What is Forex Trading and how does it work

 

What is forex trading and how does it work?

First of all, you need to know that the Foreign Exchange(Forex) Market is the largest market in the world. Over $3 trillion is traded per day.

It is run electronically across a network of banks 24 hours a day and 5 days a week(weekdays) according to your time zone.

It involves exchange of one currency for another. For example, selling the Euro to get the American Dollar.

Secondly, different currencies have different values per unit. For example, one American Dollar has more buying power(can buy more goods/services) than one Japanese Yen.

Where does active forex trading come in?

Currencies fluctuate in value against each other. For example, the American Dollar can rise in value against the Euro

This may be due to:

1. Fundamental factors such as inflation, interest and employment rates in countries/country that use those specific currencies.(Main cause)

2. Random currency exchanges done my thousands of people like travelers or business people who want to buy goods from a country that does not use the currency that they have in hand.

How does those factors stated cause fluctuation in the value of a specific pair of currency?

Let’s say America is doing better economically compared to Europe. For example, the inflation rate is low.

Investment institutions like banks and hedge funds will start to sell the Euros they had in their accounts to get the more stable American Dollar.

Due to the basic rule of supply and demand the Dollar will tend to rise in value against the Euro, because the investors will be willing to pay more Euros to get Dollars from other investment institutions.

How often do currencies fluctuate in value against each other?

Fluctuation during the day is commonly known as volatility.

It happens almost every time when the Forex Market is open but is higher when the four main global trading centers are open(during their respective day time).

These are:

London in the UK

New York City in the USA

Tokyo in Japan

Sydney in Australia

This is because lots of transactions occur in these cities which involve large units of currency.

Note that there is a time when the London session overlaps the New York session.

Volatility is highest at this time.

This occurs between 12 A.M. GMT to 4 P.M. GMT.

GMT is the abbreviation for Greenwich Mean Time.

Day traders like to trade at this time due to the increased volatility.

Which are the main currencies traded by traders

They are 8 in number.

They are denoted by three-letter codes.

They are:

 

1. USD(US Dollar)
2. EUR(Euro)
3. JPY(Japanese Yen)
4. GBP(British Pound)
5. AUD(Australian dollar)
6. NZD(New Zealand Dollar)
7. CAD(Canadian Dollar)
8. CHF(Swiss Franc)

Doing the actual trading

As you have seen, currencies rise and fall in value against each other, so they are traded in form of a currency pair. For example, the Euro against the US dollar which is denoted as EUR/USD.

Why learn FOREX Trading and how to get started in FOREX Trading

 

Why learn FOREX trading

Forex trading requires little starting capital. You can start trading with a $100 account or even less but I recommend a minimum of $100.

You can do forex trading while having a full-time job or even as a full-time student.

The forex market is open 24 hours a day so you can easily schedule your trading.

You can do it anywhere, because all you need is a smartphone and an internet connection.

How to get started in FOREX trading

As a beginner, you need to understand that there are two types of trading accounts.

That is:

   1. A demo account, which you will not be using real money to trade but fake(paper) money.

   2. A live account, which you use real money to trade.

When you are getting started, you should first open a demo account to better understand the basic concepts of Forex trading.

How are trading accounts opened?

To start forex trading, you need to install a trading platform. The best free platform is an app known as MetaTrader 4. The app is available for both android and iOS.

The app is commonly known as MT4. The app contains all the tools that a trader needs to do forex trading.

But first, the app will need to connect to your forex trading account.

But where do these forex trading accounts come from?

Trading accounts are provided by Forex Brokers, but when you open the MT4 app, you are provided with a demo account with real-time currency data by the app itself.

Who are Forex Brokers?

A Forex Broker is not a person as some might imagine. A Forex Broker is a company and a financial service provider that lets you buy and sell currency.

The broker is like a middleman between traders and the interbank(network of banks) where currency exchanges occur.

The broker provides access to the market and sends the currency data to the trading platform, while the trading platform allows you to analyse the data and perform trades on real-time. 

