The Complete Guide To Currency Trading

This is a very long article that covers virtually every important aspect that anybody who is considering participating in today's online currency market needs to know about.

The landscape of the foreign exchange market is constantly changing, and this article provides a timely discourse that covers some of the most important topics that any competent trader should be informed about, and it should help you decide whether or not currency trading can be a good choice for you.

What Does Forex Mean?

When people talk about the currency market, they will also use the term forex market interchangeably. The word forex is a shortened version of the term foreign exchange, and the reason this market has the highest level of liquidity compared with virtually every other financial or securities market out there is that everybody needs cash.

Whether you are a traveler who is going to a foreign country and needs some local currency in order to pay for your hotel and go out to dinner, or you are a multinational corporation with large foreign capital flows and an entire division of your company devoted to foreign exchange operations, money in the way that we understand it has become an essential component of life in any developed country.

Most countries around the world, and notably the major financial powerhouses like Great Britain, Europe and the United States embrace a policy of floating exchange rates where it is the market itself that dictates how much a currency is worth and not any one governmental or regulatory body. This floating exchange rate mechanism provides a vehicle for profit creation because if one currency changes in value relative to another currency then there is an opportunity to make money by buying and selling those currencies.

Is Trading In This Market Right For You?

Many brokers and currency trading websites are quick to extol the benefits of foreign exchange trading, but the truth is that this might not be a good financial answer for many people. Can you handle looking all day at a screen with blinking numbers without feeling overwhelmed? Do you want to wake up at 3AM every day during the week to trade the price swings during the London market open? Can you turn your emotions off and process your checklist of conditions that tell you whether or not there is a trading opportunity, without succumbing to base emotions like fear and greed when handling large amounts of money?

The learning curve is steep for people who are just learning about how to trade this market, and it is a fact that not only do most people who try their hand at forex trading fail, but the small minority that does succeed does so due to years worth of study and dedication. On the flip side, trading in forex can be a great opportunity for people who want to make money from home or for people who travel abroad frequently and so are aware of where the international exchange rates are.

Understanding The Global Trading Day

If you live in New York, you do not actually need to wait until the stock market opens on Monday to begin trading. You can start around 7PM Sunday night, when the sun rises in the Asian markets and they kick off the start of their business week. Trading in Japan, New Zealand, and Australia will continue on through the night and market activity can tend to peak between 2AM-5AM New York time when the financial markets open in London and dozens of other financial centers in Europe, and there is a window of time where both the European markets and the Asian markets will be trading.

Large market swings will happen during London markets because London is the largest foreign exchange center in the world. Despite the fact that the pound is the British currency, there are more dollars traded in London than in any financial center in America. As the morning progresses we will see New York and Chicago along with other American cities begin their trading day, and from around 7AM-9AM there will be another peak in activity as both the American and European markets trade simultaneously.

All across America traders will call it a day around 5PM and start to head home, while the traders in Asia are just arriving at their offices to start the next business day. This will continue all week long except in the case of national holidays, and the global market week will conclude as New York markets close on Friday until the next trading week begins when Asia resumes trading. This progression of different market centers is very interesting because it allows a trader to have market liquidity at nearly any time during day or night, which would not be possible with traditional stock trading.

Retail Forex Vs. The Interbank Market

It is important to understand the different types of forex brokers that exist and the basic structure that they will be utilizing in order to create market liquidity and make currency trading possible. Be wary of any broker that says they trade in the interbank market, because unless they are actually a large international bank where their foreign exchange operation is just an offshoot of a much larger financial corporation, this is probably not true. There are different levels on which foreign exchange activity can take place, from the true interbank market where hundreds of billions are traded, as far down as the family taking a vacation to Japan that needs to exchange some of their dollars for yen in order to conduct basic transactions during their stay.

Most forex brokers do not participate in the true interbank market because they do not have the capital or the connections necessary to be included in such activity. For the most part forex brokers will be centered on a retail trading level, where they will process orders from $10,000 up to $10 million. Most of these kinds of brokers will offer comparable account features, such as mini or standard accounts with lot sizes of $10K or $100K and leveraging your initial deposit from 50:1 up to 500:1.

