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Introduction to the Forex Market ...................................................................... 3 How is Foreign Exchange Traded .................................................................... 4 The Advantages of Trading ............................................................................. 6 Currency Pairs ................................................................................................. 7 The Concept of Leverage ................................................................................ 8 Trading Costs .................................................................................................. 9 Fundamental Analysis .................................................................................... 10 Technical Analysis ......................................................................................... 14 Risk Management .......................................................................................... 19 Psychology of the Trader ............................................................................... 20 Contacting US ................................................................................................ 22
The first currency listed in a pair is known as the base currency, while the second currency is called the counter or quote currency. The base currency is the "basis" for the Bid price (the cost of selling the base currency) or the Ask price (the cost of buying the base currency). For example, if you Ask EUR/USD you have bought euros (and simultaneously sold dollars). You would do this if you expected that the euro would rise in value against the US dollar. If the EUR/USD is quoted at 1.5460, that means that one euro is currently worth just over $1.54. If the market moves from 1.5460 up to 1.5461 that represents a move of one pip. A pip is the smallest increment of a currency pair and it is one ten thousandth of a euro, dollar or pound and one hundredth of a yen. Forex is traditionally traded in lots, which represent 100,000 units of the base currency although much smaller lot sizes are available today. In the case of the
EUR/USD currency pair, a pip is worth $10 in one lot and is $1 in a 10,000 EUR/USD
position so a movement of one pip would be worth $10 on a 100,000 position and $1 on a 10,000 position.
A Trade Example
You think that the euro will rise against the dollar and so you Ask the EUR-USD currency pair. You are correct, the price rises and you close the trade.
The EUR/USD was trading at 1.5460 when you asked (bought) it. The EUR/USD was trading at 1.5590 when you bid (sold) it. You bought at 1.5460 and sold at 1.5590 for a profit of 0.0130 or 130 pips. If your trade had been worth $100,000 each pip would have been worth $10. On 130 pips x $10 you would make a $1,300 profit
In forex, you also have the opportunity to short sell (Bid first) a currency pair if you think it will fall in price. If you had thought that the euro was going to fall relative to the U.S. dollar you would have Bid on the EUR-USD currency pair. Again, you were correct and you closed your position for a profit.
The EUR/USD was trading at 1.5460 when you bid it. The EUR/USD was trading at 1.5330 when you sold it. You sold at 1.5460 and closed your position at 1.5330 for a profit of 0.0130 or 130 pips. Again your position was $100,000 making each pip worth $10. 130 pips x $10 = $1,300 profit
Remember that these are profitable examples. Always evaluate your positions carefully; ending up on the wrong side of a trade can be very expensive.
Currency Pairs
What is the significance of currency pairs? A currency pair represents the exchange rate between two currencies. For example, the rate at which the EUR/USD is trading represents the number of US Dollars one Euro can purchase. The first currency listed is always the base currency. When to buy a pair. If, e.g. a trader believed that the Bank of Japan was likely to intervene to cause a decrease in the yen against the US dollar, then the trader would Buy USD-JPY (Ask the US Dollar/Bid the Yen) expecting that the price of the USD-JPY would rise. When to sell a pair. If a trader believed, e.g. that Japanese investors were losing faith in the United States' economy and were pulling money out of the US into Japan, then the trader would Sell USD-JPY (Bid the US Dollar/Ask the Yen) expecting that the price of the USD-JPY would fall. Below is an example of how currency pairs are listed on the XForex trading platform. The currency pairs are listed on the left side of the screen. The Bid price is the level at which a trader Bids the currency pair and the Ask price is the level at which a trader Asks the currency pair.
Trading Costs
How much does it cost for a trader to make a trade? Traders do not take positions on a currency pair at the exact rate at which the currencies are trading. Instead, they are offered two rates for the currency pair: the bid rate and the ask rate. The bid rate is the price at which traders can Sell the pair. The ask rate is the price at which traders can Buy the pair.
Above are some example currency pairs. The ask (Buy) rate is always higher than the bid (Sell) rate and the spread on the EUR/USD is 3 pips, meaning that if a trader Asks this pair, then the Bid rate of this pair will have to go up 3 pips in order for the trader to break even. The ask rate will always be higher than the bid rate. The difference between the bid rate and the ask rate is the spread. The spread is an automatic adjustment that is made to the trader's account when making the trade. Because of this spread, traders will begin every position they assume with a small loss and will need to gain some profit in order to break even. For example, if a trader Asks into a position at the ask rate, and then immediately closes the position at the bid rate, the trader will have a loss on their account that is equal to the spread. These spreads are seen in every kind of market. However, it can be difficult to identify the spread cost in the equities and futures markets due to the broker-based system they use.
