I. Introduction to a new possibility -Page 4
II. What is the Forex market? -Page 5
III. Trading Hours -Page 6
IV. Differences of FX to other markets -Page 8
V. How Currency Trading Works -Page 10
VI. What Is Long or Short? -Page 13
VII. What price to buy and sell? -Page 14
IX. What is a margin? -Page 20
X. Suitable trading styles for you -Page 22
XI. What kind of trader are you? -Page 24
XII. Knowing the psychological aspects -Page 48
XIV. Reasons to trade Forex -Page 54
XV. Benefits of Forex trading -Page 56
I. Introduction to a new possibility
Before jumping into the introduction of the Foreign Exchange market, let me point out why I decided to write this book. The main reason is that I have been working so hard for long hours and for a pay that is not worth mentioning. I found that with that job that I had, I had neglected my loved ones, and even worked myself sick! I found myself not enjoying my work days, as I dragged myself out of bed to go to work and hoping the nightmare would end. Health problems started coming, and we all know that the costs just to visit a doctor and getting your medicines can be costly.
I started questioning my worth. I talked to my superiors and did get my increments, but I knew I was still underpaid. I knew I can get more. I knew that I am worth more than what they gave me. I can make more in less time than working from others for long hours and getting the same paycheck. In my line of work, I was already exposed to the foreign exchange market but did not utilize it until I was sick and tired of my work.
Severely overworked and underpaid, with theories in hand, I opened my currency trading account, and experimented with trading techniques and styles, and learning through experiences and external sources on how to trade better, while working full time.
There were losses incurred at first, but the frequency of losses made reduced, and the gains started coming. I know I can make more. I know I am worth more, and I feel better day by day.
Trading this flexible market does help in bringing in more cash, and I can even trade this market during working hours or after that when I am at home. And, I know that I can trade this market full time if I wanted to.
Why did I write this book? Maybe I want to let more people, who are like me, know about another option of making money and not to be stuck in a situation that they are not happy at day by day. So, let me start with the introduction of this flexible and rewarding market.
II. What is the Forex market?
The foreign exchange market, or usually called the forex or FX market, is the largest and most traded financial market in the world. Foreign exchange is the simultaneous buying of one currency and selling another, and will be present when a Japanese father is looking to buy some Kiwi dollar for his children studying in New Zealand, a Malaysian company looking to invest in China and having to hedge the Malaysian Ringgit to the Chinese Yuan, a U.S. company buying parts from Canada having to pay in Canadian dollars, to an Australian traveler planning to travel to Bangkok having to buy some Thai Baht to use for his or her stay there.
There will be more examples to the above listed, but the 2 main reasons to buy and sell currencies are that about 5% of daily trades come from companies and governments that buy or sell products, or services, investments, and other interests in a foreign country or must convert profits made from foreign countries in foreign currencies to be converted into their own domestic currency. The other remaining daily trades come from speculation.
A most commonly traded market, and most liquid, will be the best market for any traders, as it will be faster and easier to buy and sell the stock or commodity. Also, liquidity is very important as it determines how quickly prices move between trades. Thus it will be easier to buy and sell at your target prices in a liquid market.
The above holds true for the foreign exchange market, and there are even more trading opportunities with the most commonly traded and most liquid currencies, which are the major currencies. It has been estimated that more than 85% of all daily transactions are taking place in the major currencies like US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar, and Australian Dollar.
III. Trading hours
The currency market opens for 24 hours for six days a week, normally from Sunday 5:00 PM ET to Friday 5:00 PM ET, and trading normally begins in Wellington, New Zealand and moves around the international financial centers to like Sydney, Tokyo, London, and New York, enabling traders to react to news and events as they happen.
Currency trading does not stop for holidays and will be open even if the other financial markets, like stocks or futures exchanges, are closed. The only holiday for the currency market is New Year’s Day, where the rest of the world stops to celebrate the arrival of a new year.
It is also the place where a hundred million dollar trade can take place in a matter of seconds and a click of a button. That will be the domain of the banks and the hedge funds. But, we do not have to worry about that, as with a daily average turnover of US$2 trillion, the hundred million dollar trade looks small in comparison. It has been stated that to understand how big the average daily turnover is, it is about 10 to 15 times the size of daily trading volume on all the world’s stock markets combined.