Brokers allow you to either open a Demo account or a Live account with them.

How to get or choose a Retail Forex Broker

To get a Forex broker, you just perform a simple search on Google to look out for REGULATED Forex brokers in your country.

The broker should be regulated to ensure that they are genuine Forex Brokers.

All reputable and regulated brokers have their websites where you are guided as you fill in your details to open either a Demo or a Live account.

After you have created your account, most probably they will reach out to you via a call, email or text.

Even if they don’t, they will have specified the platforms(app), most probably MetaTrader 4 or their own app, where you will link your account and start trading!

Where do brokers get their currency prices from

First, you need to understand that the Forex market is a decentralized, over-the-counter(OTC) market, so it is not exchange-based like the stock market e.g. in US stocks(shares), there is the New York Stocks Exchange(NYSE).

This means that currency prices may vary slightly across banks and brokers.

Regulated and reputable forex brokers base their price on the prices of other Forex participants, mostly big banks. The forex broker collects these prices in real time within milliseconds using software bots(robots), to find the best available bid and ask price for currencies.

Regulated and reputable brokers cannot show incorrect currency data or mess up with the prices because they are constantly monitored and will never risk losing clients(traders).

How money is made in forex trading

Forex traders make money by speculating on currency prices. That is, whether a certain currency will rise or fall in value against another currency.

If they speculate that a certain currency will rise in value against another currency at a specific time, they will buy it, and if they speculate that it will fall, they sell(short) it.

If their speculations come true, they can make huge profits within a short duration, depending on how they placed their trade.

A real-life example of making money by buying using this method is when you buy a product at a low price then sell it at a higher price.

A real-life example of making money by selling using this method is when you sell a product at a high price then buy it back at a lower price. This is commonly known as short-selling or simply shorting.

How are forex traders able to correctly speculate on currency prices?

Forex traders use two types of Forex data analysis to correctly speculate on currency prices.

Namely:

1. Technical Analysis
2. Fundamental Analysis

What is the difference between Technical and Fundamental analysis

Technical analysis involves the use of Forex Charts(Graphs), Technical Indicators and other tools, all provided by the trading platform to understand price action.

Fundamental analysis is the analysis of the impact of political and economic factors on the relative value of a currency.

To be able to learn and apply those two types of analysis, you will have to:

1. Know how to read a currency quote for a certain currency pair.
2. Learn the fundamental Forex terminologies and some simple calculations behind them.
3. Understand what a candlestick chart(graph) is and interpret it.
4. Learn how to use MetaTrader 4. That is, placing trades by either buying or selling currencies in the platform so as to make money.
5. Know about risk management in trading.

In my website, you will be able to learn all of the above.

Reading and Interpreting Forex Currency Quotes

 

How to read a currency quote for a certain currency pair

A currency quote for a currency pair like the Euro against the US Dollar is written as EUR/USD

In that case, the Euro is called the base currency because it comes first while the US Dollar is called the quote currency.

How are quotes used in the forex charts

Let’s assume that the US Dollar and the Euro have equal values and equal supply and demand.

In that case, EUR/USD or simply the Euro divided by the US Dollar, would be equal to 1.

But we all know that that is not the case. At the time of making this post, one Euro had more value than one US Dollar.

This means that during that time, EUR/USD was greater than 1, let’s say 1.12345

What does the quote price(number) mean

If the value of the Euro continued to rise that quote price number would continue to increase but if the opposite happened the number would reduce.

You can also translate that quote to mean that 1 Euro is worth 1.12345 US Dollars.

Note that the increase and decrease normally, is not very big and almost all the time, it involves only the numbers in the decimal places.

Representation of the increase and decrease in the relative price of currencies in the Forex Charts

The increase and decrease in price is represented in Forex Charts by Candlesticks.

Each candlestick represents a specific period of time like one hour or one day, which you can customize in the Trading Platform.

Forex Terminologies and the simple calculations behind them

FUNDAMENTAL FOREX TERMINOLOGIES AND THE SIMPLE CALCULATIONS BEHIND THEM

What is a pip

In a currency pair quote, the pip is the number in the fourth place after the decimal point.

