An Introduction to Forex Market
Chapter 1 : Introduction of Forex
What is Forex?
Forex is short for "foreign exchange" (sometimes abbreviated to just FX) and is the largest, most liquid market in the world with an average daily trading volume exceeding $5 trillion.
Now, when we say it is the largest market in the world, we mean it! The largest stock market in the world, the New York Stock Exchange (NYSE), trades a volume of ONLY about $22.4 billion each day.
The FX market is a global, decentralized market where the world's currencies change hands. Exchange rates change by the second so the market is constantly changing.
When can you trade forex?
The forex market is open 24 hours a day and 5 days a week, only closing down during the weekend.
The forex market can be broken up into four major trading sessions. The Sydney session, the Tokyo session, the London session, and Trump's favorite time to tweet, the New York session. Some traders prefer to differentiate sessions by names of the continent. This is known as the 'forex 3-session system'. These sessions consist of the Asian, European, and North American sessions.
What can you trade in the Forex market?
Trading in the forex market, it will always involve two currencies at a time. These are called 'currency pairs'.But while you can trade almost any currency pair in theory, there are certain pairs that are consistently the most traded. These are referred to as 'major pairs' or 'majors'. These major pairs make up 80% of the entire trading volume in the forex market
"Major pairs include: EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD, NZD/USD."
Understanding currency pairs
Currency pairs are made up of the base currency and the quote currency. The difference in price is where you'll make your profit or loss.
The currency that is listed first is called the base currency, and the currency listed second is called the quote (or counter) currency. For example, for the currency GBP/USD, GBP is the base currency and USD is the quote currency.
Understanding forex terminology
What's a base currency?
This is the first currency set that appears in the forex pair. It's the one that's bought or sold for the quote currency. In the example above, the GBP is the base currency.
What's a quote currency?
This is the second currency that appears in the pair, and is also known as the 'counter currency'. In the example above, the USD is the quote currency.
What's a bid price?
This is the price that a trader is willing to buy a currency pair at. It constantly fluctuates.
What's an ask price?
This is the price that a trader would ask for when selling the currency pair. The ask price also changes constantly and is driven particularly by market demand.
What's a spread?
The difference between the bid and the ask price is called the spread.
What's a pip?
Pip is an abbreviation for point in percentage and is the unit of measurement used to express the change in value between two currencies.
What are Major Currency Pairs?
While you can trade almost any currency pair in theory, there are certain pairs that are consistently the most traded. These are referred to as ‘major pairs’ or ‘majors’. These major pairs make up 80% of the entire trading volume in the Forex market.
Some examples of major pairs includes: EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD, NZD/USD.
What are the crosses or the minors?
Currency pairs that do NOT include the U.S. dollar (USD) in their pairing are known as cross-currency pairs or simply as the crosses.
The most actively traded crosses are derived from the three major non-USD currencies: EUR, JPY, and GBP.
What are exotic currency pairs?
Exotic… you’re probably thinking exotic countries and exotic belly dancers, but let me stop your imagination there. The label has nothing to do with the location or size of the country (or the number of belly dancers) where the currency is used.
Exotic currency pairs are made up of one major currency paired with the currency of an emerging economy, such as Brazil, Mexico, Chile, Turkey, or Hungary.
A benefit to trading exotic pairs is that they may offer higher potential returns due to wide price fluctuations. However, this means they are riskier to trade.
The most actively traded crosses are derived from the three major non-USD currencies: EUR, JPY, and GBP.
Long vs Short Positions in Forex Trading
If you want to buy (which means buy the base currency and sell the quote currency), you want the base currency to rise in value and then you would sell it back at a higher price.In trader talk, this is referred to as 'going long' or taking a 'long position'.Remember: long = buy.
If you want to sell (which means sell the base currency and buy the quote currency), you want the base currency to fall in value and then you would buy it back at a lower price.This is referred to as 'going short' or taking a 'short position'.Remember: short = sell.
What are the abbreviations for the most common currencies?
Currency symbols always include three letters.
The first two letters stand for the name of the country and the third letter symbolizes the name of that country’s currency, which is usually the first letter of the currency’s name.
