Complete Guide to Forex
It has never been easier for you to get into Forex than right now. In fact, it has never been this easy to start trading the Forex markets; the birth of the online trading world has significantly made it easier for the average trader to open a Forex trading account and start placing trades, all in under 60 minutes.
There are plenty of ways for you to go about trading in the Forex markets. You can even take advantage of the multitude of Futures markets that are found in all parts of the world at different market open hours.
What Is Forex?
The Foreign Exchange Market (forex) is a global market where currencies from all around the world are traded for another currency. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. The volatility of this market fluctuates the exchange rate continuously. It also refers to the global market where currencies are traded virtually over-the-counter (OTC).
If you have ever traveled to another country, you have made a forex transaction. For example, if you are an american that’s taking a trip to Japan, you would have to find a currency exchange booth at the airport to exchange your american dollar (USD) to japanese yen (JPY). The exchange between the two currencies, based on supply and demand, determines how many japanese yen you get for your american dollar.
Forex is a decentralized market that is open 24 hours a day, 5 days a week, exchanging over $5 trillion daily, making it the largest, most liquid financial market in the world. In comparison to less liquid markets such as the New York Stock exchange that exchanges over $20 billion per day, the forex market is over 200 times bigger.
History Of Forex?
It is important to learn some of the historical events relating to currencies and currency exchange.
Currency trading has been around for milleniums since the time of greeks, egyptians and babylonians. In 2600 b.c., Egyptians discovered gold and made it valuable. In 1500 b.c., Countries started using molten gold and silver to exchange currency and their value was determined by their weight and size. In 700 b.c, the first gold coins were created.
In the 15th century, the first forex market was opened in Amsterdam, Netherlands. The paper currency began later on in the 18th century and started spreading across Europe. This created the possibility to freely trade and helped stabilize the currency exchange rates. In 1875, the Gold Standard was introduced.
The Gold Standard System is a monetary system that guarantees the value of a country’s currency or paper money based on a fixed quantity of gold. A country that uses this sets a fixed price for gold and buys and sells gold at the price. Currencies were backed by the golds of their countries.
The Gold Standard System plays a huge role in the currency exchange. Later on, the system broke down during World War I because countries had to print more money to finance their expenses. This started the foreign exchange market.
The Bretton Woods Agreement was established in July 1944 and the US dollar was the only currency in the world that was backed by gold. The dollar became the new global currency because in 1944, the Bretton Woods Agreement was signed, agreeing to replace gold as the main standard of convertibility with US dollar. However, the Bretton Woods Agreement collapsed in 1971 and the digital foreign exchange started.
What Do You Trade?
The Foreign Exchange Market exchanges one currency for another currency such as the European Euro (EUR) for US dollar (USD), or Great Britain Pound (GBP) for Japanese Yen (JPY). These currencies are paired up by their nicknames so If you are trading EUR/USD, you are exchanging Euro for Dollar and would be read as EUR/USD. These are known as Quotes or Pairs.
EUR is the Base Currency. USD is the Quoted Currency. For example, if the current price is 1.2054 then for 1 EUR is equivalent to 1.2054 USD. This price constantly changes and the movement of price is measured by percentage in points or pips.
A pip is the smallest price movement in the forex market. A pip is practically quoted 1/100th of 1% percent of the 4th decimal (0.0001). Some are quoted with 2 decimal places (0.0100) like the Japanese Yen (JPY). The price of the market is usually seen on the right side of the platform you are analyzing the chart on.
For example, if you bought EUR for 1.2000 and the value of Euro increased, closing your trade at 1.2055, you just caught 55 pips!
1.2055 – 1.2000 = 0.0055 pips
The movement of the market is determined by a country’s level of economic health. Some of the leading factors that determine the market movement and volatility are Inflation Rates, Interest Rates, Government Debt, Terms of Trade, Political Performance, Recession, and more. These are also major economic factors that determine the strength of a country’s currency.
These quotes are grouped into different categories based on the currency they are paired. The Major Pairs are pairs exchanged with the dollar and the most traded currency pairs. Cross Pairs are pairs that do not involve the dollar with the exchange.The Major Pairs are the EUR/USD, USD/PY, GBP/USD, USD/CHF, AUD/USD, USD/CAD and NZD/USD. The Cross Pairs are GBP/JPY, GBP/NZD, GBP/AUD, AUD/JPY, AUD/NZD, and more.
