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Currency Trade, Forex Trade, FX Trade – these are all terms used to describe the exchanging of one currency for another; for example, the exchanging of U.S. Dollars to British Pounds. In the foreign exchange market, this is viewed as buying pounds while simultaneously selling dollars( This refers to the foreign exchange market. Trading of chmarkh.com FX Forex trading product is a derivative and does not involve any transactions in the underlying instruments ). Because two currencies are always involved, currencies are traded in the form of currency pairs, with the pricing based on the exchange rate offered by dealers in Forextrading market Review.
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Past results are not necessarily indicative of future results.
These results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under-or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown.
In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program, which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.
Material assumptions and methods used when calculating results :
The following are material assumptions used when calculating any hypothetical monthly results that appear on our web site.
- Profits are reinvested. We assume profits (when there are profits) are reinvested in the trading strategy.
- Starting investment size. For any trading strategy on our site, hypothetical results are based on the assumption that you invested the starting amount shown on the strategy’s performance chart. In some cases, nominal dollar amounts on the equity chart have been re-scaled downward to make current go-forward trading sizes more manageable. In these cases, it may not have been possible to trade the strategy historically at the equity levels shown on the chart, and a higher minimum capital was required in the past.
- All fees are included. When calculating cumulative returns, we try to estimate and include all the fees a typical trader incurs when AutoTrading using AutoTrade technology. This includes the subscription cost of the strategy, plus any per-trade AutoTrade fees, plus estimated broker commissions if any.
- “Max Drawdown” Calculation Method. We calculate the Max Drawdown statistic as follows. Our computer software looks at the equity chart of the system in question and finds the largest percentage amount that the equity chart ever declines from a local “peak” to a subsequent point in time (thus this is formally called “Maximum Peak to Valley Drawdown.”) While this is useful information when evaluating trading systems, you should keep in mind that past performance does not guarantee future results. Therefore, future drawdowns may be larger than the historical maximum drawdowns you see here.
Trading is risky :
There is a substantial risk of loss in futures and forex trading. Online trading of stocks and options is extremely risky. Assume you will lose money. Don’t trade with money you cannot afford to lose.
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Lesson 1 – Introduction to the Currency Market :
In order to exchange dollars for pounds, the actual transaction to meet this objective is to buy the GBP/USD currency pair. In this example, GBP is the ISO code for British Pounds, and USD is the ISO code for U.S. Dollars. This will be explained in greater detail in Lesson 3 – Currency Trading Conventions.
History of the Forex Market :
- Until the 1970s or so, currency trading was limited mostly to the needs of large companies conducting business in multiple countries.
- Trading for investment and speculative purposes was not widely practised at this time, and most trading was centered on commodities and individual stocks.
The Bretton Woods Accord – Courting Controversy
- After World War II, economies in Europe were left in tatters.
- To help these economies recover – and to avoid mistakes made in the wake of the First World War – the Bretton Woods Accord was convened in July 1944.
- Several resolutions arose from Bretton Woods, but it was the “pegging” of foreign currencies to the U.S. dollar that arguably had the greatest immediate impact on the global economy.
Gold Standard Currency – A commitment to fix the value of a currency to a specific quantity of gold. Under this system, the holder of the country’s currency can convert funds to an equal amount of gold.
Fiat or Floating Currency – Fiat currency is the opposite of a gold standard arrangement. In a fiat currency system, the currency’s value rises and falls on the market in response to demand and supply pressures. It is this fluctuation that makes it possible to speculate on future currency values.
Pegging U.S. Currencies to the U.S. Dollar
- By pegging (or linking) these currencies directly to the dollar, the value of the pegged currencies remained dependent on the value of the dollar.
- At the same time, the value of the dollar was tied to the price of gold which, at the time of the Bretton Woods Accord, was valued at $35 an ounce.
- The U.S government was obligated to maintain gold reserves equal to the amount of currency in circulation, making the United States a true gold standard economy.
Evolution of an Open Forex Market
Why We Have Richard Nixon to Thank
- It did not take long for cracks to appear in the Bretton Woods Accord.
- For the pegged currencies, it was impossible for individual countries to manage the value of their own currency.
- Likewise, the value of the dollar itself was subject to fluctuations in the price of gold.
- As resistance grew to the restrictions imposed by the original agreement, two events in particular would spell the end of the Bretton Woods Agreement.
The Bretton Woods Accord was not popular with every country included in the agreement. By linking many European economies to the U.S. dollar, the dollar became the de facto world currency. This made it impossible for sovereign nations to manage the value of their own currency.
Some U.S. officials were likewise unhappy with tying the U.S. dollar to the price of gold. With this arrangement, a run-up in gold prices also forced the value of the dollar upwards, and this contributed to the inflation crisis of the early 1970s.
1. The Eurodollar Market
- The first attack on Bretton Woods came in the form of what would be known as the Eurodollar market.
- The term “eurodollar”, defines any instance of U.S. dollars deposited in a bank outside the United States – initially, the source of much of the foreign-held dollars was oil.
- The Soviet Union became an important oil producer shortly after World War II, and because oil contracts sold on the international markets were settled in U.S. dollars, the Soviet Union started receiving huge amounts of U.S. currency.
- Coincidently, this period also marked the beginning of the “Cold War” between the east and the west.
- Worried that their bank accounts could be seized by the U.S., the Soviet Union opted to deposit its U.S. dollars in European banks, out of the reach of American authorities.
- As the number of U.S. dollars held in this new eurodollar market grew, it soon became an important source of lending capital for governments and large companies around the world.
