Forex Intro PDF

About Forex Forex is global market that allows the exchange of one currency for another. Let’s make it simple. You travel from to Germany to USA. Main currency in USA is dollar (USD - $). Main currency in Germany is euro (EUR - €). You have 1000 € in your wallet. The moment you arrived in USA you ne...

About Forex Forex is global market that allows the exchange of one currency for another. Let’s make it simple. You travel from to Germany to USA. Main currency in USA is dollar (USD - $). Main currency in Germany is euro (EUR - €). You have 1000 € in your wallet. The moment you arrived in USA you need to exchange euros for dollars because main currency in USA is dollar. How can you do that? Well, you can go to exchange office and buy dollar. Exchange rate is for example 1.1250, so you will see something like this: EUR/USD = 1.1250. That means for 1000 € you will get $1125. It’s simple math: 1000 € * $1.1250 = $1125. Imagine you didn’t spend any money and now it is time to go back in Germany, but now exchange rate is lower! For example, exchange rate now is 1.1020 or EUR/USD = 1.1020. This time you need euros, so let’s do simple math again: $1125 / 1.1020 = 1021 €. Now you have 1021 €, but on the beginning of the journey you had 1000 €. That means you earned 21 €. It’s these changes in the exchanges rates that allow you to make money in the foreign exchange market or Forex. This is much harder than it sounds, because you never know when exchange rate will go up or down. The foreign exchange market, which is usually known as Forex or FX, is the largest financial market in the world, with its $5 TRILLION a day trade volume. For people like you and me this doesn’t mean much. We can’t even imagine how big that is. For us is important how we can take advantage of that. Here, I will try to explain that and help you become successful trader. The Forex market is run by a global network of banks, spread across four major forex trading centers in different time zones: London, New York, Sydney and Tokyo. Because there is no central location, you can trade Forex 24 hours a day 5 days a week. Most traders speculating on forex prices will not plan to take delivery of the currency itself; instead they make exchange rate predictions to take advantage of price movements in the market. Simple rule: buy when price is low and sell when price is high. 2 Currency pairs I mentioned currency pair in the example above, but what is a base and quote currency? A base currency is the first currency listed in a forex pair, while the second currency is called the quote currency. Forex trading always involves selling one currency in order to buy another, which is why it is quoted in pairs – the price of a forex pair is how much one unit of the base currency is worth in the quote currency. Each currency in the pair is listed as a three-letter code, which tends to be formed of two letters that stand for the region, and one standing for the currency itself. For example, take GBP. GB stands for Great Britain, and P stands for pound. GBP/USD is a currency pair that involves buying the Great British pound and selling the US dollar. GBP is the base currency and USD is the quote currency. If GBP/USD is trading at 1.3550, then one pound is worth 1.3550 dollars. If the pound rises against the dollar, then a single pound will be worth more dollars and the pair’s price will increase. If it drops, the pair’s price will decrease. So if you think that the base currency in a pair is likely to strengthen against the quote currency, you can buy the pair (going long). If you think it will weaken, you can sell the pair (going short). In this table you can see most traded currencies. Table 1: popular currencies 3 Pairs are split into the following categories: Major pairs - seven currencies that make up 80% of global forex trading. Major pairs include USD, so every pair that includes USD is major pair. Picture 2: major pairs Minor pairs - less frequently traded, these often feature major currencies against each other instead of the US dollar. Includes: EUR/GBP, EUR/CHF, GBP/JPY. Exotics - a major currency against one from a small or emerging economy. Includes: USD/PLN (US dollar vs Polish zloty), GBP/MXN (Sterling vs Mexican peso). Regional pairs - pairs classified by region – such as Scandinavia or Australasia. Includes: EUR/NOK (Euro vs Norwegian krona), AUD/NZD (Australian dollar vs New Zealand dollar). The dollar is the most traded currency, taking up about 85% of all transactions. The euro’s share is second while that of the yen is third. Significant reasons why the U.S. dollar plays a central role in the forex market: - The United States economy is the LARGEST economy in the world, - The US dollar is the reserve currency of the world, - The United States has the largest and most liquid financial markets in the world, - The United States has a stable political system, - The United States is the world’s sole military superpower. 