Let’s look at the USD for instance…US stands for the United States while D stands for dollar.
Chapter 2 : Who participates in the Forex market?
Well there is a buyer, a seller and a product to sell, what more would anyone want.The Forex market is a world unto itself, with a variety of players, from individual traders like you, all the way up to the network of large companies and central banks. In fact, the Forex market participants can be organised into a ladder.
Forex market participants
1. The Giant Banks
At the very top of the Forex market ladder are the largest banks in the world, collectively known as the interbank market or flow monsters.
These include Citi, HSBC, UBS, JPMorgan, Barclays, Goldman Sachs, Bank of America, and Deutsche Bank.
They take on a ridiculous amount of Forex transactions each day for both their customers and themselves.
2. Large Commercial Companies
Next on the ladder are the hedge funds, corporations, retail market makers, and retail ECNs. These corporations mostly take part in the foreign exchange market for the purposes of doing business.
For example, a large US company (say Ford) is buying exclusive car parts from a different country (say Japan), they must exchange it’s US dollars for Japanese Yen when purchasing the parts.
Since the volume these companies trade is much smaller than those in the interbank market, they generally have to do their transactions via commercial banks. This means that their rates are slightly higher and more expensive than those who are part of the interbank market.
3. Retail Traders
Individual retail traders are the smallest fish in the Forex sea as they represent just 5.5% of the whole foreign exchange market.
But make no mistake. Even though retail traders are at the bottom of the ladder, they are still trading large volumes of money!
Total Forex trading volume for retail traders in the first 3 months of 2020 was at $22.88 trillion.
Retail traders have the ability to buy and sell the same currency pairs as other participants. However, they have to go through a longer transaction chain in order to get hold of liquidity, as such you don’t receive the same prices as participants further up the hierarchy.
Retail traders are also unable to affect the market with your trades because they are far too small to make any waves. Their role is to react to what is going on in the wider market and to position themselves accordingly.
Retail traders are focused on price fluctuations. Some have fat pockets, some roll thin, but all of them engage in the Forex simply to make bucket loads of cash.
Chapter 3 : Why Trade Forex: Forex vs Stocks Market
Stocks and Forex Trading are both viable paths to financial success, but before you start trading either, it is important to find out which is best suited for your trading strategy and risk appetite. Deciding which of these markets to trade does not have to be complicated, and many factors can be considered in order to make the best choice.Comparison: Forex vs Stocks Market
Forex is the most liquid market in the world with an average daily trading volume exceeding $5 trillion. The FX market can absorb trading volume and transaction sizes that dwarf the capacity of any other market.
All the world’s combined stock markets don’t even come close to the daily trading volume in the Forex markets. The largest stock market, New York Stock Exchange, (only) trades an average daily volume of $22.4 billion.
2. Market Hours
The Forex market never sleeps! The FX market is open 24 hours a day and 5 days a week, only closing down during the weekend. This is convenient for those who don’t want to quit their full-time job and dedicate their life to trading, because you can choose when you want to trade: morning, night, during breakfast, or whilst waiting on your girlfriend to come home from her 3rd ‘business trip’ this week.
The stock market, on the other hand, is limited to an exchange’s opening hours. For example, in the U.S., most stock exchanges open at 9:30 am EST and close at 4:00 pm EST.
There are approximately 2,800+ stocks listed on the New York Stock exchange. Another 3,300+ are listed on the NASDAQ.And yes, you may argue that with Forex, there are hundreds of currencies traded, but the majority of market players trade the seven major pairs.
And 7 major pairs are much easier to keep an eye on than thousands of stocks, don’t you think?
4. Capital Required
Getting started as a Forex trader doesn’t necessarily cost a ton of money, especially if compared to trading stocks or futures.Online Forex brokers offer ‘mini’ and ‘micro’ trading accounts, some with a minimum account deposit of just $25.
Now, we are NOT saying you should open an account with the bare minimum, but it does make Forex trading much more accessible to the individuals who want to test the waters before diving in too deep!
