Forex Trading - What Is Forex Trading?

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Professional athletes are often told by their coaches that their attitudes on the field can affect whether they win or lose. That’s even more true in Forex trading. It sounds like the standard motivational speech, but having the right frame of mind can definitely influence your trading results.

There are many aspects of Forex trading that are outside the investor’s control.

Forex market participants number in the millions - traders for the world’s largest banks, huge governments and individuals just like you. Unlike stocks, even the big traders have a tiny effect on exchange rates.

Even when setting interest rates and other actions that influence inflation, the largest governments can have no immediate impact on exchanges. The Forex markets are simply too large - $2 trillion daily - for any one player to dominate the action.

Trading strategies, which are essential, can increase the odds of making profits and help minimize or avoid losses. They give the knowledgeable trader that tiny edge that can make the difference between winning and losing on a given trade, or over time.

But before looking at market influences, and even before developing a set of technical strategies that help guide trading choices, the novice Forex investor has to honestly and objectively examine his or her own attitudes.

Forex is fast-paced, complicated and requires a well-thought out game plan. That game plan has to be executed with nerve and skill. Trading successfully in a demo account for several weeks is essential but can lead to unwarranted confidence. Traders who invest Monopoly money will often take chances, leading to successful trades, that they wouldn’t dream of taking with real money.

Real trading requires answering honestly a number of questions that can be difficult to answer objectively when the subject is the self-same trader asking them. What are your financial trading goals? Looking for a quick buck? Seek elsewhere. You will have losses that wipe them out. Looking for secure, low-risk capital accumulation? Try AAA bonds instead.

Forex trading can be simultaneously a stimulating intellectual game and an exciting adventure. The thrill of victory! The despair of (temporary) defeat! The mastery of the intricacies of Fibonacci, Parabolic SAR, Stochastic Oscillators and Doji Stars. All this, and much more, is part of Forex investing.

As a result, you will need to be very frank with yourself and decide how (and whether) you are prepared to deal with pressure and fear. Even professional traders do not have any certain system of ensuring profits and avoiding losses.

The pressure of deciding when to buy and when to sell is many times larger than in stock trading. The fear of loss is greater, in part because of the amplification provided by 100:1 or larger leverage.

Even winning can be problematic. With practice and persistence, provided you don’t quit too soon or run out of money too quickly, you will have periods when it all seems laughingly easy. That can lead to euphoria, which is great. But it can also lead to cockiness, which is fatal. Nothing will wipe out a trader quicker than arrogance. Confidence is essential, vanity is suicidal.

The other side of the coin to be avoided is too much second guessing. Successful trading requires bold moves based on sound judgment and confidence. Every decision is a small leap of faith, since no one can know in advance for certain what the outcome will be. Probability of one degree or another is the best that can be achieved.

All this will be accompanied by the fear of loss of capital, which often leads to panic selling in the face of what would have been a temporary price movement. It is of such panics that depressions are made, both economic and psychological.

Forex is a roller coaster ride. But if you have a good inner ear and a strong stomach, bolstered by the brain of a statistician and the nerves of a pro billiards player, you will be well suited to end the ride with full pockets.

The title points up an important difference between forex and stock investing.

When buying stocks you’re making an investment in a company. Buying shares is short for ‘purchasing a share of ownership’. By contrast, no one is making an investment in Japan by buying yen. We leave aside politically motivated actions by large central governments. Currency is exchanged in order to facilitate the movement of goods and the payment of services between multiple countries, but that’s a relatively small percentage of the total $2 trillion daily volume. The largest amount is simple speculation.

Well, perhaps not very simple. Trading euros against dollars against yen against pounds against… in a twenty-four hour market with a dozen time zones… it gets complicated.

Margin differences between the two markets are enormous. Most stock brokers will leverage (lend investors money) up to 2:1. In currency trading 100:1 is common. Since price movements occur twenty-four hours per day every day, margin calls can occur while the investor is sleeping. That makes for a bad awakening.

Trading cycles are generally much shorter. Stock investments are made, even by professionals, on timelines of months or years. Currency trades are often completed within a day or even minutes. Yes, that happens in the equities markets, too. But, it isn’t the norm even though it’s more common than ever.