Who Trades Forex?
The Forex market has a broad range of participants that play an important role and all of them have different motives. Here are some of the major participants:
Central Banks – Government agencies that control their national currencies in order to maintain a healthy economy. They are responsible for employment situation, interest rates, trade balance, and gross domestic product (GDP). These are impacts that affect the foreign exchange market.
Hedge Funds – Investment funds administered by professional investment firms that collects capital from investors, accredited or institutional, and invests in assets. Hedge funds are an alternate route of investing that targets aggressive returns using a variety of strategies to generate profit for their investors.
Financial Institutions – Companies that deal with financial and monetary transactions such as loans, deposits, investments, loans and currency exchange. Financial Institutions engage in a broad range of business operations for individual and commercial clients such as commercial banks, investment banks, insurance companies and brokerage firms.
Foreign Exchange Brokers – Brokerage firms that provide a platform for traders to buy and sell foreign currencies. Foreign Exchange Brokers mostly service retail investors and leverage their money so they can trade larger amounts than what is deposited in the account.
Retail Traders – Individual investors who buys and sells securities or exchange traded funds through brokerage firms or other types of investment accounts. Retail traders typically invest for their own personal accounts and often trade with small amounts as compared to institutional investors such as mutual funds.
How Does It Work?
To keep it simple, you “bet” whether or not a currency will fall down or rise up. If the price goes with your prediction, you will earn money, otherwise you will lose money.
There are many ways to predict the movement of the market. You will find that there are thousands of strategies online, each one claiming that their strategy is the best.
You can think of trading as drawing a car. If you ask different people to draw a car, each person will have their own method. One person may start with the wheels, the other person may start with the body kit. Another person may start with a sketch, the other one may just draw the final version only. There is no “wrong” way and each way will have its own unique results. Similarly in trading, the goal will be to make money consistently, but the journey to get there is the missing piece of the puzzle.
The Worldwide Market
Have you ever tried to enter a trade but you weren’t able to because the Stock market was closed? Well, you don’t have to worry about that with the Forex markets.
The Forex markets are very popular for being available around the clock during the weekdays. You can trade currencies in the Forex markets twenty fours day from Monday to Friday. Like with many other markets around the world, the weekends are taken off.
You can get any kind of transaction handled as long as one of the international trading markets is open. Fortunately, the overlap between these markets allows the Forex markets to stay open in a seamless manner allowing you to trade at any given time during the day with zero stoppages.
The four major markets that are available for trading include the following. All times for these markets are listed in Eastern Standard Time:
London – from 3 AM to noon EST
New York – from 8 AM to 5 PM EST
Sydney – from 5 PM to 2 AM EST
Tokyo – from 7 PM to 4 AM EST
Actual open and close times are based on local business hours. This varies during the months of October and April as some countries shift to/from daylight savings time (DST). The day within each month that a country may shift to/from DST also varies.
If you notice you will see that during each Forex session there is always times when more than one market is open at the same time. During the summer, from 3:00-4:00 AM EDT, the Tokyo session and London session overlap, and during both summer and winter from 8:00 AM to 12:00 PM EST, the London session and the New York session overlap.
Naturally, these are the most active times during the trading day because there is a massive surge of volume when two markets are open at the same time. This makes sense because during those times, all the market participants are constantly and actively buying and selling, which means that more money is transferring hands.
The average trader might not have much of a need to trade currencies at a very late time in the day as markets tend to slow down and move sideways as major investors start to head home. However, the market is still available to where you can get trades executed at any time. The fact that the market is open for so much time each day allows the different currency pairs to fluctuate a lot more than traditional Stocks and also presents more trading opportunities, this is another reason the Forex markets are arguably seen to be a lot more lucrative than the Stock markets.
Majority of trading in forex is focused in these financial centers. This market can be traded in 4 major sessions; the London Session, New York Session, Tokyo Session & Sydney Session. Each session is about 9 hours.
The opening of the Tokyo session at 12:00 AM GMT commences the beginning of the Asian trading session. It should be noted that the Tokyo session is sometimes referred to as the Asian session because Tokyo is the financial capital of Asia and one of the biggest market players.