5. Free Demo Account
Most online Forex brokers offer free demo accounts to practice trading before risking your hard-earned money. Free demo accounts are valuable resources for all beginner traders that want to sharpen up their trading skills and processes with pretend money and ZERO risk.Like all things in life, you must learn to crawl before you can walk. And Forex trading is no different.
Again, this is something that is unheard of in the stocks market.
Chapter 4 : What are pips in Forex?
Pip is an abbreviation for point in percentage and is the unit of measurement used to express the change in value between two currencies. Professional Forex traders express their gains and losses in the number of pips their position rises or falls.
For example, if the GBP/USD moves from 1.2713 to 1.2714, that 0.0001 rise in the exchange rate is 1 pip.
Calculating the value of a pip
So now that we know what a pip is, what does it mean to us in terms of how much money we make or lose for each movement?
This depends on the size of the position we open. Larger positions mean each pip movement in the pair will have a greater monetary consequence to our balance.
To calculate this is quite simple. Let’s take an example and stick with our GBP/USD pair.
Example: one pip move
Say we wanted to open a position size of 10,000 units.
Our calculation to establish what a one pip movement means to us is as follows:
10,000 (units) x 0.0001 (one pip) = $ 1 per pip
So a position of 10,000 means that every time the pair moves 0.0001 (or 1 pip), we make a profit or loss of $1.00 depending on which way it moves. If the position moves 100 pips, we will make a profit or loss of $100.
We can do this for a trade of any size. The calculation is simply the trade size x 0.0001 (1 pip).
5,000 (units) x 0.0001 (1 pip) = $ 0.50 per pip
50,000 (units) x 0.0001 (1 pip) = $ 5 per pip
125,000 (units) x 0.0001 (1 pip) = $ 12.50 per pip
The pip value is always measured in the currency of the quote currency of the pair, e.g. the currency on the right-hand size of the pair.
So in the example of the GBP/USD, we see our pip value is always in US Dollars.
If we were trading the USD/GBP pair, the pip value would be in Pound Sterling.
10,000 units x 0.0001 (1 pip) = £ 1.00 per pip
50,000 units x 0.0001 (1 pip) = £ 5.00 per pip
125,000 units x 0.0001 (1 pip) = £ 12.50 per pip
Example: 10 pip move
If the value of the GBP rises against the dollar by 10 pips then we would see a movie like this.
10,000 units x 0.0010 (10 pip) = £ 10.00 per pip
50,000 units x 0.0010 (10 pip) = £ 50.00 per pip
125,000 units x 0.0010 (10 pip) = £ 125.00 per pip
Example: 100 pip move
If the value of the GBP rises against the dollar by 100 pips then we would see a movie like this.
10,000 units x 0.0100 (100 pip) = £ 100.00 per 100 pips
50,000 units x 0.0100 (100 pip) = £ 500.00 per 100 pips
125,000 units x 0.0100 (100 pip) = £ 1,250.00 per 100 pips
And that’s all there is to pips!
Even though you’re now a pip legend, I know exactly what you’re thinking….
Do I really need to calculate all this every time I take a trade?
I Nearly all Forex brokers will work all this out for you automatically (…and hey now you know how they calculate it!). Or you can always use this Pip Value Calculator.
Chapter 5 : What is a lot in Forex?
Forex is commonly traded in specific amounts called lots, or basically the number of currency units you will buy or sell. A lot is the smallest available trade size that you can place when trading currency pairs in the foreign exchange market.
There are typically 4 Forex lot sizes that you will come across when trading Forex.
Standard Lots – 100,000 currency units
The standard Forex lot is what you will see most regularly when trading with the standard account types of many Forex brokers.
In Forex, 1 standard lot refers to the volume of 100.000 units. So when you buy 1 lot of a Forex pair, that means you purchased 100.000 units from the base currency.
Trading with this size of position means that each pip in your trade would be worth $10.
Let’s say that you want to buy EUR/USD and the exchange rate is 1.17.
When you buy 1 lot of EUR/USD you will be making $117.000 worth of purchase.