All these differences suggest some lessons for the investor interested in forex trading.

Do your homework.

Be aware of factors affecting currency rates. That includes not only the standard domestic economic indicators, but trade imbalance figures, central bank policy changes and others.

Watch the market.

Small, rapid changes can force your position into an area that motivates your broker to execute a margin call. Be prepared to cover your position or liquidate at times favorable to you. Know the broker’s margin call policy and practice. You’ll be required to sign a margin agreement when opening an account. Read it first.

Practice.

When starting out, take advantage of the demos offered by most brokers. Execute paper trades - trades that don’t execute on the real markets - using the real currency figures.

Get a feel for the amounts, the percentage changes and get used to converting currencies from one country to the next. You should be able to estimate without much thought how much 1,000 pounds is in dollars at the current exchange rate.

Opinions and size don’t matter.

Unlike stock markets, the size and complexity of the forex markets makes it virtually impossible for any investor, no matter how large, to dominate the price. Program trading, fund trading and so on that can cause large movements in particular equities has a negligible effect on currency prices.

Similarly, analyst projections have much less influence in currency trading. Many will read eagerly some influential columnist’s opinion of the future of IBM. Opinions of that kind are largely discounted in currency trading.

It’s a different world out there.

There are around 4,500 stocks listed on the NYSE and 3,500 on NASDAQ. And many more on other exchanges. A few hundred are major players. By contrast, only a dozen currencies account for 99% of all trades. With four major markets trading twenty-four hours per day, the action is very concentrated.

No need to be intimidated though. Currency trading has moved in the last decade from the realm of the professional trading millions at a click to mini-accounts of $250.

So, go make some money.

Prices in Forex markets are the most volatile of any trading instrument. They change farther and faster (on average) than stocks and bonds, though commodities can be pretty roller coaster, too. This presents non-professional investors with a dilemma: either sit by a computer monitor all day, looking for price movements in real time or potentially lose a whole lot of money. But there’s a way out of that dilemma. Use signal services.

Forex signals are buy and sell indicators based on technical analysis. Technical analysis uses historical price and volume data to statistically analyze trends. The goal is to establish, with a stated probability, the likelihood of future price movements.

A signal could be as simple as ‘Buy euros now at 1.1901′. Those signals are delivered in any number of ways, by email, SMS text message to a cell phone, IM message and so on. Some are no more than flashing text and/or icons on trading software. The software contains in-built algorithms that use the methods of technical analysis, combines it with current market data and generates a signal.

For example, one commonly used technical indicator is something called MACD (Moving Average Convergence/Divergence). Without going into details here, it uses the moving average - the change in an average price over time. A signal can be generated when the value of MACD crosses above (or below) a certain threshold. Buy when it moves above the line, sell when it falls below.

Some signal services allow clients to automate the process of Forex trading even further. You can leave standing orders that when a certain signal is generated, carry out the recommendation. You get an email recommending ‘Buy euros now at 1.1901′ and the broker automatically enters an order to do just that.

As with any trading tool, it has to be used intelligently in order to avoid disasters. Entirely automating your buys and sells can amount to automatically losing money. Using a signal service can make your life easier, but never abandon your investments entirely to an automated service.

If you plan to do that, you may as well simply turn your investments over to a broker with the instruction: ‘Maximize my returns, but keep the risk down to a reasonable level’. Sensible, but not helpful if you want to control your destiny.

Signal services are definitely useful, however. They can relieve investors of the need to continually monitor prices. They can simplify the sometimes bewildering complexity of charts. They can help the investor make better decisions about when to buy or sell and at what price.

All that comes at a price, of course. Signal services range from $50-$250 per month, though some are cheaper and a few are more. Only the individual investor can decide whether the cost is justified. As with any trading service, if you make more than it costs than you would without it, that’s profitable.

But, buyer beware. There are dozens of firms that will be happy to take your money. Whether their analysis, and therefore, their signals, are worth anything is a learning experience all its own.