4 EUR/USD is the most traded currency pair in the world. That is exactly why I don’t trade this pair. Big Banks and market makers can easily manipulate with price of this currency. Be aware of this! One important thing to note about the forex market is that while commercial and financial transactions are part of the trading volume, most currency trading is based on speculation. In other words, most of the trading volume comes from traders that buy and sell based on intraday price movements. The scale of the forex market means that liquidity – the amount of buying and selling volume happening at any given time – is extremely high. One thing that I worth noting is that forex currency pairs are correlated. Some have positive correlation and some have negative correlation. Positive correlation means that certain pairs move in a similar way and similar direction. For example, NZD/USD and AUD/USD have positive correlation and that means that if you decide to open “buy” (long) trade for NZD/USD, you should not look to open “sell” (short) trade on AUD/USD. Because if NZD/USD goes up, it is very likely that AUD/USD will go up too. Negative correlation means that certain pairs move in the opposite direction. For example, USD/CAD and GBP/USD. If USD/CAD goes up, it is likely to see that GBP/USD will go down. Picture 3: correlations What moves the Forex market? The Forex market is made up of currencies from all over the world, which can make exchange rate predictions difficult as there are many factors that could contribute to price movements. Forex is primarily driven by the forces of supply and demand, and it is important to gain an understanding of the influences that drives price fluctuations here. Central banks Supply is controlled by central banks, who can announce measures that will have a significant effect on their currency’s price. Quantitative easing, for instance, involves injecting more money into an economy, and can cause its currency’s price to drop. News reports Commercial banks and other investors tend to want to put their capital into economies that have a strong outlook. So, if a positive piece of news hits the markets about a certain region, it will encourage investment and increase demand for that region’s currency. Unless there is a parallel increase in supply for the currency, the disparity between supply and demand will cause its price to increase. Similarly, a piece of negative news can cause investment to decrease and lower a currency’s price. Market sentiment Market sentiment, which is often in reaction to the news, can also play a major role in driving currency prices. If traders believe that a currency is headed in a certain direction, they will trade accordingly and may convince others to follow suit, increasing or decreasing demand. Economic data Economic data is integral to the price movements of currencies for two reasons – it gives an indication of how an economy is performing, and it offers insight into what its central bank might do next. 6 Credit ratings Investors will try to maximize the return they can get from a market, while minimizing their risk. So alongside interest rates and economic data, they might also look at credit ratings when deciding where to invest. A country’s credit rating is an independent assessment of its likelihood of repaying its debts. A country with a high credit rating is seen as a safer area for investment than one with a low credit rating. This often comes into particular focus when credit ratings are upgraded and downgraded. A country with an upgraded credit rating can see its currency increase in price, and vice versa. Now when we learned about Forex and how it works we need to learn basic terms like: pip, bid and ask price, spread, lot, leverage and margin. 7 Pip A pip, short for point in percentage, is a very small measure of change in a currency pair in the forex market. It can be measured in terms of the quote or in terms of the underlying currency. A pip is a standardized unit and is the smallest amount by which a currency quote can change. It is usually $0.0001 for US. Assume that we have a EUR/USD direct quote of 1.1370. What this quote means is that for 1 €, you can buy about 1.1370 dollars. If there was a one-pip increase in this quote (to 1.1371), the value of the euro would rise relative to the US dollar, as 1 € would allow you to buy slightly more dollars. The effect that a one-pip change has on the dollar amount, or pip value, depends on the amount of euros purchased. If an investor buys 10,000 euros with dollar, the price paid will be $ 11370 (1.1370 x 10,000). If the exchange rate for this pair experiences a one-pip increase, the price paid would be $ 11371 (1.1371 x 10,000). In that case, the pip value on a lot of 10,000 euros will be $ 1 ($ 11371 - $ 11370). Here’s another example using a currency pair with the Japanese Yen as the counter currency. Notice that this currency pair only goes to two decimal places to measure a 1 pip change in value (most of the other currencies have four decimal places). In this case, a one pip move would be.01 JPY. So, in all pairs that include JPY, a pip is second decimal number. Take GBP/JPY as example: [(.01 JPY) / (145.80 JPY)] x 1 GBP = 0.0000685 GBP. So, when trading 10,000 units of GBP/JPY, each pip change in value is worth approximately 0.685 GBP. There is a simple way to calculate pips. Let’s say that GBP/USD price moved from 1.26070 to 1.26330. All you have to do is to subtract these price levels and multiply by 10000. Formula: (1.26330 – 1.26070) x 10000 = 0.0026 x 10000 = 26 pips So our price moved 26 pips. This calculation can be applied on any pair except JPY pairs. For JPY pairs, instead of 10000, use 100. 