gains is someone else’s loss. However, the cost associated with doing business in the Forex market, like commission and spreads makes the Forex market a negative-sum game.

 

Where is Forex Located?

There is no central marketplace or exchange for the Forex trading market. Unlike stocks where each country has a processing place such as the New York Stock Exchange (NYSE) in the US or the Australian Stock Exchange (ASX) in Australia, Forex is a truly global marketplace that is connected by large banks and their prices.

Because Forex has no set marketplace or exchange, there is no official daily or 24 hour closing time, although the close of the US market is generally seen worldwide as the close of the Forex market for the day and the start of the Asian session as the start of the market again.

 

Who Trades Forex?

The Forex market is traded by a variety of different organisations and individuals. Some of the main players in the Forex market are:

– Banks

– Trading Companies

– Large international companies

– Speculators/Retail traders

You will often hear a trader referred to as a ‘retail trader’. This is a trader who is speculating on the markets to try and make profits. The speculator looks to make a profit from small price increases. These traders will normally trade through a broker and use leverage to help them open large positions for small outlays.

Margin and leverage are covered a little more further on in section four of the course so keep reading on for more information.

 

Who Controls the Forex Market?

Although there is no centralized exchange for the Forex market there are lots of different structures within the Forex market that actually control the Forex prices in one way or another. There are three types of layers through where the Forex transactions is facilitated:

1. Top tier layer: Is the Interbank market level where the big Banks conduct transactions with each other;
2. Second tier layer: Is the EBS services which aggregates the bids and offers from different Banks, but also you can see in what size they are willing to transact at each level and other ECN platforms;
3. Third tier layer: the Retail Brokers;

 

 

The big banks are the largest banks in the world who do actually determine the exchange rates for currencies. According to the latest data from 2015 these are the banks with the biggest Forex market share:

– CitiBank with 16.11% market share;

– Deutsche Bank with 14.54% market share;

 – Barclays with 8.11% market share;

– JP Morgan with 7.65% market share;

– UBS with 7.30% market share;

These are the group of big banks that pretty much dictates the market price and in essence they are the market makers. The governments and the central banks are organisations that participates in Forex for several different reasons.Some of the major central banks around the world are the ECB (The European Central Bank), the Fed (The US Federal Reserve) and the BOJ (The Bank of Japan). The Central Banks take part in the Fx market for several reasons like:

– International trade;

– Handling Reserves;

– Intervening with currency prices

 

 

What is Traded in the Forex Market?

When trading in the Forex market you are buying and selling currencies. Currencies are traded in what is known as pairs – more on that shortly. The price of each currency is normally a reflection of what the market or market participants thinks of that country’s economy. Basically; if the price is rising for US dollars it is because the market thinks the US economy is strong relative to where the current price is. In other words; the price is cheap.

Some of the major currencies are listed below. Each currency is then given an abbreviation to make their trading symbol. For example; the Australian dollar is made into AUD. The AU is for Australia and the D stands for dollar. See below for the other main currency symbols.

 

 

Why do Exchange Rates Fluctuate?

Like with every other asset classes the exchange rates of a currency pair fluctuate because of the imbalances between supply and demand levels which drives the market. Essentially, if the demand for one particular currency pair is greater than the supply side that currency pair will rise in price, conversely, if the supply for one particular currency pair is greater than the demand side that currency pair will fall in price. The exchange rates will fall and rise until the supply and demand levels are again in equilibrium.

 

There are various factors that determine the exchange rate of a currency pair and since the exchange rates are relative, the macroeconomic factors have a greater degree of influencing the Forex exchange rates. The following list represents some of the most economic factors that have an effect on the currency market:

– Central Banks monetary policy;

– Interest Rate Differential;

– Inflation;

– Current-Account Deficits;

– Public Debt;

– Political Stability and Geopolitical Stability

 

 

How to Make Profit from Trading

Let’s use our imagination and assume you’re a European who spends his vacation in the USA. In order to pay for the goods and services in the USA you need US Dollar and you change your 1000 euros into US Dollar at the current exchange rate of 1.10 EUR/USD which means that at the end of the transaction you end up having $1,100, but for whatever reason you don’t have the time to spend any of your money.

When you return back in Europe you still have your $1,100 but during this time the exchange rate has fluctuated from 1.10 to 1.05 EUR/USD and instead of getting just 1000 euros back you end up making a nice profit because of the new exchange rate you actually get 1047.60 euros. You’ve just made a profit of 47.60 euros by simply holding your money in US Dollar while the EUR/USD exchange rate has depreciated in value.