Currency trading can be divided into 3 sessions. As the market starts in Wellington, the currency markets begin in the Asia-Pacific session. The principal financial trading centers are Wellington, Sydney, Tokyo, Hong Kong, and Singapore. That means news and data reports from New Zealand, Australia, and Japan will have an impact on the market during this session.
As we move across the globe, the European financial centers begin to open, giving us the European/London session. News and data reports from the Eurozone (countries like Germany), Switzerland, and London will have an impact on the market during this session. As a result, European currencies like the British Pound, the Euro, and the Swiss Franc will likely be the biggest movers here.
Continuing our move across the globe, we will come to the North American session, where the key U.S. economic data will make an impact on the U.S. Dollar. Reports are usually released at around 8.30 to 10.00 AM ET and the Canadian data coming out at around 7.00 to 9.00 AM ET.
With the overlapping of the European session with the Asian trading hours and the North American hours, this is the session where you can find the most market interest and liquidity.
Thus, after knowing the trading hours, you can plan your trading time. IV. Differences of FX to other marketsDue to the large volume of participants in the market, the risk of insider information is greatly reduced. The market usually moves in anticipation to news that is released in the market. News like whether the Bank of Japan will increase lending rate etc. Thus, the news will be made known to everyone.
Also, the volatility of the major currencies rarely exceeds 1% per day, in contrast to the volatility of stocks, which may fluctuate by up to 10% over one trading session.
Trading is not centralized on an exchange and can be conducted between two counterparts over the telephone, or via an electronic network, as the currency market is considered an Over-The-Counter (OTC) or interdealer market. Thus you do not go to the New York Stock Exchange to place your currency orders, but you will have to go through a brokerage firm to place your orders. Placing your orders can mainly be done through the trading platform that your broker will provide to you, or through telephone calls to your broker.
Of course, the biggest advantage that you will get from trading the Forex market is that this market is open 24 hours for 6 days in a week instead of the standard a few hours of trading hours per day for some other financial and commodity futures and equities markets. With the continuous trading hours, you can easily enter into a trade at your preferred time, and correct your positions at any point in time. So, you can trade when you are in the office before your lunch, during your teatime if you have that privilege, before your boring meetings, before dinner, after dinner, during supper, while watching your late night movies… You decide.
Also, with the large number of players in the market, with the narrow spreads provided, you can easily meet your target profit level faster.Remember, the best difference that the Forex market can provide you is to trade on your schedule, day or night, instead of you having to follow a certain trading hour for the day. You are the master of your trading time. This is useful for people who are burdened with a 9 to 5 work, or other professions with long working hours. This opens the game to many individuals who might not have the time available to trade normally. You can also be traveling in another country and still be trading on your currency account.
V. How Currency Trading Works.
As you know from above, currency trading is the simultaneous buying of one currency and selling another. In a stock market, when a participant buys a share, he or she will own that share. When the participant wants to exit from the position, he or she will have to sell that share.
In currency trading, the purchase of a currency will have to involve the simultaneous sale of another currency. To put it simply, remember the example of the Australian traveler? For the traveler to be able to pay for food and expenses while he or she is staying in Bangkok, the traveler will have to buy some Thai Baht, and sell the Australian dollar, the domestic currency. Thus, when the traveler is at the money changer in the airport in Australia, he or she will have to sell the Australian dollar carried in the pocket, and buy the Thai Baht.
The logic of buying and selling simultaneously is easy if you see that you are looking to buy or sell the desired currency against another currency.So if a trader is looking for the U.S. Dollar to strengthen, the trader will have to think that the dollar will have to go stronger against another currency. Thus currency trading comes in pairs, and traded or exchanged against one another.
