What is Forex?
The Foreign Exchange Market known as the Forex Market or simply the FX Market is where one currency is exchanged for another currency exactly the same as when you buy foreign currency when you go abroad, the main difference being no money ever changes hands. The FX market is big. In fact its inconceivably large with an average turnover in excess of $5.2 trillion per day which is greater than all the worlds stock markets put together.
In making an FX trade you are speculating that one currency will rise or fall against another currency.The exchange rate between any two currencies changes month by month, week by week, day by day, hour by hour, minute by minute and second by second. Currencies appreciate (rise) and depreciate (fall) due to economic and political changes, monetary policy, intervention, natural events (earthquakes and other natural disasters), war and many other influence. It is the aim of the FX trader to take advantage of these changes by buying a currency at one price and selling it a higher price or selling a currency at one price and buying it back at a lower price and banking the difference.
In this example we are speculating that a base currency (EURO) will rise against the US Dollar so we place a LONG trade to BUY the EUR against the USD. So we look at the price of EUR/USD and see it is 1.1380, in other words 1.1380 Euro will buy you 1 US Dollar. We go LONG (buy @ 1.1380) and see the price after a period of time hit 1.1395. We decide to SELL at this point. We bought at 1.1380. We sold at 1.1395 so we made 15 pips. How much that is depends on our lot sizing and leverage (see Money Management). The important part is that we made 15 pips.
Conversely, if we thought the EURO will fall against the USD, we would place a SHORT trade to SELL the EUR against the USD. So in the example above we would go SHORT (sell @ 1.1380). If the price then fell to 1.1365 we could close that trade by buying the trade back. It cost 1.1380 to SELL, its cost us 1.1365 to BUY it back – we’ve made 15 pips.
Literally millions of trades like this are occurring across the world 24 hours a day from when the FX markets open Sunday evening in Wellington New Zealand and Sydney Australia through the Asian markets of Singapore, Hong Kong and Tokyo, followed by London then the rest of Europe right the way up until they close in the US Friday evening. Unlike most financial markets the OTC (over-the-counter) FX market has no physical location or central exchange like, for example the New York Stock Exchange. These currencies are exchanged through a global network of banks, financial institutions and brokers and its through FX brokers that individuals can become part of this massive network.
How do you decide if a currency is going to rise or fall against another currency?
Currency trading is not like roulette. In Roulette the ball will either land on red or green randomly. Its a 50/50 chance (excluding the Casino’s edge – the zero). You could argue that its a 50/50 chance that the price of one currency will either fall or rise against another currency and you’d be correct so why not toss a coin and either go LONG or SHORT depending on whether the coin lands on heads or tails?
There are many reasons why this wouldn’t work and some of the reasons can be mathematically very exacting because we need to understand about probabilities and chance. The chance of correctly calling heads or tails on a coin flip is 50%. The chance of calling it twice is 25%. Three times and its down to 12.5%. Calling a coin flip 6 times you have a 1.562% chance of being right.
However the chance of calling heads or tails correctly remains 50%. This appears to be a paradox but the explanation lies in sequencing. A sequence of one correct call will always be 50/50. A sequence of 6 correct calls is less than 2% and herein lies the fundamental problem of why a coin flip doesn’t work in trading. Although prices over short time frame move apparently randomly in FX they are in fact usually moving in a trending direction over a larger time frame so if the current trend of EUR/USD is down there is a bias in that direction and the coin toss is no longer 50/50.
This is a somewhat simplified reason as many other factors need to be considered. The price of EUR/USD might move from 1.1380 to 1.1365 over 60 minutes but it might have hit 1.1400 before it turned round and had you protected the trade with a STOP ( a level where you close the trade to limit loss) you would have lost the bet.
So how do you decide if a currency is going to rise or fall against another currency?
A successful trader isn’t interested in a 50/50 chance of success. No professional trader uses a coin flip to decide which way a currency pair is moving. You need to maximize the odds in your favour by understanding price action and with the use of technical indicators.
Price action & technical indicators
Some people who claim to be professional traders and sell expensive training courses claim never to use indicators and rely on price action alone for their success. Trying to trade FX without indicators is like trying to drive a car with a sack over your head. Its not impossible but you’re not going to get very far and you’re certain to eventually crash particularly if you are a novice or inexperienced trader .For a seasoned trader, with many years experience of pouring over charts, it is possible to recognize chart patterns and identify trades in some circumstances but for the novice or inexperienced trader this is an impossibility and even for the experienced trader there are some key indicators that should always be on your charts. Many, if not most traders, claim to be able to see price action on large time frames like the Daily or the 8 hour. They can’t. They can’t because there is no “action” on an 8 hour chart let alone a Daily Chart. You need to look at the 1m and 5m charts to see what is happening on a chart. It is only on the small time frames that you can see any “action”.
The BULLS and the BEARS on the battlefield
(on this chart I ask a question – why did the price stop at 1.7889 – subscribe to my course and I’ll show you)
Looking at any 1 minute FX chart (every candle is 1m of time) shows a constant battle between the BULLS who want to push north and the BEARS who want to drive south.
Areas of support are defended by the BULLS (buyers), areas of resistance are defended by the BEARS (sellers). Areas of support and resistance can be any of a number of things. A Fibonacci level, previous area of support/resistance, a pivot level, a Moving Average, a trend line, the top or bottom of a channel are the more common areas where the BULLS and the BEARS will camp in anticipation of an attack which may come in minutes, hours, days, weeks, months or even years. They don’t always work. If the BEARS are strong, they can push through all levels of support and if the BULLS are strong, they can push through all areas of resistance but in the absence of news, the price is more likely to react to a support/resistance area than to an area on the chart with nothing. That’s not to say the price can’t bounce from an area without support or resistance but as traders we need to maximize any advantage and if we see the price behaving differently at a support/resistance area, we must be ready to enter the market.
The FX Jigsaw Puzzle.
Trading FX is difficult, very difficult – but its not impossible.
Imagine a jigsaw puzzle that has no edges, no picture and is one uniform colour.