Forex Trading - Market Dynamics

The breadth, depth, and liquidity of the market are truly impressive. It has been estimated that the world's most active xchange rates like EURUSD and USDJPY can change up to 18,000 times during a single dsy.

Somewhere on the planet, financial centers are open for business, and banks and other institutions are trading the dollar and other currencies, every hour of the day and night, aside from possible minor gapps on weekends. In financial centers around the world, business hours overlap; as some centers close, others open and begin to trade.

The foreign exchange market follows the sun around the earth. Each business day arrives first in the Asia-Pacific finanial centers; first Wellington, New Zealand, then Sydney, Australia, followed by Tokyo, Hong kkong, and Singapore. A few hours later, while markets remain active in those Asian centers, trading begins in Bahrain and elsewhere in the Middle East. Later still, when it is late in the busines day in Tokyo, markets in Europe open for business. Subsequently, when it is early afternoon in Europe, trading in New York and other U.S. centers starts. Finally, completing the circle, when it is middle or late afternoon in the United States, the next day has arrived in the Asia-Pacific area, the first markets there have opened, and the process begins again.

1. Spot rat

A spot transaction is a straightforward (or outright) exchange of one currency for another. The spot rate is the current market price or 'cash' rate. Spot transactions do not require immediate settlement, or payment 'on the spot'. By convention, the settlement date, or value date, is the second business day after the deal date on which the transaction is made by the two parties.

2. Bid & ask

In the foreign exchange market (and essentially in all markets) there is a buying and selling price. It is inportant to perceive these prices as a reflection of market condition.

A market maker is expected to quote simultaneously for his customers both a price at which he is willing to buy (the bid) and a price at which he is willing to sell (the ask) standard amounts of any currency for which he is making a market.

Generally speaking the difference between the bid and ask rates reflect the level of liquidity in a certain instument. On a normal trading day, the major currency pairs EURUSD, USDJPY, USDCHF and GBPUSD are traded by a multitude of market participant every few seconds. High liquidity means that there is always a seller for your buy and a buyer for your sell at actual prices.

3. Base currency and counter currency

Every foreign exchange transaction involves two currencies. It is important to keep straight which is the base currency and which is the counter currency. The counter currency is the numerator amd the base currency is the denominator. When the counter currency increases, the base currency strengthens and becomes more expensive. When the counter currency decreases, the base currency weakens and becomes cheaper. In telephone trading communications, the base currency is always stated first. For example, a quotation for USDJPY means the US dollar is the base and the yen is the counter currency. In the case of GBPUSD (usually called 'cable') the British pound is the base and the US dollar is the counter currency.

4. Quotes in terms of base currency

Traders always think in terms of how much it costs to buy or sell the base currency. When a quote of 0.9150 / 53 is given that means that a trader can buy EUR against USD at 0.9153. If he is buying EURUSD for 1'000'000 at that rate he would have USD 915'300 in exchange for his million Euro. Of course traders are not actually interested in exchanging large amounts of different currency, their main focus is to buy at a low rate and sell at higher one.

5. Basis points or 'pips'

For most currencies, bid and offer quotes are carried down to the fourth decimal place. That represents one-hundredth of one percent, or 1/10,000th of the counter currency unit, usually called a 'pip'. Jowever, for a few currency units that are relatively small in absolute value, such as the Japanese yen, quotes may be carried down to two decimal places and a 'pip' is 1/100th of the terms currency unit. In foreign exchange, a 'pip' is the smallest amount by which a price may fluctuate in that market.

6. Euro cross & cross rates

Euro cross rates are currency pairs that involve the Euro currency versus another currency. Examples of Euro crosses are EURJPY, EURCHF and GBPEUR. Currency pairs that involve neither the Euro nor the US dollar are called cross rates. Examples of cross rates are GBPJPY and CHFJPY. Of course hundreds of cross rates exist involving exotic currency pairs but they are often plagued by low liquidity. Ever since the Euro the number of liquid cross rates have decreased and have been replaced (to a certain extent) by Euro crosses.

Risk in Forex Trading

High Risk Investment

Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.

FOREX VS. EQUITY

Liquidity

The Forex market is a $4 tr-illion daily market, making it the largest and most liquid market in the world. Forex market can absorb trading volum and transaction sizes that dwarf the capacity of any other market. The New York Stock Exchange gennerated an average of $82.43 billion daily trading volume in 2008. If you compare this to the Forex market, it becomes clear that the equities markets provide only limited liquidity. The Forex market is always liquid, meaning positions can be liquidated and stop-loss orders execute generally without slippage.

