Forex (Forex, FX, aka the foreign exchange market) is the largest liquid financial market in the world for the sale and purchase of foreign exchange. The work of Forex should not be confused with buying and selling physical currency (for example, when traveling abroad). Forex work is based on taking advantage of changes in the exchange rate in relation to each other.
In other words, when working in Forex, entrepreneurs speculate on the value of currencies. The simplest example is the ratio of the euro to the dollar. In this case, the euro acts as the base currency, so it will be written first in the designation of the currency pair, and only then the quoted currency is written, in our case the dollar. Let’s say we are buying euros by selling the dollar. If, due to fluctuations in the market, the price of the euro rises, this will allow us to benefit from selling it. At the same time, the price of a currency in Forex directly depends on the demand for it.
What are currency pairs?
As already noted, the FX market is traded using so-called “currency pairs”. Let’s dwell on this concept in more detail.
A currency pair is the ratio of the prices of two currencies included in a given pair in the foreign exchange market.
The currency pair includes the base and the quoted currency.
Base currency is that currency, the price of which is always measured in units of the quoted currency, and the quoted currency, therefore, is the currency in which the price of one unit of the base currency is expressed.
If we go back to the example of the euro and the dollar, their currency pair will be displayed as EUR / USD.
Factors on which the exchange rate in the market depends
Fluctuations in the exchange rate in the Forex market depend on many factors, both economic and political. This includes inflation, known to everyone, the country’s balance of payments, the bank interest rate, supply and demand of foreign currency, as well as political changes in the country, such as a change of government, decisions of executive authorities, and so on. News published by the media also has a certain impact on the economic situation in the market.
The main features of the Forex market
The first and main characteristic of the market is its decentralized device system . The Forex market does not have a main fixed trading platform. Trade through computer networks takes place around the world twenty-four hours a day. Hence, the following feature of the work of this foreign exchange market follows: Forex works around the clock, five days a week. And the time of its work is subdivided into certain sessions. Basically, there are four of them in accordance with the geographic characteristics of the location of the countries. On Forex, both central banks, along with large banks, and smaller, medium-sized banks are represented.
The market also has high liquidity due to large trading volumes. Access to Forex trading is very easy, also thanks to the «leverage».
Forex Markets Classification
There are several classifications of Forex markets.
Basically, they are classified depending on the duration of transactions:
Spot market — buying and selling currency is carried out at the market value, also known as the «spot rate»;
Forward market ;
Futures market .
The last two types of markets operate with a currency for which clearly established requirements are provided, including a fixed cost per unit of currency.
Depending on the nature, transactions carried out on the market are divided into:
Conversion operations (5%)
As already mentioned, most of it is occupied by speculative operations.
Benefits of Forex Trading
Let’s list the main advantages of the Forex market:
1. Round-the-clock work — Forex allows you to conclude transactions at any time of the day, which is very useful. This expands the possibilities for the purchase and sale of currency.
2. Forex is the most popular foreign exchange market. This fact guarantees high market liquidity.
3. Forex provides ample trading opportunities due to the use of «leverage».
«Leverage » — a mechanism that allows the trader to use the funds in excess of its own deposit. At the same time, only personal deposits are at risk of loss.
4. You can enter the foreign exchange market even with a small and insignificant initial capital. We are talking about 1 dollar in the account, sufficient to start trading. But such a trader may face certain problems when opening a trade, even when using leverage.
5. High level of income — this advantage is one of the main advantages of the Forex market. A high level of price fluctuations makes it possible to make good money, but it should be understood that there are also great risks in such transactions.
6. Advanced investment system. Market traders are provided with a wide range of opportunities to invest their capital thanks to a developed and efficient system.
7. High protection. Forex is subject to tight regulation to protect traders’ transactions. The market provides security guarantees, and special bodies monitor their implementation. In the event that the firm was unable to prevent an error, it takes on the responsibility to compensate for losses.
Forex Trading Basics
Short and long positions.
