Basics of Forex trading
We will see very basics of currency trading aka Forex (Foreign exchange) trading. This post will try to explain forex related terms, conditions and how does Forex trading work. Also we will try to understand what is Forex market and how it works.
What is Forex trading or currency trading?
In simple words, forex trading means buying and selling of various currencies. For example, you buy 1000 US dollars with a currency you own and you sell it when you think it is proper. Trades executed as currency pairs in Forex market like EURUSD, GBPUSD , USDCAD etc. All transactions or trades are happening in various exchanges. The tern “Forex market” is a broad term, which implies whatever trades executed by various exchanges.
Forex (FX) market or currency market
Forex market is the largest financial market in the world. This is where all trades happen. Otherwise you can say that FX market is where you can buy and sell currencies. By 2010, estimated daily turnover of Forex market was around 4 trillion dollars. Forex market has no centralized exchange. A networked financial institutions, banks and brokers are the platforms where real trades takes place. The Forex market works 24 hours a day and 5 days in a week. Weekends(Saturday and Sunday) market does not work.
Since market is global and trades are happening in many exchanges across the world, It is mainly divided in to three trading sessions for convenience.
- Asian trading session : This is where the first market session opens in a week. It is usually considered as Tokyo exchange timings, 11PM to 8AM GMT (6PM EST to 3AM EST) . But there are many other countries which start trading before Tokyo exchange. For example Australian trading session start at 5PM EST (This is exactly when New York session ends)
- European trading session : Starts and ends with London exchange trading session. (3AM to 12PM EST)
- American trading session : Starts and ends with New York exchange trading session ( 8AM EST to 5PM EST)
How it works or how the currency trading happens?
During the trading transactions, security exchanges trade with currency pair. A currency pair is like EURUSD or GBPUSD. Let us see what is a pair.
As mentioned above, trading of currencies is in pairs (Forex pairs). For example, EURUSD is a currency pair. First part of the pair is EURO (EUR) which is the base currency and the second part is US Dollar(USD) which is a quote currency. It means How much USD needed to buy 1 EURO. If EURUSD price is 1.2040 means , you need 1.0204 US dollar needed to buy 1 Euro.
You can specify the quantity of Forex pairs in lots while executing a trade. One lot means 100,000 units of currency.
1 standard lot = 100,000 unit
1 mini lot = 10,000 unit
1 mini lot = 1000 unit
How to start Forex trading
To trade, you need a trading account. You can start a trading account with any brokers or banks which offer trading facility. Before trying to open a trading account, you must make sure forex trading is legally allowed in your country.
Brokers are companies which give the traders access to the market through trading platforms. You can trade currencies only through a broker or a trade account opened with a bank.
You can open a trading account with any of the broker available. Deposit the amount you want to start the trading to these trading accounts. You can buy and sell currencies through this trading account. Brokers take their brokerage by spread or commission which we will discuss later.
How brokers work?
Broker gives you a platform to place your orders to buy or sell. In back-end, they can send the order directly to security exchange or trade internally. There is ECN ( Electronic communication network) trading account and standard trading account. ECN allows the direct access to trades by all market participants. Brokers take commission as brokerage for ECN accounts and for standard account , the brokerage depends on spread.
Basic account types based on account size
All brokers offer different kind of accounts for clients, mainly based on account sizes. For example, let us take the account types provided by FXCM. According their website, this broker provides three types of accounts based on starting deposit. Mini, standard and active trading accounts. The terms and conditions are different for different account types. You need to research and compare to choose the best one for you.
PAMM accounts (Percentage allocation management module)
What is a PAMM account?
PAMM means a fund managed by a professional trader or institution where clients can invest their money. The PAMM account manager takes care of the fund management, all the trades, risk and money management. You have to give a percentage of the profit as a commission for the PAMM service.
Example for PAMM account functioning
Suppose there is a PAMM account with 20% commission. Initial deposit by account manager is $5000. Minimum amount to invest in this account is $500. So if the PAMM account makes 10% profit with two clients invested $500 each.
Total PAMM value = $5000 + $500 + $500 = $6000
Percentage of each investor :
account manager:- $5000 = 83.33%
Investor 1 :- $500 = 8.33%
Investor 2:- $500 = 8.33%
Profit 10% of $6000 = $600.