8 Bid and Ask price All forex quotes are quoted with two prices: the bid and ask. In general, the bid is lower than the ask price. The bid is the price at which your broker is willing to buy the base currency in exchange for the quote currency. This means the bid is the best available price at which you (the trader) will sell to the market. If you want to sell something, the broker will buy it from you at the bid price. Ask price is the price at which your broker will sell the base currency in exchange for the quote currency. This means the ask price is the best available price at which you will buy from the market. Another word for ask is the offer price. If you want to buy something, the broker will sell (or offer) it to you at the ask price. The difference between the bid and the ask price is known as the SPREAD. On the EUR/USD quote below, the bid price is 1.1005 and the ask price is 1.1006. If you want to sell EUR, you click “Sell” and you will sell euros at 1.1005. If you want to buy EUR, you click “Buy” and you will buy euros at 1.1006. Picture 4: currency pair 9 Market Orders There are 2 main types of market orders. Market execution and pending orders. Market execution is the method by which traders execute orders at the current price within fractions of a second. This means that system will automatically open the order when trader decide to click on “buy” or “sell” button. Pending Order is an order that has not yet been executed and therefore has not yet become an actual trade. Unlike market orders executed immediately at the current price, pending orders are queued and executed only when the market reaches the specified price, allowing traders to automate their entry and exit strategies based on predetermined conditions. These are the types of pending orders: - Buy Limit – trade request to buy at the Ask price that is equal to or lower than that specified in the order. The current price level is higher than the value in the order; - Sell Limit – trade request to sell at the Bid price that is equal to or higher than that specified in the order. The current price level is lower than the value in the order; - Buy Stop – trade request to buy at the Ask price that is equal to or higher than that specified in the order. The current price level is lower than the value in the order; - Sell Stop – trade request to sell at the Bid price that is equal to or lower than that specified in the order. The current price level is higher than the value in the order; - Buy Stop Limit – this type is the combination of the two first types being a stop order for placing Buy Limit; - Sell Stop Limit – this type is a stop order for placing Sell Limit. 10 11 Margin Trading and Lot When you go to the grocery store and want to buy an egg, you can’t just buy a single egg, they come in dozens or “lots” of 12, so what is a lot in Forex? Currencies are traded in lots – batches of currency used to standardize Forex trades. As Forex tends to move in small amounts, lots tend to be very large: a standard lot is 100,000 units of the base currency. So, because individual traders won’t necessarily have 100,000 pounds (or whichever currency they’re trading) to place on every trade, almost all Forex trading is leveraged. In Forex, it would be just as foolish to buy or sell 1 euro, so they usually come in “lots” of 1,000 units of currency (micro), 10,000 units (mini), or 100,000 units (standard) depending on your broker and the type of account you have. You probably don’t have enough money to buy 10,000 euros. That is no problem, and yes, you still can trade. The answer is margin trading. Margin trading is simply the term used for trading with borrowed capital. This is how you’re able to open $1,250 or $50,000 positions with as little as $25 or $1,000. You can conduct relatively large transactions, very quickly and cheaply, with a small amount of initial capital. It is very important to understand this. Example: You believe that signals in the market are indicating that the British pound will go up against the US dollar. You open one standard lot (100,000 units GBP/USD), buying with the British pound at 3% margin and wait for the exchange rate to climb. When you buy one lot (100,000 units) of GBP/USD at a price of 1.20000, you are buying 100,000 pounds, which is worth $120,000 (100,000 units of GBP * 1.20000). If the margin requirement was 3%, then $3,600 would be set aside in your account to open up the trade ($120,000 * 3%). You now control 100,000 pounds with just $3,600. Your predictions come true and you decide to sell. You close the position at 1.20200. You earn about $200. 