Learn all the specifics in How to Trade Forex with the Defensive Trading course An Introduction to Trading Forex.
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An Introduction to Trading Forex
What Is Forex?
Starting right at the beginning in this thorough guide An Introduction to Trading Forex we shall start by establishing, What is Forex?
FOREX, also known as FX is the foreign exchange market, where the worlds currencies are traded. It is the most traded and most liquid asset class in the world. Trade volumes are currently around US$1.8 Trillion a day (2018) and were as high as US$5.8 Trillion in 2013.
The concept of Forex is simple enough, buy low and sell high. However, in practice it is a lot more complicated than that.
Before we explore that side of things, let’s first discover what assets we are talking about when we discuss Forex.
Major, Minor and Exotic Currency Pairs
The next step in this course An Introduction to Trading Forex is to establish exactly what will be traded. Here we will be looking at the currency pairs. Currency Pairs are categorised into three areas, Major, Minor and Exotic as below:
EUR/USD – Euro/US dollar
USD/JPY – US dollar/Japanese yen
GBP/USD – British pound/US dollar
USD/CHF – US dollar/Swiss franc
USD/CAD – US dollar/Canadian dollar
AUD/USD – Australian dollar/US dollar
NZD/USD – New Zealand dollar/US dollar
EUR/GBP — Euro/British pound
EUR/AUD — Euro/Australian dollar
GBP/JPY — British pound/Japanese yen
CHF/JPY — Swiss franc/Japanese yen
NZD/JPY — New Zealand dollar/Japanese yen
GBP/CAD — British pound/Canadian dollar
EUR/TRY – Euro/Turkish lira
USD/HKD – US dollar/Hong Kong dollar
JPY/NOK – Japanese yen/Norwegian krone
NZD/SGD – New Zealand dollar/Singapore dollar
GBP/ZAR – British pound/South African rand
AUD/MXN – Australian dollar/Mexican peso
Other Tradable Assets
Commodities – Precious Metals
XAU/USD – Gold
XAG/USD – Silver
UK Oil – Brent
US Oil – Crude
Indices – United States
US30 – Dow Jones
US100 – Nasdaq
US500 – S&P
DE30 – DAX 30 Germany
FRA40 – CAC 40 France
100UK – FTSE 100
Asia / Pacific
JPN225 – NIKKEI
AUS200 S&P ASX
HK33 – Hong Kong
India50 – India
A Short History of Forex
The next point to establish in this course, An Introduction to Trading Forex, it to understand where Forex came from.
While we think of currency markets as a relatively new invention, money changers were first mentioned in the Talmud, in 4th century. The money changers charged a commission, of course.
The next instalment of the industry comes with The Gold Standard, which was set in 1880, the year which many people hold as the start of modern Forex.
Following that, in July 1944 the Bretton Woods agreement was established, which gave way to Forex trading. This agreement established fixed exchange rates between countries whose currency values were all pegged to the U.S dollar, and subsequently the US dollar’s convertibility to Gold at a fixed rate of $35 dollars per ounce.
By the end of 1971 this system had essentially collapsed and was aborted in favour of a Free Market Capitalism strategy where speculation in currency markets determined a floating currency’s value.
This realm was once exclusively available to banks, hedge funds, corporations and other financial institutions who exchanges took place for speculative reasons. However, with the advent of the internet, the scope of the reach of this facility was extended to everyday participants and Forex trading as we know it today was available to everybody.
Detailed Explanation of the Major Currency Economies
In order to fully understand how the exchange rates of economies interact we need to establish the specific character of each economy. Here in this part 1 of the course An Introduction to Trading Forex will will look at the major economies and how they for a part of this course An Introduction to Trading Forex.
Known as the Dollar generally speaking. (Other economies with a Dollar as their currency are referred to, usually, by their name specifically i.e. the Australian Dollar is colloquially referred to as the Aussie in trading circles.)
It has been said that due to the dominance of the US Dollar, “when America sneezes, the world gets a cold”. This is a quaint way of describing the intrinsic nature of the american economy in global business. Afterall, oil and gold and many other commodities are quoted in US Dollars, American foreign policy has an immense effect on global political, and therefore economic, matters.
While many argue that this dominance is coming to its end, due to the meteoric rise of various Asian economies, such as China, it still remains that in the West, at least, the Dollar is King and America dominates.
In terms of stats, nominal GDP and net worth of the entire world are held by the United States, which has the most developed mixed-market economy in the world. In terms of purchasing power parity (PPP), it is second only to China in size. As of 2022, its nominal per capita GDP ranks seventh globally and its PPP per capita GDP ranks eighth.
