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Money is made in Forex trading by either the currency bought going up in price or the currency sold going down in price. In practice, it does not matter whether you are buying EUR/USD because you think upcoming data will favor the EUR, or selling the USD and using the EUR as the vehicle because you think developments will reduce support for the dollar. You may choose the EUR as the vehicle because it has high liquidity, but you could equally well express your negative view on the USD by buying (say) NZD/USD, which means by definition you are selling the USD.Forex trading is a zero-sum game in which one party wins and the other party loses. If you buy the AUD/USD at 0.8500 and sell it at 0.8700, you have made 200 pips. The person who sold to you at 0.8500 has an opportunity loss equaling those 200 pips. It is conceivable that the seller is not unhappy, because perhaps he bought when the AUD was at 0.8300, and so he made a cash profit of 200 pips himself, but the fact remains that if he had held the position, he would be 200 points richer, and not you.We can also note that the seller may have been closing a hedging position. Let’s say the hedger had a debt or was short an asset denominated in euros and had bought the euros as a hedge of the currency part of the asset position. If the asset rose (giving him a loss on the asset) but the euro fell, the hedger would get some gain to offset the loss on the underlying asset. Once he has closed out the asset position, he had no more need for the currency position. In practice, hedging positions are held for far longer (and in far greater amounts) than the usual retail Forex trade, although the underlying asset in the hedging case may have been another short-term currency position, including an option.Similarly, if the AUD keeps rising after you sell it at 0.8700, to (say) 0.8900, you are the one with the opportunity loss. It is not a true cash loss, but can cause distress all the same. Trading coaches warn against crying over spilt milk — opportunity losses. They advise never to dwell on what you “could have” done. This is named in the vernacular “woulda, coulda, shoulda.”If you sell first and buy back later, you are technically shorting the first-named currency in any pair — but you are buying the second-named in the pair. Say you sell the USD/CAD at 1.0950 and buy it back later at 1.0900. You have a gain of 50 pips from selling US dollars and buying Canadian dollars. But nobody will vilify you for shorting the US dollar because for all they know, you were simply buying Canadian dollars because you like Canada, and paying for the CAD using US dollars.You can make as much money with a shorting strategy as by going long, although many people find it easier on the eye to project a price trend upward than downward. The stigma attached to short selling in general is not present in trading Forex. This is one of great virtues of Forex trading over other asset classes. It is still “going short” some currency but also at the same time going long some other currency, and does not carry the same negative connotations as shorting equities or commodities. When you short a stock, it’s because you think there is something wrong with the company or at the least that the market has overpriced it. Short-sellers are reviled as “destructive” forces in the equity market and short selling is banned from time to time during crisis situations, as during the banking crisis starting in 2008. Just about every major country instituted bank short-selling bans, including the US, UK, Australia and most European countries. Equity short-sellers get blamed for everything from the Crash of 1929 to the Crash of 1987, even when it is clear that plenty of other factors contributed.In equities, to go long is to be hopeful and optimistic that that economic and financial conditions will favor growth generally and corporate profits specifically. Companies will be well-managed, profits will rise and price-equity ratios will rise, too. There is a distinct long-side bias in equity trading. Not so in Forex, although we do have an anti-USD bias that has persisted for many decades for structural reasons. And yet it is not safe to always choose to buy currencies while selling USD. We see plenty of occasions when the USD rallies across the board. As a general rule, the best way to gauge overall USD sentiment is to look at the dollar index (USDX). During the late winter through early summer of 2016, for example, the dollar index was in a falling trend with a peak in early June:We see many occasions when a currency goes into an easily identifiable trend, and we can also identify the reasons why traders are favoring (or trashing) the currency. The AUD, for example, has had a lasting 10-year yield advantage over other developed country 10-year notes. As a consequence, we see an upward bias in the AUD against lower-yielding currencies, especially the Japanese yen but also the USD. However, this does not mean that bad data about the Australian economy, or jawboning the AUD down by the central bank or treasury, will not trigger a sudden drop in the AUD.Sterling has a distinct personality, too, especially against the USD. When the prospects for the UK are brighter than elsewhere, the pound rises. But the London traders who specialize in the pound are also famous for “gunning for sterling” when the outlooks dims. This makes upmoves a struggle and corrections and downmoves particularly vicious.These examples point out that it is the suddenness of changes in the Forex market that makes trading so difficult, and leads traders to trade on a short-term basis of a few hours when overall Forex trendedness would call for a longer-term holding period.
