Forex Trading – What You Should Know
Before you throw yourself head first into Forex trading, risk your hard earned capital and potentially draw-down your Forex trading account we suggest you take some time to educate yourself on the upsides and the potential downsides of the FX market.
Here at Netpicks, we are big fans of the Forex market in terms of day trading and swing trading. While sometimes trading the Futures version of a currency is a good play, there is often more liquidity in the OTC market which will improve your fills.
One of the biggest reasons for trading FX is the leverage that is available. While leverage is a double edged sword, for those that understand leverage and the risks involved, it is not the demon it is often made out to be.
With leverage of 50:1 or in some cases much more (depending on where you live) there’s no question the ability to have a substantial Return on Investment (ROI) is possible but newer traders in particular forget that leverage can also lead to much larger risk.
Forex Trading Is Big Business
It often helps to have some information about the markets you will trade and with FX, you are entering one of the largest markets in the world.The foreign exchange market dwarfs the combined operations of the New York, London, and Tokyo futures and stock exchanges.
According to its size and scope it is many times larger than all other markets.
Stats shows that spot transactions and forward outright Forex trading take place in the inter-bank market.
- 51% of the market is in spot Forex transactions,
- 32% in currency swap transactions.
- Forward outright Forex transactions represent another 5% of this daily turnover
- Options on ‘interbank’ Forex transactions making up another 8%.
Therefore the inter-bank market accounts for 96% of the global foreign exchange market, with the remaining 4% being divided among all the global futures exchanges.
For traders, Forex trading provides an alternative to stock market trading. While there are thousands of stocks to choose from, there are only a few major currencies to trade (the Dollar, Yen, British Pound, Swiss Franc, and the Euro are the most popular).
Forex trading also provides a lot more leverage than stock trading, and the minimum investment to get started is a lot lower.
Add to that the ability to choose flexible trading hours (Forex trading goes on 24 hours a day) and you have the reason why so many stock traders have flocked to day trade currencies.
Why Are Two Currencies Listed?
When trading Forex, you are betting on the strength of one currency against the weakness of another. Each currency is given a name and the first is called the base currency and the second is the quote currency.
The most popular traded currency pair is the EURO/USD and due to the popularity of this pair, you can often get less than 1 pip spread.
So what do you do with a pair of currencies?
Let’s use an example where you purchase the EURO and on the flip side, you are selling the USD to buy the EURO. What you generally see in a Forex quote screen is the following:
What this means is if you want to buy the EURO using USD, it will cost you $1.4502 USD to purchase $1.00 EURO. Conversely, you can sell 1 EURO for 1.4500.
What is the spread?
See that “2” difference between the two prices? That is called the spread and equate to 2 pips. That is what the broker gets whether you win or lose. Hype touts commission free trading in Forex but the truth is you do pay every time you trade.
To make it a little easier, each rate has a name as you can see in the graphic, bid and ask. The “Bid” price is what the broker you use is willing to pay for (buy) the currency if you sell. The “Ask” price is what the broker will sell to you when you chose to buy.
A pip is short for “percentage in point” and represents a price change in a currency. A price change from 1.4500 to 1.4509 is a pip difference o f 9 pips.
When you hear/read a trader saying they made 30 pips, what they are saying is the price they bought/or sold went in their favor by 30 pips. This however gives you zero insight into how much money they made as each pip value for individual traders can be very different.
The value of that pip is going to depend on your position size which is dependent on your account size, leverage and risk % per trade.
What Trading System Will You Use To Trade?
A Forex trading system is a method of trading that uses objective entry and exit criteria based on parameters that have been validated by historical testing on quantifiable data.
Like all of our systems at Netpicks that have been put through the wringer with testing, you must back test the system you are considering and ensure there is an edge.
Everybody who is committed to making as much money as possible with foreign currencies needs to understand the importance of having the best Forex trading system possible that suits their trading goals.
The real benefit to having a system to rely upon to make trading decisions stems largely from the fact that we cannot really make the best decisions possible without having a framework in place.
While it’s certainly true that you can trade without actually having a strategy in place where you simply guess at market direction, your odds of being successful will be almost zero over the long term.