Market-Maker – A dealer or broker that provides a two-way quote (i.e. a bid and ask price) for which the dealer agrees to buy or sell. Offering both sides of a trade literally “makes” a market for those wishing to engage in currency trading. OANDA is an example of a forex market-maker.
2. U.S. Inflation and the Energy Crisis
- In 1971, inflation in the U.S. continued to erode the purchasing power of the dollar. At the same time, an energy crisis was simultaneously pushing up the price of oil and other commodities.
- As a result, investors – as is often the case when confusion reigns in the markets – turned to gold as a hedge to protect savings.
- The increased demand caused gold prices to soar and because the dollar was tied to gold, the U.S. dollar followed suit, further exacerbating the inflationary pressures.
- Finally, in an attempt to deal with surging inflation in the U.S. economy, President Nixon dropped the gold standard requirement and devalued the U.S. dollar to 1/35th of an ounce of gold.
- This effectively ended not only the gold standard, but also the Bretton Woods-imposed pegging of currencies, leading ultimately to free-floating individual currencies based on market conditions and other economic factors.
A hedge is the practice of buying a physical commodity to protect against a possible currency devaluation.
The Interbank Market and OTC Trading
- Sometimes referred to as institutional forex trading, the Interbank market consists of a small group of large banks. Non-bank outsiders are forced to pay high service fees to trade in this market.
- Forex trading is an “over-the-counter” (OTC) market, and is not conducted in a physical location such as a stock exchange.
- A forex deal exists as a contract between two parties.
- The Chicago Mercantile Exchange (CME) became the first exchange to offer currency trading.
- In 1971, the CME launched the International Monetary Market (IMM).
The Rise of Web-Based Trading and Forex Market-Makers
- In recent years, new developments in web-related technologies have made it possible for a number of independent brokers to develop internet-based trading platforms.
- These brokers serve as market-makers and provide a two-way quote for each currency pair they support.
Forex Training Summary and Quiz :
Introduction to Currency Trading
- The earliest form of currency trading was mostly for the facilitation of international commerce.
- Forex trading is managed through an established interbank market and only large financial institutions are able to deal directly in this market.
- In recent years, a large secondary currency market has evolved, resulting in a network of online brokers offering direct currency trading services through online trading platforms.
- Forex is an “over-the-counter” (OTC) market supported by forex dealers serving as market-makers.
- The Bretton-Woods Accord of 1941 was a major international policy intended to minimize economic chaos with the conclusion of World War II. It involved pegging currencies to the U.S. dollar which was itself pegged to the price of gold.
- Eurodollars are U.S. funds held in banks outside the regulatory control of the U.S. government.
- In 1971, U.S. President Richard Nixon eliminated the gold standard for the U.S. dollar to combat rising gold prices contributing to high inflation levels. This action led directly to free-floating currency exchange rates and gave rise to the modern currency OTC market.
Trading in The Forex Spot Market
Role of the Forex Market Maker
- Often referred to as a dealer or a broker, a forex market maker provides a two-way quote for each currency pair it offers.
- A two-way quote consists of a bid price and an ask price, and represents the exchange rate at which the market maker is willing to buy or sell the currency pair.
- The exchange rate as published by a forex broker, advertises the current rate at which you can trade (exchange) one currency for another.
- If currency A is worth 1.25 of currency B for example, and you wanted to exchange 500 units of currency A, you would receive 625 units of currency B (500 × 1.25).
- Looking at this the other way, if you instead needed 1200 units of currency B, but only had currency A, you would need to exchange 960 units of currency A to get the required amount of currency B (1200 ÷ 1.25).
Exchange Rate – Describes how much of one currency can be bought or sold in exchange for one unit of another currency.
Spot Trade Settlement
- Spot trades in the forex market are intended for immediate settlement.
- This means the trade is considered to have been completed (or executed) once the buyer and the seller agree to the terms of the trade.
- The physical delivery of the currencies involved in the trade however, can take up to two days after the trade itself. This is the settlement date.
- In the industry, this is referred to as “T+2” which stands for “trade day plus two days” for the settlement (the physical delivery of the currencies) to be completed.
- T+2 is a throwback to the days when trading was conducted mostly using fax machines or over the telephone. While these methods allowed for instantaneous agreement between the trade participants, it could take several days for the actual transfer of funds between the buyer and seller accounts.
Spot Trade – A contract to buy or sell a specified amount of a currency pair at a given exchange rate.
While many forex trades are still conducted under the restrictions of a “T+2” settlement, chmarkh etoro offers immediate settlement on all trades and updates accounts accordingly. This is because as a market maker, chmarkh etoro can support both sides of each trade.
Buying and Selling Currency Pairs
- The exchange rate describes the price for which the currency of a country can be exchanged for another country’s currency
- For example, the most commonly-traded currency pair consists of the euro and the U.S. dollar. It is always listed as EUR/USD and never the reverse order.
Anatomy of a Currency Pair
- The first currency listed in the currency pair is called the base currency; the second currency is referred to as the quote, or sometimes counter currency.
- When published with an exchange rate, the currency pair indicates how much of the quote currency is required to purchase one unit of the base currency. For example, EUR / USD = 1.5467 indicates that one euro can buy 1.5467 US dollars.
- When selling a currency pair, the exchange rate shows how many units of the quote currency you will receive when selling one unit of the base currency.
- By enforcing these strict standards on how to refer to currency pairs, mistakes are reduced and it is easier to keep exchange rates organized and clearly understood.
- When trading currency pair derivatives you are not trading the underlying; you are trading a derivative of this market.
Exchange Rates and Spreads
- Each currency pair listed by your broker is accompanied by an exchange rate that shows the bid and ask price for the currency pair.