The BIS, in its latest Triennial Central Bank survey, says that an average of $5.1 trillion traded hands in currency markets in April 2016, down from $5.4 trillion in 2013. Almost two trillion dollars was in spot foreign exchange (where the bulk of retail trading action is seen) and $2.4 trillion was executed in FX swaps and $700 billion in outright FX forwards.In order to have a better understanding of the foreign exchange market’s structure and size, it is helpful to look the breakdown of turnover by counterparty in the BIS survey.There are three main categories:Other financial institutions created 51% of all trades' volumes.Reporting dealers - 42%.Non-financial customers - 7%.The BIS considers a reporting dealer as:...all other financial institutions such as smaller commercial banks, investment banks and securities houses, and mutual funds, pension funds, hedge funds, currency funds, money market funds, building societies, leasing companies, insurance companies, other financial subsidiaries of corporate firms and central banks.In the past 10 years, the line between investment bank and commercial bank has been blurred. Citibank and JP Morgan Chase are considered investment banks, despite the fact that they also have commercial bank enterprises (they take deposits and make loans). Goldman Sachs and Morgan Stanley are investment banks also, even though during the US financial crisis they received Troubled Asset Relief Program (TARP) funds.The BIS considers other financial institutions as:The other financial institutions umbrella is quite large, with various sub-buckets. The category includes “proprietary trading firms that invest, hedge, or speculate for the own accounts,” with high-frequency trading (HFT) firms and other algorithmic trading firms in this sub-bucket. Big speculators such as Soros or Bridgewater are in this camp also.The other financial institutions category also includes “Official Sector Financial Institutions,” such as global central banks (The Federal Reserve, European Central Bank, Bank of England, etc.), sovereign wealth funds (Abu Dhabi Investment Authority, China Investment Corporation, SAMA foreign holdings etc.) , international financial institutions of the public sectors (such as the BIS, International Monetary Fund), development banks (World Bank, Asian Development Bank, European Bank for Reconstruction and Development, etc.), and agencies. Last but not least, there is also a sub-bucket “Other” for all other remaining financial institutions (such as the retail aggregators).One of the big surprises in the 2013 BIS survey was another big jump in the “other financial institutions” category in terms of trading activity:In the 2010 survey, other financial institutions had for the first time surpassed other reporting dealers (i.e., trading in the inter-dealer market) as the main counterparty category in the Triennial Survey. Transactions of FX dealers with this group of customers grew by 48% to $2.8 trillion in 2013, up from $1.9 trillion in 2010.The BIS sees a non-financial customer as:...any counterparty other than those described above, i.e. mainly non-financial end users, such as corporations and non-financial government entities. May also include private individuals who directly transact with reporting dealers for investment purposes, either on the online retail trading platforms operated by the reporting dealers or by other means (e.g. giving trading instructions by phone.)Currency trading continues to be concentrated in a handful of global financial centers, the BIS reported:In April 2016, sales desks in five countries – the United Kingdom, the United States, Singapore, Hong Kong SAR and Japan – intermediated 77% of foreign exchange trading, up from 75% in April 2013 and 71% in April 2010.If all this seems confusing, remember that the bulk of the business done in the currency market is done by the large banks. The other two important players are the various global central banks and the sovereign wealth funds (state owned investment fund typically seeded with either revenues from commodity exports or central bank FX reserves). These big players tend to be the market makers. Major banks put two-way (bid/offer) FX prices into EBS and Reuters and their own in-house platforms. Central banks and sovereign wealth funds typically step in for specific reasons. A central bank might become involved in the currency market if a larger order needs to be filled that might disrupt the market or if their domestic currency has become too weak or too strong. A sovereign wealth fund trades currencies either for speculation or as a vehicle to enter into and or exit investment strategies in other countries.