Canada’s economy is a highly advanced mixed-market economy. Its nominal GDP ranks eighth, and its PPP GDP ranks fifteenth, globally. The service sector, which employs nearly three quarters of Canadians, dominates the economy of the country, as it does in other affluent nations. The estimated total worth of Canada’s natural resources, which was estimated at US$33.98 trillion in 2019, is third largest overall. It is the third-largest exporter of crude oil and has the third-largest proven oil reserves in the world. It is also the fifth-largest natural gas exporter.
The British economy is a highly developed social market and market-oriented economy. When measured by nominal gross domestic product (GDP), purchasing power parity (PPP), and GDP per capita, it ranks as the sixth-largest national economy in the world and accounts for 3.3% of global nominal GDP. In terms of PPP (purchasing power parity), the UK accounts for 2.34% of global GDP.
The United Kingdom, which consists of England, Scotland, Wales, and Northern Ireland, has one of the most globally integrated economies.
The UK was the fifth-largest exporter and fifth-largest importer in the world in 2020.
The collective economy of the European Union’s member states makes up the EU’s economy (EU). After the United States and China, it has the third-largest nominal economy in the world, and after China and the United States in terms of purchasing power parity (PPP). According to estimates, the nominal GDP of the European Union will reach over $16.6 trillion in 2022, or about one-sixth of the world economy.
Switzerland’s economy is one of the most developed and advanced free-market economies in the world. Particularly the Swiss banking sector and tourism have grown to play a substantial economic role in the service sector. Since the 2015 Global Innovation Index and the 2020 Global Competitiveness Report, Switzerland’s economy has placed #1 globally. Switzerland is the third-richest landlocked nation in the world, behind Liechtenstein and Luxembourg, according to United Nations data for 2016. They are the only three nations in the world that are neither island nations nor ministates that have a nominal GDP per capita (US$70,000) or more, together with Norway.
The second-largest vehicle manufacturing nation in the world is Japan. It consistently ranks among the most inventive nations in the world, leading in terms of a number of worldwide patent filing metrics. With China and South Korea posing an increasing threat to its market share, Japan’s manufacturing industry now predominantly concentrates on high-tech and precise products such integrated circuits, hybrid cars, and robotics.
Australia’s economy ranked 14th in terms of nominal GDP (Gross Domestic Product), 20th in terms of PPP-adjusted GDP, 22nd in terms of commodities exported and imported, and 24th overall as of 2022. With the March 2017 financial quarter, Australia set the record for the developed world’s longest stretch of continuous GDP growth.
The service sector, which accounted for 62.7% of the country’s GDP and 78.8% of all jobs in 2017, dominates the Australian economy. The overall value-added of the mining sector was 8.4% of GDP at the height of the mining boom in 2009–2010. The Australian economy had remained resilient and steady despite the recent fall in the mining sector and did not go through a recession from 1991 to 2020.
New Zealand’s economy is a highly advanced free-market economy. When measured by nominal gross domestic product (GDP), it is the world’s 51st-largest national economy. When measured by purchasing power parity, it is the world’s 63rd-largest (PPP). For a country with a 5 million inhabitants, New Zealand has a sizable GDP, and its revenue sources are dispersed over the vast island nation. The economy of the nation is one of the most globalised and heavily reliant on commerce with other nations, particularly those in the Americas, such as Australia, Canada, China, the European Union, Japan, Singapore, and South Korea.
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Why Trade Forex?
Before we can really start to understand how to trade forex, as a trader we will need to understand why we trade Forex. Here in this An Introduction to Trading Forex we will discuss the motivation traders have in trading Forex.
Forex is the biggest, fastest and most liquid financial market in the world. It has an average daily trade volume of between $2-$3 trillion. It is also very appealing to traders from all walks of life because it is a 24/5 market. That being said, the greatest volumes are seen during the UK and US sessions.
In addition, the Forex market also has high level of ‘Liquidity’ which allows fast and easy entry and exit of positions. This is not always so with stocks, for example.
Furthermore, as with most trading, Forex allows for multidirectional trades (long or short positions), so that no matter if an asset is trending upwards, or downwards, you are always able to trade that movement accordingly and ideally make money either way.
In contrast to Equities, Forex has very low associated costs (commissions) and barriers of entry (deposit requirements). Of course, the smaller the account you have, the smaller and less often you can trade, and therefore, the slower you will make any meaningful amount of money. However, as a beginner, simply learning the skill should be payment enough. You can build on this in time.
Lastly, in Forex, you are trading (usually) on a Leveraged account. This effectively means that you are borrowing the majority of the money needed to invest/trade and it is offered by the broker. As a result, when you trade Forex, you are required to have a Margin balance in the account to cover the trades you intend to make. This is essentially, the minimum balance required to place a trade.
