What is Forex Trading
Forex trading - What is it? What instruments are we trading and when can we trade? We answer all the questions surrounding the topic of trading. Covering all bases and getting you set for the rest of The Social Traders killer Pattern Play & Smart Money Concepts strategy. What is the foreign exchange? Who trades it? When can it be traded? Forex or FX stands for ‘Foreign Exchange’, the foreign exchange market it is the largest financial market in the world. It is a global market that allows the exchange of one currency to another. When traveling abroad, you’re essentially using the FOREX Market; you are selling one currency for the chosen alternative. For example, if we wanted to travel to the USA from the UK, we would need to buy United States Dollars (USD) and sell our Great British Pounds (GBP). To understand the size of the Forex Market - The New York Stock Exchange trades around $22.4 billion a day, whereas the Forex Market trades $5 trillion a day therefore proving huge volatility and liquidity. This is great for us as it creates amazing liquid trading conditions and opportunities for us to capitalize on frequently. So what are we actually trading? We’re essentially just trading MONEY! Think of Forex as buying a share in a particular country, like buying a stock in a company. If you’re buying Dollars, you’re buying a share in the US Economy. You are in effect making a bet that the US Economy is doing well, and hopefully will continue to do well, so therefore you will return a profit in the future when you decide to trade back. Vice versa, if you are selling the dollar, you are betting against the US Economy. The exchange rate of one currency versus another currency is a reflection of that country’s economy, in comparison to other countries' economies. Consequently, the stronger the economy of a country, the stronger the currency. You may have noticed that currency pairs are broken into abbreviations? All currencies have 3 letters to aid us in distinguishing one from another. The way in which this is done is simple: The name of a country, paired with the name of their currency! The first two letters of the abbreviation identify the name of the country and the last letter identifies the name of the currency. For example, 'USD' stands for the United States Dollar. 'United States' being the country and the 'Dollar' being the currency. Most currency fit within this rule, However, the Japanese Yen is a slight exception as it is broken down into its syllables. It’s broken down to JPY. The Swiss Franc is also an exception this is abbreviated to CHF. Later on in the strategy we will be developing a small trading watchlist and so should help identify a few of the top traded currency pairs. A currency pair is the value of a currency unit against the unit of another currency in the foreign exchange market. The currency that is used as the reference is called the Quote currency and the other currency that is quoted in relation is called the Base currency. Let’s use EURUSD as an example: The Quote currency is the Euro The Base Currency Is the United States Dollar CFDs In forex trading you do not need to take possession of the currency to trade. When trading on the Foreign Exchange Market, you are trading a ‘CFD’ This stands for ‘Contract For Difference’. This is essentially a contract between an investor like you and I and a broker or bank. At the end of the contract, the two parties exchange the difference between opening and closing prices of a specified financial instrument, including shares, commodities and currencies. When you are exchanging your currency to go abroad, you OWN the exchanged currency. When you are trading a CFD, you DO NOT OWN the exchanged or traded currency; you are simply trading the contract to make money on the difference when closed. So who actually moves the Market? Supply and demand of a currency is the main driver of the Forex Exchange movement. If the demand for a currency - for example, the US Dollar - increases, so will the rise in people looking to convert their currency into Dollars. This will lead to its price to go up, unless supply also rises to match the increased demand. This is the same with supply: If the supply of a currency goes up without a parallel rise in demand, then its currency will drop in value. With $5 trillion dollars being traded daily your input into the market your trades won't make the market move noticeably. This is where the central banks come in. We will be entering the market in the area of high probability to capitalise on the movement created by the larger banks and institutions. Central banks have a massive role to play in currency movement – they can control the supply and demand of a currency by controlling economic factors such as Base Interest Rate. Without going into too much economic detail - interest rates increase/decrease the foreign direct investment into a country. Typically, higher rates reduce investment, because higher rates increase the cost of borrowing. It also requires investment to have a higher rate of return to prove profitable and vice versa. Investment creates a demand for a currency causing the currency to rise in value. When we put a buy position on USDCAD for example we are buying the United States dollar, we have created a demand for the dollar therefore increasing the price of the dollar against the Canadian Dollar - although the sizes of our positions within the entire market is negligible. Remember, $5 Trillion dollars is traded on a day to day basis and we have created an edge that can tap into these institutional liquidity flows. Other than traders like you and I, who Trades Forex and When Can It Be Traded? Forex traders and investors are a diverse group, coming from a broad spectrum of backgrounds, ages and disciplines. From the individual who is brand-new to the market, to the most seasoned currency trader, engaging in forex trading is one of