- The bid price is the rate that your broker is willing to pay for the currency pair; in other words, this is the rate you receive if selling to the market.
- The ask price is the rate at which your broker is willing to sell and represents the rate you must pay to buy the currency pair.
- The bid price is always less than the ask price because brokers pay less than they receive for the same currency pair. This difference – known as the spread – is how your broker generates much of its revenue.
- The illustration at the top of this page shows how brokers typically display a currency pair to show the current bid and ask price.
- In this example, the bid is 1.4745 dollars to each euro, while the ask is 1.4746 dollars to each euro.
- The bid price is always shown before the ask, and because the difference between two prices tends to be very small, brokers usually only display the last two digits when showing the ask price.
The spread represents your cost to trade with the broker. Spreads can vary significantly from broker to broker so it is very much in your interest to trade with the broker offering the best (i.e. the tightest) spreads in order to minimize your trading costs.
What are Pips in Forex
- Pip = “price interest point”.
- A pip measures the amount of change in the exchange rate for a currency pair.
- For currency pairs displayed to four decimal places, one pip is equal to 0.0001. Yen-based currency pairs are an exception and are displayed to only two decimal places (0.01).
- Some brokers now offer fractional pips to provide an extra digit of precision when quoting exchange rates for certain currency pairs.
- A fractional pip is equivalent to 1/10 of a pip.
chmarkh etoro fx forex trading introduced fractional pips – or “pipettes” – to allow for tighter spreads on certain currency pairs. For instance, it is possible to view the EUR/USD currency pair with pipettes (i.e. five decimal places), while currency pairs with the yen as the quote currency can be viewed to three decimal places instead of the default two decimal places.
Forex traders often use pips to reference gains or losses. For a trader to say “I made 40 pips on the trade” for instance, means that the trader profited by 40 pips. The actual cash amount this represents however, depends on the pip value.
Determining Pip Value
- The monetary value of each pip depends on three factors: the currency pair being traded, the size of the trade, and the exchange rate.
- Based on these factors, the fluctuation of even a single pip can have a significant impact on the value of the open position.
- For example, assume that a $300,000 trade involving the USD/CAD pair is closed at 1.0568 after gaining 20 pips. To calculate the profit in U.S. dollars, complete the following steps:
- Determine the number of CAD each pip represents by multiplying the amount of the trade by 1 pip as follows:
300,000 x 0.0001 = 30 CAD per pip
- Divide the number of CAD per pip by the closing exchange rate to arrive at the number of USD per pip:
30 ÷ 1.0568 = 28.39 USD per pip
- Multiply the number of pips gained, by the value of each pip in USD to arrive at the total loss / profit for the trade:
20 x 28.39 = $567.80 USD profit
- Determine the number of CAD each pip represents by multiplying the amount of the trade by 1 pip as follows:
|Currency Pair||Exchange Rate at Close||Pip Change||Trade Amount|
|Currency Pair||Exchange Rate at Close||Pip Change||Trade Amount|
|Currency Pair||Exchange Rate at Close||Pip Change||Trade Amount|
|Currency Pair||Exchange Rate at Close||Pip Change||Trade Amount|
* For the sake of simplicity, assume all examples are buy transactions.
Naturally, all brokers claim they offer the best spreads, but simply saying something, does not make it so. It is up to you to do your investigative homework to identify brokers that offer the best value.
How Uncertainty in the Market Affects Spreads
- Impending news, such as inflation reports and central bank meetings, are the most common events that cause spreads to widen.
- Once the news of an event is absorbed by the market and it becomes clearer which way the currency will go, the spread generally snaps back to typical levels.
- We’ll talk more about spreads and what causes spreads to vary in Lesson 5 – A Primer to Fundamental Analysis.
How to Close an Open Position in Forex
- Active trades are referred to as open positions.
- Open positions remain subject to fluctuations in the exchange rate.
- Open positions are closed by entering into a trade that takes the opposite position to the original trade.
- The net effect is to bring the total amount for the currency pair derivative back to zero.
Realizing Gains / Losses
- It is important to understand that gains or losses for open positions are still unrealized.
- Only when you close a position do you actually realize the gains or losses for the trade, thereby affecting the actual cash balance of your account.
Closing a Long Position
- To close a long position, you must sell an equal amount of the same currency pair derivative to reduce your long position to zero.
- For instance, if you are long $100,000 EUR/USD, you need to sell $100,000 EUR/USD back into the market to reduce your EUR/USD holdings to zero.
- If you receive more when you sell than you paid to buy the order, you earn a profit. If you receive less, you realize a loss.
Closing a Short Position
- A short position is the opposite of a long position – think of it as holding a negative amount of a currency pair derivative.
- In order to close a short position, you need to buy enough of the currency pair derivative to bring your position back to zero.
- For instance, if you are short $100,000 EUR/USD, then you must buy $100,000 EUR/USD to close the short position. If you can buy this back for less than you earned when you sold it originally, the difference is retained as profit.
Partial Position Close
- It is possible to partially close an open position by only selling or buying enough to partly offset the open position.
- For example, selling only $75,000 when you have an open position of $100,000 EUR/USD, closes three-quarters of the original position, leaving an open EUR/USD position of $25,000.
The chmarkh etoro fxTrade trading platform automates the process for closing a position for you. If, for instance, you have a short position consisting of 50,000 units of USD/CAD, you need only click a single button to instruct fxTrade to create a buy order for 50,000 USD/CAD to close your position and realize your return.
What are End-of-Day Rollovers in Forex
- An end-of-day rollover – also known as a rollover swap – is used by brokers to process open positions so they can be held over to the following day.