12 Leverage Leverage is the ability to use something small to control something big. Specific to Forex trading, it means you can have a small amount of capital in your account controlling a larger amount in the market. This is trading on margin mentioned above. In forex trading, there is no interest charged on the margin used, and it doesn't matter what kind of trader you are or what kind of credit you have. If you have an account and the broker offers margin, you can trade on it. The apparent advantage of using leverage is that you can make a considerable amount of money with only a limited amount of capital. The problem is that you can also lose a considerable amount of money trading with leverage. It all depends on how wisely you use it and how conservative your risk management is. Money and risk management are extremely important in trading. Without proper risk and money management, you will fail as a trader! Leverage makes a rather boring market incredibly exciting. Unfortunately, when your money is on the line exciting is not always good, but that is what leverage has brought to Forex. Without leverage, traders would be surprised to see a 10% move in their account in one year. However, a trader using too much leverage can easily see a 10% move in their accounts in one day. While typical amounts of leverage tend to be too high, some trade with five times leverage; it is important for you to know that much of the volatility you experience when trading is due more to the leverage on your trade than the move in the underlying asset. Leverage Amounts Leverage is usually given in a fixed amount that can vary with different brokers. Each broker gives out leverage based on their rules and regulations. The amounts are typically 50:1, 100:1, 200:1 and 400:1. 50:1 → Fifty to one leverage means that for every $1 you have in your account you can place a trade worth $50. As an example, if you deposited $500, you would be able to trade amounts up to $25,000 (50*500$) on the market using 50:1 leverage. It's not that you should be trading the full $25,000, but you would have the ability to trade up to that amount. 13 100:1 → One hundred to one leverage means that for every $1 you have in your account, you can place a trade worth $100. This is a typical amount of leverage offered on a standard lot account. The typical $1000 deposit for a standard account would give you the ability to control $100,000 (100*1000$). 200:1 → Two hundred to one leverage means that for every $1 you have in your account, you can place a trade worth $200. This is a typical amount of leverage offered on a mini lot account. The typical deposit on such an account is around $300. With $300 you would be able to open up trades up to the amount of $60,000 (200*300$). There's no need to be afraid of leverage once you have learned how to manage it. The only time leverage should never be used is if you take hands-off approach to your trades. Otherwise, leverage can be used successfully and profitably with proper management. Leverage must be handled carefully – once you learn to do this, you have no reason to worry. How to calculate? So now that you know how to calculate pip value and leverage, let’s look at how you calculate your profit or loss. Let’s buy US dollars and sell Swiss francs. The rate you are quoted is 1.4525 / 1.4530. Because you are buying US dollars you will be working on the “ASK” price of 1.4530, the rate at which traders are prepared to sell. So you buy 1 standard lot (100,000 units) at 1.4530. A few hours later, the price moves to 1.4550 and you decide to close your trade. The new quote for USD/CHF is 1.4550 / 1.4555. Since you initially bought to open the trade, to close the trade, you now must sell in order to close the trade so you must take the “BID” price of 1.4550. The price which traders are prepared to buy at. The difference between 1.4530 and 1.4550 is.0020 or 20 pips. Using our formula from before, we now have (.0001/1.4550) x 100,000 = $6.87 per pip x 20 pips = $137.40. I guess you are probably little confused and that is totally normal. No reason to be worried. When you start practicing all this will be simple. Now, lets simplify these calculations. This is general idea how much 1 pip is worth: - for lot size 0.01, one pip is approximately $0.1; - for lot size 0.1, one pip is approximately $1; - for lot size 1, one pip is approximately $0.1. Keep on mind that this is just approximate worth as exact $ amount depends on a currently pair and currency that you deposited on your account! 