Forex Trading Guide

Submitted by fxpros on Fri, 04/08/2022 - 10:03
Forex trading is certainly not a toy, although it is advertised by brokers as one.

Fx Trading Guide -Forex Trading Briefly Explained

Online Forex trading looks easy but actually is very complex. There are hundreds of fundamental and technical variables, changing 24hour per day. Thereore, Forex trading is certainly not a toy, although it is advertised by brokers as one.

What is Forex Trading

Forex or else FORex EXchange is an electronic network that enables the exchange of global currencies, one for another. Currency pairs are exchange mechanisms used for the global trading of goods and services. Importers and exporters, large corporations, investors, and banks are only some of the participants in the Forex Market. The Forex market operates like the internet, it is not centralized, and it exists in the electronic network of banks, which is called the ECN network. Forex is a huge market with a daily activity turnover worth more than 4 trillion USD. The Rules of the game in Forex are different from those in equity and bond markets, but many similarities can be found too.

This guide aims to present some major fundamental aspects of Forex trading.

What Distinguishes Forex from Classic Investment Types

Three factors mainly distinguish the Forex market from other types of investment: i) Liquidity ii) Capital Leverage and iii) Pre-Determined Loss

1) High Liquidity

Liquidity matters a lot and Forex is more liquid than any other financial market in the world and that means orders can be filled at any time. Furthermore, liquidity creates competition among brokers, so the trading cost is minimized (using an STP/ECN broker). The trading cost in Forex Trading mainly includes the spread between the ask and the bid, plus trade commissions. The spread may be as low as 0.3 pips on popular currency pairs, and that usually means 0.00003 of the arithmetic value of the exchange rate. It is a very small percentage, but note, that high leverage can make it very expensive.

  • ECN brokers charge trading commissions
  • STP Brokers charge only commissions
  • Market Makers (Dealing-Desk) charge an extra spread between bid/ask

2) High Capital Leverage

Trading leverage made Forex popular among retail traders. Leverage in Forex Trading can be up to 100:1, or even more. But here is a trap.

“Trading leverage looks like a friend but actually most of the time is an enemy”.

As long as you are not a highly experienced trader, it is far better to use leverage no more than 10:1. Leveraging more than 10:1 will increase your trading risk to a very unfavorable extent. Keep also in mind that tight spreads are found only on the Forex Majors (1) such as EUR/USD and GBP/USD, USD/JPY, etc.

Less popular Forex pairs, called the Minors (2), are provided in much higher spreads and that combined with high leverage may be bad news for any trader.

Even-less-popular currency pairs are called the Exotic Pairs (3). The Exotic pairs are offered in extremely high spreads and therefore traders should generally avoid them. To provide an example, the following variable spreads are measured on a popular STP Forex broker (not charging commissions):

Table: Typical Spreads without any Trade Commissions charged

SYMBOL

CURRENCY PAIR

SPREAD (pips)

EUR/USD

Euro versus the American Dollar

from 0.5 pip

to 2.0 pip

EUR/AUD

Euro versus the Australian Dollar

from 1.2 pip

to 3.0 pip

NZD/SGD

New Zeeland Dollar versus the Singapore Dollar

from 10.0 pip

to 35.0 pip

It is obvious that the less popular an asset is, the more expensive becomes to trade it, and the less Leverage you must use. Also, keep in mind that brokers often use stop-hunting techniques. Therefore, limit your trading leverage to a point that your position is not vulnerable to unfavorable intraday volatility

3) Stop-Loss Orders and Profit/Loss Ratio

Placing the right Stop-Loss orders can make a difference in Forex trading. A stop-loss order predefines the maximum level that you are willing to risk in the market at any time. So if EUR/USD is at 1.3000 and you think that is going up, you buy it and at the same time, you give a Take Profit and a Stop-Loss order. In the example:

  • Buy at 1.3000 | Stop Loss: at 1.2949 | Take Profit: 1.3150

Now using a simple equation it is possible to find out if this order is right. By dividing the Profit Potential which is calculated as 1.3150-1.3000=150 pips to the Loss Potential which is calculated as 1.3000-1.2949=51 pips, we get the profit to Loss Ratio, which in this example is 150/51=2.94.

This is a good P/L Ratio, as it is more than 2.5.

The Profit to Loss Ratio on your trades must always exceed the arithmetic value of two (P/L ratio>2).

■ Profit / Loss Ratio = {Potential Profit-Spread Charged}/{Potential Loss}

Essential Steps to Increase your Odds of Winning

Here are four (4) steps:

Step-1: Use a Highly Regulated and Highly Competitive ECN/STP Forex Broker

In a few words this is the profile of the ideal Forex Broker for an average trader:

i) ECN/STP Forex Broker (that means direct order placement without intervention and execution delays), avoid Dealing-Desks

ii) Highly Regulated by trustful authorities (for example FCA UK, etc) and providing of course segregated accounts to its clients

ii) Offering a wide variety of Forex pairs to choose from

iii) Charging narrow spreads (For example EUR/USD spread no more than 1.1 pip without charging commissions)

iv) Providing low slippage and fast order execution (an absolutely important fact for day-traders)

v) Offering many options, such as scalping, automated trading, and EAs

vi) Offering a demo and a micro-lot account, which is necessary for Forex beginners. A micro-lot is the best way to try a new broker without risk

» Compare Forex Brokers at FxPros

Step-2: Study Technical Analysis

To identify the right Forex Pair among the tens of available pairs, you must take advantage of market research and technical analysis. Technical analysis is very important when trading Forex and therefore it is highly used by professional traders.

