Discovering Forex Trading Basics:

Diving into the Forex market without proper planning and taking the time to figure out what makes this global market tick is a recipe for disaster. Sure, it would land you squarely among the 66% of traders who lose money in this market, and that is not a place you want to be.

So, the question is how do you get into Forex trading and become successful Forex trader. The following two questions will help you find the answers:

-Why do currencies move the way they do?

-How can I profit from that movement?

Understanding why currencies move the way they do is fundamental to your success in Forex trading because once you understand why they move, you can start predicting where they will move under certain circumstances. And once you can start to predict where currencies are going to move, ou have arrived as a currency trader.

Here’s what you need to know to be able to answer the question of why currencies move the way they do:

-What drives currency prices: supply and demand;

-Who drives currency prices: people called traders;

-The individual personality of each currency: no two currencies are alike – you need to understand their individual personality;

-How currencies react to economic announcement and other news;

-Which indicators you should be watching: the need to understand early warning signals of where a currency may be headed.

And, here’s what you need to know in order to profit from currencies’ movement:

-Where you can invest your money: trade spot Forex, buy an exchange-traded fund (ETF), sell a futures contract, and more;

-How to execute short-term trading strategies: most traders a drawn to short-term trading strategies because of the fast pace and high leverage available in the Forex market;

-How to invest for the longer term: Forex market is also ideal for longer-term trades;

-How the currency market functions and how you can protect yourself: you need to understand how to avoid the pitfalls that have tripped up many experienced traders.

Forex Trading – The Concept of Currency Pairs and Pips

As a currency trader you will always sell one currency and then use the proceeds to buy another currency. In other words, currencies don’t fly solo. This concept of trading in pairs is one of the toughest concepts for first-time traders to wrap their heads around.

When you look at a currency pair, the first currency that is listed is called the base currency, and the second is called the quote currency. Here’s the easy way to remember which is which: the movement of the currency pair is based on how strong or weak the base currency is, and the price of the currency pair is quoted in terms of the quote currency. For instance, in this pair EUR/USD, the euro is the base currency and the US dollar is the quote currency:

-if base is stronger than quote, then it’s a rising currency pair

-if base is weaker than quote, then it’s a falling currency pair

-if quote is stronger than base, then it’s a falling currency pair

-if quote is weaker than base, then it’s a rising currency pair

It takes two to the tango.

Currency pairs are normally divided into the following three major groups:

-Major currency pairsforex trading

-Emerging market currency pairs

-Currencies crosses

Here are the major currency pairs:

-EUR/USD (euro/US dollar)

-USD/JPY (US dollar/Japanese yen)

-GBP/USD (British pound/US dollar)

-AUD/USD (Australian dollar/US dollar)

-USD/CHF (US dollar/Swiss franc)

-USD/CAD (US dollar/Canadian dollar)

Emerging market currencies are called so because they are less liquid currencies, but they are quickly becoming popular, which is improving their liquidity. Some examples:

-USD/HKD (Hong Kong dollar)

-USD/SEK (Swedish krona)

USD/SGD (Singapore dollar)

Currency crosses are currency pairs in which neither currency is the US dollar (USD). The most popular currency crosses are:

-GBP/JPY (British pound/Japanese yen)

-EUR/GBP (euro/British pound)

-AUD/JPY (Australian dollar/Japanese yen)

EUR/CHF (euro/Swiss franc)

-CAD/JPY (Canadian dollar/Japanese yen)

Forex Trading  – Currency Pairs Move in PIPS

In the Forex market, currency pair prices are quoted in pips, which is short for “price interest point.” Pips are sometimes referred to as “basis points.”

In the majority of cases, a single pip represents one ten-thousandth of a single unit of a currency.

So, how much is a pip worth? To compute the value of a pip you need to know which currency is the base currency and how large the contract you are trading is, or the notional amount. Full-size contracts cover 100,000 units of currency and mini contracts cover 10,000 units. Here’s the formular to calculate the value of a pip:

(1 Pip/Exchange Rate) x Notional Amount = Pip Value

Example: the value of a 1-pip move on a full-size contract on the USD/JPY currency pair, where the excahnge rate is 82.65:

(0.01/82.65) x 100,000 = $12.10

If the USD is not the base currency, and you still need to know how much a pip is worth in US dollars, use this formular:

Pip Value x Exchange Rate = USD-based Pip Valueforex trading basics

You can do this conversion for any currency you want.

Forex Trading – Supply and Demand Basics

Let’s keep it simple:

-price rises as the demand for the currency increases

-price falls as the supply of currency increases

-price falls as the demand for currency decreases, and

-price rises as the supply for currency decreases

Supply and demand in the currency market are driven primarily by the following five factors:

1. Trade flows: foreign demand for domestic goods, and domestic demand for foreign goods;

2. Investment flows: foreign demand for domestic assets, domestic demand for foreign assets, and repatriation of assets;

3. Money supply: more money in circulations tends to lead to higher currency values, and vice versa

4. Government interventions and currency manipulation: governments intervene because they are worried that the currency is getting either too strong or too weak, and pegging the currency to another currency.

5. Investor fear:  one of the most potent forces in today’s currency market. Investor fear can send some currencies crashing down when times turn sour, or send some currencies soaring when times are rough.

Safe-Haven Currencies:

Safe-haven currencies thrive when investor fear is running amok. They are called safe-haven currencies because of the perceived protection that they offer during times of financial turmoil. Currently, the tree safe-haven currencies are the US dollar (USD), the Swiss franc (CHF), and the Japanese yen (JPY).

How do we measure investor fear? We use the CBOE Volatility Index (VIX):

-the VIX is based on the implied volatility levels of S&P 500 Index options;

-when the VIX is Moving higher, it indicates that investor fear is increasing;

-when the VIX is moving lower, it indicates that investor fear is decreasing.

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Filed under: Forex

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