Mini Lots – 10,000 currency units
A mini Forex lot is a great choice for those who may want to trade with slightly lower amounts.
Even though they are referred to as mini lots, they still represent a very significant investment for many traders.
Mini lot is equal to 10% of standard lot (100.000 x 0.10 = 10.000 units). In Forex, 1 mini lot refers to the volume of 10.000 units. So when you buy 1 lot of a Forex pair, that means you purchased 10.000 units from the base currency.
That is 10,000 units of your account funding currency.
If you are using a dollar-based account and trading a dollar-based pair, each pip in your trade would be worth $1.00.
Let’s say that you want to buy EUR/USD and the exchange rate is 1.17.
When you buy 1 lot of EUR/USD you will be making €11.700 worth of purchase.
Micro Lots – 1,000 currency units
Micro lots are one of the smallest tradable lots. They provide a safe platform for beginner traders to get a good value for money taste of the industry, whilst keeping the risk to a minimum.
Micro lot is equal to 1% of standard lot (100.000 x 0.01 = 1.000 units). In Forex, 1 micro lot refers to the volume of 1.000 units. So when you buy 1 lot of a Forex pair, that means you purchased 1.000 units from the base currency.
If your account is funded in U.S. dollars, this means that a micro lot is $1,000 worth of the base currency you want to trade, and each pip would be worth 10 cents.
When you buy 1 lot of EUR/USD you will be making $1,170 worth of purchase.
Nano Lots – 100 currency units
Nano lot is the smallest trading lot size available. It offers real money trading beyond a demo trading account, but with a much smaller level of risk involved.
This trading lot consists of 100 currency units which have a total value of $100 in the case of our USD trading example. Trading with this size of position means that each pip in your trade would be worth $0.1 cents.
In Forex, 1 nano lot refers to the volume of 100 units. So when you buy 1 lot of a Forex pair, that means you purchased 100 units from the base currency.
Let’s say that you want to buy EUR/USD and the exchange rate is 1.17.When you buy 1 lot of EUR/USD you will be making $117 worth of purchase.
Which lot size is best for Forex market trading?
The Forex lot size that works well for you depends on a number of different factors based on how you want to trade. Among this is how much you have to risk, and how much of your money you actually WANT to risk.
We recommend that you have at least $100,000 of trading capital before opening a standard account, $10,000 for a mini account, or $1,000 for a micro account. But remember, even small movements in the market could send you to the point of no return.
Chapter 6 : How does leverage work?
In Forex trading, it is defined as an act of using borrowed money to increase earning potential.
To put it simply, leverage is essentially borrowed money provided by a Forex broker to get involved in potentially high-profit trades without having to invest vast swathes of your own capital.
$50,000 for a $50,000 investment. This is called 1:1 or no leverage. Fortunately, it is now 2020 and you’re not leveraged 1:1, you’re leveraged anywhere from 3:1 all the way up to 500:1.
Let’s take 100:1 leverage as an example…
Leverage of 100:1 means you can trade a notional value 100 times greater than the capital in your trading account.
For example, to control a $50,000 position, your broker will set aside $500 from your account and you can control $50,000 with $500.
Let’s take GBP/USD as an example…
Without leverage, opening a 1 lot trade (100,000 units) would require a trader to invest around $127,000.Using leverage of 500:1, we can dramatically reduce the amount of capital required.
$127,000 / 500 (leverage used) = $254.00 required capital
Using this leverage size, we can use a simple formula to work out the amount of investment needed:
Buy trade: Ask price x contract size / leverage
Sell trade: Bid price x contract size / leverage
1 lot = 100,000 contracts (contracts worth is based on the base currency which in our case is GBP)
And don’t get fooled by the broker’s favourite selling point – high leverage.
Yes, you can make a huge killing using huge leverage, but also know that you could easily be killed by huge leverage as well.
What do I mean by that?
When leverage works, it significantly magnifies your profits. But there’s a twist. Leverage can also work against you.
If your trade moves in the opposite direction, leverage will amplify your losses.
Here’s a chart of how much your account balance changes if prices move depending on your leverage.