One important fact is that Japan is the third largest Forex trading center in the world. In fact Japanese traders are increasing at a much higher rate than American traders. This shouldn’t be too surprising since the Japanese Yen is the third most traded currency, partaking in 16.50% of all Forex transactions. Overall, about 21% of all Forex transactions take place during this session.
The most commonly traded pair is the USD/JPY which also oftentimes carries the lowest spread or commission to trade as well.
The following is a list of important information that should be taken into consideration with the Tokyo session:
Traders don’t only focus on the Japanese markets. Billions of dollars’ worth of Forex transactions are made in other financial hot spots like Hong Kong, Singapore, New Zealand and Sydney.
The Bank of Japan (BOJ) has been known to inject a massive amount of government printed money into the markets should they feel their currency is getting too strong. This method has caused the markets at times to move over 2000 pips within 20 minutes.
The major market movers and participants during the Tokyo session are commercial companies (exporters) and central banks. Remember, the Japanese economy is primarily dependent on exporting and, with China also being a major trade player, there are a lot of transactions taking place on a second to second basis.
Liquidity can sometimes be very thin. There will be times when trading during the Tokyo session becomes boring and inactive, this period will be like watching paint dry – you might have to wait a long, long time before getting a bite as most traders are known to focus more on the New York and London markets.
It is more likely that you will see stronger moves in Asia Pacific currency pairs like AUD/USD and NZD/USD as opposed to non-Asia Pacific pairs like GBP/USD as news for each specific currency also comes out only during that currencies market open hours.
During those times of thin liquidity, most pairs may stick within a range. This gives us the opportunity to either scalp the markets or prepare for a major breakout during more active market opens.
Most of the action takes place early in the session, when more major economic data is released. The news often causes major movement in the markets, the AUD/USD has been known to move violently during major news releases.
You will often get the National Bank of Australia or Reserve Bank of New Zealand releasing interest rate statements early on in the session which can create turbulence across US Dollar pairs.
As the Asian market participants are starting to withdraw from the markets, their European cousins are just about to start their day.
Although Europe has hundreds of financial hubs, it is London that 99% of Forex traders keep their eyes on as London controls essentially the entire European market movements.
London has been long known to be the Forex capital of the world with tens of thousands of investors, businessmen and holding companies moving billions of dollars within the markets every single second. Thanks to where London is strategically located on the map, it has always been known to be at the center of some sort of trade. Roughly 30% of all the Forex markets transactions happen during the London session.
The following is a list of important information that should be taken into consideration with the London session:
Due to the fact that the London session overlaps with two other major trading sessions, and with London being massive player in the Forex industry–a large chunk of Forex transactions are made during this time. This leads to a massive surge in liquidity which can also lead to lower transaction costs as there will be more volume per user at the broker level.
The London session is known to be specifically volatile for the EUR/USD as there is a plethora of European news that is released within a couple hours of the London markets being open.
Most major moves that occur within different currency pairs that usually start during the London session generally also carry on into the New York session as well.
The best times to trade the EUR/USD and GBP/USD is during the overlap of the London and New York session as both markets will be open at the same time.
Price action may slow down and trends may start to change direction as European traders start to close their trades and take their profits.
New York Session
As the European traders start to take their profits and leave office for the day, the US traders are just waking up and getting ready to attack the big day. The New York trading session begins at 8 AM EST.
The New York session is the most traded session amongst all Forex traders, primarily for the fact that the most influential market news and market movements occur during this session. The most commonly traded pair during the New York session is the USD/JPY, EUR/USD and sometimes Gold as well.
Overall the New York session is one of if not the most participated in market globally.
The following is a list of important information that should be taken into consideration with the New York session:
Most major news events are released right at the beginning of the New York session. Remember that almost every major transaction in the world involves the US Dollar, so whenever major economic news comes out which affects the US Dollar, anything that is directly related to it will move drastically.
The New York session starts to drastically slow down after 1 PM EST as not only traders are slowly calling it a day but the European markets are closed.
There is almost little to no movement Friday afternoons as Asian traders are already done for the weekend and London traders are out at the bar drinking their favorite beer.