For the major currencies that we have discussed above, the following will be the codes for the most frequently traded currency pairs:Major U.S. Dollar Currency Pair:
- EUR/USD, or Euro-Dollar
- USD/JPY, or Dollar-Yen
- GBP/USD, or Sterling-Dollar
- USD/CHF, or Dollar-Swiss
- USD/CAD, or Dollar-Canadian
- AUD/USD, or Aussie-Dollar
- NZD/USD, or Kiwi-Dollar
- EUR/CHF, or Euro-Swiss
- EUR/GBP, or Euro-Sterling
- EUR/JPY, or Euro-Yen
- GBP/JPY, or Sterling-Yen
- AUD/JPY, or Aussie-Yen
- NZD/JPY, or Kiwi-Yen
If the above Australian traveler wants to go to the United States of America, the traveler will require some U.S. Dollar to spend there. Therefore, the traveler will have to sell the Aussie and buy the Dollar, or exchanging the Aussie for Dollar, or selling AUD/USD. If the traveler is going back to Australia and has some excess Dollar that is not required, the traveler will sell the Dollar and buy Aussie, or buy AUD/USD.
In AUD/USD, the first currency in the pair, the Aussie, is the base currency, and the Dollar is the quoted or secondary currency. The base currency is what you are buying or selling against the secondary currency. Thus, when you are thinking that the Euro will strengthen against the Dollar, you are looking to buy Euro and sell Dollar. Thus, you will be buying EUR/USD. If you are looking to buy the Yen against the Dollar, you are selling USD/JPY, because you have to sell the Dollar to buy the Yen. Similarly, if you are looking to buy Yen against the Euro, you are selling EUR/JPY. Get the pattern?
To explain further, the base currency is what you are buying or selling. Thus, when you buy 50,000 EUR/USD, you are buying 50,000 Euros and selling the equivalent amount in the US Dollar. If you sell 50,000 EUR/JPY, you are selling 50,000 Euros and buying the equivalent amount of the Japanese Yen.
The secondary currency will be the profit and loss that you will make, or what you get at the end of the day. If you buy EUR/JPY today and you take profit after it goes up two days later, your profit will be in Japanese yen and not in Euros.
An easy way to understand this is to think that you have some Euros on hand and you are planning to go to Japan next week for a holiday. You feel like going to the money changer today to sell your Euros and buy some Japanese Yen. But you feel that the Euro will strengthen against the Yen, so you wait for two days. In two days, the Euro did strengthen against the Yen and you went ahead to the money changer to make the change.
In reality, you have gained more by selling your Euros and buying the Yen today than from two days ago. So, if you bought the EUR/JPY two days ago, and sold the EUR/JPY today, you actually buying the Euros and selling the Yen two days ago, the Euros strengthened and the Yen weakened in comparison, and by squaring your trade today, you are actually selling the Euros at a higher rate, and thus buying the Yen at a comparatively cheaper price.
VI. What Is Long or Short?
As a participant in the Foreign Exchange market, there is one thing that you have to understand. Imagine that you have just opened a currency trading account. You think that the Euro will strengthen against the dollar and bought the EUR/USD. Your position in your account will be long EUR/USD. No matter if the Euro weakened or strengthen against the Dollar, as long as you still have this position open in your account, you are still long EUR/USD. When the Euro strengthened against the Dollar and you decide to take profit, you will sell EUR/USD, thereby squaring your position. Having no position is to be square.
If after squaring, you feel that the Euro will weaken against the Dollar, you will be selling the EUR/USD. Thus you are now holding a short position in your account. You will only be square when you buy back the EUR/USD and close the position.
Thus, when you have just opened your currency trading account, you have zero, or no, position in your account. Your position in your account will be long when you make a fresh purchase of a currency pair, and will be square when you sell that currency pair. Think of it as going back to square one.
With a square position, if you made a sale on a currency pair, your position in your account will be short.VII. What price to buy and sell?
If you have seen the prices on any trading platforms or websites for any securities and commodities, you will know that there are two prices that you will see for each security. This is also the same for the currency trading. The price on the left is called the bid, and the price on the right is called the offer. Sometimes the offer is also called ask. The bid price is where you sell the base currency, while the offer is where you buy the base currency.
Since the bid price will always be quoted lower than the offer price, you may ask why you are buying at a higher price and selling at a lower price. The brokers will have to make something as they provide a service or trading platform for you, and thus, they will have to sell you basis the offer price when you are looking to buy. The price difference between the bid and offer is called the spread, and this spread will vary from broker to broker and by currency pairs.