What Is a Currency Pair?All Forex entails exchanging one currency for another and therefore each Forex quote involves a pair of currencies. When you buy a bag of apples, you pay a specific sum of money for the bag, but when you buy a “bag” of a foreign currency, you are still paying a specific sum of money but the thing you are buying is also money. The price of the bag of foreign money is quoted as a ratio of the money you are paying, or an exchange rate.The euro exchange rate versus the US dollar might be say, $1.3500. This means for 1 euro you receive 1.35 US dollars. The yen exchange rate versus the dollar might be ¥105.00. This means for 1 US dollar you receive 105 yen.The euro versus the dollar is a pair and the dollar versus the Japanese yen is another pair.A pair does not need to be dollar based. The euro versus yen is also a pair, as would be UK pound sterling versus yen. Every single currency quote you see should name the two currencies in the pair. It you see just “euro,” you can assume the other half of the pair is the US dollar, although sometimes it pays to make sure that you are talking about the same pair as your counterparty.Memorize the Three-Letter AbbreviationsYou need to memorize the three-letter abbreviation for each currency that populates your workspace when you trade Forex.They are relatively easy to memorize since they usually refer directly to the first letter of the name in English, like United States dollar (USD). As a general rule, the first two letters name the country and the last letter names the currency.Having memorized them will be useful if you ever start to trade cross-rates. Exceptions include the South African Rand, which starts with a Z instead of an S (from Dutch Zuid-Afrikaanse Rand). Sometimes you can deduce logically what an exchange rate abbreviation should be (like NZD for New Zealand dollar), but other times you just have to look up the symbol (TRY for Turkish lira and KRW for South Korean won). You might think the Swiss franc would be SWF, but it is not — it is CHF, the CH standing for the name of Switzerland in Latin, Confoederatio Helvetica.USD = US dollarGBP = Great Britain poundEUR = EuroCHF = Swiss francJPY = Japanese yenCAD = Canadian dollarAUD = Australian dollarNZD = New Zealand dollarZAR = South African randWhat Are the Most Commonly Traded Currency Pairs?According to the Bank for International Settlement’s latest Triennial Central Bank Survey conducted in April 2016, the dollar, the euro and the yen constituted the lion’s share of all spot transactions.We will discuss spot versus forward and futures trading in Trading Forex via Futures.Of the $5.34 trillion traded in the currency market each day, $2 trillion was done in spot. Of that $2 trillion, $1.69 trillion was in dollars, $754 billion was in euros and $612 billion was in yen.This makes euro-US dollar (EUR/USD) and US dollar-yen (USD/JPY) the most commonly traded currency pairs.The next two currencies, in terms of size traded in the spot market, are sterling at $227 billion daily and the Australian dollar at $196 billion. Sterling versus US dollar (GBP/USD) and Aussie versus US dollar (AUD/USD) are the next most commonly traded currency pairs.Cross Rate PairsAs mentioned in the first lesson, cross rates have evolved to indicate a currency pair that has no US dollar component.Euro-yen (EUR/JPY), sterling-yen (GBP/JPY), euro-Aussie (EUR/AUD), Aussie-Canada (AUD/CAD), Korean won-yen (KRW/JPY), etc. are all examples of cross rate pairs.Because cross rates are less frequently traded, prices are often more volatile and have wider bid-ask spreads. Euro-yen is an exception to this rule, with a deep and liquid market.Trading LingoIt is important to know some lingo, or the special vocabulary used in the forex market. The most prominent nickname is cable, meaning the UK pound. The word cable refers to the transatlantic telegraph cable laid in 1858. At that time, the UK pound was the top currency for US traders and so to ask for a price in UK pounds, they would ask for the price of cable. At the time, traders who made the prices were called cable dealers and even today, the person trading sterling at a bank is called the cable dealer.The New Zealand dollar is called kiwi, for the kiwi bird that New Zealand is famous for and the Canadian dollar is called the loonie, because there is a picture of a loon (Canada’s national bird) on the back of the Canadian one-dollar coin.Traders ask for a price in cable and know that this means a price for UK pound sterling versus the US dollar. Similarly, a price in kiwi or the loonie would mean the price at which someone would buy or sell the New Zealand or Canadian dollars versus the US dollar.The Norwegian krone is called the Nocky and the Swedish krone Stocky. Asking for a price in Nocky or Stocky would get you the price where someone would buy/sell US dollars versus the Norwegian krone or Swedish Krone. If you wanted a price in euro versus the Norwegian krone, you would ask for euro-Nocky. The Mexican peso would be Mex and the Hungarian forint Huf.The language of foreign exchange is no different from other languages; there are rules and then exceptions to the rules. Rather than ask for a price for the euro versus the US dollar, a trader will simply ask for a “euro” price. Similarly, an Aussie price would be a price of the Australian dollar versus the US dollar.To complicate matters further, FX convention quotes most currency pairs in dollar terms. A trader will ask for dollar-yen when wanting the price of the US dollar versus the Japanese yen, or dollar-rand, when asking for the price of a US dollar versus the South African rand.
