Introduction to FOREX: FREE Webinar

by Ed Liston · May 8, 2013

Introduction to FOREX: FREE Webinar

Today we are going to do a brief walk through of the FOREX market and try unpack some of the ambiguity around this asset class

Here is a quick overview of what we will be discussing:

First we are going talk about FOREX and bring definition to the term

Second we will begin digging into the interworking’s of the FOREX market, reading quotes, understating the terminology

Thirdly, we will follow that up with the market players. This is a zero-sum game so we want to know who we are up against when we are trading.

The forth and final thing that we are going to discuss are the risks benefits of trading in this space. There is inherent risk with any market that we trade, so its important to know what we are up against before engaging the market directly to make sure that all is in line with our risk tolerance levels.

What is FOREX?

FOREX stands for Foreign exchange also referred to as currency trading. If you have ever traveled outside of the country and purchased a good or service overseas, then you have engaged in a facet of currency trading. For example, if you live within the United States and have ever traveled to Europe then you were required to convert your US Dollars for Euro’s, so in that exchange you have engaged in a type of currency trading.

The rate of exchange that you received when the transaction was made fluctuates everyday providing some quite significant trading opportunities for the average trader.

So we need a little bit more depth to understand what this currency trading is all about… For those of you that trade in the stock market, you guys know that you are trading a stock or asset that represents a singular entity. In the Forex world, we are trading economies and always two at a time. So when we are looking at the EUR.USD for example we are trading the economic fluctuations that exist in both the united states and in Europe simultaneously. This will become clearer as we move forward.

Essentially, all currency trading is about is supply and demand. As the demand for a particular currency increases then the perceived value of that currency will also increase. Conversely, when their is an overabundance of supply for a given currency then the perceived value of that currency will decline.

So even though we are trading the ebs and flows of two different economies, we are always just trading off of one chart. Above is a chart of the EUR.USD. I put this up here because I have received questions in the past about the fear of using multiple charts to trade a singular currency pair, for example one for the Euro and another for the US Dollar. So for those of you that have engaged the stock market, you should see some similarities between the chart above and what you look at in the Stock Market… because they look exactly the same. You can also apply the same indicators and similar forms of analysis. That to say there are certainly SOME similarities between these markets.

But where it differs rests within what moves price. To understand what cause price to rise and fall as you see on the chart above, we have to be aware of the market drivers within this space.

What Moves the FOREX Market?

Interest rates: Investors and traders can look at the interest rate of a particular economy to determine the perceived strength or weakness of that economy.

If an economy is doing poorly then the Fed or Central Bank will decrease interest rates in an effort to stimulate the economy. In other-words, low interest rates are a sign of economic weakness. Conversely, if interest rates within a given economy are on the rise then investors will look upon that as favorable because the Fed or Central banks believe the economy is doing well enough to increase interest rates. So rising interest rates speaks to economic strength.

Economic Growth: There are other things that we can be looking at that would speak to the percieved strength or weakness of an economy such as GDP (Gross Domestic Product), Employment data, Housing data, so on and so forth.

Geo- political: This is another big one… When there is political uncertainty it can spark increased volatility in the market. Simply because there is a degree of uncertainty present. Durring election season it is expected that there will be turbulence in the market, typically there is one candidate that has more favorable views that the other. Also shifts in policy also has bearing on market volatility.

Trade and capital flows: Big businesses are buying and selling goods and services from around the world. When transactions are made these business have to convert their home currency to the countries currency with which they are doing business. This will of course stimulate movement within this market.

The other things that could be factored into this category are hedgefunds and institutions (Big banks). The are moving money in and out of the market every day with enough volume to leave a footprint in the market.

Mergers and Acquisitions: If a business within the united states were to merger or acquire a business in Europe for example, (and I am talking big business here) then that would certainly have economic implications that could move markets depending on how the arrangement is structured.

So the fascinating thing about this market is that we can map out just about all of the high impact market moving events prior to the trading week by viewing an economic calendar

Major Markets

Take a look at the US stock market. In a given day, there is an estimated $100 Billion dollars that flows through the market.

In the US Treasury market, $300 billion per day…

The FOREX is 9 times larger than the combined US equities market. Moving an estimated 3.9 Trillion dollars in and out of the market on a daily basis. This is speculated to be the largest market in the world.