Overall, if you are looking for the best times to trade and find major volatility, look for times when two markets overlap, when two markets overlap naturally there will be a lot more volume and many more transactions. This will allow you to not only capitalize on major market movements but also enter and exit trades at a much lower cost due to a higher level of liquidity which in turn also lowers the spreads and commissions of specific trading instruments.
It is also extremely important to note that trading on Sundays and Fridays can be a costly venture. On Sunday’s when the markets are fresh there is really no direction as investors wait on news during the New York session to create a market path, markets can oftentimes start going north on Sunday and make a drastic turnaround on Monday, for this reason it is always best to spectate and watch on Sunday’s and allow the markets to form and find their direction before jumping in.
Such is a similar case on Friday. On Friday’s as markets are closing liquidity starts to get thin which not only makes the cost of trading more expensive but it also exposes you to holding a position over the weekend. By holding a position over the weekend you are exposed to any major news announcement that occurs Saturday or Sunday which may cause a gap in the markets when they re-open. A gap is when the price of the market opens significantly higher or lower than where it had originally closed. Should you get stuck on the wrong side of a market gap, you can find yourself losing a lot of money really quick with no way of protecting yourself, so for that reason we tend to stay away from Friday trading as well.
What Brokers Do
In order to successfully place trades within the Forex markets you will need some sort of institution or platform to help you facilitate your transactions. That is where a broker can come in handy. Traditionally in the past, traders would have had to keep their individual brokers on speed dial and call them every single time they wanted to make a transaction but with the birth of electronic trading, opening and closing an order in the Forex markets has never been easier. A quick search on the internet will bring up a massive list of online brokers ready to start working with you.
The broker is responsible for arranging transactions between buyers and sellers. That is, the broker will help facilitate the trades you execute by bridging the gap between yourself and the financial markets. Essentially the broker does exactly what their name implies, broker a deal between yourself and another major bank willing to buy or sell to you.
The broker will do this in exchange for a commission or a spread. This is a percentage of the total value of whatever you are trading or at least a fixed rate based on how much you are trading with. If the broker charges a specific spread then you will see this reflected in the price of the specific currency pair, for example if the EUR/USD traditionally has a raw market spread of 0.2 pips and the broker charges 1 pip spread, then the EUR/USD on that specific brokers platform would always be roughly around 1.2 pips which includes the raw spread plus their commission. However if the broker charges a base commission per trade executed, then you will see that in the finance tab of your trading terminal usually under the tab which says commissions. Every broker has its own rules as to how they structure their fees and commissions so be sure to shop around and do your due diligence as each broker is very different.
A Book and B Book
Trading the Forex markets is a lot different than trading the Stock markets because your broker can actually choose to go directly against you and take the risk on every trade you execute, with or without your knowledge. When your broker sends all of your trades to the real market or their liquidity providers, this is known as A Booking. When the broker keeps the trade in-house and takes the other side, this is known as B Booking.
In the traditional Stock markets every trade is sent directly to the exchange and matched with other buyers and sellers. In Forex your broker can keep all of the trades “in house”. This basically means that the trades you execute are never really sent to any market and there is no other investor or trader on the other side, instead your trades are opened at random by the broker where the broker himself takes the risk on the executed position. If you make money, they have to pay you out of their pockets. If you lose money, they just keep it all which has raised a lot of concerns for individuals because if the broker profits when you lose, wouldn’t it be to their benefit for you not to win? If that is the case, can they and would they manipulate the markets in their own benefits to prevent you from profiting?
Before we move on to why brokers B Book let’s quickly find a solid way to identify B Bookers from A Bookers. Brokers who B Book tend to offer very low initial deposits, they also tend to offer massive deposit bonuses, giveaways, gifts, etc. This is to entice the trader to start investing their money. The intelligent trader who has been trading for years and knows how to win at trading will never care to look at bonuses or prize giveaways, instead the new trader with little or no experience will be the one easily drawn to these flashy prizes, the broker easily identifies this and takes the risk on every trade that is taken by individuals that open an account with them using their flashy giveaways. Using these simple tell-tale signs we can prevent ourselves from being B Booked by a market making broker.
One thing to note, brokers who are A Bookers are also referred to as STP brokers which stands for Straight-Through-Processing. This term refers to the process where the orders are directly processed from user to bank without the broker taking any risk on the user’s trades. STP Brokers tend to advertise with pride so be on the watch for them as they won’t be hard to miss. Be careful though, a lot of brokers these days say they are STP brokers yet still take risk, always look for the major tell-tale signs we discussed earlier.