- Rollovers implement a cut-off point for the day’s business, after which any new business is dated the following day and becomes part of the next day’s business.
- Rollovers are necessary to determine a daily valuation for open transactions in order to calculate finance charges for the positions.
- When trading in a margin account, you receive finance credits on your long positions, while paying finance charges on short positions.
- The net interest difference is known as the carry.
- Positive carry results when you receive more in finance charges than you are required to pay, and is added directly to your account. If the carry is negative, it is subtracted from your account.
- Most brokers perform the rollover automatically by closing open positions at the end of the day, while simultaneously opening an identical position for the following business day. This is also known as a “tomorrow next” transaction, or simply a “tom next”.
- Intra-day trades are not included in the finance charge calculation for those brokers who use rollovers in this manner. If you open and close a trade within the same day and do not hold it open at the time your broker performs the end of day valuation, the trade has no finance charges implications.At the time of this writing, chmarkh etoro is the only forex broker to offer second-by-second finance charge calculation. This means that finance charges are calculated for all open positions for the entire time your position is open. This eliminates the need for an end-of-day rollover swap transaction.
At the time of this writing, chmarkh etoro is the only forex broker to offer second-by-second interest rate calculation. This means that interest is calculated for all open positions for the entire time your position is open. This eliminates the need for an end-of-day rollover swap transaction.
Forex Training Summary and Quiz
Currency Trading Conventions
- Currencies are traded in currency pairs – for example EUR/USD. In this case, EUR is the base currency and USD is the quote or counter currency.
- Exchange rates for currency pairs are displayed with both a bid price (what you receive when selling) and an ask price (what you pay when buying).
- The difference between the bid price and the ask price is known as the spread.
- “Pip” stands for “price interest point” and is equal to 0.01 for exchange rates expressed to two decimal places. For rates expressed to four decimal places, one pip is equal to 0.0001.
- Some brokers offer an additional digit of precision for certain exchange rates. This extra digit is commonly referred to as a “fractional pip”.
- Buy = to take a long position. Sell = to take a short position.
- To close a position, you need to buy or sell an equal amount of the open order, thereby reducing the open position to zero.
- Unrealized gains / losses are the profits or losses that would result if an open position were closed at the current exchange rate. Once the position is closed, gains and losses are said to be realized.
- An end-of-day rollover – or rollover swap, is used by most forex brokers to close out an open position at the end of the business day. A new position is automatically created for the next business day and the net financing charge or credit (finance earned minus finance paid) is calculated for the open position at the time of the rollover.
Lesson 4 – Making The First Forex Trade :
Now that you have completed the first three lessons of this course, you have the basic information you need to make your first forex trade. Before you take that first step and commit your money to a trade, there is something more you can do to help prepare yourself for the real world of trading:
Most online forex brokers offer practice accounts that simulate the real trading experience. Instead of risking your hard-earned cash, you can trade using virtual money. The lessons you learn using a practice account are immediately transferable to live accounts, so to receive the greatest benefit, you must treat the practice account seriously and trade as if you were trading real money.
Do this for at least a few weeks and then make an honest assessment of your performance. If you have more losing trades than winning trades, you must adjust your strategies and continue practicing before you open and fund an actual trading account.
Many new traders find it difficult to replicate the success they have on a practice account once switching to a live trading account. This is often due to a tendency to alter trading practices once “real” money is involved.
Trading Intervals in Forex :
- Trade intervals in this context refers to the length of time positions are held open in the account.
- Because there is no standard definition, it is helpful to think of trades as falling into one of two main types – intra-day trades and inter-day trades.
In Lesson 3, we looked at how most brokers use an end-of-day evaluation to determine the daily net financing for open positions. These positions are then closed and “rolled-over” into an identical position for the following day. Because day trades are closed prior to the end of the business day, day trade positions are not typically included in the financingcalculation for your account.
- Commonly referred to as day trades, intra-day trades are opened and closed during the same business day.
- The length of time intra-day trades remain open could range from just a minute or two, to several hours.
- Intra-day traders hope to profit on the currency pair’s volatility as exemplified in the following price chart.
- Note that even though the exchange rate fluctuated continuously between 14:00 and 16:00 hours, overall, the rate declined.
- In this case, taking a short position around 14:00 hours and holding it for only two hours, would have resulted in a gain of approximately 35 – 40 pips.
- An inter-day trade remains open overnight.
- Because these trades are held over from one day to the next, they are included in the end-of-day rollover and also the financing calculation for the account.
- Inter-day traders are usually employing one of the following three strategies:
- Trading a long-term view
- Establishing a carry-trade
- Hedging future currency exposures
Trading a Long-Term View
- A long-term view is the forming of an opinion on the future direction of an exchange rate.
- If you believe, for instance, that Japan’s economy will contract over the next quarter, while the Eurozone countries led by industrial powerhouse Germany will expand, you might conclude that the euro will appreciate in value over the yen over the long term.
- To take advantage, you could go long the EUR/JPY with the intention of holding the position open for the next two to three months, or even longer.
- As time goes on and your assessment proves accurate (or not), you can close the position at any time at the current market price.
- Depending on the market price, closing the position will serve to either realize your gains, or limit your losses.
Eurozone – The name given to the collection of countries that use the euro as their currency.
Establishing a Carry Trade
- A carry trade is used to take advantage of the interest rate differential between the two currencies in a currency pair.
- The basic goal of a carry trade is to buy currencies with a high interest yield, while shorting currencies with a low yield.