Here are the key technical analysis tools of Forex Trading:

a) Support & Resistance Points -Define a possible reverse of the mid-term trend. Focus on the monthly and weekly closings, and on closing prices of months and weeks (body of the candle/bar), not on the wicks

b) Pivot Points -Defines a possible reverse of the short-trend

c) Trend Lines, (/) or (\) -Define a possible reverse of the short-term or the mid-term trend

d) Fibonacci ratios -Define the correctional levels of the short-term or the mid-term trend

It is very crucial to start from a historical chart and pinpoint there the major support and resistance levels of a Forex pair. Focus also on the correlations between the currency pair that you are trading with other related pairs. For example, if you trade EUR/GBP you must concentrate on GBP/USD and EUR/USD also. These two pairs are more liquid than EUR/GBP and their performance will highly affect the performance of EUR/GBP on any given trading day.

More advanced traders could also try a Forex Robot, but with extreme care and by testing this piece of software extensively on a demo account first.

» Compare Forex Robots at FxPros

Step-3: Be sure that Upcoming News is not going to Disturb your Trade

This is very important. You can use an economic calendar to check the news. If you can not understand macroeconomics it is better not to trade 30 minutes before and 30 minutes after important news is released in the market. In the following chart, you can see what happens on days when the news is good for a particular Forex currency (in this example the Euro Currency).

EUR/USD
EUR/USD -Focus on the Mid-Term and Take Advantage of a Strong Trend.

Step-4: Focus on the Mid-Term and Take Advantage of a Strong Trend

Many understand Forex as a gambling machine and that is why they end-up trading intraday. Trading Forex every day incurs many risk hazards for traders and thus after some time may lead them to total losses. The secret is to trade thinking in the mid-term and acting in the short-term. It is always better to choose Forex pairs that are on the move every month. In Forex trading you must always follow the trend, but not the short-trend, the mid-trend instead. Usually, currencies are following certain cycles, and that is because Currency rates are highly affected by macroeconomic conditions. Historically speaking, the macroeconomic conditions of any economic zone tend to make certain cycles. A regular macroeconomic cycle usually lasts 7 to 8 years. The best way to trade is to choose a pair using mid-term analysis and to pick your optimal entry/exit point levels using short-term analysis.

“Thinking Like an Investor while Acting Like a Trader”

Take advantage of a Long-Term Forex Trend

If you research many long-term charts you will find that many pairs are following a certain long-term pattern. For example the currency pair EUR/TRY (EURO against the Turkish Lira). As Turkish inflation is traditionally 10-15% more than inflation in Eurozone, EUR/TRY has a bullish long-term tendency. But it is not moving straight forward, instead, it fluctuates in a certain uptrend channel, moving up and down. You must buy a pair that has already reached the low limit of its cycle. Here is the historical chart of EUR/TRY:

Chart: EUR/TRY

EUR/TRY

The Two Forex Analysis Methods

As in every other financial market, Forex market analysis includes fundamental and technical analysis. News is incorporated into Fundamental analysis.

1. Fundamental Analysis

This type of market analysis is based on demand and supply market figures. It is mainly used by mid-term or long-term currency investors. This type of analysis does not take into consideration the short-term currency fluctuations which are seen as the ‘Market Noise’. The fundamental analysis mainly includes macroeconomic factors such are:

i) The future level of interest rates (very important) -Learn to use the » FED Watch Tool

ii) Unemployment reports (very important) for upcoming interest rate decisions

iii) Inflation indicators (very important)for upcoming interest rate decisions

iv) The GDP, national budget, and the government deficits

v) The national income, money supply, consumption, and private investment

vi) The domestic industrial production, retail sales, and the level of factory orders

vii) The volume of consumer and mortgage credit

viii) The trade balance and the current account balance

2. Technical Analysis

This type of market analysis is based on historical data such are closing prices, open prices, high/low prices, and volume activity. Popular technical analysis tools in Forex Trading include Moving Averages, the RSI index, MACD, and the Fibonacci Retracement. Technical Analysis aims to define the master trend of the market which may be either being bullish, bearish, or neutral. Automated Forex trading uses also technical analysis. Automated trading is achieved using Forex Robots which are also called Expert Advisors.

-Technical analysis is the ideal tool to trade both trending and ranging markets

-When there is a major fundamental change at the Macro level avoid using technical analysis and trade only using fundamentals

Forex professionals are using both fundamental and technical analysis to forecast future market movement, it is highly recommended for every trader to do the same.

» More on technical analysis

Fx Trading Guide -Final Thoughts

Most new traders think that they can become rich in a matter of weeks. They usually lose all their funds in no time. Every trader should always:

1) Implementing a trading strategy that fits his trading profile and risk tolerance

2) Preferring to trade swing positions than intraday positions

3) Not using high trading leverage (5:1 is great most of the time)

4) Calculating all trading costs before opening any position (trading spreads, commissions, and overnight rates)

5) Monitoring the time of important upcoming news, and mainly avoiding them

6) Recognizing major Support & Resistance levels and place stop orders by respecting them (minimum 20 pips above/below major S/R levels)

7) Placing a stop-loss when maintaining positions overnight, the extent of what is coming is simply unpredictable

8) Seeking price movements that may last for a couple of days by focusing on higher timeframes

9) Using a Profit/Loss Ratio of more than 3

10) Taking nothing for granted, researching and double-checking all information on the internet

11) Opening real accounts only with reliable ECN/STP brokers

It is better to avoid trading live, place your orders and go spend some time with your family and friends. Trading live will lead you to execute a great number of trades each day. You don’t need many trades to make good money, you just need a couple trades.

Forex Trading Guide

G. P. for FxPros.net -Copyright (c)