So, why do the Forex brokers B Book? Simple. 90% of traders are losers and it would make a lot more sense to keep their losses than give it away to the banks for a small commission. Now if you really think about it there is really nothing wrong with B Booking, in fact someone is always being B Booked one way or another as one person has to take the risk for the other person to win or lose. Where things get sticky is when brokers become greedy for profits and realize that since they are generating oodles of money when traders lose, why not force the trader to lose? Instead of waiting for the trader to naturally lose their money via a bad trade, brokers have started manipulating the markets to their advantage to increase the rate of loss amongst traders and to furthermore prevent traders from being profitable. They do this by either manipulating the stop losses, increasing spreads significantly higher than they would normally go during a major economic event or slipping entries and exits so that the trader always loses a couple pips every time they open or close a trade. This is the reason the B Booking industry or the market maker broker has developed such a bad reputation globally.
How To Read A Currency Pair
So you’ve finally got your own Forex account and you’re ready to go out there and start trading. But what about your actual trades? What do you plan on trading? Better yet, do you even know how to read a chart?
This module is designed to better help you understand the structure of a currency pair and to furthermore teach you the multiple ways a specific currency pair can be analyzed and assessed. This includes a look at how you will analyze a pair and how you can read a chart on multiple time frames. The information you can get out of these charts can certainly help you make an educated decision on whether to buy or sell when trading the Forex markets.
Although to some it may seem a daunting task, placing a trade within the Forex markets is actually rather simple. The mechanics of a trade are very similar to those found in other markets (like the Stock market), so if you have any past experience trading any other financial market, it would be rather easy for you to pick up the art of Forex trading pretty quickly.
The objective of Forex trading is to capitalize and make nominal profits by exchanging one currency for another in expectation that the price will eventually change, we are basically looking for the currency we bought to increase in value during a specific period of time.
How To Read A Forex Quote
If you have ever used a trading platform or reviewed a currency pair you would have noticed that currencies are always quoted in pairs, such as EUR/USD or CAD/JPY. The reason they are quoted in pairs is because in every foreign exchange transaction, you are simultaneously buying one currency and selling another.
The following diagram illustrates an example of a foreign exchange rate for the Euro versus the U.S. dollar:
When observing the example above the currency listed first or to the left of the (“/”) is referred to as the base currency (in this example, the Euro), while the currency to the right is called the counter or quote currency (in this example, the US dollar).
When we request a long position or we buy the EUR/USD, the exchange rate at the time tells us how much we would have to pay in units of the quote currency to purchase one unit of the base currency. In our example above, we would have to pay 1.0785 US dollars to buy 1 Euro.
When we request a short position or we sell the EUR/USD, the exchange rate at the time tells us how many units of the quote currency we would get for selling one unit of the base currency. In our example above, we would get 1.0785 US dollars if we sold 1 Euro.
When placing trades within the Forex market the base currency is always the “basis” for the buy or the sell. For example if you were to buy the EUR/USD this would simply means that you are buying the base currency and simultaneously selling the quote currency. In simple terms, “buy EUR, sell USD.”
The first thing a Forex trader does when he opens his charts is identify the main trend of the currency pair he is looking at and determines whether he is going to go long or go short.
If after performing your analysis you decide you want to go long or buy (which actually means buy the base currency and sell the quote currency), you would look for the base currency to rise in value and then you would sell it back at a higher price. Just remember: long = buy.
If you want to sell or go short (which actually means sell the base currency and buy the quote currency), you would look for the base currency to fall in value and then you would buy it back later a lower price. This is called “going short” or taking a “short position” where in the previous example you were “going long” or taking a “long position”. Just remember: short = sell.
When reviewing a Forex quote you will always notice that they are quoted in two different prices: the bid and ask. The majority of the time, the bid price is lower than the ask price.
The bid is the price at which your broker is willing to buy the base currency in exchange for the quote currency. This basically means that the bid price is currently the best available price at which you can sell to the market.
The ask price is the price at which your broker will sell the base currency in exchange for the quote currency. This means the ask price is currently the best available price at which you will be able to purchase from the market. Another word for ask is the offer price.