- For your carry trade to be profitable, your long position must yield more interest than you are forced to pay for your short position. The difference is called carry, and if the carry is positive, you profit – if the carry is negative, you lose money.
- In addition to earning profit on the interest rate carry, you can also profit on a change in the exchange rate. Keep in mind however, that if the rate moves against you, it could eliminate any profit you earn through the interest, so you must continually monitor your carry trades.
- For more information on how forex brokers calculate interest on open orders, see End-of-Day Rollovers for Open Positions in Lesson 3.
Hedging Future Exchange Rate Exposures
- A future exchange rate exposure exists when you will be required to convert your own currency to a foreign currency at some point in the future.
- For instance, you could be faced with an upcoming payment that must be submitted in another currency, or you could be expecting some form of payment that will be converted from a foreign currency to your own.
- Both situations include an element of risk in that you cannot control future exchange rates.
- This means that your upcoming bill could cost you more than expected if your own currency loses value against the currency in which you must pay the bill.
- On the other hand, if your currency gains in strength and you are expecting a future payment, it will be worth less to you once converted to your own currency.
Using Spot Forex Trades to Hedge Future Exchange Rate Exposures
- To protect against an unfavorable change in the exchange rate in the future, you can enter into a spot market Forex-trade.
- For example, a UK resident intends to buy property in the U.S. later in the year. To think of this in currency trading terms, the buyer is long GBP and short USD.
- To protect against the dollar gaining on the pound before the buyer can complete the transaction, the buyer could sell GBP and buy USD, and hold this position open in a forex trading account.
- This effectively “locks in” the current exchange rate as the buyer is holding USD in the trading account.
- If the dollar gains in value, the buyer will receive more pounds back when the position is closed, and the extra can be used to buy USD.
- On the other hand, if the dollar falls in value, the buyer will still have the equivalent when converted to USD – which is the purpose of the hedge in the first place.
A word of warning before engaging in any long-term, inter-day trading – you will need to be able to withstand the normal fluctuations that will most certainly occur for any currency pair over a longer time frame. You may suffer through several days in a row where the price moves against you, but you must have the courage to stick to your strategy and remember that you are in it for the long haul.
Trends are rarely in a straight line and rates will fluctuate. But, if the overall trend is in the direction you predicted, you will come out on top. If you don’t think you can handle this pressure, or if you question your ability to identify such opportunities, then this form of trading may not be appropriate for you.
Forex Trading Strategies and Best Practices :
- The idea of listing your strategies or trading guidelines, is to create the equivalent of a “policies and procedures” manual for trading.
- Defining your strategy before you enter into a trade helps prevent emotion taking over your trading.
Trading on the Technicals
- “Technicals” refers to the use of charts and graphs to identify potential buy and sell levels.
- Traders who employ these tools are often called “chartists” – see Lesson 6 – An Introduction to Technical Analysis for more information on technical trading.
Trading on the Fundamentals
- Trading on the fundamentals – also referred to as trading the news – is the study of news events and economic statistics to determine trading opportunities.
- Referred to as fundamentalists, these traders pay close attention to changes in economic indicators such as interest rates, employment rates, and inflation. See Lesson 5 – A Primer to Fundamental Analysis for more information on fundamental trading.
Trading When Indicators Conflict
- It is a fact of trading that there will be times when you will face conflicting information as you evaluate the likely future direction for a particular currency.
- When faced with contradictory information, you have two options; 1) formulate your own opinion as to the direction the exchange rate will likely go, or 2) simply refrain from dealing in that currency pair until a clearer picture emerges.
- Successful trading requires the discipline to stick to a strategy.
- No matter the market direction, the worst thing you can do is act rashly and without thought – this only exaggerates losses.
- If you have entered into a trade based on the best analysis available to you at the time and the trade still goes against you, it may be best to cut your losses and move on.
- While no trader likes taking a loss, randomly buying and selling on every market fluctuation is not a trading strategy – it is however, a sure way to lose money.
- While we are on the topic of losing money, incorporating stop-losses into your orders can help protect your investment. See Stop-Loss Orders later in this lesson for more information.
When in Doubt, Don’t
When conflicting information prevents you from determining a clear direction, avoiding that currency pair for the time being is a perfectly valid strategy.
Forex Order Types :
- Most brokers offer the following order types:
- Market Orders
- Limit Orders
- Take Profit Orders
- Stop Loss Orders
- Trailing Stop Orders
- Your trading style will dictate the order type that best suits your needs.
- A market order is executed immediately when placed. It is priced using the current spot, or market price.
- A market order immediately becomes an open position and subject to fluctuations in the market.
- This means that should the rate move against you, the value of your position deteriorates – this is an unrealized loss.
- If you were to close the position at this point, you would realize the loss and your account balance would be updated to include the revised totals.
To prevent the executed rate from slipping too far from your intended price, OANDA fxTrade allows you to include upper and lower bounds with your market order. If the executed price falls outside these bounds, fxTrade prohibits the execution of the order.
Because of the rapidly changing nature of the forex market, the executed price may differ from the last price you saw on the trading platform. This is referred to as slippage. Sometimes slippage works to your favor, and sometimes to your disadvantage.
- A limit order is an order to buy or sell a currency pair, but only when certain conditions included in the original trade instructions are fulfilled.
- Until these conditions are met, the order is considered a pending order and does not affect your account totals or margin calculation.
- The most common use of a pending order is to create an order that is executed automatically if the exchange rate reaches a certain level.
- For example, if you believe that EUR/GBP is about to begin an upswing, you could enter a limit buy order at a price slightly above the market rate. If the rate does move upwards as you predicted and reaches your limit price, a buy order is executed with no further input on your part.