 

In essence, this is what Forex trading is all about, we buy and sell a determined amount of one currency at a certain exchange rate and try to either make a profit if the Forex exchange rate moves in our favor or encounter a loss if the Forex exchange rate moves against us. How to trade the Forex market is essentially what we’re teaching throughout the rest of our learning tutorial lessons.

 

Currencies Traded as Pairs

When you buy or sell a currency through a broker or dealer you are trading in pairs. Whilst this may sound like confusing to some, it is very simple once explained. “Pairs” are made up of two currencies. For example; you have the EURUSD which is the EURO and US Dollar.

When you buy the EURUSD you are buying the Euro and selling US dollars. If you are buying you think that the EUR is strong compared to the US dollar. If you were to enter a trade on the EURUSD thinking that the EUR was weak compared to the US dollar, you would short the EURUSD. This is how all Forex pairs work. You are trading on the assumption one side of the pair is stronger or weaker than the other side of the pair.

Some of the major pairs are listed below:

How to Read a Forex Quote

If the EUR/USD exchange rate is trading at 1.1500, this means that it will cost you 1.1500 US Dollars in order to purchase one unit of Euros. The first listed currency (in our case is EUR) represent one unit of that currency while the Forex exchange rate (in our case 1.1500) represent how much of the second currency (in our case USD) is needed to purchase that one unit of the first listed currency (in our case EUR).

In our example, the EUR/USD exchange rate it tells us how much it cost to buy one Euro using US Dollars. If we want to reverse the process and find out how much it cost to buy one US Dollar using Euros we need to apply the following formula:

If we apply the formula to our base case 1 / 1.1500 = 0.8695, it means that it will cost us 0.8696 Euros to buy one unit of US Dollars. This new price would also represent the exchange rate of the USD/EUR currency pair; where we can see that the currencies have switched their positions.

The Base Currency and the Quote Currency

The first currency listed in any currency pair is called the Base Currency (in our case it’s the EUR) while the second currency to the right of the slash is called the Quote or the Counter Currency (in our case it’s the USD)

When the buying and selling in the Forex market occur the Base Currency is always the currency of reference. In our base case if we’re buying EUR/USD this implies that we’re buying the Base Currency (in our case, it’s the EUR) while if we’re selling EUR/USD this imply that imply that we’re selling the same Base Currency.

Since all currencies are quoted in pairs when we’re buying EUR/USD we’re simultaneously buying the Base Currency (in our case, it’s the EUR) and at the same time selling the Quote Currency (in our case it’s the USD), simply put it we “buy EUR, sell USD.”

Understanding the Forex Jargon

The Forex market has a distinctive language and in the professional world of Forex trading is a common practice to use a specific jargon and refers to each currency pair by its nickname. The most common currencies and the most traded currencies have a nickname designed to just simplify the way we address and interact. Here are just a few of these common nicknames;

• EUR / USD – It’s also known as Fiber;
• GBP / USD – It’s also known as Cable;
• AUD / USD – It’s also known as Aussie;
• NZD / USD – It’s also known as Kiwi;
• USD / CAD – It’s also known as Loonie;
• USD / JPY – It’s also known as Yen;
• USD / CHF – It’s also known as Swissy;

Long or Short

When trading Forex you have two options. You can either enter a “long “position which means you are buying, or a “short” position which is selling. The easiest way to remember it is like this;

• Long – Buy
• Short – Sell

A lot of people come straight from trading stocks and have only ever bought a stock and tried to make money by selling once that stock has gone onto a higher price. In Forex it is just as easy to both buy and sell and to make money from either way. The same amount of profit can be made as if price moves lower as if it had moved higher, so looking for high probability “short” trades is just as good as looking for long trades. In many cases price will move a lot faster when it moves lower than what it does higher.

This gives traders a lot more options. Instead of watching a market trending down and not being able to make money from this, Forex traders can sell high and buy back low and make money the same as if they had bought low and sold high.

Types of Forex Orders

In order to be able to make a transaction in the Forex market and enter or exit from a position, you have to use one of the few available order types. There are a few different order types available for entering into a position that the majority of the brokers will provide, keeping in mind that a lot of traders will not just enter at market order, but will set pending orders where price has to confirm or break to enter them into the trade without them.