In the Forex community the “spread” refers to the difference between the bid and the ask price. So whenever you hear someone say “the spread on the Euro is currently high”, it simply means the difference between the current bid and ask price of the Euro vs the US dollar is currently higher than usual.
On the GBP/JPY quote above, the bid price is 143.099 and the ask price is 143.145.
If you want to sell GBP, you click “Sell” and you will sell pounds at 143.099. If you want to buy GBP, you click “Buy” and you will buy pounds at 143.145. The transaction is performed with a simple mouse click.
Prior to engaging in Forex trading it is vital that you first understand the structure of each tradable instrument, once you have mastered the format of reading a currency quote you then must master the art of reading and analyzing a Forex chart. Remember, patience is a virtue that will take you far, you cannot rush this process nor can you cheat or jump ahead, if you truly want to master an art you must submerse yourself within it and spend as many hours possible understanding and learning each and every aspect of it. Forex trading can be a wonderful asset in your life if you study hard and learn the systems properly without jumping ahead, always remember, be patient and absorb as much as you can and when you feel you have read enough, read a bit more.
Methods of Analysis
In order to be successful in the Forex markets you need to know how to analyze a Forex chart perfectly. When first opening your trading terminal you generally notice naked charts which refers to patterns that have not yet been mapped. Imagine going on a long cross country drive without plotting anything on your map, you would get lost. The Forex markets are essentially the same way, in order to be successful you must be able to plot on the charts properly to better understand the movement of price action which will allow you to enter and exit trades in a profitable fashion.
Traders often breakdown the analysis of the charts or Forex pairs into three different categories: technical analysis, fundamental analysis, and traders sentiment.
Technical analysis is the art of reading the charts using a series of technical tools which normally involves tools that are developed using some sort of mathematical equation and using the historical information provided throughout charts to predict what is likely to happen next. This means you can load these technical tools on what would normally be naked charts and analyze what has happened or what may happen in the future using data from as far back as you can see or in some cases from the birth of online Forex trading, right up to the last second that just passed. The concept is that the price reflected on the charts when analyzed using multiple mathematical equations or technical tools will go up or down because it is a reflection of historical to current market movement and that history tends to repeat itself. If you learn to properly analyze Forex charts you will be able to predict with certain accuracy the movement in price action or to execute trades and be on the right side of the market the majority of the time.
One of the main beliefs of technical analysis is that historical price action will always predict future price action. Since the Forex market is open 24 hours a day, 5 days per week, there tends to be a rather large amount of data that can be used to gauge future price activity, thereby increasing the probability that the specific technical tools being used to analyze the charts would predict accurately the markets next moves. This makes the Forex markets the perfect market for traders that use technical tools, such as trends, charts and indicators to enter and exit their trades.
Fundamental analysis is more than just a review of how the values of a currency pair change. It is also a review of the economic and political forces that might come into play when forecasting the direction of a currency pair or tradable instrument. To put it simply, fundamental analysis is examining the underlying drivers affecting a currencies wellbeing. Traders will look at the overall health of a specific currencies economy, the industry in which it participates in, and other major factors surrounding the economic health of the region in which that currency is most dominant in. A great example of a successful fundamental trader is Warren Buffet. He has managed to achieve exceptional returns by analyzing the economic growth of specific regions and sectors and investing in instruments that he believed to be undervalued at the time. The majority of fundamental traders rely solely on news released daily, weekly or monthly to decide whether they will buy or sell an instrument. Fundamental analysis can also be referred to as quantitative analysis because it involves looking at revenue, expenses, assets, and liabilities of the traded instrument. The majority of traders who rely solely on fundamental analysis are often Stock traders due to the fact that when trading a Stock you are actually buying or selling shares of a specific company or entity. Currency traders refer to fundamental analysis a bit differently than Stock traders, mainly because many forces can influence how a currency is being traded, it can entail a weak or strong economy or it can involve acts of war or corruption within a region. Sometimes interest rate changes in certain countries or even the relationships between countries can influence the values of currency pairs significantly. Some commonly used fundamental indicators are: CPI, consumer confidence reports, payroll reports, interest rate statements, PPI, and GDP reports.
Sometimes it can be a challenge to use traditional analysis to figure out how the market is changing. The sentiments that people have towards the economy can prove to be more important than anything else.