How Forex Works
You are already probably a Forex market participant. If you have ever travelled abroad and had to exchange currency, then you completed a physical transaction which is exactly the same as a forex trade. The difference being that, as you needed to use that currency in your destination country, you took ‘delivery’ of the currency and not just speculated on price movements. There are even strategies to use Forex to hedge in anticipation of upcoming travel or business scenarios as a hedge.
As listed above, the Forex market is made up of various quoted exchange rates. That is, the price of a particular currency relative to another. Take for example EUR/USD (Euro / US Dollar). This is given as a single amount because it is indicative of the amount of USD you can buy for 1 EURO.
The BASE currency, in this example, the EURO. This is always the first of the two in the ISO code, so, USD/JPY, the USD would be the base currency. The quote would be how many Japanese Yen you can buy for 1 USD.
The second currency is called the QUOTE or CROSS. This amount is variable dependent on market conditions at a particular time on a particular day.
When you see an increase of the EUR/USD that would mean that the purchasing power of the EURO increasing. This can be for two reasons, either the EURO is getting stronger against the USD, or the USD is getting weaker against the EUR. For 1 EURO you would be able to buy more USD. This would be an opportunity to buy the EUR//USD as the value when you close the trade would be greater than the value when you opened the trade. Let’s say you buy at 1.09 and you sell at 1.12. You made a profit of 0.03.
If you would like to reverse the quote to see how much, for example, a USD/EUR quote price would be you can simple divide 1 by the quote price, e.g. EUR/USD is 1.10, then USD/EUR would be 1/1.10 = 0.9090. so that 1 USD would purchase 0.9090 EURO.
Trade size, in the above example, the profit of 0.03 may not seem like much, however, you need to take the size of the trade into consideration. The amount of a pip/point is variable depending on the size of the trade, measured in LOTS. Depending on a trade size, 0.01 might be worth $0.01 or it might be worth £500.
The overall objective of currency trading is to buy a currency that increases in value relative to the one that you sold. If you have bought a currency and the price appreciates in value, then you sell the currency back to lock in the profit.
Now you have an idea of how the currencies relate to one another, the next question should be, well what makes them move then? In the above example, what would be causing EUR strength or USD weakness and how can I tell the difference? This is where the holy grail of trading Forex comes in, the Economic News These news releases are very largely responsible for the movements in a particular currency on a particular day. These are all conveniently released at predetermined times and at predetermined levels of significance, all of which can be located on an Economic Calendar.
There is a fantastic range of economic calendars available for free on the Internet, however, as with most resources, I cannot go past the range of information published by Bloomberg.com.
Calendars can be used as a reason to trade a specific asset at a specific time. Conversely, as these News releases can have very unpredictable effects on the markets.
Defensive Trading Tip: A Defensive Trader will use the Economic Calendar as a reason not to trade, choosing to stay out of the markets in the hours leading up to a big event. This is due to the, at times, immense and unpredictable volatility that can be seen in an asset prior to a significant release. It is preferred to wait until the dust settles before entering a position, which may be immediately after the release.
This is as we can never be sure of what effect a particular release will have on the price of an asset. I have personally seen a bad NFP number released, which was actually worse than consensus, but the USD/JPY rallied. The interpretation was that it was still a better figure than the month prior, thus, the market took this figure as being good news for the US Economy and priced in the anticipated forthcoming recovery. We explore these Economic releases in detail in Part 3.
Setting Up A Forex Trading Account
Before we can start trading Forex, we need to have a platform through whom to trade. In this course An Introduction to Trading Forex we will here explain how to set up a trading account.
In order to trade forex, you will need a trading account which you will open with a Broker.
Various brokers offer slight differences in their services, however, one of the main differences that you will notice as a trader is the type of spread they offer on their assets are either fixed or floating. I discuss spread in more detail in Part 2 of the course.
You are completely at liberty to choose a broker who you feel is more suited to your needs but make sure that they offer the best software and that they are regulated, ideally in your jurisdiction. Here at Defensive Trading we work with several partner brokers whom we strongly recommend for a range of reasons, chiefely of them being execution speed, customer service and range of tradable assets.
Throughout this course we recommend that you learn to trade by using downloadable charting software known as MetaTrader™. This software is offered for download for free by all reputable brokers. If you require any assistance with this process, please contact us for more information broker.
Setting Up Forex Charts
This step in one of the most important in this part of the course An Introduction to Trading Forex. In order to trade you will need to access the trading charts, either in your web-based account with your chosen broker, or on MetaTrader™.
When starting to trade you will have to select one of each of the following options:
1. Asset (Currency Pair/Index): Open a chart in whichever asset you are interested in trading in.
2. Chart Type (Line/Candlesticks/ Bar): Choose which type of chat you prefer to look at. Most use candlesticks but also line chart can be useful at times.