Without further ado, these are the most common order types available to enter a trade:

• Market Order is a customer order for immediate execution at the best available price for immediate execution. Most of the times when you place a market order it will be executed at the current market price, however, sometimes during news events they will be executed at the best available price due to the high volatility and you may encounter slippage;
• Buy Stop Order which is an entry buy order to get in the market when the price is above the current market price. Buy stops are a popular orders to use when trying to buy above resistance levels;
• Buy Limit Order is an entry buy order when the current market price is above the price one would like to buy;
• Sell Stop Order is an entry sell order to get in the market when the price is below the current market price. Sell stops are popular orders to use when trying to sell below support levels;
• Sell Limit Order is an entry sell order when the current market price is below the price you would like to sell;
• Stop Loss Order is a protective order designed to limit your losses if price moves against you;
• Take Profit Order is an order designed to lock in profits at the desired market price;

Bid and Ask

When looking to take a trade on a Forex pair the trader will be quoted two prices. These prices are known as the Bid and Ask. A picture of this is below.

The bid price is the current price you can sell this pair. You can see the price on the left of your order ticket. This is also the same price that the broker is offering to sell you this pair. The ask price is the current price on offer to buy this pair from the market.  The difference between the two price is the spread as discussed below.

Spread

You will notice that there is a margin in between the bid and ask price. This gap in price is known as the spread. On every round trade you make you will pay the spread. The spread is a how the broker makes money from their traders making trades.

Brokers take their live prices from a live data feed which is normally a group of banks linked together. The broker then takes the live bank price and adds the spread to the price. From there they quote you the price you see on your trading platform.

Note: Quite often when opening an account a broker will offer traders the choice of two accounts. The first account will be an account with very tight spreads. Traders need to be aware of this account because whilst this account may offer tighter spreads, this account will often then charge commissions on every round trade placed on top of the spreads. The other account is often then the standard account that offers slightly larger spreads, but with no commissions.

This is something that each trader’s needs to work out for themselves and which account they want to choose.

More on how brokers operate can be found in later sections including a very good broker that recommended for price action traders.

When trading Forex, traders have the use of leverage. Leverage can be a really dangerous tool for traders if they don’t understand it and don’t use correct position sizing. For the trader who is well educated leverage can provide a very powerful tool to build profits.

Leverage works by letting traders enter into trades with only a fraction of the money down. In straight stock trading, traders have to pay for every dollar they invest. For example; if a trader buys $5,000 worth of stock XYZ, they would then have to front up the whole $5,000 to buy those shares.

 

 

In Forex traders can use leverage to enter trades whilst only paying a small amount up front. The most common leverage amount is 100:1. This means that for every $100 traded, the trader only needs to front up $1 to enter that trade.

Recently in the US the government has brought in stricter rules with leverage in trading which states US brokers can only allow clients a maximum of 50:1 leverage. In other countries outside of the US leverage ranges from 50:1 right up to 1000:1. If leverage is used as a professional tool 50:1 or 100:1 is more than enough to trade successfully.

Another example of using leverage would be; if trader Joe was going to place a $100,000 with 100:1 leverage, Joe would only need to put up $1 for every $100 of the $100,000 trade. How this would work out in the brokerage account is that whilst the trade is open, the broker takes and holds the margin or the $1 for every $100 until the trade is closed.

Once the trade is closed the broker gives back the money that was held and used as margin. In this scenario Joe would have to front up $1,000 margin to place the trade because that is $1 for every $100 of the $100,000 trade placed.

The reason that leverage can be a huge problem for the uneducated trader or gambler is because it allows them to enter huge trades with only a small outlay. Trading this way will increase the risks massively and lead to potentially wiping out their account.

If leverage is used in a more professional manner it can be used as a tool to manage risk and increase profits. I discuss how traders can use leverage like a professional and with the correct money management in this trade lesson; Using the Correct Money Management

 

Margin

Margin goes hand in hand with leverage. Margin is the amount your broker asks you to place up front for any trades you are in. The amount of margin required by the broker will depend on both the size of the trade and how much leverage is being used.

If you are using 100:1 leverage the broker will require $1 dollar for every $100 you have in an open trade. If you are in a trade that is worth 10,000 you will be required to put up $100. The bigger the trade size the more the broker will require. The smaller the leverage the more the broker will require.

Margin is not money that the broker holds onto. When you close out your trade you will get your margin back, the broker just holds it as security for your trade. Whilst this margin is being held, you cannot use it to place other trades. If you have a $5,000 account and with trades on have margin required of $2,500 you can only place trades using the last $2,500.

 

How to Calculate Forex Margin Requirements?