For example, if the EUR/USD is at 1.12365, 6 is the pip.

But there are currency pairs like US Dollar against the Japanese Yen where the quote looks like USD/JPY 135.627

So, do you give up on such a pair? Well, not so fast. The pip in that case is the number in the second place after the decimal point. In that case, the pip will be 2.

Price Terminologies

Bid price = The price that you can sell at, at the moment.

Ask price = The price that you can buy at, at the moment.

Spread = The difference between the bid and ask price. B book brokers have a spread, from which they make a small profit from, but at most times, they charge no commission.

Swap = The interest that a broker can charge you if you keep a trade overnight.

Other Common Terminologies

Going Long = Buying

Going Short(Shorting) = Selling

What is leverage

Leverage is the money that you borrow from your broker.

It is shown in form of a ratio, e.g. 1:100

Let’s say you have a $1000 trading account and you select a leverage of 1:100 when creating your trading account.

$1000*100 = $100,000

That shows, you can place trades like a person who has a $100,000 trading account.

Leverage is good but is dangerous if misused. Some countries like the US have a leverage limit of only 1:50, but even if you are in the US, you can use overseas regulated brokers who can offer huge leverages if you need them.

Misconceptions about leverage

Most people say that huge leverage by itself is risky but that is not true.

Huge leverage can only become risky in two cases:

1. When you enter into very many trades at the same time because the leverage allows you to do so.
2. When you enter into a trade with a huge lot size, because the leverage allows you to do so.

What is Lot Size

Lot size is the amount of currency units that you are entering in a trade with

The most used lot sizes in the forex market are:

1. Standard lot, also known as 1 standard lot, which equals 100,000 units of the base currency
2. Mini lot, also known as 0.1 standard lot, which equals 10,000 units of the base currency
3. Micro lot, also known as 0.01 standard lot, which equals 1,000 units of the base currency

You can see trading those lots need a lot of money(currency units). That is why you need leverage.

In MetaTrader 4, there is a section where you select the lot size that you want to enter a trade with. I will guide you in my MetaTrader 4 tutorial.

What is pip value

In the previous sections, we looked at what pips and lots are.

Pip value is based on pips and lots, so we had to learn them first.

Pip value, basically tells you how many dollars you will make or lose for each pip movement.

For example, you bought the USD/CAD pair when it was at 1.31235 and then it rose to 1.31245. That is considered to be a rise of 1 pip.

In that case, how much money will you have made? Well, that will depend on the lot size you entered the trade with.

Pip value calculation

To get the pip value, the simplest method is to multiply your lot size by 10, with the Japanese Yen pairs being an exception to this formula, where you multiply the lot size by 1000

Note that the pip value that you get in those calculations is usually in the quote currency. In our USD/CAD case, our quote currency is the Canadian Dollar, so the pip value you get will be in Canadian Dollars.

If you had bought 1 standard lot of USD/CAD, the pip value would be 1*10 = 10 CAD. If the pair finally went up by 5 pips you would have made a total of 10*5 = 50 CAD.

If your trading account is in US Dollars, the broker will automatically convert your profits and loses to USD. In most pairs, the quote currency is usually the USD, so there is no that conversion stuff.

But if you want to know how to convert that gain to US Dollars manually, just divide the 50 CAD by the price(exchange rate) which you bought the pair e.g. 1.31235. That is: 50/1.31235 = 38.1 USD

Main purpose of pip value calculation

But do you need to do all that pip value calculation stuff? Well, the good news is no. You don’t need to.

The whole purpose of learning pip value and how it relates to the lot size, is to introduce you to the basics of one of the major pillars of successful forex trading known as risk management and position sizing.

The good thing, is that there is a free software you can use to calculate the position size(lot size) to use whenever you are placing a trade, without calculating the pip value.

In my risk management and position sizing post, you will be able to learn more about position size and how to calculate it in a few seconds using a free software.