A short position is a trade that makes a profit when the exchange rate falls. It is called «short» due to the fact that in this transaction, profit is brought by the fall in the price of the currency, which occurs much more rapidly, in contrast to the growth. Such trades are often referred to as “short trades”.
Long positions are a long trade.
With such a stock, the profit is expected from the appreciation of the exchange rate. The transaction involves the purchase of currency with the expectation of a rise in price and its subsequent sale for a higher price. These trades are filled with less risk compared to short positions.
Margin is funds that are transferred to a broker to provide insurance security at the time of a loan. It is the main element of the leverage mechanism. When making a loan, you are obliged to maintain a margin, which is often determined by the interest on the loan. When using leverage, the percentage of the loan can be 1%.
A lot is the amount of currency that is represented in one position during trading. The lot has different volumes. There are: lots (100,000 units \ 1 lot), mini lots (10,000 units \ 0.1 lot), micro lots (1000 units \ 0.01 lot), etc.
A trading strategy is a trading model thought out by a trader. It indicates the entry and exit points for buying. There are various trading strategies:
Day-trending is a strategy based on the purchase and sale of cash, assets, shares, in which this financial instrument is bought and sold on the same day. Possession of valuable assets can last from a couple of seconds to several hours. When trading with this strategy, constant monitoring of price fluctuations is required. After all, the essence of day trading is a well-chosen moment for buying and selling.
Therefore, this type of strategy is not very suitable for those who cannot devote themselves entirely to the foreign exchange market.
The following types of day trading are
Scalping is one of the strategies of speculative operations, the features of which are:
— fast deals — in the realities of the modern world, they sometimes last for fractions of seconds;
— completion of the transaction with the receipt of the first profit.
The purpose of such trades is usually to make a profit from small price fluctuations. Such a strategy, as a rule, involves many small trades that are carried out throughout the day. This strategy can be very profitable if the situation is well chosen, but it is also filled with great risk, because in such transactions, which require quick and thoughtful behavior, delay or inattention can bring huge losses.
Trade with the trend
With this type of strategy, the trader seeks to profit from the trend movements in the market, correctly weighing the risks. Simply put, following this strategy, you can track the regularity of the rise and fall of currency prices. Most often, such a circumstance is associated with the human factor and unchanging human nature, which pushes people to certain actions because of the desire for profit or, on the contrary, the fear of losing their profit. The goal of a trader when trading according to such a strategy is to identify trends in a timely manner and make money on them. But this requires trading experience.
Also, to identify a trend, certain indicators can be used that allow you to track a pattern in price changes. The following indicators are distinguished: «Moving Average» (a line that reflects the history of price fluctuations over a certain period of time), an average direction index (reflects the strength of a trend) and a relative strength index (reflects the rate of change in price direction). They will be discussed in more detail below.
Trading on the news
Many news from the world of politics, geopolitics, financial policies of states are reflected in the foreign exchange market. The essence of news trading is that a trader finds suitable news, which will cause changes in the foreign exchange market, and, adjusting to the predicted fluctuations, makes a deal. Like all other strategies, this type of trading is very risky, but under the best circumstances, the income from such trading can be huge. This strategy reflects the impact of world news on the prices of currencies, and the goal of traders is to make money on this. Usually, successful trading begins from the moment the influence of one event or another on the currency exchange takes place and ends with the first signs of a reverse movement.
This type is a trade in which a deal remains open for a long time due to the activities of traders. This period can stretch over several months, and sometimes even years. All this is done with the aim of capitalizing on the intermediate trend. Traders rely on macroeconomic factors to identify such trends. Although the price movement does not play such a significant role for position traders, they still need to plan to enter and exit the market, as well as work on a strategy that would allow them to manage risk.
Range trading is a Forex trading strategy that involves looking for overbought and oversold zones. In this case, when the price reaches a particular zone, the trader sells or buys currency. This strategy is especially effective during directional market movements.
Unlike beginners, for whom trend trading is the best option, experienced traders are able to profit from price reversals.
