Forex quite simply is the most exciting market in the world. The Foreign Exchange is the “Mother” of all markets. This is where the BIG BOYS play—specifically referring to the world banks and largest financial institutions in the world. On average, the Forex market trades upwards of 3 to 4 Trillion dollars daily. That’s right, 3-4 TRILLION!! This is exactly why Forex is our market of choice.
So what exactly is traded on the Foreign Exchange market? The quick answer is money. It is where exchange rates, which tell us how much of one currency you can buy with another, are determined. The currencies are traded in pairs and each is listed as a three letter abbreviation. So you might trade the British Pound vs the US Dollar which would be listed as GBPUSD. The first currency listed is referred to as the base currency and the second is the counter currency. While all currencies can be traded, the MAJORS are those that are traded most often. They include the EURO (EUR), British Pound (GBP), US Dollar (USD), Swiss Frank (CHF), Japanese Yen (JPY), Australian Dollar (AUD), New Zealand Dollar (NZD) and Canadian Dollar (CAD). So, rather than buying IBM or Microsoft stock you would trade, exchange or buy/sell one currency for another. Trading currency is the simultaneous buying of one currency and selling of another. More info: http://en.wikipedia.org/wiki/Foreign_exchange
Forex is an Over the Counter or “OTC” market, which means that there is no centralized exchange like the New York Stock Exchange or AMEX but is an electronic network of banks, brokers and other participants. This allows access to the market by anyone from anywhere as long as you have an internet connection. Isn’t the internet great!?
In addition to what is traded and where, when and how is also different from most other markets. Because Forex is a Global market, trading is not limited to a single domestic trading session. Market participants can trade 24 hours per day 5 days per week because there is always a market open and trading only stops on the weekends. Trading opens at 5pm EST Sunday and continues 24 hours per day until 5pm EST Friday. Trade your own schedule and get weekends off. Can’t beat that!
Trading is separated into 4 sessions according to which countries are active. The Sydney session starts at 5pm EST. Tokyo is next at 8pm EST, London at 3am EST and finally New York at 8am EST. Of these sessions, London is largest followed by New York. It is for this reason that, generally speaking, from 3am to 12 noon when these two sessions overlap we see the most volume traded. However, it does not mean that there are no trading opportunities outside these times, but if you’re going to plan a Forex strike, this would be a good time to do it.
Ok, so we know where, when and how it’s traded so how do we actually make money? When a position is opened or trade is placed it establishes our entry price. From here the market will move up and down. Each tick or movement up or down represents one pip. A pip, or Price Index Point, is the smallest price movement in the market. Each movement up or down represents money gained or lost. How much will depend on the size of the position.
Forex prices are quoted in several different ways which will vary depending on your broker. The price you see shows how many of the second currency it takes to buy the first. A price on GBPUSD of 1.5055 lets us know that if we wanted to buy 100,000 British Pounds it would take $150,550 US dollars. You may also see a price quote with an additional digit like 1.50553. This is referred to as a fractional quote. Again, which type of quote you see will depend on your broker.
Before placing a trade you will have to input the position size. This is done by inputting the number of LOTS that you will be trading. A LOT is the tradable unit used in Forex. A Lot is simply a specific amount of the base currency. There are 3 sizes that you will hear referred to when discussing lots:
- Standard Lot – 100,000 units of the base currency
- Mini Lot – 10,000 units of the base currency
- Micro Lot – 1,000 units of the base currency
Let me guess, you’re still asking, “ok, so how do I make money?” Let’s look at the math. If we buy 1 lot (100,000 Pounds) of GBPUSD at 1.5050 which would cost 150,500 dollars and the market goes up 1 pip to 1.5051 the math looks like this:
- 1.5050*100,000 = $150,500
- 1.5051*100,000 = $150,510
So we would have made $10 on a 1 pip move from 1.5050 to 1.5051. Clear as mud? If you’re not into math this simple rough estimate may help. Generally speaking you are looking at around $10 per pip on a standard lot, $1 per pip on a Mini lot and $0.10 per pip on a Micro lot.
Let’s talk about Brokers: the friend you love to hate. In order to trade Forex you will have to open an account with a brokerage. Which broker to go with is a hotly debated topic. It’s kind of like asking “what’s your weapon of choice.” There are many things to consider when choosing a broker. First, is the broker regulated or registered with the regulatory authority in the country in which is established? Regulated brokerages must meet and maintain certain requirements given them by the regulating agency. These may deal with capitalization, presentation of information on a website or application as well as establishing penalties for not abiding by these requirements.
The CFTC is the government agency which oversees Forex trading in the U.S. It is helped in this task by the National Futures Association (NFA). The NFA is not a government agency, but a self-regulatory agency which establishes rules for its members and enforces any penalties or punishments for breaking those rules. Each of its members must pay annual dues for membership. In addition, members must meet specific guidelines with respect to their business practices, policies and procedures and other aspects of their business.
Another question might be is the broker an ECN (electronic communications network) or a dealing desk. An ECN broker uses a network of market participants including banks, financial institutions and even other traders to establish counterparties for your trades. This allows for execution of trades between active parties in the market. The other choice would be a dealing desk broker. In this case, the broker can take the opposite side of your trade. What this means is that if you buy your broker is the counterparty and takes the sell position. So if you make money on the trade your broker loses and if you lose money on the trade your broker makes money. While this may seem like a conflict of interest, it is allowed and the way many brokers structure their business model.
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