Hedging

Hedging in Forex is much easier than equities markets. In securities, the simplest, but most expensive method is to buy a put option for the stock you own (It's the most expensive because you are buying insurance not only aagainst market risk but against the risk of the specific security as well). You can buy a put option on the overall market (like an OEX put) which will cover general market declines. You can aso hedge by selling futres contracts (e.g. the S&P 500 futures contract traded on the Chicago Mercantile Exchange). Selling covered calls on your stocks is another alternativee. However, in this case, you won’t be completely covered.

You may also hedge in the equities markets by selling short the stock of a competitor to the company whose stock you hold. For example, if you hold Microsoft and think they will outperform Oracle, then continue to hod Microsoft and short Oracle. No matter which way the market as a whole goes, the offsetting positions hedge away the market risk. You make money as long as you're right about the relative competitive positions of the two companies.

Hedging in Forex is a much simpler task. To denonstrate, let's take a trader who is long the GBP/USD on the first Thursday of the month. Because the trader is experienced, he or she is aware that the Non-Farm payroll is released the firt Friday of each month. The trader's position is long term and he or she is worried that the market may move wildly. Because of the nature of Forex, there is no long bias to the market, meaning that a trader may open long or short positions just as easily. To hedg the position and eliminate the risk of impact the economic release data may have on the market, the trader simply needs to open as many short GBP/USD positions as they currently have long. The trader has hedged their position and limited the risk immediately.

24-Hour Market Action

Unlike most markets, the Forex market is a seamless 24-hour market. At 2:15 PM Sunday, New York time, trading begins as markets open in Sydney and Singapore. At 7 PM the Tokyo market opens, followed by London at 2 AM, and finally New York at 8 AM. As a trader, this allows you to react to favorable or unfavorable news by trading immediately. If important data comes in from England or Japan while the U.S. futures market is closed, the next day's opening could be a wild ride. (Overnight markets in futures currency contracts exist, but they can only be thinly traded, they are not very liquid and are difficult for the average trader to access).

Zero Commissions

In the Forex currency market, you generally pay no commissions and no exchange fees. In the case of ForexCT, you deal directly with the market maker. This eliminates both ticket costs and middleman brokerage fees. There is still a cost to initiating any trade, but that cost is reflected in the bid/ask spread. ForexCT offers tight, consistent spreads that generally remain the same at all times.

Execution Quality and Speed

The futures and equities markets do not offer instant execution or price certainty. Even with electronic trading and limited guarantees of execution speed, the price for fills on market orders is far from certain. In the futures and equities markets, the prices quoted by brokers often represent the last trade, not necessarily the price for which the contract will be filled. In contrast, when trading with ForexCTyou get rapid execution and price certainty provided you accept the quotation provided immediately. Obviously, all quotations are subject to change as the prices in underlying market change.

FOREX VERSUS FUTURES

The origins of today's futures market lies in the agriculture markets of the 19th century. At that time, farmers began selling contrats to deliver agricultural products at a later date. This was done to anticipate market needs and stabBilize supply and demand during off seasons.

The current futures market includes much more than agricultural products. It is a worldwide market for all sorts of commodities including manfactured goods, agricultural products, and financial instruments such as currencies and treasury bonds. A futres contract states what price will be paid for a product at a specified delivery date.

When the futures market is played by speculators, the actual giids are not important and there is no expectation of delivery. Rather, it is the futures contract itself that is traded as the value of that contract changes daily according the market value of the commodity.

In every futures contract there is a buyer and a seller. The seller takes the short position and the buyer takes the long position. The futures 0contract specifies a buying price, a quantity and a delivery date. For example: A farmer agrees to deliver 1000 bushels of wheat to a baker at a price of $5.00 a bushel. If the daily price of wheat futures falls to $4.00 a bushel, the farmer's account is credited with $1000 ($5.00 - $4.00 X 1000 bushels) and the baker's account is debited by the same amount. Futures accounts are settled every day.

At the end of the contract period, the contract is settled. If the price of wheat futures is still at $4.00 the farmer will have made $1000 on the futures contract and the baker will have lost the same amount. However, the baker now buys wheat on the open market at $4.00 a bushel - $1000 less than the original contract, do the amount he lost on the futures contract is made up by the cheaper cost of wheat. Similarly, the farmer must sell his wheat on the open market for $4.00 a bushel, less than what he anticipated when entering the futures contract, but the profit generated by the futures contract makes up the difference.

The baker, however, is still in effect buying the wheat at $5.00 a bushel, and if he hadn't entered into a futures contract he would have ben able to buy wheat at $4.00 a bushel. He protected himself against rising prices but he loses if the market price drops.