15 How can I start Forex trading? You’ve read about pips, leverage, margin, bid and ask price and all other basic stuff. It is time to start practice. Today it is very easy to start Forex trading. First thing you need to do is select a Forex Broker. There are many brokers and for new trader it may be hard to choose the best one. Remember, most of them offer a demo account, where you can test their trading platform. Usually, registration is quick. If you look at Forex broker offer, make sure that he allows to trade with lower sizes such as nano or at least micro. One of the most important criteria for traders when choosing a Forex Broker is the regulatory status of the broker and under which regulatory body it is governed. Brokers who conduct business without regulation do so at their own discretion and pose a direct risk to the security of their clients’ money. Here is a list of Forex brokerage regulators for a few select countries: - Australia - Australian Securities and Investments Commission (ASIC) - Cyprus - Cyprus Securities and Exchange Commission (CySEC) - Russia - Federal Financial Markets Service (FFMS) - South Africa - Financial Services Board (FSB) - Switzerland - Swiss Federal Banking Commission (SFBC) - United Kingdom - Financial Services Authority (FSA) This is most important thing when choosing a broker, so before you choose yours, check their regulation status. It is easy to do that. Just find their license number and check on the Internet. If you can’t find license number or they don’t want to give it to you, simply avoid that broker and find new. Install trading software With selected broker you need to install trading software. This will be Meta Trader 4 platform or other custom platform from broker. Some brokers use their own trading platform. The big advantage of Meta Trader 4 is that you have many custom indicators, expert advisors. It is a good platform overall and I recommend brokers who offer MT4. 16 When you have registered an account, you can add funds. It is very easy. You can start with few hundred dollars on mini account. Minimum amount is different for each broker. Test platform on demo This is the most important thing for new traders. Opening a demo account is the best thing that you can do at the beginning of your trading career. Before you decide to open real account, test a platform on demo. You will have some virtual 10k or 100k to play with on demo. Test how order placing works, how to place stop loss, take profit etc. You do not want to learn these things with your real cash. The main advantages of Forex demo trading: - You do not put at risk real money – yours loses and gains are virtual, so there is no risk that you will lose all you trading capital; - You can test your trading system and different trading strategies; - You can see how to use leverage; - If you are using mechanical system, you can test it in practice. The main disadvantages of demo trading: - You do not put at risk real money – you react different when it is real money you are losing; - You make trades that you normally wouldn’t make with real money. When you are on demo and you switch to real money trading, you will notice difference. Now you care. When you are losing money, you feel fear. You hesitate to close losing position because it may turn around. When your trade is in profit, you are greedy. You hesitate to close position, because it may go even higher. This kind of emotions occurs only when you are trading with real money. You will learn over time that most of yours loses come from not following trading plan and allowing emotions to play too big role in your decision making process. You are not able to switch off your emotions. On the other hand, you must be aware of them and not allow to take control. That is why you need to have your trading plan on paper. Write down as many things you can in your trading plan – that way you will minimize impact of emotions in your trading. 17 Demo trading in trader learning process: 1. Open demo account; 2. Build strategy and trading plan; 3. Test different position sizes – add to trading plan size of positions. Test different currency pairs, different time frames; 4. Test your trading plan – set goals such as do not lose money in next few months. 19 Fundamental vs technical analysis Technical analysis relies on past price movement data to predict currencies’ future value. Traders focus on charts of price movement and various analytical tools to evaluate a security's strength or weakness. In technical analysis, a trader examines the prices of specified currencies over time. In most cases, they will recognize repeated patterns, which they then use to predict the movement of the market. With automated technical analysis, computer software analyzes the history of the currencies’ price movement. Currency values tend to fluctuate in fairly predictable patterns, which give this style of analysis a value. Technical analysis is the most popular type of forex analysis. Fundamental analysis relies on current factors affecting countries’ economies. These traders look at related economic, financial, and other qualitative and quantitative factors. In fundamental analysis, traders examine factors such as a country’s inflation rate, interest rates, GDP and other economic indicators. Traders consider interest rates particularly important when making decisions. A higher interest rate will attract more investors, which, over time, will increase the value of that country’s currency. What you will focus more is personal choice, but do not ignore the other side. If someone says that he is technical trader and do not look at fundamentals and news, then he is not someone you want to follow. There are so many evidences that news can move the market. Many big players simply close all trades before important news, because market can be unpredictable. Technical and Fundamental analysis are base of Forex trading. 