A pending limit order has no impact on your account totals and can be cancelled at any time without consequence. If the conditions of a limit order are met however, the pending order is executed and becomes an active market order.
- A take-profit order automatically closes an open order when the exchange rate reaches the specified threshold.
- Take-profit orders are used to lock-in profits when you are unavailable to monitor your open positions.
- For example, if you are long USD/JPY at 109.58 and you want to take your profit when the rate reaches 110.00, you can set this rate as your take-profit threshold. If the bid price touches 110.00, the open position is closed by the system and your profit is secured.
- Your trade is closed at the current market rate. In a fast moving market, there may be a gap between this rate and the rate you set for your take-profit.
- Similar to a take-profit, a stop-loss order is a defensive mechanism you can use to help protect against further losses, including avoiding margin closeouts
- A stop-loss automatically closes an open position when the exchange rate moves against you and reaches the level you specify.
- For example, if you are long USD/JPY at 109.58, you could set a stop-loss at 107.00 – then, if the bid price falls to this level, the trade is automatically closed, thereby capping your losses.
- It is important to understand that stop-loss orders can only restrict losses, they cannot prevent losses.
- Your trade is closed at the current market rate. In a fast moving market, there may be a gap between this rate and the rate you set for your stop-loss.
- If your stop-loss is triggered when trading resumes on Sunday, your trade is executed at the current market rate, which may be lower than your stop-loss rate — resulting in additional losses.
- It is in your best interest to include stop-loss instructions for your open positions. Think of them as a very basic form of account insurance.
Traders use the term “stopped-out” to describe the situation where a stop-loss closes a position.
Trailing Stop Orders
- Similar to a stop-loss, a trailing stop can be used to restrict losses and avoid margin closeouts.
- A trailing stop resembles a stop-loss in that it automatically closes the trade if the market moves in an unfavourable direction by a specified distance.
- The key feature of a trailing stop is that as long as the market price moves in a favourable direction, the trigger price automatically follows the market price at a specified distance.
- This allows your trade to gain in value while reducing the amount of loss you are at risk for.
- For example, if you hold a long position the trigger price will keep moving up if the market price moves up, but stays unchanged if the market price moves down. If you hold a short position, the trigger price will keep moving down if the market price moves down, but stays unchanged if the market price moves up.
Forex Training Summary and Quiz
Making First Trade
- Use practice accounts to experience realistic trading scenarios without actually risking your funds.
- Create a “watch list” of currencies for which you intend to specialize. Learn the factors that tend to affect the value of each currency on the list.
- Intra-day trades (also known as day trades) are trades that are opened and closed within the same trading day.
- Inter-day trades are trades held open overnight and remain in effect the following day. Inter-day trades are typically used to:
- Trade on a long-term view
- Establish a carry-trade
- Hedge future currency exposures
- Trading on a long-term view is the forming of an opinion on the expected direction of a currency pair over an extended period of time.
- Carry trades are a special trading strategy designed to take advantage of an interest rate differential between two currencies in a currency pair. To profit on the difference in interest rates, you need to be long the higher-yielding currency and short the lower-yielding one.
- Technical Analysis is the use of charts and graphs to predict future exchange rates.
- Fundamental Analysis is the study of news and economic results to predict future exchange rates.
- Forex order types include:
- Market order – executed immediately at the current market price.
- Limit order – buy or sell order that is executed only when price conditions are met.
- Take-Profit order – automatically closes an open position at specified rate to lock in profits.
- Stop-loss order – automatically closes an open position to prevent further losses.
- GTC order – limit order that remains pending until you physically cancel the order if not executed by the trading system.
- GFD order – limit order that remains pending only until the end of the business day if not executed by the trading system.
- OCO order – combination of two limit orders; if one is executed, the other order is immediately canceled by the trading system.
- Beware of setting take-profit or stop-loss thresholds so close to the market price that normal rate fluctuations can trigger them.
Lesson 4 – Forex Fundamental Analysis :
Fundamental analysis is the interpretation of statistical reports and economic indicators. Things like changes in interest rates, employment reports, and the latest inflation indicators all fall into the realm of fundamental analysis.
Forex traders must pay close attention to economic indicators which can have a direct – and to some degree, predictable – effect on the value of a nation’s currency in the forex market.
Given the impact these indicators can have on exchange rates, it is important to know beforehand when they are due for release. It is also likely that exchange rate spreads will widen during the time leading up to the release of an important indicator and this could add considerably to the cost of your trade.
Therefore, you should regularly consult an economic calendar which lists the release date and time for each indicator. You can find economic calendars on Central Bank websites and also through most brokers.
The Role of Central Bank
- Most countries have some form of Central Bank serving as the principle authority for the nation’s financial matters.
- Primary duties for a Central Bank include:
- Implement a monetary policy that provides consistent growth and employment
- Promote the stability of the country’s financial system
- Manage the production and distribution of the nation’s currency
- Inform the public of the overall state of the economy by publishing economic statistics
Fiscal and Monetary Policy
- Fiscal policy refers to the economic direction a government wishes to pursue regarding taxation, spending, and borrowing.
- Monetary policy is the set of actions a government or Central Bank takes to influence the economy in an attempt to achieve its fiscal policy.
- Central Banks have several options they can use to affect monetary policy, but the most powerful tool is their ability to set interest rates.
How Central Banks Use Interest Rates to Implement Fiscal Policy
- A primary role for most Central Banks is to supply operational capital to the country’s commercial banks. This is done by offering loans to these banks for short time periods – usually on an overnight basis.
- This ensures the banking system has sufficient liquidity for businesses and individual consumers to borrow money, and the availability of credit has a direct impact on business and consumer spending.