In order to calculate the margin requirements for any open trade or trade position that you have on your account the following general formula is used:

 

Example: Let’s assume you want to buy 2 standard lots of EUR/USD at a currency exchange rate of 1.1500, using 1:100 leverage with an account denominated in US dollars. We will get down to putting these values into our margin requirement formula as follow:

– Contract size = 100,000 (Standard Lot = 100,000);

– Lot size = 2;

– Account Leverage = 1:100;

– Open Price = 1.1500;

Margin requirement = (100,000 * 2 * 1.1500)/100 = $2300

So, in order to be able to make that trade, you’ll need to have in your account at least $2300, which means that your account balance needs to be at least $2300 otherwise the trade will be rejected due to insufficient margin available.

 

Margin Calls

Margin calls are something that a lot of traders are very scared of. This should not be the case and if traders are trading sensibly and not like gamblers they do not have to fear margin calls. Please read the above lesson on money management for how you can avoid margin calls.

A margin call is when your account is getting low and getting to the point where you will not have enough money to meet the margin requirement of your broker. Margin calls can come when you make a trade that is too big for your account size and the trade begins losing. If this losing trade starts to get close to the point where you don’t have enough in your account to meet the required margin, the broker will contact you. At this point you will be asked to either close out the trade or add more funds to meet the margin requirements. If you fail to do either of these the broker will close your trades.

 

Lots

When trading Forex traders enter what is called a “lot”. A lot simply refers to how much of a currency a trader is trading. Instead of buying massive amounts of an individual currency pair a trader enters the amount of lots that is suitable. There are 3 main lot amounts which are:

• Standard Lot – 100,000
• Mini Lot – 10,000
• Micro Lot – 1,000

An example of entering a trade using lots would be as follows; Trader Joe wants to enter a trade buying 60,000 EURUSD. To do this Joe will enter 6x Mini lots.

 

Pips

A pip is the smallest increment a currency pair can move. Each currency pair is normally quoted in either 4 or 5 decimals and in the case of some Japanese Yen pairs they are normally quoted in either 2 or 3 decimals. The pip is quoted on the 4th decimal or 2nd decimal(for some Yen pairs). When trading we use the amount of pips to work out things like our entry, stops and targets as well as things like the profit made and amount of risk.

The picture below shows an order window. The 4th decimal or the 2nd decimal is known as a Pip with the 5th decimal known as 1/10th of a pip and they are also called “pipettes.”

For example if the EUR/USD exchange rate moves from 1.1500 to 1.1501, that 0.0001 move represents a one pip change in price.

 

 

How to Calculate Pip Value

The pip value will allow us to translate “pips” into dollars and it will help us understand how a certain number of pips means a certain amount of profit or loss in our account and ultimately it will help us to understand Forex risk better. Besides the “pip” variable we also have a specific volume of our transaction which is represented by the number of Lots variable, and together these two variables combined will determine the Pip Value for our transaction.

The Pip Value is not just a function of the currency pair you trade as Pip Value depends on the number of pips the currency pair has moved and also on the volume of your transaction. If you enter into a trade with a higher number of lots than your pip value will be higher and if you enter a lower number of lots than your pip value will be lower.

It’s important to understand how to calculate the pip value in order to know how much money you’re going to make or lose. Each currency has its own relative value and the pip value will depend on that.

Whatever currency the account is, when that currency is listed second in a pair the pip values are fixed. 

If you have a USD base account, any pair that is xxx/USD, such as the EUR/USD will have a fixed pip value.

A standard lot will then be worth USD $10, a mini lot USD$1, and a micro lot USD$0.10.

This method also applies if your base currency is different.

If the US dollar is the base currency (E.g. USD/CAD) we’re dealing with a direct rate and the Pip Value can be calculated by using the following formula:

Pip Value = (One Pip / Exchange Rate) * Lot size

Example 1: If we buy 1 standard lot USD/CAD at an exchange rate of 1.3500, each pip move in your favor will be worth 7.4 USD.

Pip Value = (0.0001 / 1.3500) * 100.000 = 7.4 USD

 

If your account currency is USD and we want to know the pip value of the EUR/CAD, the standard lot for the CAD is 10 CAD$ for this pair. We need to convert that 10 CAD$ to USD by dividing it by the USD/CAD rate. If the rate is 1.3500, the standard lot pip value is USD $7.40

So, for every 1 pip move in EUR/CAD, you’ll earn 7.40 USD if the exchange rate moves in your favor our lose 7.40 USD if the exchange rate moves against you.

To find the value of a pip when the USD is listed first, divide the fixed pip rate by the exchange rate. For example, to find the value of a standard lot, if the USD/CHF exchange rate is 0.9920, a pip is worth USD $10.08.

 

Other Lessons On Forex Money Management

– Forex Money Management That Actually Works and How to Use it!

– Working Out All Forex Positions in Money and NOT Pips!