The Two Main Types of Market Analysis

It is important to perform a market analysis before you engage in any live trading to make sure that there are viable trading opportunities and to see where there might be any market trends. There are two basic types of market analysis that can be performed, which are called technical and fundamental analysis. The difference between these two has to do with the time frame that a trader will keep an open position, as well as what type of data they are going to be looking at for their analysis.

A technical trader will focus on the price data itself, and will look for trading signals in the form of price trends, trading channels, support and resistance levels, moving averages, momentum indicators and candlestick formations. All of these tools are displayed directly on the price chart and derive their mathematical levels from the price data itself. A fundamental trader will consider factors outside of the price data that are usually economics-based in nature such as interest rates, monetary policy, popular economic indicators such as GDP, inflation, unemployment and consumer prices, as well as considering things like governmental stability and financial policy changes.

Equity & Risk Management Principles

Money management is an important part of your personal financial life, and it is even more important for your currency trading. If you are willing to follow certain preset rules about how much money you are willing to risk on any given trade, you will save yourself a lot of trouble and also save yourself from ever having the unfortunate experience of a margin call. One important rule to start off with is to make sure that you are never risking more than a certain percentage of your account balance on any single trade, so this means that if you have a standard account then you should not fund it with any less than $10,000 and only trade one lot at a time until your account grows.

It is also important to always trade with a stop loss order to minimize potential risk, and to calculate your reward to risk ratio which should be between 1.5 and 3. A good way to set up your stop loss orders is to calculate levels of support and resistance, and then place your stop level a few pips above or below an established support or resistance line to minimize the risk of being stopped out of the market prematurely.

What Are The Different Types Of Orders?

Most forex software will offer a number of different types of orders, so it is important to understand the basic types of orders that are available to traders. The simplest form of trading would be simply clicking on the buy or sell buttons, and some newer software will allow for trading directly from the price charts. The market order is the most basic type of order that most traders will use, and usually when you open up the order box there will be a space for the entry price, the stop loss level, and the take-profit level. Another popular order that is used during volatile trading times is called the one-cancels-other or OCO trade (some people also call it the saddle trade), where you are betting on a large price swing but are not sure in which direction so you will enter two different entry levels for buy and sell orders and as soon as one of them is triggered then the other one is cancelled.

One other important thing that will depend on the type of software you are using is whether or not your broker would allow for hedging a position that is already open. This can be determined by testing the demo account, as some software will allow there to be two simultaneous open positions for a currency pair and some software will take the order in the opposing direction and simply use it to cancel out the one that is already open.

Market Makers Vs. ECN Brokers

The two main models that are predominantly used by forex brokers are either a market maker or an electronic communications network (ECN). A market maker will create liquidity for traders by taking the opposing side of any open position, and an ECN broker will provide the software platform that connects different traders and matches up buy orders and sell orders. Some ECN brokers will also have relationships with large banks and have their software feed into the bank's software so that larger orders can be matched up on the interbank market.

Most of the forex scams usually are based around market makers, but trading with a market maker does have certain benefits that an ECN broker does not offer such as software that has built-in charting capability and news feeds, and also it is usually a larger company with more people which means they can have a live chat feature and respond to customer service tickets faster. Another benefit of using a market marker is that you can call them up and contest any trades or account activity that you do not think is fair.

Important Terminology & Indistry Jargon

The smallest unit that an exchange rate can fluctuate in is called a pip, which is usually in the fourth decimal place and is an acronym for "price interest point." The reason that many brokers can offer commission free trading is because they will usually price the buy and sell prices a few pips apart (larger for more exotic currency pairs), so this means that the first few pips that are gained on an open position are to cover the cost and break even. This price difference is referred to as the spread, and it is the difference between the bid price (at which currency is bought) and the sell price (at which currency is sold).