Not only is this the largest market in the world, but it is also speculated to be the fastest growing market in the world.

If you look at the trend here from 2001 to 2010, you can see that the market has nearly tripled in growth. In 2001 there was an estimated $1.4 trillion dollars moving in and out of the market. In 2010, that figure climbed to $3.9 trillion moving in and out on a daily basis.

So what has contributed to this kind of growth?

There is a book out there by Thomas Friedman called “The World is Flat” and it basically discusses the leveling the the playing field for businesses (Friedman’s book is a good read of you are interested). Due to technological advancements such as the internet, global trade is now more prolific than any other time in history. So the growth of interenational trade is a large contributor to the positive development of this market.

Also, the forex market use to be regulated to the halls of the largest banks and institutions but after regulatory shifts somewhere near the early 2000’s the market was opened up to the spectators and retail traders also contributing to growth factors

By the way, the forex market is open 24 hours per day, 5 days per week… so in terms of appeal, it has it.

So to reiterate we are not trading stocks or tickers in the Forex Market, we are trading currency pairs, and always two currencies at a time. So sticking with our EUR.USD example from earlier. If we were to take a position long in the EUR.USD then we would simultaneously be long the Euro and short the US Dollar. The inverse of that is also true, if we were to short the EUR.USD then we would be simultaneously short the Euro and long the US Dollar.

Why is this important?

Understanding the interworkings of the trade allows us to look at look at correlations that speak to the strength or weakness of the US Dollar. For example, if we see that the Dollar Index (Ticker: DXY) is rallying and we were looking at a LONG position in the EUR.USD, that may not be a good idea because the Index in a bullish trend would be indicative of US Dollar strength. We can also look at things such as the price of gold or oil which bear and inverse relationship on the US Dollar. If Gold and Oil are on the decline, again that would mean dollar strength, so it I would hesitate on taking a position long in the EUR.USD.

To the right, in the image above, we have the major pairs listed. The pairs highlighted in blue are the most heavily traded pairs on the market. I threw in the AUD.USD because that is one of my focal pairs. When I am trading I solely focus on the GBP.USD, the EUR.USD and the AUD.USD because I want to understand the personality of each asset that I trade.

So the first currency listed in the sequence is called the “base currency” and the second is referred to as the “quote currency”. The price that you see on your screen represent the value of the base currency relative to the quote currency. So if the EUR.USD is trading at 1.3100 then it means that one Euro is worth $1.31 US dollars.

What is a Pip?

When the market moves, how do we calculate that move in the Forex Market? In the stock market, movement is calculated in terms of points… BUT in the Forex market we are looking at pips. A pip is the smallest increment of price that a currency pair can move. To calculate a single pip look 4 decimal places to the right of the quote. The JPY pairs are an exception to the rule here….

So if we were to take a long position in the GBP.USD at $1.5001 and let it ride to 1.5011 that would be a 10 pip move. So the next question should be, what is the value of a pip? If you are trading a standard lot, then a pip is worth $10…so that hypothetical 10 pip move would be worth $100.

This is where this gets a little bit more exciting…

A standard lot is $100,000 US Dollars, but due to leverage capabilities which are HUGE in the Forex market, it would only require $2,000 to be able to make a $100,000 trade.

If you are here in the United States, leverage is 50:1, but if you are outside of the United States, the leverage capability is up to 400:1… So what does that mean? If you had $10,000’s in your trading account at 50:1 leverage, you would have $500,000 to trade with.

Leverage can be a great thing or an a terrifying thing depending on how you manage your positions.

Major Players/Competition

So remember that I said we have to know who we are up against in this market, the major players here are hedgefunds and institutions. They certainly have an advantage because they have the means to move the markets.

To move the market in the FOREX world it takes about $50 million dollars. Some of these institutions come in with a billion dollars plus in a trade.

So as currency traders, our objective is to understand how these major players think and act, and then ride the waves that they create.

… Trading is sort of counter-intuitive to what most of us have been taught over the years. We were taught not to follow the crowd, but if you were to try trading against these large institutions you would lose your shirt fast.

It’s important to understand that these big players can’t just enter a position at any random place on the chart, they have to enter larger positions at key levels so that they do not run the price up the currency pair up as they are entering their position, which would increase the expense of the trade… thus they have to be strategic and we have to understand their strategy.

Introduction to FOREX: FREE Webinar