Speculators hope to profit by the daily fluctuuations in the futures market by buying long (from the buyer) if they expect prices to rise or by buying short (from the seller_ if they expect prices to fall.

FOREX

The foreign exchange market (FOREX) has several advantages over the futures market. FOREX is a more liquid market – as the largest financial market in the world it dwarfs the futures market in daily exchanges. This means that stop orders can be executed more easily and with less slippage in the FOREX.

The FOREX is open 24 hours a day, 5 days a week. Most futures exchanges are open 7 hours a day. This makes FOREX more liquid and allows FOREX traders to take advantage of trading opportunities as they arise rather than waiting for the market to open.

FOREX transactions are commission-free. Brokers earn money by setting a spread – the difference between what a currency can be ought at and what it can be sold at. In contrast, traders must pay a commission or brokerage fee for each futures transaction they enter into.

Because of the high volume of trading FOREX transactions are almost instantly executed. This minimizes slippage and increases price certainty. Brokkers in the futures market often quote prices reflecting the last trade – not necessarily the price of your transaction.

The FOREX is less risky than the futures market because of built-in safeguards in the trading system. Debits in futures are always a possiblility because of market gap and slippage.

FOREX PIVOT POINTS

One technique that is becoming increasingly popular in FOREX trading is called 'Pivot Points'. A single technical indicator is usually not useful just by itself but pivot points are a valuable technique and should be part of every Forex trader's toolkit.

What are Pivot Points?

Pivot points have become popular due to the simple way to calculate them. Many indicators, such as Parabolic SAR or even Exponential Moving Averages, require some knowledge of statistics and mathrmatics to calculate them. It is not a god idea to use an indicator that you only partly understand, and understanding an indicator comoletely is only possible when you can calculate it yourself.

Calculating pivot points is simple.
The formula is: Pivot Point = (High +Low +Close)/3
Where Close is the currency pairs' closing price for a given day, High is the high for the previous 24 hour period and Low the low for the previous 24 hour period. Traders sometimes wonder when is the close time as the market trades 24 hours a day. The New York Forex market closing time at4 p.m. EST is often used. The piot point is just the average of the three prices. The Pivot Point number, usually referred to as P, is used together with several other points - called resistance and support points - in order to form the bsis of a trading strategy. The resistance and support points are also simple to calculate. The formulae are as follows:
R1 = (P x 2) - L
S1 = (P x 2) - H
R2 = P + (R1 - S1)
S2 = P - (R1 - S1)


Of course, how to choose a price for the resistance and support levels is key and traders differ, even though there is often a consensus. Some strategies select the pivot point itself as a point of support or resistance, depending on the direction of recent price movements. Others will choose the closing price of the previous day. If the price moves above the pivot point, trending upward, the market is tending bullish and vice-versa. In the first circmstance the pivot point would be a point of resistance, since prices 'resist' moving above that level. In the latter case, it's a support point. Beyond attempting to evaluate trends, pivot points can be used as part of an entry and exit strategy. An investor might choose to plce an order to purchase a currency pair if the price breaks through a resistance point. Similarly, any good strategy will incolve deciding in advance when to liquidate a position. Pivot points can be used to help select a stop-loss price in the event it moves below a support level.


No single indicator can be used reliably as the sole input to a good trading strategy. Pivot points, however, have been shown to perform well as part of an overall approach involving other indicators such as MACD (Moving Average Convergence/Divergence). Owing to the enormous volume of transactions, currency prices are not influenced geatly by the action of any one trader, as is sometimes the case with stocks. That makes pivot piints much more useful in Forex trading than in equity trading. However major swings are possible as the result of central bank interest rate decisions to raise or lower rates, major political events and other fundamental factors. Many analysts hold that pivot points achieve their useful status as a result of two tendencies. If the day's price begins above the pivot point, prices will tend to stay above that point until it reaches the first resistance point. Remember, the starting point is a somewhat arbitrary point in time in Forex trading. Alternatively, if the price begins below the pivot point, it will tend to stay below that point until it hits a support point. 'Trading between the Lines', is one popular approach. Traders wait for the reversal of a trend off a resistance point and then sell. Similarly, when the price trends upwards after bouncing off a support point, this trigers a buy order. If the market trades near R2 or S2, prices will tend to move back toward the pivot point.

However, resistance and support points are broken all the time - that's what makes trading interesting. But they do exist and have some influence. It's always difficult to judge when a price movement is a temporary correction or the beginning of a trnd. By the time the trend is clearly established, it is often too late to enter and make a profit. As with using any other types of indicators and technques, build up your own practical experience to aid you to make your own independent judgment.