Commission : 20% of profit = $120
Remaining profit : 600-120 = $480
So profit for each trader :
Account manager = 83.33 % of $480 = $400
Each investor = 8.33% of $480 = $40
PAMM accounts for those clients who are not familiar with trading strategies or simply do not want to trade themselves. Many brokers offer PAMM service, where you can invest in any PAMM account. PAMM account manager is responsible for money and trade management. Here is a link to compare PAMM service by brokers. You can even find out best PAMM accounts by comparing them in various broker sites.
These are the softwares which allows you to execute your trade. Most popular trading platforms are given below.
- mt4 (Metatrader 4) . You can download this from metatrader 4 site.
- mt5 (Metatrader 5). You can download mt5 platform from metatrader 5 site.
There are different platforms provided by different brokers. When you open an account with them, they will give the software to trade.
Basic terms like pips,spread,commission, stop loss
Here is to explain basic Forex terms.
Pips (price interest points) : Pips are the smallest price movement of a given price. Most of the Forex pairs are given in 4 decimal points. So 1 pip is 0.0001. For example,You bought EURUSD at price 1.2542 and sold it at 1.2600. This means the price has grown up by 58 pips.
Spread : Spread is the pips difference between BID price and ASK price of a pair at a particular moment. This varies in almost every tick. Standard spreads are as low as 1-2. But in a volatile market, spread can become big like 20-30. Standard brokerage is the spread at the time of order execution.
BID price and ASK price
Bid price is the highest price of a pair offered to buy. Ask price is the lowest price, a trader is ready to sell the pair.
Commission : Commission is the charge taken by broker for each trade. It depends on account type. Usually a broker takes brokerage either by spread or by commission.
Stop loss (SL): This term comes with trading strategies. With proper SL you can cut down the loss if your executed trade is going against you. You can specify the loss you are ready to take in a trade. For example, if you buy EURUSD at 1.2500 and you keep and stop-loss of 1.2450. It means you have kept an SL of 50 pips. If the price goes down against your expectation, SL triggers at 1.2450 and your trade will close with -50 pips loss.
The basics of Forex Trading analysis
Now you are familiar with trading account , platform and basic terms. Now let us see what is Forex trade analysis. In simple words, this where you will analyse the situation and various conditions before placing your trade order. There are mainly two ways of analyzing the market situation.
- Fundamental forex trading analysis
- Technical forex trading analysis
Fundamental trading analysis mainly depends on financial situation and events at particular time. Awareness of global financial events and news help to analyse the market fundamentally, also it helps to understand how they are going to affect the price movement of a particular forex pair.
Technical forex trading analysis mainly based on technical price charts and strategies based on this price movements.
Basics of Forex trading Technical analysis
Since most retail traders depend on technical trade analysis, let us go through the basics of technical analysis. Charts and strategies are the major tools for technical trading. Let us see some of the chart types.
- Japanese candle stick charts. These visual representation price in each time frame. It shows open, high,low and close price in a chosen time frame.
- 2.Renko charts . These kind of charts depends only on price movements and do not consider the time. Each brick is a predefined price size.
Other major chart types are Heikin Ashi, Bars, Lines and area charts
Forex trading strategies and methods
Every technical trader follow a strategy to execute their order. There are many methods and strategies are available in trading world. Some of the most popular methods are price action trading and trading using indicators.
Price action trading: This method depends behavior of price movements in a given time frame. They use other technical tools like support , resistance levels, trend lines and patterns.
Indicators : Indicators mainly mathematical tools to calculate the price movements. Most of the indicator use the past price values to calculate the value of indicator. examples are MA (Moving averages), RSI (Relative strength index) etc.
You can use any method to trade according to your comfort and trading style. Every method can win as well as fail in Forex market because of its dynamic nature. To master the art of trading one must have enough experience and solid strategy for both trading and risk management.
Demo accounts : If you are new to forex trading, it is better to start a demo account with any broker and start demo trading. This will help you to understand how market works. You can also test all your strategies and methods with a demo account before investing your money in a live market.