The sentiment refers to how people can devise their own opinions over how the market is changing and where it is heading into. People can create their own conclusions as to whether the economy is in a bear or bull market. In essence sentiment refers to crowd psychology.
The terms bearish or bullish are often the terms used to describe the conditions in the market or the sentiment of traders. Traders can take great advantage of both bullish and bearish markets if they have sufficient knowledge of the market conditions that are associated with these cycles. Once a trader has mastered the conditions of a bearish or bullish market and is able to identify the cycles, the trader will learn to make profits in any market condition.
Traders with bearish sentiment will sell or short a currency pair in the hopes that it will continue to decline where traders with bullish sentiment will buy a currency pair in the hopes that it will continue to rise.
It is important to note that in Forex, markets seem to flip flop back and forth between risk-on and risk-off, so it is important to understand trading on a wide level in order to ensure you are entering on the correct side of the trade.
This kind of analysis helps traders figure out where the market is going and what changes are taking place. It helps traders to see what is happening in the economy and to help them determine if particular changes are going to make currency pair values go up or down in the medium to long term horizon.
Regardless of the type of analysis format you plan on using, you have to understand what you are doing when reading a chart. A properly plotted chart will show you more than just how the value of a currency pair is changing over time. It will also help you understand more about how often people trade certain currencies and so forth. As a trader it is absolutely vital to understand the differences in charts, how to read them, and how to use them to execute your trades if you are planning on becoming a full time market analyst, money manager or broker.
The following list is the most commonly used methods of charting, we will take a brief look at how they are used, why they are used, and what makes them so powerful.
Each time frame in a chart will consist of Open, High, Low, Close.
The Open is the opening price of that current time frame. The High is highest price of that current time frame. The Low is the lowest price of that current time frame. The Close is the closing price of that current time frame.
The image below is a bar chart. Each bar represents a time frame. Each one could be one day, one hour, or one minute. It’s a way to be able to look at price in a visual way and know what price is doing.
The Bar chart shows how movements in a currency pair work. Notice how the sticks on the chart show how the value of a currency pair either goes up or down over the course of a trading day while the lines coming out of each bar shows how high or low the pair went during the day. Bar charts were a method used mostly in the early 90’s by Stock traders who were mainly trading on naked charts with little to zero indicators.
Bar charts work almost identical to candlestick charts, the only difference in the two is that candlestick charts also have a real body which is colored, green or red for bullish or bearish.
Bar charts are far more accurate than line charts because much like the candlestick charts, they show the price movement for the day. As a technical analyst this is vital as it reveals massive clues as to what transpired during the course of the day.
The way to read a bar chart is simple. The tick on the left represents where price opened on that specific period, where the tick on the right represents where price closed. The vertical bar represents the extreme highs and lows of price movement. Although OHLC charts can reveal price action just as well as candlesticks, traders today rarely use this form of charting although most platforms still offer it.
Candlestick charts originally came into existence in the 17th century by the Japanese who used it primarily to trade rice. Although the patterns and ideas behind candlestick charts have changed tremendously since Charles Dow initiated the US version around the year 1900, the majority of the core principals have stayed the same.
The methods we know today first appeared sometime after 1850 according to Steve Nison. The core principals however of candlestick patterns and charting is credited to a legendary Japanese trader named Homma. Over the years his ideas and methods have been adopted and re-created to become the principals we use today.
In order to properly plot candlestick charts you need the following data: open, high, low and the close values for the specific instrument or currency pair you are analyzing. The hollow or the filled portion of the candlestick is referred to as the real body or the body. The longer portions of the candlestick which extend out of the body are called shadows or the wick, these points represent the absolute highs and absolute lows for a period or segment of price action. The high is marked by the top wick or shadow where the low is marked by the low wick or shadow. If a candle is bullish it is always colored and has a full body, the standard colors for bullish candles are either green or blue. A hollow body represents a bearish candle and may also be colored in red.
Candlestick charts are the most commonly used plotting methods by traders worldwide, in fact 99% of traders today only rely on this method to analyze their trades. Not only does the candlestick chart go in depth to reveal prices and trends but it provides colored illustrations which allows the trader to very rapidly identify the direction of the market and where prices may go to next.