Forex candlestick charts

 

Forex candlestick charts

Forex traders analyze currency pair data on a unique graph known as the Forex Chart that has candlesticks, which represent the price action.

Each candlestick represents what has happened to the price in a specific period of time.

In the trading platform, you can set a custom time which each candlestick represents. This is known as setting a time frame.

How to interpret a candlestick

A candlestick has a body and one or two wicks(shadows).

The body represents the price range between the open and close of the candle. For example, if you had set a timeframe of 1 hour, each candle will show the price level when a certain hour started and when the hour ended.

The wicks will show the maximum and the minimum price level during that time frame.

In the diagram above, you can see that the candlestick shows a lot of market price data in a simplified way.

From the candle, you can identify the maximum price reached during the time frame, the closing price, the opening price and the minimum price reached.

Types of candlesticks(candles)

There are two types of candlesticks. These are:

1. A bullish(bull) candle.
2. A bearish(bear) candle.

 A bullish candle shows that the price of the base currency has increased against the quote currency over the period it represents while a bearish candle shows that the price of the base currency has decreased.

Well, how do you differentiate between a bull candle and a bear candle?

Simply, it’s just the colour.

At most times, the default colour of a bull candle is either green or white, while for the bear candle it’s either red or black.

You can customize the colour and the timeframe in MetaTrader 4.

 The diagrams above, can help you to differentiate a bear candle and a bull candle.

Because a bear candle shows decrease in price of the base currency, you can see that the opening is higher than the closing of the candle.

The bull candle, shows increase in price of the base currency, hence the closing is higher than the opening of the candle.

How to Install MetaTrader 4 and open a Demo Account

 

How to Install MetaTrader 4 and open a Demo Account

Go to the Google Play Store or Apple App Store.

Search MetaTrader 4

Tap Install

Open the app after installing and a screen like the one shown below will appear

Tap accept and the app will automatically create a Demo Account for you.

But let me show you the best way to open a Demo Account.

After MetaTrader 4 had created a Demo Account for you, a screen like this will appear

Tap on the menu icon on the top-left of your screen as shown above.

Tap manage accounts.

Tap the plus icon on the top-right of your screen.

The best Demo Account to use is the one that you have opened with an actual broker.

This is because it familiarizes you with the broker.

If you have already opened a Demo Account or a Live Account with a broker, tap login to an existing account.

Find a broker by searching in the search bar.

If you have not opened a Demo Account with a broker, just tap open Demo Account.

Tap MetaQuotes Demo.

Fill in your personal information.

Account type, select Forex-USD

For leverage, just select the maximum, which is 1:100

For deposit, $10,000 dollars is okay.

Then tap create account.

Finally, tap done.

Your Demo Account is now set!

My next blog, will be a MetaTrader 4 masterclass. I will guide you step by step, on how to use the platform.

MetaTrader 4 Masterclass. Using the platform and placing a trade

 

METATRADER 4 MASTERCLASS

The four major tabs of MetaTrader 4 and placing your First Trade

From left, the four major tabs of MetaTrader 4 are:

1. The Quotes Tab
2. The Charts Tab
3. The Trade Tab
4. The History Tab

Take a look of the Tabs below.

This is the landscape view of the MetaTrader 4 app, with the four main tabs listed.

Quotes Tab

The tab below, is the quotes tab.

The most common quotes that traders trade are in the tab on default.

But if you want to add another quote that is not there because you want to trade it, just tap the plus icon.

If you want to remove a certain quote, tap the edit icon.

You can always add a quote even after removing it.

The spread is also shown in the quotes tab.

For EUR/USD, you can see the spread is written as 16, but you should divide that number by 10 and read it as a 1.6 pips spread.

The quotes tab is the most convenient tab to place a trade.

To trade a certain pair, just tap it.

In this example, let’s use the EUR/USD pair because it is the most commonly traded pair and at most times, it has the lowest spread which is good for you as a retail trader.

After taping the pair, a window will appear where you will tap new order to place a trade.

The upper selection bar shows the type of order.

Immediately after it, is the Lot Size.

