The Forex Market Part 1

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.

When price is making a series of Higher Highs and Higher Lows, that is classified as an uptrend. During an uptrend, you want to be looking for buy opportunities, and the best area to look for them would be when price forms a Higher Low. When price is making a series of Lower Highs and Lower Lows, that is classified as a downtrend. The Lower Highs of the downtrend is where you want to be looking for sell opportunities. However price will not always be in a trending market. Many times price will consolidate or form a sideways pattern, signifying that there is neutral strength between buyers and sellers. In that case, it’s best to stay away from the market, especially when there is no clear trend direction as price can go either ways.

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.

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. 

WHEN DO YOU TRADE FOREX?

The Forex market is open 24 hours a day, 5 days a week. You can trade anytime you want throughout the week and the market is closed on the weekends from friday 4pm CST to sunday 4pm CST.

Traders prefer to trade during active trading periods, known as sessions. With the forex market being open most of the time, it is important to know which are the most active trading periods. Active Traders known as Scalp Traders or Day Traders often look for large movements to make large profits in a short amount of time. If you are looking for times of large movements, that is during when sessions overlap such as the London Session overlapping the New York Session.