Overall the candlestick chart is the most common method of charting that you will ever use. The candlestick chart uses a bar-like display with colors that will state if the value of the pair went up or down over the course of the trading day.
What also makes the candlestick chart so special is that it focuses more on an intense amount of detail. As previously stated the two wicks on the candlestick show what values the instrument had based on trading activities during the day. The main body will show the open and close values while a specific color informs us whether the value went up or down on that day.
Almost every single trading platform in existence today automatically defaults to this method of charting.
Line charts have long been known to be the original method of forecasting a specific currency pair or instruments trend, although they provide the least amount of data; this doesn’t necessarily render them useless. Some of the world’s most advanced traders believe the closing price of the day is the most significant price to look at and this is exactly where the line chart shines. The mere fact that line charts are so simple, make them very useful when identifying well-defined trends.
Line charts allow you to very quickly view the overall trend of a specific currency pair or instrument due to their smooth plotting. One can easily assess a currency pair by viewing it as a line chart and quickly determine whether the sentiment is bullish or bearish. The majority of traders who use line charts are position traders who want to see the overall movement of prices and determine where prices may be 6 months to a year down the road. Even a day trader can easily switch to line charts to identify the overall trend, making line charts ideal for those that are interested in trading on a medium to longer term horizon.
Overall, the line chart is the most basic option to use. It shows how the value of a currency pair has changed from one closing period to the next. It focuses less on trading activity and more on the close of the instrument on each day. It can also show specifics as to when the value of a pair changes during a trading day.
Price Action In The Forex Market
Price action – the movement of a currency pair’s price over time – forms the very basis of Forex trading. Price action is reflected in technical and chart pattern analysis, which attempt to identify trends, reversals and breakouts in the price movement of a particular currency pair. But what exactly moves a currency pair? Why does the value of one currency change against another? To answer these important questions, we need to briefly revisit the history of the Forex market, only this time focusing on the context in which currencies are traded in today’s market. Without this foundational knowledge, you’ll forever view currency pairs as some abstract entity with no intrinsic value. But nothing can be further from the truth.
Modern Forex Market
As we outlined in Section 1, the modern foreign exchange market – the one you’re actively participating in now – has its origin in the early 1970s. August 15, 1971, to be exact. That’s the date that US President Richard Nixon effectively ended the Bretton Woods Agreement, which was established in 1944 to help rebuild the world economy after the Second World War. The Bretton Woods Agreement, among other things, established a “pegged rate” or “adjustable peg” currency system. Under Bretton Woods, the US dollar was the international reserve currency. Countries that adopted the Bretton Woods system declared a par value for their national currency against the dollar. This essentially meant that governments agreed to not let their exchange rates float freely on the open market. To prove its credibility on the world stage, the United States agreed to exchange dollars for gold at a fixed price. This system ran into significant problems in the 1960s and 70s, finally forcing the US government under Nixon to terminate it. While there were efforts to revive the system of fixed exchange rates over the next two years, it would inevitably fail, leading to the era of floating exchange rates we see today.
This is why you often hear about the “post-Bretton Woods system” when reading about the currency markets. In the post-Bretton Woods era, the foreign exchange has become a global decentralized market for international payments and currency trading. This system includes a multitude of multinational banks, governments, corporations, investment funds and retail Forex traders. It’s this complex system of supply and demand that is responsible for price fluctuations in the Forex market. Multinational banks are by far the biggest players and account for about 70% of daily turnover in the $5.3 trillion per day global Forex market. Deutsche Bank, Citi, Barclays, UBS and HSBC combined represent more than half of global market share in Forex. Financial institutions such as pension funds, insurance companies and hedge funds also actively participate in the Forex market. Increasingly, the market is being filled by retail Forex traders just like you. Today, around 4 million people are involved in retail Forex trading, a figure that is expected to grow significantly over the next five years as more people stumble upon the opportunities offered by the Forex market. The vast majority of these retail Forex traders have no idea about the origins of the market, which means they are never truly able to appreciate why prices fluctuate in the first place, let alone grasp the sheer multitude of players involved. Make no mistake, the Forex market is absolutely massive! This is why it provides so much opportunity. With this information in hand, it’s time to explore the structure of the market and the supply and demand characteristics that dictate it.