Our advice, Be realistic in your expectations and don’t start trading with real money and huge leverage. Play it safe. Protect your capital. If you don’t, your account will die.
Chapter 7 : What is margin?
As we discussed in the previous chapter, when trading Forex, you only need to put down a small amount of capital, also known as the margin, to open a new position.
In simple terms, it is a portion of your funds that your Forex broker sets aside to ensure that you can cover the potential loss of the trade.
For example, if you want to buy $100,000 worth of USD/JPY, you don’t need to invest the full amount, you only need to deposit a portion (depending on your Forex broker and leverage).
This portion is ‘locked up’ by your broker for the duration of the specific trade.Once the trade is closed, the margin is released back into your account and you can now use it again… to open new trades.
What is Margin Requirement?
Margin is usually expressed as a percentage of the full amount of the position. For example, most Forex brokers say they require 0.25%, 0.5%, 1%, 2%, 10% or 25% margin. This percentage is known as the Margin Requirement.
Here are some examples of margin requirements for different currency pairs:
What is Required Margin?
When margin is expressed as a specific amount of your account’s currency, this amount is called Required Margin. Each and every position you open when trading Forex will have its own Required Margin amount that will need to be locked up.
For example, to buy or sell a 100,000 of GBP/USD without leverage would require the trader to put up the full value of the position, $100,000. But with a Margin Requirement of 5%, only $5,000 (the Required Margin) of the trader’s funds would be required to open and maintain that $100,000 GBP/USD trade.
How to calculate Required Margin?
If the base currency is the same as your account’s currency:
Required Margin = Notional Value x Margin Requirement
If the base currency differs from your account’s currency:
Required Margin = Notional Value x Margin Requirement x Exchange Rate Between Base Currency and Account Currency.
Example #1: Open a long GBP/USD position
Let’s say you’ve deposited $1,000 in your account and want to go long (buy) GBP/USD at 1.3100 and you want to open 1 mini lot (10,000 units) position.
How much margin will you need to open this position?
Since GBP is the base currency, this mini lot is 10,000 pounds, which means the position’s Notional Value is $13,100.Assuming your trading account is funded in USD and the Margin Requirement is 5%, the Required Margin will be $655.
Example #2: Open a long EUR/USD position
Let’s say you’ve deposited $1,000 in your account and want to go long (buy) EUR/USD and want to open 1 mini lot (10,000 units) position.
How much margin will you need to open this position?
Since EUR is the base currency, this mini lot is 10,000 dollars, which means the position’s Notional Value is $11,900.
Assuming your trading account is denominated in USD, since the Margin Requirement is 2%, the Required Margin will be $238.
Chapter 8 : How does a trade work in Forex?
On some days, currencies will go up in value. On other days, the currencies will go down in value. It is these fluctuations in currency prices that Forex traders use to profit in Forex.
The objective of Forex trading is to exchange one currency for another in the expectation that the price will change in your favour.
But before you start making money, you need to determine whether you want to buy or sell, or in Forex terms take a long or short position.
How do I profit from Forex trading?
Joey has USD$12,700 to invest in the Forex market. He decides to trade the currency pair GBP/USD which is currently trading at 1.2700. This means that one Pound buys 1.27 US Dollars. Joey does some research and believes the Pound will rise even more, relative to the US Dollar and so he exchanges his USD$12,700 and purchases £10,000.
Joey is correct in his assumption. The Pound strengthens against the US Dollar. It’s now trading at 1.3100. He now exchanges his £10,000 back into USD, except now it’s worth $13,100. As a result, Joey now has $13,100 in his trading account and made a profit of $400.
n the example above, Joey believed that the value of GBP would rise up against the USD, so he bought GBP/USD hoping to sell it later at a higher price.
Would you say that Joey took a long or short position?
Joey made a profit from taking a long position.
In another example, what should you do if you expect the GBP to go down against the USD? You should do the opposite – sell the GBP/USD with the hope to buy it cheaper later on. This is called going short and it is how you take advantage of exchange rates that are going down.And that’s how money is made or lost in the Forex market in nutshell.