20 How many pairs should you trade? As a new trader, you should start with one or two pairs. Why? Three or more pairs are hard to follow. Remember that you should check situation on few time frames to take a trade. With two or more pairs you will struggle to follow price actions. Select two pairs. It is enough. Every pair has its own characteristic. If you jump between pairs, you won’t notice this. Also, it is important to check situation on higher time frames. When you do that on many trading pairs, it is hard to follow price action for new traders. How much money do I need to start Forex trading? This is one of most popular questions about Forex trading. You can open trading account with as little as 100$ (or even less in some cases). Is it enough to trade? Technically, yes. With that money, you can place trades if broker has nano or micro lots in his offer. If you want to trade for living, you will need much more. But you need to start from somewhere like everyone else. When you learn how to trade, use money you can afford to lose. That is very important. Never trade with money you can’t lose. This is brutal game. Save some money for your trading account. People see all that adverts, read about leverage and think that they do not need much capital. That is a huge mistake. 21 Trading plan You must have a trading plan. Of course, there is a whole learning process and you will be testing different Forex trading strategies. Eventually you should decide what works best for you and explore that part. Your goal is to create trading plan. You should write down things like: - Which currency pair you trade; - Which time frames you trade; - When you enter a trade (based on what strategy/signals); - When you exit a trade (based on what strategy / signals); - Stop losses – what is your risk per trade; - Taking profits and money management. If you do not have things like this written down, then you will be changing lot of things at once. That way you will never find out what you are doing wrong. When you start to learn how to trade Forex, it is normal that you will be testing different systems and strategies. In the end, you should choose one and take your time to master it. I have my own strategy that I developed after years of learning on demo account. You will find more about my strategy in my lessons. I wait for the setup and I go in. No emotions, no pressure. Is it perfect? NO. You will never find perfect strategy. Even 80% or more win rate is impossible. When you find strategy with win rate over 50% you are on the right path. In Forex even with 50% win rate you can be profitable at the end of the month. How? Answer is good trading plan. Imagine that every time you are wrong, you lose $ 2, and every time you are right, you win $5. This month you traded 10 times. Simple math again: 5 (trades you won) * $5 =$25; 5 (trades you lost) * $2 = $10. Balance: $25 - $10 = +$15. This is why Forex is not gambling and why Forex is much better than gambling. It’s not about luck, it’s about your decisions! 22 How to Place Profit Targets? Frankly speaking, the most feasible approach of how to use stop-loss and take profit in Forex is perhaps the most emotionally and technically complicated aspect of Forex trading. The trick is to exit a trade when you have a respectable profit, rather than waiting for the market to come crashing back against you, and then exiting out of fear. The difficulty here is that you will not to want to exit a trade when it is in profit and moving in your favor, as it feels like the trade will continue in that direction. The irony is that not exiting the moment the trade is significantly in your favor usually means that you will make an emotional exit, as the trade comes crashing back against your current position. Therefore, your focus when using the stop-loss and the take profit in Forex should be to take respectable profits, or a 1:2 risk/reward ratio or greater when they are available - unless you have predefined prior to entering, that you will try to let the trade run further. What is a Take-Profit order? A take-profit order (TP) is a type of limit order that specifies the exact price at which to close out an open position for a profit. What is a Stop-Loss order? A stop-loss order is an order placed with a broker to sell a security when it reaches a certain price. Stop-loss orders are designed to limit an investor’s loss on a position in a security. Although most investors associate a stop-loss order with a long position, it can also protect a short position, in which case the security gets bought if it trades above a defined price. Some traders don’t use stop loss order. It takes a lot of guts and knowledge. For new traders it is recommended to use stop loss. You can put it above previous high or below previous low. 23