The following are a few points that make the Forex trading market unique:
The Foreign Exchange Market, abbreviated to Forex (or FX), simply put is the global market place where you can buy and sell currency.
The Forex market vastly overshadows the stock market, as forex trading measure up to 5 trillion USD a day.
FX brokers give access to all three major FX markets (New York, London and Tokyo) where almost all currency pairs are traded. Therefore, currencies can be traded 24 hours during the weekdays.
Unless a major event such as 'Brexit' comes around, prices of a currency moves very slowly. Due to this reason currencies are in fact quoted with 4 decimal points (barring Japanese Yen). A currency may move about 0.0010 – 0.0030 in value on a normal day.
In addition, the size of the Forex trading market means that, even very large transactions have minimal impact on price, making Forex markets less receptive to market manipulation by a single party.
Due to the stability of a currency, Forex trade almost always uses the power of leverage. Leverage means that a smaller amount of money is set forth to trade a large sum of money. As an example, a leverage of 1:100 means that the Forex trader can use 100 USD in their trading account and buy 10,000 USD worth of Euros. As one Euro changes by 0.0001 USD in value, the trading position changes by 1 USD. As you can see, a very small change in a currency’s value fluctuation can result in a large gain/loss for the trader. Additionally, this means that a retail trader can start trading FX with a relatively small sum.
FX commissions come through the bid and offer spread (discussed later) which results in a varying commission fee rather than the flat commissions.
In every transaction, there’s something the buyer gives to the seller and vice versa. In FX, the buyer gives money to the seller and the seller gives money of a different currency to the buyer. Therefore, every FX transaction happens as a currency pair.
Currencies are denominated using the ISO 4217 currency code. They’re always in three characters. The following table shows the currencies traded on FX markets in 2016 against their respective market share.
- USD 88%
- EUR 31%
- JPY 22%
- GBP 13%
- AUD 7%
- CAD 5%
- CHF 5%
- CNY 4%
- Other 35%
As currencies are traded in pairs, the total market share adds up to 200%. Due to the massive US economy and most commodities (such as oil) being traded in USD, the FX market for USD is far greater than the other currencies as well.
The FX currency pair is always quoted in the following manner
- USD/CAD 1.30425
The left-side currency which is USD in this example, is called the base currency. The right-side currency is called the quote currency. The base currency is spent to buy the quote currency. The number represents how much of the quote currency is gained by spending a unit of the base currency. In this example, by spending one US dollar you can buy 1.3042 Canadian dollars. The 0.0001th decimal is referred to as a pip. A pip is the smallest tradable unit in the FX market. Therefore, the fifth decimal point is only for informational purposes and is called a pipette. Some brokers won’t quote the pipette.
The exception to the above is when a currency pair involves Yen. Then the pip becomes the second decimal point as one Yen is comparatively much less valuable to other major currencies. Therefore, the USD JPY pair take the following form.
- USD/JPY 111.604
Due to the dual nature of the currency pair, if a FX trader wants to buy the base pair using the quote currency, they can sell the currency pair instead of buying it. For example, you may buy 1 US dollar using 111.60 Yen according to the example above.
The Electronic Communications Network (ECN) is used by the major banks and other institutions who provide price feeds to the ECN pool. The broker has access to this ECN pool thus can offer the best bid and offer prices to the trader. This can result in a very low bid offer spread which sometimes can close on to zero (i.e. bid and offer price are the same). The brokers usually take a fixed commission off each trade. Therefore, high value traders can save money by using ECN brokers.
STP Brokers are similar to ECN brokers in the sense that they connect traders to liquidity providers as well. The main difference lies in the fact that STP brokers have connections to liquidity providers individually. They also usually profit through an added bid ask spread rather than a commission.
Although, the above categorizations are generally accurate, in the real world there can be specific characteristics, fee structures and trust factors relevant to different brokers. Therefore, one must be careful and perform research on individual brokers before selecting one.
Trading platforms are basically the types of software traders use to input the trades through. Different brokers may offer their services through different platforms. Most of the FX brokers offer MT4 as it has become the world’s most popular FX trading platform. Therefore, it’ll have the most amount of education as well as automated scripts (called Expert Advisors) available.
After selecting a trading platform and a broker, the next step is to learn how to trade. The most basic tool for this purpose is the line chart. It’s simply the price of the currency pair graphed against the time. Although simple to read, the line chart loses lot of information related to quick market movements which can be very important to short term traders. The main reason is that, a line chart connects the closing price of every time period, thus the price movement within that time period is lost. Candle stick charts on the other hand presents most of the relevant data in an elegant manner.
There are three main categories of analysis FX traders can use to predict market behavior.
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