Your broker will also usually offer a large amount of leverage, which can allow you to trade with significantly more money than the size of your intial deposit. Most amounts of leverage will be offered at 1%, which means that you can control up to a $100,000 position with $1,000 in capital. Giving inexperienced traders so much leverage can sometimes be profitable, but more often then not it is just your broker handing you more rope to hang yourself with. If you are going to use such high amounts of leverage, it is important to follow strict equity management and risk control strategies in order to minimize downside.

A rollover order is what happens when you have an open trading position at the end of the trading day, where the position is rolled over to the next day so that you can avoid ever actually taking delivery of the currency you are trading which obviously you would not want to do. The rollover is calculated by the interest rates of the two different currency pairs in an open position as a factor of the trading volume.

Government Regulations & Forex Scams

The retail forex market has seen its share of many companies that were out to scam people, and while much of this has been eliminated there is still probably going to be some shady outfits that are looking to scam you. When you are considering signing up with a broker or a forex-related service, check to see if they are registered with the CFTC and the NFA, as well as even the BBB. You can also look online to see if there are any reviews of their services, to see how other people are working with them. Often times people will chat in forums about their experiences with so and so company, or they might post a review on a forex review site.

If a company is making claims that seem to good to be true, then they probably are. Now granted, there are many benefits that foreign exchange traders will have that supercede those of other markets such as high liquidity and even higher daily trading volume, but it is still just as harder to make trades that can win consistently. If a company ever offers a guaranteed rate of return, it might be a good indicator that they do not operate with integrity.

Picking Your Forex Trading Broker

There are many different factors to consider when picking your broker, such as which type of trading software the use and what the conditions are that they base their accounts on. Some brokers will offer different kinds of trading packages depending on how large your intial deposit is, and you may receive certain benefits such as a dedicated account specialist or free access to trading signal software.

It is important to consider how large the spreads are for the different currency pairs you will be trading, and you should also make sure that you are comfortable with using the software itself. There are different ways that you can access your trading account, and if you travel frequently then it is important to make sure that you can trade from a web browser as well as from a mobile version of the trading software. The first step is to research a broker's offerings and then sign up for a demo account, and before transferring money for a live account you will need to check to make sure they are registered with the appropriate regulatory agencies depending on the country they are based in.

Automated Algorithmic Trading Systems

Many of the currency trading products that are available today will offer a piece of software called an expert advisor that is an automated trading system which can trade in the market per a certain set of defined rules as long as the software is running. Expert advisors are designed to work with the Metatrader 4 software which is currently in use by over 100 different forex brokers. There is also other trading software out there such as Tradestation that has its own proprietary programming language which can be used to create automated trading systems, and some brokers will also offer custom automated trading solutions to qualified clients.

Many of these systems are becoming quite complex, and so theory plays a large part in the development of such systems. Artificial intelligence is being used more frequently in the development of such systems, as well as mathematical patterns called neural networks which simulate the mathematical principles of nature. One of the trading systems that won the Automated Trading Championship was based on neural network patterns, and it was first created in the programming language c++ and then ported over to MQL 4 which is the language used to create expert advisors.

Ethically Questionable Broker Behavior

Since there is not nearly as much regulation in foreign exchange trading as there is in stock trading (for example there is no such thing as "insider trading" in forex), some brokers can engage in complicated price fixing strategies to make it less likely that a trader can win consistently. If your broker is a market maker then they are literally taking the opposing side of every one of your trades in order to provide liquidity, so it is not unheard of for a market maker to trade against their own clients. This can include not filling orders at the right levels in order to limit a trader's profit, or it can include something called running stops which means that the broker will artificially inflate the price data that is quoted on the trading software in order to trigger stop loss orders prematurely.

Since fast profits for a trader are more likely to happen around major news releases than at any other time, your broker may not let you enter the market during fast moving price action. What can also happen during this time is called ballooning, where the pip spreads temporarily increase in order to discourage active trading during this time.

Conclusion

Trading in the foreign exchange market can take many failures and many years of study to fully master, but I do believe that no other opportunity affords individuals the chance for such rapid wealth creation as the forex market. A final piece of advice would be to triple your demo account twice before you ever trade live, and to never fund your live trading account with money that you cannot afford to lose.