the most common methods of participating in the world's financial markets. The great thing about forex is low entry barriers to the market. To trade forex all you need is a computer, an internet connection and brokerage account. While each person who enters the marketplace has a unique set of goals and objectives, forex traders are typically divided into two major categories. These are Institutional and Retail Traders. So who are the institutional players? First up we have: The Government or Central Banks - examples include the European Central Bank, the Bank of England, and the Federal Reserve or the FED as you may hear it called. These are regularly involved in the Forex Market. Just like companies; national governments participate in the Forex Market for their operations, international trade payments, and handling their foreign exchange reserves. Another big player are The Investment Banks For example, JP Morgan, Citibank, UBS, Deutsche Bank. These banks have huge amounts of capital and due to the banks large presence in the Forex Market, they have the ability to drive short term market trends and counteract retail traders due to the sheer size of the accounts and positions being traded. You may have heard of market manipulation before? It's the big players like the one mentioned now that have the capital to break through potential support or resistance zones created in the market and change the overall trend of price action. We will be trading alongside these positions. Now surprisingly we also have large companies and business as a big player in the FX markets In the 21st century companies are now more global than ever. Tesla, for example, might produce its car batteries in China, infotainment screens in Vietnam and Logic boards in the United States. But, at each stage of production Tesla would have to convert its base currency into different currencies in order to purchase the parts required. This moves the Foreign exchange market as currency is being transferred from one country to another. And then finally we are then left with, Speculators and Individual Investors This is where we come in! Often referred to as ‘Individual Traders’ as we buy or sell securities for personal accounts. The majority of market movement comes from the Large companies and Super Banks. Our aim is to get into the market at the right point in order to be taken with the market movement and volatility created by the large institutions. We don't want to be caught on the ‘wrong side of the market’, When Can the Forex Market Be Traded? The Forex Market can be broken up into 4 main trading sessions: The Sydney trading session : this trading session runs from the 9 pm GMT to 5 am GMT The Tokyo trading session : this trading session runs from 11 GMT to 7 am GMT The London trading session : this trading session runs from 7 am GMT to 3 pm GMT And then lastly the New York trading session : this trading session runs from 12 am GMT to 8 pm GMT Between 8 am GMT and 3 pm GMT is where you’ll see the most forex movement as this is when the London and New York session cross over. The London/New York crossover is when the markets become really interesting, in this period you’ll get traders from the two largest financial centres in the world begin to trade (14:00-16:30pm GMT). This is especially volatile when political news is released surrounding the United States Dollar and Canadian Dollar. The volatility created will see the largest FX movements so we must be prepared to capitalise on these moves hours, days or weeks in advance - this is where our forecasting comes in (we’ll touch upon this later in a later video). Entry Types When entering the market there are 5 different types of entries that all traders NEED to know. All of these entry types will be covered in this video, we’ll be going over what each entry type is and then later in the strategy you understand how we use them on the live markets. These are the 5 Entry types: Buy stop Sell stop Buy limit Sell limit Market execution. Market Execution So first up is the Market execution, this one is really straight forward. A market order is a buy or sell order to be executed immediately at the current market prices. As long as there are willing sellers and buyers, market orders are filled. Sometimes within the Forex market there are not willing buyers or sellers to meet your order and so ‘slippage’ occurs. Slippage is more likely to occur in the forex market when volatility is high, perhaps due to news events, or during times when the currency pair is trading outside peak market hours. Buy Stop A buy stop order is when you are buying a financial instrument above the market. Unlike a market execution this is an order type that will NOT automatically enter you into the trade. You will only be entered into a buy position when price action touches your entry order. Sell Stop A sell stop order is essentially the opposite of a buy stop. A sell stop order is when you are selling a financial instrument below the market. You will only be entered into a sell position when price action touches your entry order. We have found that both the Buy and Sell stop orders offer the best risk protection out of all the order types, so take note of these they’re going to be used a lot. Buy Limit A Buy limit is an order to enter a buy position below the market. You will be buying a financial instrument when the price has been sold down to your order price to then be entered into a buy position. You use this type of entry order when you believe the price will reverse upon hitting the price you specified. Sell Limit Essentially the opposite to a Buy limit. A Sell limit is an order to enter a sell position above the market. You will be selling a financial instrument when price has been brought up to your order price to then be entered into a sell position. You use this type of entry order when you believe the price will reverse upon hitting the specified price.