You need to have a basic strategy or framework in place that will govern all of the trading decisions that you make.
Invest in A Ready-Made And Tested FX System
Fortunately, you don’t need to invent your own Forex trading system. There are a wide variety of different trading systems that you can look at so as to be able to pick one that is most suitable for you and your goals.
What you should do if you are brand-new to the world of currency trading is familiarize yourself with some of the different currency trading approaches that exist.
Not only will this give you the vantage point of being able to see how others go about the process of trading currencies, it will also help introduce you to some of the different Forex trading system variables that (in some cases) are universal among all the different currency trading frameworks.
Above all else, it is important to realize that the only way to really make a determination as to which Forex trading system is best for you is to actually experiment with a wide variety of different systems to see what kind of results you get. It’s not enough to simply look at the results obtained by somebody else.
At the end of the day, the only results that really matter are those that you were able to obtain for yourself through the use of a particular system. Therefore, you need to be open-minded to trying different approaches to see what kind of results you get.
Technical Analysis Trading In Forex
There are some traders who will use the various technical methods for trading. This will be indicators, price patterns, market structure or in some cases, a combination of all of them. One of the most talked about technical analysis tool is support and resistance.
The way that many traders naturally view market price levels is as support and resistance where they can potentially take trades and define their level of risk.
The idea is a straight forward and sound one.
If you’ve identified that a price or price zone has acted as strong support for example and you believe the market might be about to move higher, then going long around this support with a stop beyond it is sensible in that it allows you to know exactly how much you are going to risk on the trade to see if it does then break higher.
Simple, Not Easy
But a potential problem is that trading based on market price levels alone can lead to a blinkered trading approach.
It’s all too easy to identify specific prices that have historically demonstrated their value as support or resistance and the temptation which follows is to take a trade at the price when it’s revisited.
This however, is a recipe for disaster as every moment in the market is indeed a unique one.
- Are the same traders who turned the market before going to be there again?
- Are the same market conditions present? Is the context the same?
When I’m talking about a level of support or resistance, I’m not talking about mathematically generated market price levels.
I’m not talking about pivot points or Fibonacci retracements for example.
What we are talking about are price levels where actual trading activity has previously entered the market and prevented prices from rising/falling further or started a larger move.
These market price levels can be weak just as they can be strong.
Weak levels can hold just as strong levels can fail.
So what any level is in reality is a reference to previous trading activity. Sometimes the market will turn from them, sometimes the market will break them and sometimes the market will push through them by just enough to stop you out before it reverses and moves to your target.
Whatever the market does, by observing the action at or around a level you are able to find precious context with which you may subsequently be able to identify excellent trading opportunities.
In order to better understand how context can be extracted from the market’s reaction to a level, it’s useful to discuss an example. In this ES primary session example, prices were dropping hard in spite of the fact that in early trading there had been a decent attempt at moving higher.
The first context was in fact that it wasn’t able to hold above the prior session’s high and close.
As prices approached the prior day’s low at 1620.75, selling was pretty decent and given that the earlier attempt to go up had failed, there was good reason to suggest that 20.75 wouldn’t hold for too long if at all.
However, at 1621.50 there was a quick turnaround. In the face of all that selling, the ES rejected Monday’s low before even getting there. It then tested lower a couple of times without getting close to making new lows and crucially it held. At this point, the chances of a move higher into close were elevated.
In the end, the ES pushed 57 ticks from its low to its last high before the RTH close. Using this context to support you, there was decent money to be made given the context.
Market Levels Can Be A Trading Edge In Forex
Realistically though, there will be times when it’s very profitable to take trades at specific levels. As already pointed out, the very fact that you are identifying market structure to define the amount of risk you are willing to take is certainly one compelling reason to use market price levels for entries.
Sometimes levels work so well that it’s not hard to see why traders can be convinced at their unconditional validity.
However, if all market price levels were going to hold all of the time the markets would never move. So the question is that if you are going to enter at levels of support or resistance, which do you choose and when are they valid?
The example above got very close to the low of the prior session without actually tagging it and so in this case it may have been a difficult trade to take. More importantly however, the test higher and increased selling into the level would’ve made it a difficult trade to justify at the time.