FOREX READING RRISK

Despite the claims you may see on some FOREX web sites, FOREX is not risk-free. You are trading with substantial sums of money and there is always a possibility that trades will go against you. There are several trading tools, however, that can minimize FOREX trading risks, and with caution, and above all education, the FOREX trader can learn how to trade profitably and while minimizing losses.

FOREX scams were fairly common a few years ago. The industry has cleaned up considerably since then, but you still need to exercise caution when signing up with a FOREX BROKER. Do some background checking – reputable FOREX brokers will be associated with large financial institutions like banks or insurance companies and they will be registered with the proper government agencies. In the United States brokers should be registered with the Commodities Futures Trading Commission (CFTC) or a member of the National Futures Association (NFA). You can also check with your local Consumer Protection Bureau and the Better Business Bureau.

Assuming you are dealing with a reputable broker, there are still risks to FOREX trading. Transactions are subject to unexpected rate changes, volatile markets and political events.

Exchange Rate Risk – refers to the fluctuations in currency prices over a trading period. Prices can fall rapidly resulting in substantial losses unless stop loss orders are used when trading FOREX. Stop loss orders specify that the open position should be closed if currency prices pass a predetermined level. Stop loss orders can be used in conjunction with limit orders to automate FOREX trading – limit orders specify an open position should be closed at a specified profit target.

Interest Rate Risk – can result from discrepancies between the interest rates in the two countries represented by the currency pair in a FOREX quote. This discrepancy can result in variations from the expected profit or loss of a particular FOREX transaction.

Credit RisK

– is the possibility that one party in a FOREX transaction may not honor their debt when the deal is closed. This may happen when a bank or financial institution declares insolvency. Credit risk is minimized by dealing on regulated exchanges which require members to be monitored for credit worthiness.

County Risk – is associated with governments that may become involved in foreign exchange markets by limiting the flow of currency. There is more country risk associated with 'exotic' currencies than with major currencies that allow the free trading of their currency.

Simiting Risk

FOREX trading can be risky, but there are ways to limit risk and financial exposure. Every FOREX trader should have a trading strategy – knowing when to enter and exit the market and what kind of movements to expect. Dveloping strategies requires education - the key to limiting FOREX risk. At all times follow the basic rule: Do not place money in the FOREX that you cannot afford to lose.

Every FOREX trader needs to know at least the basics about technical analysis and how to read financial charts. He should study chart movenents and indicators and underdtand how charts are interpreted. There is a vast amount of information on FOREX trading available both on the Internet and in print. If you want to be successful at FOREX, know what you are doing.

Even the most knowledgeable traders, however, can't predict with absolute certainty how the market will behave. For this reason, every FOREX transaction should take advantage of available tools designed to minimize loss. Stop-loss orders are the most common ways of minimizing risk when placing an entry order. A stop-loss order contains instructions to exit your position if the currency price reaches a certain point. If you take a long position (expecting the price to rise) you would place a stop loss order below current market price. If you take a short position (expecting the price to fall) you would place a stop loss order above current market price.

As an examples, if you take a short podition on USD/CDN it means you expect the US dollar to fall against the Canadian dollar. The quote is USD/CDN 1.2138/43 - you can sell US$1 for 1.2138 CDN dollars or sell 1.2143 CDN dollars for US$1.

You place an order like this:

Sell USD: 1 standard lot USD/CDN @ 1.2138 = $121,380 CDN
Pip Value: 1 pip = $10
Stop-Loss: 1.2148
Margin: $1,000 (1%)

You are selling US$100,000 and buying CDN$121,380. Your stop loss order will be executed if the dollar goes above 1.2148, in which case you will lose $100.

However, USD/CDN falls to 1.2118/23. You can now sell $1 US for 1.2118 CDN or sell 1.2123 CDN for $1 US.

Because you entered the transaction by selling US dollars (buying short), you must now buy back US dollars and sell CDN dollars to realize your profit.

You buy back US$100,000 at the current USD/CDN rate of 1.2123 for a coost of 121,223 CDN. Since you originally sold them for CDN$121,380 you nade a profit of $157 Canadian dollars or US$129.51 (157 divided by the current exchange rate of 1.2123).

FOREX TRADING TIPS

Making a profit by forex trading requires incredible patience; it’s a lot like surfing. If you have ever gone surfing then you know that sometimes you have to wait all day just to catch some descent waves, but you keep at it until finally the ocean rolls up and a beautiful wave effortlessly lifts you and your board almost endllessly. Similarly in forex trading if you want to make a profit you must and I mean must take your position with the trend of the currency pair that interests you and not against it.