Fundamental Analysis
What influences prices in the forex market? Prices in the currencies market are affected by macroeconomic factors, such as inflation, unemployment, and industrial production. Information on events such as these is easy to find. Fundamental analysis is based on the analysis of economic data, and traders try to use this information to take positions in the market in order to make profit. There are three main macroeconomic factors a trader should focus on when analyzing foreign exchange rates: Interest Rates: Each currency has an overnight lending rate. This is determined by a countrys central bank. Lower interest rates usually lead to the value of the country's currency declining. This is largely due to traders who execute carry-trades. A carry-trade is a trade where a currency with a low interest rate is sold and a currency with a high interest rate is bought. This is based on the idea that currencies with higher interest rates will generally rise in value, and will rollover and allow trades to earn interest on a daily basis. Employment: The unemployment rate is a key indicator of its economic strength. If a country has a high unemployment rate, it means its economy is not strong enough to provide people with jobs, and this leads to a decline in the currency value. Geopolitical Events: Key international political events affect not only the foreign exchange market, but all other markets as well.
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weaken against the dollar as the British devalue their currency in anticipation of merging with the euro. USD/CHF Global stability and global recovery send the USD/CHF higher, the USD/CHF weakens on geopolitical instability. For example, if you think that the market is headed towards a period of global stability and economic recovery, meaning that investors no longer need to park their money in a safe haven currency such as the Swiss franc, you would click ASK, expecting the U.S. dollar to strengthen against the Swiss franc. If you believe that due to instability in the Middle East and in U.S. financial markets, the dollar will continue to weaken, you would click BID, expecting the Swiss franc to strengthen against the dollar. EUR/CHF The Swiss government uses verbal intervention to weaken the franc, sending the EUR/CHF higher. If inflation took off in Germany and France it could drive the EUR/CHF lower. Thus, for example, if you think the Swiss government wishes to devalue the currency to help exports in Europe, you would click ASK, expecting the euro to increase in value against the Swiss franc. If inflation started taking off in Germany and France, you would click BID expecting the Swiss franc to increase in value against a devalued euro. AUD/USD Rising commodity prices send the AUD/USD higher. Droughts hurt the Australian economy and the AUD/USD. For example, if you think that commodity prices are going to rise dramatically, thus benefiting the Australian dollar, you would click ASK, expecting the Aussie to strengthen against the U.S. dollar due to Australia's status as one of the world's leading commodity exporters. If you believe that Australia will face another drought, hurting the domestic economy, you would click BID, expecting the U.S. dollar to strengthen against the Australian dollar. USD/CAD Canadian economic underperformance against the US sends the USD/CAD higher. Higher interest rates and a rebounding labor market in Canada will help to drive the USD/CAD lower. If, for example, you think that the U.S. economy is going to rebound while the Canadian economy goes into recession, you would click ASK,
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expecting the U.S. dollar to strengthen against the Canadian dollar. If you believe that the higher yields and rebounding labor market in Canada warrants a higher valuation for the Canadian dollar against the U.S. dollar, you would click BID, expecting the Canadian dollar to strengthen against the U.S. dollar. NZD/USD Bad weather in the US, increasing demand for foreign wheat, would send the NZD/USD higher. The expectation that New Zealand Interest rates will decrease would send the NZD/USD lower. If, for example, you think that Hurricane damage in the US will lead to an increase in wheat imports from foreign nations, such as New Zealand, you would click ASK, expecting the New Zealand Dollar to strengthen in value against the U.S. dollar. If you felt that interest rates in New Zealand will fall in the future while interest rates in the US will continue to rise, you would click BID expecting the New Zealand dollar to drop in value against the U.S. dollar.