For the type of order, select the first one which is Market Execution, also known as Instant Execution.

We will discuss about other types of orders later in this article.

For the Lot size, you can select the micro lot, which is 0.01 Standard Lot.

It is the lowest lot size you can select, so it lowers your risk.

But when you are using your live account, you will not select your lot size randomly, the way we are doing it here.

When we look at risk management and position sizing, you will know how to perfectly select your lot size, which is also known as position sizing.

After selecting your Lot Size tap either Buy or Sell, since this is just a random trade in your demo account.

Because you had selected Market Execution, your order will be filled instantly at the then Buying or Selling price.

But what about other types of orders.

Types of orders

Other Types of Orders apart from Market(Instant) Execution

They are also known as pending orders.

They can also be categorized into two groups:

1. Limit orders.
2. Stop orders.

Limit orders

They are two: Buy limit and Sell limit orders

Buy limit order

You select buy limit when you want to buy at a price lower than the current market price.

When you select buy limit, you have to specify that low price you want to buy at. In all pending orders you will have to type the price you want to enter the trade at, MetaTrader 4 will prompt you to do so.

That order will only be executed if the price goes down, up to the price level you had specified. That can take minutes or days. If the price never goes down to the level you had set , your order will never be executed.

Sell limit order

You select sell limit when you want to sell at a price higher than the current market price.

Stop orders

They are two:  Buy stop and Sell stop orders

Buy stop order

You select buy stop order, when you want to buy at a price higher than the current market price.

Sell stop order

You select sell stop order, when you want to sell at a price lower than the current market price.

 

Chart Tab

Let’s now look at the Charts Tab.

The best way to go to the Chart Tab is to tab is to tap the currency pair in the Quotes Tab that you want to analyze.

 After taping, a window will appear where you will select open chart.

After doing that, you will be now in the Charts Tab.

You can customize the colour of the Bull and Bear Candle by taping on the menu icon on the top-left of your screen.

Then go to settings.

Tap colours

Tap the colours of the Bull and Bear candles and a window will appear, where you can change them.

Here, you can see that I have changed the colour of the Bull candle to green and the Bear candle to red.

Here, you can see that the chart looks better and easier to analyze after changing the colours.

To select the Time Frame in portrait view, tap anywhere in the chart and a Time Frame selection wheel will pop out.

You can now select a custom Time Frame.

I will guide you on how to select a time frame that will suite you in another article.

To get a better view of the charts for Technical Analysis, rotate your screen to have a Landscape View.

Tap anywhere on the screen for side bars to appear.

You can select a time frame in the left-side bar, while the right-side bar contains tools for Technical Analysis.

Tap the f-function sign to add indicators.

Tap the upper f-function sign to add indicators in the main chart.

Tap the lower f-function sign to add indicators in the lower indicator window.

Note that you don’t have to add any indicators.

I will show you how to use the most useful indicators when we will be studying Technical Analysis.

To add objects like lines in the chart, tap the icon that is made up of various shapes.

Tap on any object to add it in the chart.

Indicators and objects just help you to do your technical analysis.

Trade Tab

Now, let’s look at the Trade Tab

The trade tab shows the active trades and the money you have made or lost in them.

Also, there are account details in the trade tab, which are:

1. Balance
2. Equity
3. Free Margin
4. Margin Level Percentage
5. Margin

Let’s look at what they mean

Trade Tab Terminologies

Balance = This is the value of your account before taking into account any open positions

Equity = This is the current value of your account including the value of any open positions

Free margin = This is the amount in your trading account that is available for trading

Margin = This is the amount of money you need to have in your account to cover any open positions

Margin level (%) = Indicates the health of your account while you are in a trade

A healthy account must have a margin level percentage of 100 and above.

If it goes below 100, you get a notification called a margin call from your broker, to deposit more money in your trading account or close the open positions.

If you don’t do that, your margin level percentage might get to a stop out level, where all your open positions are closed automatically by your broker.

 

History Tab

This is the History Tab.

The tab shows all your closed trades, and the profit or loss you made in them.