You see advertisements that Forex trading is a popular new thing and better than trading equities because you can get much higher leverage. In equities, maximum leverage is 1:2, meaning you can borrow 50% of the price of the position. For a security that costs $1,000, you need to put down “initial margin” of half that, or $500.But in Forex, you can have 1:50 leverage or more if you live outside of the US, meaning that for a starting capital amount of $500, you can trade a security whose current market price is 50 times that, or $25,000. That’s the rule in the US, instituted in 2010, with a maximum leverage of 10 times in the lesser-traded currencies (such as the dollar/Mexican peso). Outside the US, a broker may offer you leverage of 1:100, 1:500, or even higher, meaning that for a starting capital amount of $500, you could buy as much as $250,000 worth of currencies.Every person who starts out in Forex does this calculation or something like it: Let me assume that I can make 20 points per day per lot for 240 trading days and I trade 10 lots each day. That is 20 x 10 x 240 = 48,000 points at about $10 per point = $480,000. Golly, I can make nearly half a million dollars by trading! Even if my losses are 50%, that is still $240,000 net gain. And I would be making that gain on an initial “down payment” of only $10,000 leveraged 50 times = $500,000.Moreover, that is assuming I keep the initial amount at $10,000 without reinvesting gains to increase the amount traded from 10 lots to a higher number. For example, after I have doubled my money from $10,000 to $20,000, now I can trade 20 lots instead of 10. If I double the stakes, I double the profit (this is named a Martingale strategy, by the way).How realistic is this scenario? Not realistic at all. If gains like these were easily attainable, the world would be full of rich Forex traders. Instead, we see case after case of the person who may make some early big profits, but then loses most or all of the gains and has to start over. We hear of traders spending years and decades trading Forex but barely making a living. What is going wrong?The first problem lies in not being able to fine-tune your analysis so that it is immediately relevant to the exact trade you want to take next. You may know from both fundamental and technical analysis that the euro is on an upswing, but your trade long is a loser because your stop gets hit on an aberrant price spike.There is no solution to this problem. Your analysis can be brilliant and absolutely correct, and still some or many of your trades are losers. In other words, you can be right and still take losses. Neither fundamental nor technical analysis is precise, but trade orders need to precise — enter at X and exit either at Y for a gain or at Z for a loss.The second problem is that your money management may not match up well with the currency you are trading. Let’s say you can afford to take a loss of only 10 points but your currency typically trades in an average range of 50 points in the timeframe you are trading, say 240 minutes or four hours, a popular timeframe. To halt an excessive number of stops getting hit, you need to save up more capital to be able to afford a wider stop, or switch currencies to another one that varies by less than 50 points over your chosen timeframe, or reduce your timeframe.Most traders accumulate too much loss because even if they have more winning trades than losing trades, they win less on winning trades than they lose on losing trades. From a money management point of view, it is always better to have a dollar win-loss ratio that is at least 1.1 to 1 (meaning you make $1.10 for every $1 lost). Ambitious people aim for 3 to 1 ($3 won for every $1 lost) or more, but this is very hard to hit.All this boils down to not having a trading system that blends both technical trading rules with money management rules, named a trading plan. This is not the work of a single day, or week, or even year.Let’s say that you spend the time to create a trading system that blends technical rules and money management rules. Can you count on it to deliver the same gain-loss ratio over a long period of time? No. Markets change. You will need to adapt your trading system to changing conditions.Let’s say you have a system and you are able to keep adapting it. Do you have the self-discipline to execute it to the letter? Sloppy execution will ruin even the best system. Fail to take a trade or two on a hunch, or take an extra trade or two on an impulse, and you are no longer trading your system.So why not buy somebody else’s expert trading system? After all, let’s say the track record shows a gain/loss ratio of 3 to 1. The answer is that the expert may have made 90% of the gain on a handful of trades over the course of a year and 90% of the trades were losers. Ask yourself would you be able to keep trading when 9 of 10 trades are losers. Or perhaps this particular system requires making a dozen in-and-out trades every day — but you have a day-job. Appreciation of risk is more than P&L arithmetic — it affects your emotions and sense of self-worth, too. Take too much risk and you burn out. Take too little and you fumble along never making any serious money. The problem is that “too much risk” is a personal thing and no other person on the planet has your exact risk appetite.Perspective: You may think you do not have something called a “portfolio,” but you probably do. You must have some savings in a savings account, an IRA, or company 401k plan, even if you do not have a taxable brokerage account. If your only savings consists of equity in your house, you have capital but it is not liquid. You would not be able to sell your house in 3-5 days in order to pay a debt to a broker. Do