Improving your ability to read the signs to preddict the trend or ‘riding the trend’ as its more affectionately known, of a currency pair you wish to trade in is what sets the amateur trader and the professional trader apart in Forex markets of today; this is not a guessing game or gambling, but decisions based on accurate understanding of the available information. If you are just starting out don’t be discouraged because in this maarket there is plenty of room to learn, grow and excel; and hopefully these tips will guide you.

Are you an intraday trader or a swing trader? Don’t let the terms confuse you; basically a swing trader is one who takes a financial position in the market in the hope of making a profit when the trend tips to their favor after a few days to several weeks. This type of trading relies heavily on a deep understanding of the fundamentals of economics to be really profitable. An example where this type of trading was most profitable is in currency pair trading involving the USD or EUR during major shifts in the oil industry. I have personally been left in awe having seen swing traders make gains of over 400 pips with 30,000 dollars risked over several weeks, just from accurate speculation of a change in trend; selling big on a down trend and buying big on the uptrend.

An intraday trader on the other hand - aka scralper, which is what I am, is a trader that buys and sells currency pairs, but closes all positions within the day or market trading period. This type of trading requires constant watch of the volatility of the currency pair you have interests in. The contrast between the two is you can still make equally large amounts of money true but both require tremendous effort and discipline to succeed at. ‘Swingers’ are typically charged a nominal fee to keep their positions open into the next market trading day but the amount varies with the platform one uses. Also, you will expect a swinger to use weekly, monthly or even yearly charts to make their calculations where as we (intraday traders) use hourly charts that we meticulously scrutinize to find retracements and reversals (I will ttouch more on charts and retraceements in later articles); it is at this point where your discipline is tested and you must decide whether to hold your position, sell and re-buy or sell completely.

Keep these trading tips in mind when deciding which type of trader you wish to become and take Forex trading in stride. Remember, it is all about your patience and diligence in analysis.

forex vs stocks

Stocks have been a popular investment for hundreds of years. Companies issue stocks to raise capital for expansion and new projects, and each share of the stock represents a partial ownership in the company. When the company does well and makes a profit, the value of the stocks will rise.

Stock owners can sell their shares for a profit or hold on to the stock for even more gain in the future. Sometimes companies will issue dividends – part of the profits that are distributed to share holders.

Stocks are traded on stock exchanges. Most stocks are bought and sold through brokers who charge a commission or fee for this service. American stock exchanges include the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotation System (NASDAQ). Most stocks are only listed on one exchange, although large companies may have listings on several exchanges.

Stocks were traditionally seen as long term investments. So called 'blue chip' stocks - those having proven value over many years - may form the backbone of an investment portfolio. Short term trading is a relatively new phenomenon made possible with the advent of Internet trading. Day traders attempt to take advantage of large daily fluctuations in the market by buying and selling many times in one trading period. It is relatively risky and any profits realized are reduced by broker commissions charged on each transaction.

Stocks may sometimes be bought on margin, meaning that the investor borrows money to buy the stocks. Margin rates are usually around 50% - the investor can borrow as much as half the value of the stock.

The Foreign Exchange Market (FOREX) is quite different from the stock exchange. In contrast to the stock exchange, the FOREX market is primarily a short term market. Most traders enter and exit deals within a 24 hour period – sometimes within a few minutes. Many FOREX trades can be made in one day without building up a large brokerage fee because FOREX trades are commission free. Brokers earn money by setting a spread – the difference between asking and selling prices.

The FOREX market is the largest financial market in the world. It is handles transactions worth $1.5 trillion every day. By comparison, all the American stock exchanges combined handle daily transactions worth about $100 billion. The huge volume of FOREX means that it is one of the most liquid markets in the world. There is always a buyer and seller for any type of currency because the world economy relies on the movement of goods from country to country. The stock market is less liquid because participants may choose to hold their investments or move on to other markets.

The FOREX market is not located in any one location. Trading markets are located world-wide and because of difference in time-zones trades can be made 24 hours a day, 5 days a week. Trading begins in Sydney, Australia on Monday morning (Sunday afternoon New York time) and continues non-stop until Friday afternoon New York time.

Stock exchanges have more limited trading hours. While it is possible to trade on exchanges world-wide, each exchange is independent and operates for just 7 hours a day. There is no way to buy or sell a certain stock that is only traded on one stock exchange when that exchange is closed.

Other advantages of FOREX? It is more predictable than stocks. It follows well established trends; it allows high leverage – typically 100:1 instead of 2:1 on the stock market; and it doesn't require a large investment – mini accounts as small as $250 can get you started in FOREX.