At minimum, investors should use order types that help control risk. Stop-loss orders, limit orders and other common types are an essential means of limiting losses and timing buy and sell orders. That technique, commonly employed in stock trading, is even more critical in the volatile world of Forex.

Forex trading is always about buying one currency and selling another one simultaneously. The world of currency exchange, Forex (Foreign Exchange), employs terminology not used elsewhere in the investment world. Defining those terms, and providing a sample trade, will go a long way toward taking the ‘foreign’ element out of foreign exchange.

Currency trading is always done in pairs. In other trading, such as stocks and bonds, cash is exchanged for something else (a percentage of ownership, a promise to pay interest).

In Forex, cash is traded for cash. Euros are traded for dollars, dollars for yen, yen for euros and so on. There are dozens of trading pairs, just as there are dozens of currencies around the world that participate in the currency exchange markets.

The major players are US Dollar (USD), Euro (EUR), Australian Dollar (AUD), British Pound (GBP), Canadian Dollar (CAD), Japanese Yen (JPY) and Swiss Franc (CHF). Most of all daily transactions involve trading of these major currencies.

So, when reading quotes, investors will see prices listed as:

Name    Bid  Ask   Change    %Change  High  Low     Time

EUR/USD 1.1901 1.1903 -0.0091 -0.76% 1.2024 1.1891 15:26
GBP/USD 1.7439 1.7442 -0.0004 -0.02% 1.7573 1.7410 07:01

The currency listed on the left is called the ‘base currency’ (EUR & GBP) and the second is the ‘quote currency’ (USD).

The ‘bid’ is the price at which brokers are willing to buy the base currency. The ‘ask’ price is that at which brokers are willing to sell the base currency. The quotes are always listed from the brokers’ point of view. So if you (the trader) wants to buy the base currency the ask price will apply. If you (the trader) wants to sell the base currency the bid price will apply.

EUR/USD 1.1901/03 means

If you buy 1 EUR you will pay 1.1903 USD
If you sell 1 EUR you will receive 1.1901 USD

GBP/USD 1.7439/42 means

If you buy 1 GBP you will pay 1.7442 USD
If you sell 1 GBP you will receive 1.7439 USD

The difference between bid price and ask price at a single specific time is called ‘the spread’. The spread is measured in pips (price interest points). The ‘pip’ is often said to be the smallest increment by which the price changes.

If the bid price of the EUR/USD pair changes from, say, 1.1901 to 1.1902 that’s a single pip. That’s a (bid or ask) price at two different times. Remember not to confuse this difference with the spread, which is a difference between the bid and ask price at a single, specific time.

Forex is not a new household cleaning product. Forex or FX is simply short for foreign exchange, but refers more specifically to currency trading.

This is exchanging dollars for pounds, or euros for yen and so on. It has one thing in common with a household cleaning product, though - if you are not careful you can get cleaned out in a hurry trading currencies.

The currency exchange markets are the largest, most volatile and among the most risky forms of trade in the world. Amounts exchanged are large, magnifying small price changes, and the total daily volume is in the range of two trillion dollars. Yes, that’s ‘trillion’… a two followed by twelve zeros!

There are dozens of markets, with the largest centered in New York, London and Tokyo. Although, ‘centered’ is slightly misleading, since there’s no physical exchange that trades currency - unlike the New York or London Stock Exchanges for equities (stocks).

Instead, the playground primarily of large institutions - international banks, insurance companies and governments via their central banks - currency exchange is carried out by phone and via computer networks, formerly all private or government but now including the Internet.

And that latter means of communication, along with changes in trading methods, is what makes possible the opportunity for the individual investor with less than a few million dollars to participate in the fast-paced, highly speculative game of trading one country’s money for another’s.

In order to play that game without getting immediately run over, the investor will need to learn some new terminology, do some research in new areas, find a broker who trades currency and stock up on some courage pills. Enormous sums are traded in forex and only commodities trading offers similar ease in feeling dumb and getting poor fast.

But losing money isn’t inevitable for the prepared investor.

An investor will need to become familiar with new phrases and quoting methods - pips, spreads, cable and the like. Calculations formerly carried out with ease will now need a little more thought. Everyone is used to their own currency and seeing a $10 stock go up by a dollar one immediately sees a 10% gain. Trading currencies requires a little more knowledge.