not even consider speculating in Forex if you have no liquid capital at all.A focus on high-leverage Forex can also put your overall portfolio management out of whack. Say, you have $250,000 in long-term savings and you have all of it invested in a money market fund, a mutual fund or two, and equities (with no leverage). Now you add a Forex account and you fund it with a relatively modest $10,000, but you leverage it 50 times for a total exposure of $500,000. Your total market exposure is $750,000 and two-thirds of it is leveraged. This is disproportionate. If you lose 50% on your Forex account, that is $250,000 or all of your savings. As noted above, you would need to make 100% on the remaining amount in your Forex account to get back to your starting point, and that is unlikely. By adding Forex to your portfolio, you have ruined the entire portfolio.The solution is to add a percentage of your total portfolio to the speculative account and not a multiple, say 10%. In other words, if you have $250,000 in your portfolio today, the face amount you will risk in Forex is 10% or $25,000. If you want to allocate $10,000 to Forex trading, that would put your leverage at a far more sane and reasonable 2.5 times.A little voice will nag at you every time you make a gain. Let’s say you gained 20 points on a single lot, or about $200. Your rate of return is $200/$10,000 = 2%. This is better than you can get in a savings account but if you had used all the leverage available to you in Forex, you would have had 10 lots and made $2,000, Now the rate of return is 20% and that kind of wonderful gain is why you got into active speculative trading in the first place. You will be tempted to listen to the little voice.Listen instead to the big voice of optimum portfolio management — do not speculate with more than 10% of your investment capital.
What is the Purchasing Managers' Index?The Purchasing Managers' Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors. It consists of a diffusion index that summarizes whether market conditions, as viewed by purchasing managers, are expanding, staying the same, or contracting. The purpose of the PMI is to provide information about current and future business conditions to company decision makers, analysts, and investors.KEY TAKEAWAYSThe Purchasing Managers Index (PMI) is a measure of the prevailing direction of economic trends in manufacturing.The PMI is based on a monthly survey of supply chain managers across 19 industries, covering both upstream and downstream activity.The value and movements in the PMI and its components can provide useful insight to business decision makers, market analysts, and investors, and is a leading indicator of overall economic activity in the U.S.How the Purchasing Managers' Index WorksThe PMI is compiled and released monthly by the Institute for Supply Management (ISM). The PMI is based on a monthly survey sent to senior executives at more than 400 companies in 19 primary industries, which are weighted by their contribution to U.S. GDP. The PMI is based on five major survey areas: new orders, inventory levels, production, supplier deliveries, and employment. The ISM weighs each of these survey areas equally. The surveys include questions about business conditions and any changes, whether it be improving, no changes, or deteriorating. The headline PMI is a number from 0 to 100. A PMI above 50 represents an expansion when compared with the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates no change. The further away from 50 the greater the level of change. The PMI is calculated as: PMI = (P1 * 1) + (P2 * 0.5) + (P3 * 0)Where:P1 = percentage of answers reporting an improvement P2 = percentage of answers reporting no change P3 = percentage of answers reporting a deterioration Other companies also produce PMI numbers, including IHS Markit Group, which puts out the PMI for various countries outside the U.S. How the PMI Affects Economic DecisionsThe PMI and relevant data produced monthly by the ISM from its surveys are critical decision-making tools for managers in a variety of roles. An automobile manufacturer, for example, makes production decisions based on the new orders it expects from customers in future months. Those new orders drive management's purchasing decisions about dozens of component parts and raw materials, such as steel and plastic. Existing inventory balances also drive the amount of production the manufacturer needs to complete to fill new orders and to keep some inventory on hand at the end of the month.Suppliers also make decisions based on the PMI. A parts supplier for a manufacturer follows the PMI to estimate the amount of future demand for its products. The supplier also wants to know how much inventory its customers have on hand, which also affects the amount of production its clients must generate. PMI information about supply and demand affects the prices that suppliers can charge. If the manufacturer's new orders are growing, for example, it may raise customer prices and accept price increases from its suppliers. On the other hand, when new orders are declining, the manufacturer may have to lower its prices and demand a lower cost for the parts it purchases. A company can use the PMI to help plan its annual budget, manage staffing levels, and forecast cash flow.Investors can also use the PMI to their advantage because it is a leading indicator of economic conditions. The direction of the trend in the PMI tends to precede changes in the trend in major estimates of economic activity and output, such as the GDP, Industrial Production, and Employment. Paying attention to the value and movements in the PMI can yield profitable foresight into developing trends in the overall economy.