- The Central Bank charges interest on the short-term loans it provides. The rate charged by the Central Bank affects the interest rate that the banks charge their customers as the banks must recover their cost (the interest they paid) plus earn a profit.
- Central Banks use the relationship between the short-term rates at which it offers loans, and the interest rate the banks charge, as a way to influence the cost for the public to borrow money.
- If the Central Bank feels that an increase in consumer spending is needed to stimulate the economy, it can lower short-term rates when providing loans to the commercial banks. This usually results in the banks lowering the interest they charge, making borrowing less costly for consumers which the Central Bank hopes will lead to an increase in overall spending.
- If a tightening of the economy is needed to slow inflation, the Central Bank can increase interest rates making loans more expensive to acquire, which could lead to an overall reduction in spending.
Supply and Demand of Currency
- Just like any commodity, the value of a free-floating currency is based on supply and demand.
- To increase a currency’s value, the Central Bank can buy currency and hold it in its reserves. This reduces the supply of the currency available and could lead to an increase in valuation.
- To decrease a currency’s value, the Central Bank can sell its reserves back to the market. This increases the supply of the currency and could lead to a decrease in valuation.
- International trade flows can also influence supply and demand for a currency. When a country exports more than it imports (a positive trade balance), foreign buyers must exchange more of their currency for the currency of the exporting country. This increases the demand for the currency.
Monetary and Fiscal Policy
Common Economic Indicators
GROSS DOMESTIC PRODUCT (GDP)
- One of the most influential of the economic indicators, GDP measures the total value of all goods and services produced by a country during the reporting period.
- An increase in GDP indicates a growing economy, and for this reason, GDP is used to measure the level of inflation within the economy.
CONSUMER PRICE INDEX (CPI)
- Measures the cost to buy a defined basket of goods and services. It is expressed as an index based on a starting value of 100.
- A CPI of 112 means that it now costs 12% more to buy the same basket of goods and services today than it did when the starting index value was first determined.
- By comparing results from one period to the next, it is possible to measure changes in consumer buying power and the effects of inflation.
- Inflation is a concern to currency traders as it affects the price of everything bought and sold within an economy, and this has a direct impact on the supply and demand for a country’s currency.
Inflation is an increase in the price of goods and services. While inflation by its very definition suggests economic growth, inflation that occurs too rapidly actually weakens consumer buying power as prices increase at a faster rate than salaries.
PRODUCER PRICE INDEX (PPI)
- Also an inflation indicator, the PPI tracks the changes in prices that producers receive for their products.
- Expressed as an index relative to 100.
- Excludes volatile items such as energy and food to avoid distorting the index.
- By measuring the prices received by domestic producers, it is possible to project how the consumer-level prices could be affected.
- Employment reports have an immediate impact on currencies because employment levels directly affect current and future spending habits.
- An increase in unemployment is a negative indicator as it implies that more people are not receiving a regular salary. This is a sure signal that consumer spending will decline.
- The following table lists some of the most important labor reports by country:
|Australia||Wage Price Index||Measures changes in wages.|
|Canada||Labor Force Survey||Provides a snapshot of current employment rates and a breakdown of employment by sector.|
|United States||Non-Farm Payroll (NFP)||Provides a study of U.S. employment statistics for all workers except:
|Unemployment Insurance Initial Claims||Tracks the number of new unemployment insurance claims for the reporting period.|
|United Kingdom||Claimant Count Change||Determines the change in Unemployment Insurance claims from one reporting period to the next.|
- Most Central Banks maintain a “benchmark” interest rate.
- Depending on the jurisdiction, the Central Bank rate serves as the guide for the rate at which the Central Bank and other commercial banks lend each other funds to meet short-term operational needs.
- Commercial lending rates are also affected by the Central Bank rate, and it is this linking of short-term rates to the commercial rates that makes interest rate policy the primary monetary tool for Central Banks.
- As noted earlier, the Central Bank can increase rates during periods of high growth (inflation) in a bid to reduce consumer spending which should help bring growth back to a more manageable level.
- If deflation is a problem and the economy needs a boost, Central Banks can lower interest rates to entice more consumer lending. The expected outcome is that overall consumer spending will increase as consumers have access to less costly loans.
- Forex traders in particular pay close attention to changes in interest rates as investors tend to seek out currencies offering higher returns and this demand can cause a currency to appreciate.
- Also, the greater the interest rate differential between two currencies, the greater the profit potential of a carry trade strategy. See Trading Strategies and Best Practices in Lesson 4 for more information on carry trades.
- Yield is the interest on fixed-income securities which includes such investments as futures contracts and government bonds.
- Referred to as “fixed” income because the payment stream (the yield) remains constant until maturity.
- For example, a simple 5-year bond with a 3 percent annual yield, would pay $300 a year for the next five years on an initial $10,000 investment.
- The yield curve shows the relationship between the yield, and the time to maturity.
- When dealing with fixed-income securities, investors want to ensure that the fixed yield remains profitable right up until maturity.
- As an investor you may be happy with a 5 percent return when the basic lending rate is 2 percent. However, if short-term interest rates rise and the lending rate jumps to 6 percent, your 5 percent return is no longer so attractive, and there are probably other options that could generate more income for your investment.
- Liquidity spread is the term used to describe the difference between the yield and short-term rates.
- If short-term interest rates rise above the fixed yield, the bond holder is said to be in a position of negative liquidity spread.
- When plotted on a chart, the yield is represented along the y-axis, while time to maturity is charted vertically on the x-axis. This results in a yield curve shape that some investors suggest offers insight into future interest rates.