Generally, the more liquid the currency pair is, the narrower the spread will be. Intuitively, the less liquid the currency pair is, the wider the spread will be.
Let us not forget that currencies are also affected by what is happening in the world, one of them being inflation. If there is something happening in Australia, the AUD/USD or other AUD crosses will be affected. Changes in the relative interest rates will also exert a major influence on the Foreign Exchange markets.
Taking into account that the United States of America is the biggest economy in the world, the following are some of the data releases that may affect the currency markets:
- Institute for Supply Management (ISM): An index watched closely for changes in business sentiment. This monthly index shows production trends and covers both the service and manufacturing sectors.
- Retail sales: This monthly data, released by the US Department of Commerce, captures consumer spending.
Non-farm payroll data: This is the port of call when looking for signs -
of a rise in employment. Released every month by the US Labor department.
- Consumer confidence: The closely watched monthly consumer sentiment index from the University of Michigan tracks consumer spending, which accounts for two-thirds of all economic activity in the USA.
Do note that there will be other news indicators, political voting seasons, comments made by the Federal Reserve, among other news, that will have an impact on the overall economic growth, and thus an impact on that country’s currency.
VIII. Calculating your P&L
First of all, we have to understand that all prices in the foreign exchange market are quoted with 4 decimal points in a quote. An example will be EUR/USD 1.3888. Only a small percentage of currencies are quoted otherwise. Take example the USD/JPY, which is quoted with a 2 decimal points, USD/JPY 81.87.
Following that we will have to understand what a pip is. A pip, or Percentage in Point, is the smallest increment in the fluctuation of the prices for the currency. We can also refer a pip to a point.
Let us take a look at how we calculate pip increases and decreases. When a base currency is stronger, the value of the quoted currency will appreciate, and if the quoted currency is lower, then the base currency is depreciating. Let us take the EUR/USD example at 1.3888. If the EUR/USD increases to 1.4088, that means the EUR has strengthen by 200 pips. Thus you ignore the decimal points when quoting the pips. Thus, if the EUR/USD goes up to 1.4195, we can say that the EUR has increased by 307 pips.
Calculating the profit is also straightforward. For a 100,000 EUR/USD position, the 200 pips increase can be calculated as EUR 100,000 x 0.0200 = $2,000. For a smaller lot size of EUR 50,000 with a pip increase of 307, the profit will be calculated as EUR 50,000 x 0.0307 = $1,535. Remember that we have covered previously that your profit and loss will be in your secondary currency, and in this case, the USD.
If we take the example of the EUR/USD increasing from 1.3888 to 1.4088, thereby increasing 200 pips, we can expand the calculation further. If we take into account the 1% margin requirement, your initial margin deposit will be (EUR 100,000 x 1.3888) x 0.01 = $1,388.80, when you enter into the position and buy the EUR/USD at 1.3888. When the EUR/USD reaches 1.4088 and you take profit, the profit can be calculated as follows: you bought (EUR 100,000 x 1.3888 = $138,880) and you sold (EUR 100,000 x 1.4088 = $140,880), the difference of ($140,880 - $138,880 = $2,000) will be your profit. Thus, taking into account your initial investment for the margin deposit at $1,388.80, your return on investment (ROI) will be ($2,000/$1,388.80) x 100 = 144%.
It is easy to calculate the profit and loss (P&L) for EUR/USD because the P&L accrues in dollars. (Remember that the P&L is denominated in your secondary currency).
If we take the USD/JPY example, there will be an extra step in calculating your P&L because your P&L will be in Japanese yen, which is the secondary currency. If you have just sold USD 100,000 USD/JPY at 81.87 and the USD/JPY declined to 81.23, your profit will be what you sold (USD 100,000 x 81.87 = Yen 8,187,000) – what you bought (USD 100,000 x 81.23 = Yen 8,123,000) = Yen 64,000. To convert it into USD terms, you will need to divide the Yen 64,000 by the last done USD/JPY rate, which is at 81.23. Thus, you will get Yen 64,000/81.23 = USD 787.89.
Basis the above, understanding how profit and loss works is very important, because this will affect the sizes of your trades and how long you can keep your trades open.