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Every article and website on Forex will point out that Forex is a splendid trading vehicle. Here are some of the reasons given. Some are true and useful and some are untrue or silly.Glamor: Forex is glamorous and sophisticated — the very pinnacle of international high finance.Size and liquidity: Forex is the biggest single market in the world and offers high liquidity — you won’t get stuck with no bids or too wide a bid-offer spread as in thinly traded issues.24-hour trading: When you have a day job, it is nice to have your market open in the evenings and even late Sunday. Something is always being actively traded in Forex.Easy account opening: You can open a trading account with a Forex broker far more easily than with an equity or commodities broker, with far less money, and by disclosing a lot less information about your financial condition. Some brokers let you open an account with a few hundred dollars that you can put on a credit card and start trading the same day.Free platform: Brokers offer very good trading platforms that have the relevant data and technical tools for free. Many regular equity and commodity brokers charge for data and charting.No commissions: In spot retail, you do not pay a commission, just the bid-offer spread. In regular equity and commodities trading, commissions can consume 20-40% of your profits, depending on your gain/loss ratio.These all sound like good reasons to trade Forex. However, just about everything on this list above is either not true or not useful.Glamor: give yourself a break. Securities prices trade for the same reasons and in the same patterns whether they are Apple shares, soybeans, or the Swiss franc. Trading skills, which are really money management and risk management skills, are the same whatever the asset class. There is nothing inherently more “sophisticated” about trading dollar/yen than trading Sony. In fact, trading dollar/yen is more complicated than trading Sony shares, if only because you have two economies to track, not to mention risk factors that do not affect equities, like territorial disputes, oil prices, and other things. Studying the fundamentals of Sony and its markets is no mean task in its own right, but FX fundamentals are broader and deeper. Do not confuse complexity with sophistication.Size and liquidity: while it’s true that if you are trading the pink sheets (over-the-counter equities that are unlisted on a primary exchange), you will probably run into liquidity problems, but the world is chock-full of securities that have liquidity that is more than adequate for your account management. How much liquidity do you need, anyway? If you were trading equities, you might want to scan the universe for names that traded a minimum of a 100,000 shares per day. You would get a list in the US alone of hundreds of names. The oil futures contract trades over $1 billion per day.As for 24-hour trading, plenty of commodities trade on the electronic exchange GLOBEX that is nearly 24 hours per day, and after hours equity trading on the NY Stock Exchange and NASDAQ has been around since 1998. Besides, if you know what entry you want and its associated stop and price target, what do you care when, exactly, it gets executed? Do you really want to watch the screen for hours on end?This brings up another issue — let’s say you are in the Western Hemisphere times zones and have a day job. You want to trade the early Asia market that starts in New Zealand and moves to Tokyo, Singapore and Hong Kong. Unless you are trading what is for them a local currency (NZD, AUD, SGD, yen), liquidity is not that high. More to the point, trading action tends to be rangey and sideways. We hardly ever get a breakout move (except in the local currencies) in that time period. We see a similar lull during the transition period from Hong Kong to Frankfurt. Middle East trading may offer plenty of liquidity but it hardly ever offers big moves that the savvy trader wants to exploit.As for easy account opening, brokers make it easy for you to open the account because it is easy money for them. The probability of your making high profits from your first trade onward is practically zero. All traders take losses and you will, too — it is the nature of the beast. As soon as you take a loss, the broker wants you to add more money so you can continue trading. Stories abound in the chart rooms about traders who did make gains with these brokers but could not withdraw their funds.Even after the US government raised capital and registration requirements — making US residents off-limits to most foreign brokers — plenty of fly-by-night retail Forex brokers remain. We have central clearing in the primary interbank FX market but no central clearing for retail spot Forex. Most governments do not even try to regulate the retail market. Retail brokers have many tricks to cheat the customer. Probably the most common one is that they do not even place your trade. They know you have a low capital amount and your stop is (say) 10 points. They are willing to bet that your stop will get hit and they will not have to cover the trade from their side. If your target is hit