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Technical Analysis
What is so great about technical analysis? Once a trader masters technical analysis, it can be easily applied to any currency or time frame. Technical analysis allows the user to figure out, in a relatively short time, where trends are going. Because of the short time it takes to study price curves, technical analysts are able to follow many currencies at the same time, whereas fundamental analysts usually focus on one or two pairs of currencies, because there is so much information in the market for them to analyze. Technical analysis offers many different ways for traders to analyze market information. Traders who use fundamental analysis can sometimes run into trouble because the sheer amount of data they are attempting to organize can be overwhelming. This can lead to misdirection, misunderstanding and ultimately, loss of money. On the other hand, technical analysis can be much more straightforward. Many traders even consider it to be self-fulfilling, meaning that it works well because so many traders use it. This is an important aspect of technical analysis because if many traders are basing their decisions on technical indicators, then the indicators must be watched since they reflect the sentiment of the market and the majority of the traders. Why is the foreign exchange market the best market to use technical analysis? The foundation behind using technical analysis is to find trends when they first develop, which allows the trader to follow the trend until it ends. The foreign exchange market is typically composed of trends and is, therefore, a place where technical analysis can be effective. Traders are able to speculate on both up and down trends in the foreign exchange market because it is possible to Ask a currency and Bid against another currency. This aspect of currency trading works well with technical analysis, because technical analysis helps determine where the trends are and which way they are going, thus giving the trader a chance of profiting from the market, regardless of its direction. In comparison to the equities and futures markets, technical analysis is much more common and popular within the foreign exchange markets, which causes the traders to pay attention. The market partly moves because of all the technical analysis performed. For example, according to technical analysis, if a currency pair decrease, then the majority of traders will Bid the pair, causing it to drop further.
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Support and Resistance in Momentum Markets Another way to use support and resistance is to trade outside of the range; in other words, to anticipate a breakout. This involves placing orders to Ask above resistance and to Bid below support. The rationale is that the market will gain momentum once it breaks out of the range, and thus by placing orders just below or above of support or resistance, traders may be able to profit if the market continues to move out of the range and they are on the right side of the market. Momentum trading is a bit counter-intuitive, as it involves Asking at a higher price and Biding at a lower price. Below is a chart that illustrates the concept of momentum trading.
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RSI was useful in detecting this USD/JPY short after a crossover of the 70 "overbought" level materialized on the daily. Following the clear Bid signals, the pair moved down 450 pips over the next 30 days. .
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Risk Management
There are three basic questions that every trader should answer BEFORE entering any trade: How much do I believe the market will move and where do I want to take my profit? Limit Orders allow traders to exit the market at profit targets. If you are short (sold) the system will only allow you to place a Limit Order below the current market price because this is the profit zone. Similarly, if you are long (bought) the system will only allow you to place a limit order above the current market price. Limit orders help create a disciplined trading methodology and enables traders to walk away from the computer without constantly monitoring the market. How much am I willing to lose before I exit the position? A Stop Loss order allows traders to set an exit point for a losing trade. If you are short on a currency pair the stop loss order should be placed above the current market price. If you are long on the currency pair the stop loss order should be placed below the current market price. Stop Loss orders help traders control risk by capping losses. Stop Loss orders are counter-intuitive because you do not want them to be hit; however, in the long-run you will always be happy that you placed them! Where should I place my stop loss and take profit? As a general rule of thumb traders should set Stop Loss orders closer to the opening price than take profit. If this rule is followed, a trader needs to be right less than 50% of the time to be profitable. For example, a trader that uses a 30 pip Stop/Loss and 100 pip take profit needs only to be right 1/3 of the time to make a profit. Where the trader places the stop and limit will depend on how risk-adverse he/she is. Stop Loss orders should not be so tight that normal market volatility knocks the position out. Similarly, take profit should reflect realistic expectations of gains, given the markets trading activity, and the length of time one wants to hold a position.
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the position with a loss or they are hoping that the position will become more profitable than it already is. This psychological viewpoint causes many traders to lose the profit that they had made, or to lose more than they originally would have lost. A mistake made by many traders is over trading, meaning that they trade much larger amounts of their account than is reasonable or trade too frequently. Although leverage allows traders to trade one lot of currency with only $1,000 as a margin deposit, it does not mean that traders should trade their entire available margin in one or two trades. The psychological mistake they are making is that they are thinking of their trade as a $1,000 investment, when in actuality it is a $100,000 investment. Although most traders perform adequate analysis of currencies before placing trades, they sometimes use too much of their margin and are later forced to exit the position at the wrong time. A general rule that traders can try to follow in order to keep from getting over-leveraged is to never use too much of their account at any given time; keeping enough margin available to cover your positions is critical to succesful trading.
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Contacting Us
If you would like to begin a Live Chat now, please click Here. If you wish to speak to one of our personnel over the phone we are open 24 hours a day seven days a week. For direct contact numbers please click here. Our email address is: onlinecs@xforex.com For support enquiries you can email support@xforex.com and for financial and billing enquiries billing@xforex.com. On behalf of XForex, welcome; we wish you every success in your trades!
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