The Forex market is characterized by the use of reversal trading strategies.
An example is the Price Action reversal strategy, which is a system of two elements. The principle of operation of this system is based on a combination of candlestick patterns of support and resistance levels, on which they are formed.
The most popular reversal patterns are the Pin Bar and Outside Bar.
Anchor points(Pivot points) or pivot points allow you to determine the key levels to which the price can react. At the same time, the indicator displays potential support or resistance levels. The price at which the pivot point is located is calculated based on data from previous periods.
A breakout is a price breakout of a certain support or resistance level with an increase in volume.
This type of trading is used by traders in order to open a position at the initial stage of a trend. Such a strategy can be the starting point for major price movements, widening volatility, and, if done correctly, carries justifiable risk.
In this form of trading, a trader enters a long position after the price reaches above the resistance level, or enters a short position if the price falls below the support level.
As soon as the price breaks the boundaries, the volatility increases and the price usually moves in the direction of the breakout, which in most cases is the beginning of price trends.
Technical analysis indicators
FX technical indicators are an integral part of technical analysis. They play an important role in helping the trader determine the movement of the market.
These indicators include:
The name of the oscillator originates from the Latin word oscillo — «swing». In technical analysis, it is a mathematical expression of the rate of price movement in time. This indicator works in the range from 0 to 100.
The basic concepts that you need to know when working with oscillators are the state of «overbought» and «oversold» of the market. The market is considered overbought if the price takes its upper position, and its further rise is hardly possible. An oversold market, on the other hand, occupies the lowest price position.
Moving Average or Moving Average
Moving Average is the oldest method of analysis. It is based on the application of an average price over a period of time. In cases where the price exceeds the level of the moving average, investors’ expectations are higher, and the market, accordingly, has an upward trend. If the price is lower, then the expectations are also underestimated.
The following classification of the moving average is distinguished:
1. SMA (simple moving average) — this form displays the arithmetic average price level for a certain period;
2. EMA — moving average with exponential smoothing;
3. VMA or volume-dependent moving average, which is characterized by taking into account not only the values of indicators, but also their weight.
Quite often, a moving average for a price is determined by comparing its dynamics and price behavior. That is, if the price exceeds the level of the moving average, this is a favorable situation for buying, but if it is lower, it is a signal to sell.
Relative Strength Index.
The Relative Strength Index (RSI) is an oscillator that follows price. Its values range from 0 to 100. This technical indicator was developed by W. Wilder, who believed that the most optimal value for the oscillator is RSI = 14.
RSI measures the level of the current price in relation to previous levels.
The oversold level, which is a signal to buy, for the RSI is 30, and the overbought level is 70.
MACD (Moving Average Convergence / Divergence) is a trend indicator showing the relationship between two price moving averages. This indicator was developed by D. Appel in the 1970s and is considered one of the best indicators to determine the direction of the trend. It fluctuates towards zero. If the indicator is above the zero level, then the trend is upward, which contributes to its purchase, and vice versa: a level below zero indicates the need to sell.
Forex market analysis methods
The Forex currency exchange is a very unpredictable financial institution, in connection with which the methods of analyzing this market, aimed at predicting price changes in the future, are of particular importance.
Let’s take a closer look at each of the currently existing analysis methods:
Fundamental analysis — this method sets itself as the main task of the analysis of the current economic and political situation in the countries, the currency of which is provided on the market.
Fundamental analysis predicts how certain changes in politics and economics will affect the exchange rate.
It should be noted that when using this method, traders take into account not only macroeconomic, but also microeconomic indicators, as well as some geopolitical data.
Technical analysis — as the main forecasting method, graphical models are used, which contain all the data about the current market situation. And since the market has “memory,” the available data can be used to predict what price changes are expected in the future.
Sentiment analysis or sentiment analysis — that is, the main role for this form is played by taking into account and analyzing the existing market sentiments, on which future changes in demand for a particular currency directly depend.