instead, they may say your stop got hit anyway even though you don’t find that price anywhere on a database of prices for the day. This is one of the benefits of futures trading, by the way, compared to spot. The Chicago Mercantile Exchange posts “time and sales” for every blessed trade done and you can prove whether a stop or target was hit. Such proof stands up in a court of law, too.This brings up the no-commission “benefit.” Be sensible here — how does the broker make any money if he does not charge commission? By adding a spread of 2-5 pips to your cost and subtracting it from your closing price. Let’s say you are trading a standard retail amount of $100,000 and paying 3 pips, or $30. The price has to move 3 pips for you to break even, and another 3 to stay even on the exit. You need to make 7 pips minimum to start making a net gain.Now we have to ask the essential question — how much do you intend to make on a $100,000 trade? If you want to day-trade three times per day and your profit target is 20 pips with a stop at 10 pips, you are aiming to make 3 x 20 = 60 pips possible gain or $60/100,000 = 0.06%. If you can do that every day with no losses, on 240 trading days per year you would make $14,400/100,000 = 14.4%. Okay, now consider that to keep the 20 points, you actually have to make 23 points because you are paying the broker 3 of them.What is the average daily range of your currency and how big a piece of it is 23 points?Let’s say your currency is the AUD and it has an average daily range of 80-100 points (actual readings for January-May 2016). You would be seeking to get 23-33% of the daily range in the right direction every day. Ask yourself how realistic that is.To add another dose of reality, consider that you may trade profitably only 51% of the time, in other words, your stop is hit a little less than half the time. You are losing 10 points per trade on about 380 trades per year or $3,600, against a gain of $7,200 for a net gain of roughly $3,600. On a face amount of $100,000, that’s 3.6%. Since you are using leverage and not actually putting up the full $100,000, your percentage return is considerable higher, of course. Nevertheless, it is a great deal of work — trading three times per day, every day, and keeping losses to 49%, for a net gain of only $3,600 per year.If you are a swing trader and put on one position that you hold for several days or even weeks, you are avoiding paying 3 points on every trade, but you have a new expense — the cost of rolling over the contract every day. We will come back to that in another section. For the moment, consider that to make the same $3,600 as the day trader who trades three times per day, you would have to get (say) 36 points but only ten times over the course of the year, net of losses. Because Forex prices are trending, this is actually not that hard to achieve.The broker being paid with spread points has an important implication for your choice of trading strategies — it is more cost-effective to be a swing trader than a day-trader.However, let’s be honest – the real reason that people want to trade Forex is leverage. Leverage is a blessing and a curse. You are in essence borrowing most of the face amount of the $100,000. In some place, you can borrow virtually all of it, but in the USA, leverage is limited to 50 times since October 2010. That means if you want to trade one lot worth $100,000, you need to put down $2,000 as your initial margin ($100,000 divided by 50). If you first trade goes against you and you take a loss, you have to top it up with more money. In practice, your first trade should be backed by the $2,000 required under the regulations plus the amount you could lose if your stop is hit (plus maybe a little extra), or at least $2,500.But the point here is not how much you should fund your first account — it’s why the broker is willing to lend you $97,500 interest-free in the first place. The first reason is that the broker expects you to fail. He expects that more than half your trades will be stopped and they will be stopped right away, at the beginning of your trading career. The broker may not have placed your trade onward with a counterparty in the first place, so if your loss was (say) $250, he gets to keep all of it. Some brokers have been accused of “hunting stops” in their own account specifically to hit the stops of small traders.The second reason he is lending you this huge amount of money interest-free is that he is earning 3 points per lot per side, or roughly $6 per round turn. On the three-trades per day described above, that is $4,320, or 4.43% on $97,500. Since the broker can borrow the $97,500 at a rate less than 4.43%, he gets to keep the difference. But in practice, he usually doesn’t need to borrow the $97,000 at all in the first place — the broker is being extended credit free or very cheaply by the banks and brokers where he is passing on your trades. In essence, they give the broker free or cheap credit to drive volume to their trading desks. Bottom line, the broker is motivated to get and to keep your trading business, and the more day-trading you do, the better he likes it, because of that $3 per side profit he is making.