- Consider the following so-called “normal” yield shape:
U.S. treasury bills – or “T-bills” – are a form of debt issued by the U.S. government. The maximum maturity is one year, but the 3-month T-bill is a popular choice for short-term investment.
Unlike bonds that pay a regular, fixed-rate amount, T-bills are sold at a discount to par (the “face” value). At maturity, the buyer receives the full face value of the T-bill. For example, if an investor buys $10,000 worth of T-bills for $9,900, at maturity, the investor receives $10,000. The difference – $100 in this case – is the yield earned by the investment.
Normal Yield Curve
Flat Yield Curve
Inverted Yield Curve
Humped Yield Curve
INSTITUTE OF SUPPLY MANAGEMENT (ISM)
- The ISM report is another inflation indicator. It measures the level of new orders and helps predict manufacturing activity for the upcoming period.
- It is expressed as an index based on 50. A number less than 50 means that manufacturing has contracted from the previous period, while a number greater than 50 indicates growth for the previous period.
- Because the ISM captures current factory production levels, it provides insight into the expected level of consumer demand for goods in the immediate future.
RETAIL SALES REPORT
- The Retail Sales Report tracks consumer spending patterns – items such as health care and education are not included.
- An increase in the Retail Sales Report is likely to be seen as positive for the currency as it suggests growing consumer confidence.
INDUSTRIAL PRODUCTION INDEX (IPI)
- Shows the monthly change in production for the major industrial sectors including mining, manufacturing, and public utilities.
- Considered an accurate assessment of employment in the manufacturing sectors, average earnings, and overall income levels.
- An increase in IPI suggests continued growth which is seen as a positive for the economy.
COMMODITY PRICE INDEX (CPI)
- Tracks the changes in the average value of commodity prices such as oil, minerals, and metals.
- This index is particularly relevant for countries like Canada and Australia (known as the “commodity dollars”) that serve as major commodity exporters.
- For commodity exporters, an increase in this index suggests greater potential for earning higher prices from these exports.
- Compares the total value of imports to the total value of exports for a reporting period.
- A negative value indicates that more goods were imported than were exported (a trade deficit) – while a positive trade balance means that exports exceeded imports (a trade surplus).
- If the balance of trade shows a surplus or declining deficit, then there may be an increased demand for the currency.
- If the report shows a growing deficit, then the increased supply – together with a decrease in demand for the exporting currency – could lead to a devaluation against other currencies.
- 1 learn Forex trading strategies for beginners :
- 1.1 The best Social Trading platform on Earth eToro fx forex trading :
- 1.2 Lesson 1 – Introduction to the Currency Market :
- 1.2.1 History of the Forex Market :
- 1.2.2 Pegging U.S. Currencies to the U.S. Dollar
- 1.2.3 Evolution of an Open Forex Market
- 1.2.4 Forex Training Summary and Quiz :
- 1.3 Lesson 2 – Benefits of Forex Trading & Market Participants :
- 1.3.1 Benefits of Forex Trading
- 1.3.2 Market Hours and Liquidity
- 1.3.3 Low Cost of Forex Trading
- 1.3.4 Advantages of Margin-Based Trading
- 1.3.5 Potential Profit Regardless of Market Direction
- 1.3.6 Understanding Leverage – What You Don’t Know Can Hurt You :
- 1.3.7 Forex Market Participants
- 1.3.8 Businesses
- 1.3.9 Investors and Speculators
- 1.3.10 Commercial and Investment Banks
- 1.3.11 Governments and Central Banks
- 1.3.12 Risks Involved in Forex Trading :
- 1.3.13 Leveraged trading carries a high degree of risk
- 1.3.14 Risks of trading multiple markets
- 1.3.15 Risks associated with a Margin Close Out
- 1.3.16 Risk associated with Volatility and Liquidity
- 1.3.17 Deal Only with Reputable Forex Brokers
- 1.3.18 Insist Upon Regulation
- 1.3.19 Forex Training Summary and Quiz :
- 1.4 Lesson 3 – Currency Trading Conventions :
- 1.4.1 What You Need to Know before Trading
- 1.4.2 Trading in The Forex Spot Market
- 1.4.3 Buying and Selling Currency Pairs
- 1.4.4 Anatomy of a Currency Pair
- 1.4.5 Exchange Rates and Spreads
- 1.4.6 What are Pips in Forex
- 1.4.7 How to Close an Open Position in Forex
- 1.4.8 What are End-of-Day Rollovers in Forex
- 1.4.9 Overview
- 1.4.10 Forex Training Summary and Quiz
- 1.5 Lesson 4 – Making The First Forex Trade :
- 1.5.1 Trading Intervals in Forex :
- 1.5.2 Inter-Day Trades
- 1.5.3 Trading a Long-Term View
- 1.5.4 Establishing a Carry Trade
- 1.5.5 Hedging Future Exchange Rate Exposures
- 1.5.6 Using Spot Forex Trades to Hedge Future Exchange Rate Exposures
- 1.5.7 Forex Trading Strategies and Best Practices :
- 1.5.8 Forex Order Types :
- 1.6 Stop-Loss Orders
- 1.7 Lesson 4 – Forex Fundamental Analysis :
- 1.8 Fiscal and Monetary Policy
- 1.8.1 Monetary and Fiscal Policy
- 1.8.2 EMPLOYMENT REPORTS
- 1.8.3 INDUSTRIAL PRODUCTION INDEX (IPI)
- 1.8.4 Forex Training Summary and Quiz
- 1.9 Lesson 4 – Forex Technical Analysis
- 1.10 A Final Word