3. Time periods: Each asset is available in a variety of set timeframes (minutes, hours, days, weeks) and much can be understood from this, which will affect your view of a currency’s future direction
Why Are Charts So Important?
If you think about it, charts are a visual representation of the movements in the price of an asset represented as a graph. Without these charts, we would not be able to perform any kind of technical analysis whatsoever. It is also a way of us being able to go back and look at key moments in the asset’s price history. This can provide us with valuable information on how the asset tends to behave under certain conditions, which can allow us to form an opinion as to what the likely future behaviour may be.
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Styles of Trading Forex
This is the shortest time frame of trading. The idea is to keep the charts on the 1, 5- or 15-minute timeframes and relies on incredibly fast action opening and closing positions, often within a few seconds. The aim is that the profits of each successful trade are small, but that the volume of them is large enough to add up to an overall profit which is decent enough to warrant the time investment.
This style of trading is dependent on traders having access to very tight spreads and a very fast and reliable internet connection. It also required stop-loss limits being set every trade so that any bad decisions that lead to losing trades do not wipe out the entire amount of profits made. It is also a style of trading that can take advantage of economic news releases which can be the occasions which can cause largest predicted vitality in an asset.
Please note that many brokers or market makers discourage this style of trading and some will outright ban it due to the difficulty posed for them to cover opposite side of the positions that are opened and closed in such quick succession.
This is arguably the most popular and well-known style of trading. As the name would indicate, it is trading on a timeframe whereby the duration of a trade does not exceed a single day. The idea is not to hold positions overnight to avoid rollover costs and the risk associated with the unpredictability of price changes that take place while you are asleep or away from the charts.
This style of trading is not as frantic as scalping, however, it relies heavily on the trader’s time investment and patience waiting for good quality trading opportunities to arise. As with scalping, the Day Trader relies heavily on the economic data releases to predict when a particular asset will experience a significant move.
This style of trading is characterised by traders holding positions for a several days to a week or so. As with Day Trading, the trader’s objective is to identify trends early and ride the move to maximise profits. The profit level is set higher than with Day Trading or Scalping and the time allowed for a move and the range of the move is set higher. This style of trading, however, is set to incorporate overnight risk.
Swing traders need to keep up to date with fundamental and technical analysis of the changes in the markets, even when not watching the charts.
This is the trading style that spans the longest timeframe and can see traders holding their open positions for weeks or months. Position traders aim to identify medium to long term trends playing out. It allows traders to make very sure that they are correct in having identified trend before they enter the position, it also allows them to have several different entry points over the course of several day’s, or weeks, as the trend deepens in the trader’s favour. In this style of trading, positions can also be closed by placing a trailing stop to gradually close out of positions as the asset trend starts to move against the trader, while still being in profit.
This method of trading is the least onerous in terms of time investment and the profit expectation is also by far the largest among the trading style options. It is, however, dependent on a particular asset trending in a certain direction, which often isn’t the case, so this can mean that much of the year is spent with no trading activity on your account at all, but waiting patiently for the right trade to appear.
Which Trading Style Is Right for You?
Here in this course in An Introduction to Trading Forex we discuss which style of trading is right for you. In reality, this depends on two factors. One is the time investment that you are realistically able to make. Understandably, due to the volume of trading, you do not usually see magnitude of moves in assets during the Aussie session as you would expect to during the European session leading into the US session, based on sheer numbers of traders. It is, of course, possible, however, you will also see many traders staying up all hours of the night waiting for asset prices to move during the aforementioned sessions.
The second factor is, what the nature of the markets is at the time? There are really two main types of market. Volatile and not volatile. They each have their advantages, however they both require drastically different approaches in order to navigate them successfully. We explore volatility and what this means for your trading further on in Part 2.
Personally, as a defensive trader, I use all styles are various times with the exception of scalping. This is a very onerous style in terms of time investment and arguably one of the most high-risk approaches as it is largely based on luck and a high level of intimate knowledge of the behavioural tendencies of an asset. However, please do not fall into the trap of thinking you have to pigeonhole yourself into one particular style of trading. That is foolish. Use all beneficial elements of trading to your advantage.
On a typical day, I will do analysis (if it isn’t already in place) on a daily and 4 hour timeframe to get a broad idea of where the asset has been and, therefore, to get an idea of where I believe it is likely to go and when / what my trade should be. I will then go down to an hourly and half hourly time frame in order to get some more focused information on where the best enter my trade, how long I am required to wait for the order level to be hit.
Ultimately it will come down to personal preference, however, the more adaptable trader is, the greater their ability to respond to changing market conditions and thus trade accordingly.
Follow on from this with the Ultimate Course in How to Trade Forex – Part 2.
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