If you are trading via an online FX broker or platform, like most of the traders do, chances are they will provide you with a real-time update of the bids and offers of the quoted currencies available in your trading platform, the margin used, the margin available, balance, your P&L among others. Thus, you will also be able to see your margin balance, realized P&L, and unrealized P&L, and are provided in real-time and mark-to-market.
When you have an open position in a particular currency, say long EUR/USD, and the market is going in your favor, the mark-to-market calculation will be using the point where you go long on the currency and taking the difference of where the bid price (or the price that you can sell) is currently at, thereby informing you your potential gain if you so decide to take profit at that particular time. This potential gain will be shown as a positive in your unrealized P&L. If the market is going against you, your unrealized P&L will be negative.
Of course, if you have a number of open positions, say long EUR/USD, short USD/JPY, long AUD/USD, short USD/CHF, the combined profit and loss from the 4 positions will be reflected in the unrealized P&L, and will continue to fluctuate with the movement of the market.
If you decide to take profit and close the EUR/USD position above, the profit taken will be reflected in the realized P&L. Thus, your EUR/USD position will be shown as closed instead of open, your unrealized P&L will not capture the P&L movement of the EUR/USD that you have closed, and the profit that you have made will be added into the realized P&L, among the other profit and loss that you have made previously.
Your margin balance will thus be calculated as the total sum of your initial margin deposit, your unrealized P&L, and your realized P&L. Do note that your margin balance will always fluctuate as the foreign exchange prices change because you mark-to-market unrealized P&L fluctuates with the movement of the market.
Understanding how to calculate your P&L will help to you to make informed trades and prevent making mistakes like entering into a trade that is too large for your account to handle, putting a stop loss order that is way too far from what the market is trading that your account balance will fall below the margin requirement. Understand that most of the trading platforms out there will have a program that will not execute your order when you placed something too large for your account to handle, but it is good to know that you are in control.
If you decide to trade overnight and carry open positions, there is another thing that you should need to know about the FX market. What happens when you make a deposit in a bank? You will earn on the interest. What happens when you borrow money? You will have to pay interest for the loan. Trading the currency has the same principles as the above. When you go short on a currency, it is like borrowing a currency that you do not have to sell it first, and incurring a charge for the short. When you go long a currency, it is like making a deposit and earning the interest.
Thus, when you enter into a trade and leave it open past the settlement date and is rolled over into another date, say in the EUR/USD, you will earn the interest in the currency that you are long, and will incur an expense for the currency that you are short.
If you have sold the EUR/USD, you will earn the interest rate for the USD that you have bought, and will have to pay the interest for the EUR that you have sold, if you kept the EUR/USD position overnight.
As the euro and the dollar will have different interest rates, the rollover rate is the difference between the two rates for the currencies that are in your open position. If the dollar pays you more interest rate than the euro, a net interest will be paid to you since you are long the dollar and short the euro. If the dollar pays less interest rate than the euro, an interest charge will be deducted from your account, since you are short the euro and long the dollar.
Of course, the amount will be small in comparison, depending on the size of your open positions, and that you do not have to worry about the rollovers if you do square your positions at the end of your trading day. IX. What is a margin?
A margin is a deposit needed by the brokerage when you open an account with them. The cash deposit will be your collateral to support the margin requirements.
When you first deposit cash into your new trading account, the cash that you have deposited will be your initial margin deposit, and that becomes your margin balance. All of your trades after deposit that will be collateralized basis that margin balance, until you decide to make more deposits into your trading account to support your increasing trading volume, or to withdraw a portion of your profit and cash from trading account, thereby reducing your trading volume to the amount of margin balance left in your account.
The good thing about currency trading is that it has the lowest margin requirements among all other trading financial instruments in the market, and unlike other financial and commodity futures markets, your foreign exchange brokers will not call you up asking for top ups (called a margin call) when your open positions are going against you. Instead, currency trading goes by margin ratios.
The margin ratio in currency trading is usually 100:1 or 1%, the percentage needed for your minimum margin requirement. Thus, if you are looking to have an open position of $50,000, you will only need $500 in your account, which is 1% of the open position. If you are looking to have an open position of $10,000, basis the 100:1 ratio, you will need $100 in you
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