In order to trade at a level it’s important to see context, confluence (ideally other reference points aligning) and the right sort of trading activity on approach, all working together.
Using A Technical Indicator
There are many types of trading indicators that you can use but remember that all indicators are a derivative. They need input such as price/volume in order to move so they will lag behind the market. That does not make them useless though.
Indicators get a bad rap by many people but if used properly and minimizing the amount of trading indicators you use for Forex trading, you can sidestep that landmine.
For this example, I am not going to use an indicator that is talked about a lot such as moving averages. There are many pages written about that indicator and how it can be useful. I want to focus on the Keltner channel and how I personally use it for my trading.
I use the Keltner to give me an objective view of a market that is overextending and where extremes of price can be measured. This will often set up a reversal trade (given the proper context) or a pullback-continuation play.
It is mostly used to give a heads up to something that is happening outside the normal movement of price. I can then use a plan specific to what is occurring to look for a trading opportunity.
This is a great example of how I use the channel in FX (any market really).
Any time price hugs the top or bottom of the channel we can assume there is a lot of strength (or weakness) in the market.
Price action will tell you a story as seen by the grey arrow but the channel gave us a signal to be on alert. You can see there is not much conviction in each of the candles until there is the large momentum candle into highs.
Momentum Can Be Tricky
Price is outside the channel and after seeing momentum like we did in that candle, you’d expect follow through. There isn’t. Bulls take the last stand and are soundly rejected. In this context, a sudden burst of strength in an already strong market and failure to continue, a short trade is appropriate.
Price drops to the center line and briefly consolidates. It is not atypical to see price take another run to the downside with such a violent rejection of price as seen in the candles. This move marked the current high in the USDCAD Forex pair.
Notice that is was a combination of price action, price structure and a technical indicator that helped set up the astute trader to the current top in these currencies.
FOREX TRADING TOOLS
You’ll find that although there’s plenty of opportunity to spend money for trading services or “special indicators” , free Forex trading tools are some of the most useful that you will find during your online search.
For the most part, the trick is to know what you’re looking for.
Plus it’s also important to realize that although many websites offer a number of tools in one place, you’ll find that you might tend to prefer certain sites that feature specific features that may suit your trading style.
You must know what news releases are upcoming. There are many that can cause the volatility in the markets to spike and you do not want to be taken out of a trade because of lack of information. You’ll probably start with something like an economic calendar and many seem to gravitate to Forexfactory perhaps as they offer a substantial forum-based community.
But for FX calendars, I prefer Dailyfx. They also have tools and commentary available on their website. But perhaps the most substantial free economic calendar for Forex traders supplied by Investing. It is highly customizable with 85 different countries in the filter section along with the type of release and relative level of importance.
But these on their own are just not substantial enough when minutes and even seconds can sometimes make a big difference to your P/L. This is why I like financialjuice – a free financial news source aggregator that allows you to filter for your specific areas of interest and alerts you in real-time.
forexlive is also a fantastic site for current market information, order price levels and trade ideas.
But personally, the one critical news source to me as a day trader is a live news squawk. I like the one provided by talking-forex as it keeps me up-to-date with all the current market moving information as it happens and gets me the economic figure releases in real-time.
CHARTS, ANALYSIS AND TOOLS
There are a good number of sites out there that offer live, real-time forex charts for free. One that I like a lot though is Tradingview. Their charts are high quality, feature-rich and run in any browser using html5.
Because they are also cloud-based, their servers do the “heavy lifting” reducing the need for high-powered trading systems. They also have a fantastic chart/idea sharing facility where you can view other traders’ analyses.
Forex Trading Wrap-Up
We covered a lot of ground in this article but there is a lot more that you must learn before venturing out into the live markets with real money. Without question, the most vital component of Forex trading is risk management.
We have a great tutorial on risk management in trading that I hope you take the time to read. It is absolutely vital to your trading success.
If you are going to implement trading indicators in your trading, Netpicks has put together a superb guide to trading with indicators that comes with videos and a PDF at no cost to you.
There is much more to cover in regards to Forex trading and we have special Forex 1,2,3 trading course that is another gift to you.