Learn Forex Trading

In order to better understand Forex, please read the following article explaining basic and fundamental information about specifics of the Forex market.

CURRENCY PAIR

Reading a foreign exchange quote may seem a bit confusing at first. However, it's really quite simple if you remember two things: 1) The first currency listed first is the base currency and 2) the value of the base currency is always 1.

The US dollar is the centerpiece of the Forex market and is normally considered the 'base' currency for quotes. In the "Majors", this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the second currency quoted in the pair. For example, a quote of USD/JPY 120.01 means that one U.S. dollar is equal to 120.01 Japanese yen.

When the U.S. dollar is the base unit and a currency quote goes up, it means the dollar has appreciated in value and the other currency has weakened. If the USD/JPY quote we previously mentioned increases to 123.01, the dollar is stronger because it will now buy more yen than before.

The three exceptions to this rule are the British pound (GBP), the Australian dollar (AUD) and the Euro (EUR). In these cases, you might see a quote such as GBP/USD 1.4366, meaning that one British pound equals 1.4366 U.S. dollars.

In these three currency pairs, where the U.S. dollar is not the base rate, a rising quote means a weakening dollar, as it now takes more U.S. dollars to equal one pound, euro or Australian dollar.

In other words, if a currency quote goes higher, that increases the value of the base currency. A lower quote means the base currency is weakening.

Currency pairs that do not involve the U.S. dollar are called cross currencies, but the premise is the same. For example, a quote of EUR/JPY 127.95 signifies that one Euro is equal to 127.95 Japanese yen.

When trading forex you will often see a two-sided quote, consisting of a 'bid' and 'offer'. The 'bid' is the price at which you can sell the base currency (at the same time buying the counter currency). The 'ask' is the price at which you can buy the base currency (at the same time selling the counter currency).

PIP

Learn to love this word, because this is what you will be seeking for the rest of your forex career. A pip is the smallest denominator of a particular currency pair, so for the above example, if the EUR/USD moves from 1.2150 to 1.2155 then it has moved up 5 pips.

LEVERAGE

Leverage is a simple concept. If you have $10,000 to trade with, your forex broker will let you borrow money from him so that you can trade in larger quantities. They will let you borrow as much as 400 times (400:1) what you put up in a trade. Most brokers allow between 50:1 and 100:1 margin. So, if you put up $1,000, and your broker allows 100:1 margin, then you’ll be trading $100,000 worth of currency (instead of $1,000).

That’s important, because every pip equals a certain dollar amount. When you trade $10,000, each pip movement equals $1. The chart below shows how it goes from there. If you trade 10,000 worth of currency, each movement would be equal to $1. So if you bought at 1.1445 and sold at 1.1545, you would make 100 x $1, or $100. If you trade $100,000, each pip movement would equal $10 and so on.

LONG AND SHORT

Now there is two different ways you can trade on the forex market, and many beginner traders are surprised to learn that you can actually make just as much money when a currencies price moves down as you can when it moves up. Let’s start with the most logical movement, when the price moves up.

Most people are very familiar with the concept of buying something at a low price and selling it when the price increases. So the concept of buying the EUR/USD at 1.2150 and selling it at 1.2160 for a 10 pip gain should seem logical. This process is called going long.

However, you can also do this in reverse! If you think you know that a currencies price is going to go down rather than up, the you can go short. This is just the opposite of the above transaction, selling it first and buying it back later in the hope that the price will go down for you to make a profit.

This can be somewhat strange for those hearing this for the first time, but the concept remains the same either way, that being, that you always want to buy something at a low price, and sell it at a higher price than you bought it at. Which order you do it in doesn’t matter, just that for a transaction to complete you must both buy and sell, as long as you sell at a higher price than you buy then you make profit.

SPREAD

The difference between the stock markets and the forex market brokers, is that in the forex market, broker commissions are either very low or zero. So how do the make money?, they make it from the "spread" or the difference between the actual price and the offered price through a broker.

To the right here you can see a typical board of currency pairs and their spreads. This one is taken from our feed this morning, and you can see for example the difference between the Offer (the price you can place a sell order) and the Bid (the price you can place a buy order) is 3 pips (the spread).

What does this mean to you though?, well, let’s look at the board, if you bought the EUR/USD at 1.2158 as it is offered under the Offer column, and immediately sold it again before the price moved, you would only get 1.2155 as is shown in the Bid column. So the net result is -3 pips, or a loss to you, and a profit to the broker. Remember to always take the spread into account when placing a trade, setting targets and stop losses.

BEARS AND THE BULLS

You will constantly see the term "Bears" and "Bulls" in forex books and chat rooms. So why are we talking about animals when we are supposed to be trading? These are terms that describe the general mood of the market. A "bear" market, is when the general mood of the market is down, i.e. when there are more sellers than buyers in the marketplace. A "bull market" is the opposite, when there are more buyers than sellers and the general mood of the market is up.

Forex and any other marketplace, is just a struggle between the bulls and the bears, it if you can identify who is gaining the upper hand, then you can identify the direction of the price. Easier said than done of course.

Well that about covers the basics, there are so many more areas to cover of course but I hope it helps those starting out in this exciting marketplace. If I have missed something you wanted to read about please leave a comment below and I will be sure to add it to the article if I can.