The prepared investor will need to expand the scope of his research. Finding out the likely future of a home-based business is complicated, but straight forward. Conditions in one or two sectors and a few economic indicators can be grasped without requiring a PhD in finance. Learning about the factors influencing the currencies of two or more countries is an order of magnitude more difficult.

And more interesting.

Fast pace, global scope, large liquidity and volume, and a dozen different ways to hedge your bets. Yeah, that sounds good. Gotta get some of that right away!

Choosing a good Forex broker can be as complicated as Forex trading itself. For that reason, investors should do their homework as diligently as they would for a trade. Here are some tips to keep in mind to make your research and choice easier.

In the U.S., any worthwhile Forex broker will be registered as a Futures Commercial Merchant (FCM) with the CFTC (Commodities Futures Trading Commission). Finding one doesn’t end the need for research, it’s just the bare minimum you should require.

Since Forex trades are highly leveraged (in effect, the broker ‘lends’ an investor up to 99% of the money required to make a trade), the broker you select should be associated with a firm with deep pockets.

Forex accounts are not FDIC (Federal Deposit Insurance Corporation) insured, so you can not expect the U.S. government, or anyone else, to bail out the brokerage firm or reimburse you if the market turns sharply downward. Large institutions, with ample capital to withstand downturns in the market, and rapid drains on their deposits if clients withdraw en masse, are crucial to your financial peace of mind.

Beyond those rock bottom basics there are many options.

Since the Forex markets trade 24 hours per day all around the world, you may want to trade after normal business hours in your home country. Whether your broker resides in the same country (usually, for language and legal reasons) or not, you want one who will pick up the phone when you call.

Forex trading has moved into the Internet age, but it is still very much a phone-based business. Getting a broker on the phone at any time of the day or night can mean the difference between profit and loss. Sometimes, big profit or loss.

Since Forex brokers don’t work off standard commissions the way stock or bond brokers do, you need to research the firm’s spreads. Forex trading is always done in currency pairs. A spread is the difference between the bid and ask price - what the broker pays to buy versus the amount they sell a currency for.

Some brokers will offer fixed spreads on all trades, which has the advantage of predictability. It’s a kind of fixed ‘commission’. But that may or may not suit your trading style or your budget, since they tend to be larger than variable spreads.

Any broker will offer a standard account to a qualified client. Typically you have to fill out an application form that states you have adequate capital and understand the risks involved in Forex trading. Standard accounts trade currency in standard lots of 100,000 units. You can’t buy 100 euros for $150, you have to buy 100,000 euros.

Since that’s a very large investment for the average trader, brokers offer leverage. Professional traders use leverage as well, of course. In other words you put in, say 1% of the total, the broker puts up the rest. That has huge profit (or loss) potential, but it entails significant risk. So be aware of a broker’s margin call policy.

Many brokers today will offer some form of ‘mini’ account. Instead of trading in standard lots, they trade in smaller units, such as 10,000. This lowers the investment required from, say $2,500 to only $250. Most clients can easily meet that minimum.

But that lower leverage requirement limits the potential for profits. That may or may not suit your investment needs. Only you can decide.

You’ll want a broker with software that provides you with the research and other trading tools you will need to be effective in Forex trading. Forex investing is much more complex and volatile than even stock or bond trading, which is already not simple when done well.

Be sure to use the trial accounts offered and make several ‘fake’ trades in order to test out the software and research available. You need real-time prices - Forex moves very fast - and lots of technical and fundamental analysis information at your fingertips.

There are websites and forums where specific brokers are discussed, but take what’s said there with a grain of salt. Just as with complaints about vendors on eBay or Amazon and other large Internet trading arenas, a few bad remarks shouldn’t ruin the reputation of honorable brokers.

Beyond all that, the factors become a little more difficult to judge. Above everything, you want to feel you trust the person on the other end of the line. They are not there to be your friend or listen to personal complaints or trade tips. But you should get the sense that they are competent, professional and ethical.

Take your time to research. After all, your decision will affect ALL your trades.

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