One day you will see the euro quoted at 1.3832 and nine days later, it is 1.3296. (These price quotes are the high on 2013-10-25 to the low on 2013-11-07.) A change in price by 536 points is not abnormal. Later we will talk about what is normal and how we know what is normal, but for the moment, you need to accept that Forex prices can move very far, very fast.What is behind the change? The obvious answer is that euro traders were in the process of changing their minds about the value of either the euro or the value of the dollar. Actually, since no one knows or can even guess what true value might be, the euro trader is guessing what others will think in the future about the appropriate price of the euro or the dollar. If the euro trader is a seller today at 1.3832, it is because he interprets some piece of data or news unfavorable to the euro that will make others not willing to pay as much for it as today’s price. The future may be two minutes, two days or two weeks, but the skill of the trader lies in assigning a probability to the interpretation of the data or news by the rest of the market.In other words, the euro trader is reading their minds about future demand for euros.This sounds ridiculous but it is an accurate way of describing the process. There are three components to the euro trader’s guess.Component One: The ChartThe euro had become “overbought.” This term refers to a majority of euro traders believing the euro should go higher and having already built a big long position. The chart reader does not care whether the rest of the market is correct. He sees that in terms of the upmove that has already taken place, the other traders are overinvested in the bullish point of view.If everyone has already bought the euro and they are out of cash or credit to increase their holdings, there’s nobody left to buy. The price must fall as the holders unload their positions in order to get cash to put on new trades. The chart reader uses any of several technical indicators to identify when the market is overinvested or overbought. The most commonly used indicator is the relative strength index or RSI. Another is the stochastic oscillator.It is important to note that in Forex, we do not have volume figures like the volume available in equity trading. If we had volume, we could see that as the price is rising, volume is failing to keep pace proportionately. A divergence between rising prices and falling volume is a classic technique in equities to gauge when a security is becoming overbought. Alas, in Forex, we do not have volume as a tool.Component Two: The EconomicsThe only reason to buy something is to use it or to sell it later for a higher price. While the Forex trader will not actually use euros in the sense of spending them on goods and services, he anticipates that others will want to use the euro’s purchasing power to buy stuff, not only socks and haircuts but also securities denominated in euros. Therefore, Forex traders follow the macroeconomics and news stories pertaining to the relative purchasing power of the euro vs. the dollar, including inflation (or deflation), wages increases, the robustness of the economy, and so on. At any one time, the market as a whole has a consensus view of which economies are growing and how fast, and which economies have immediate economic problems that the government and specifically the central bank should be addressing. As a rule, traders’ economic understanding is oversimplified and even crude, and usually boiled down to a catchy one or two-word descriptor, but it does not pay to be snobbish about the relative lack of sophistication of these views—they move markets.Component Three: The NewsThe macroeconomics form the background against which traders judge news. The single most important piece of news is a change in interest rates or other stimulus/contraction by a central bank. A good example is the interest rate decision by the European Central bank (ECB) on November 7, 2013. Because inflation had fallen to a new low and there was fear of Japanese-style deflation, the consensus of Forex commentators was that the ECB would cut rates or impose negative rates on bank deposits to encourage banks to lend more. Accordingly, the euro was on a sharp falling trajectory. However, the ECB declined to cut rates and the euro reversed on the same day, rising nearly to the level it started eight days earlier.ECB announcement influences EUR/USD in November 2013 — daily chart.You would be hard-pressed to say the euro reversed into an upmove because traders were thinking about purchasing power parity or other relative economic data — here the move was due to the ECB rate decision, made a little stronger because the market’s expectations were proved wrong.
What Is Forex?“Forex” is the abbreviation most used today for “foreign exchange,” meaning the price of one currency in terms of another currency. By definition, all Forex prices refer to the relationship between two currencies, i.e., a pair of currencies.The term “Forex” is used interchangeably with the term “FX.” Both are used today and both refer to the same thing, foreign exchange. The term “FX” is mostly used in the US while “Forex” was more broadly used in the UK until recently. Professional traders in the US at banks and brokers tend to use the term “FX” while “Forex” is the term used in the retail market, adopted from the British usage. Also used is the word “currency,” as in “I trade currencies” or “something happened in the currency market.”Foreign exchange refers literally to money, or more accurately, to money in two different denominations. The “exchange” part of the term means giving one thing of monetary value in return for a different thing of equivalent value. The word exchange refers to the transaction in which each of two parties is willing to exchange his respective basket of money for the equivalent amount of money denominated in the second currency. The price at which the two parties are willing to make the exchange is the exchange rate.The price of one currency in terms of another currency is called a “rate” and not a “price,” although the word “price” is equally valid and often used. Foreign exchange is the only market in which the word rate is used in place of the word price. The reason for this usage is probably due to the word “rate” being used since the Middle Ages to refer to a tariff or tax levy, since converting one currency to another entails applying a ratio or a proportion to one currency relative to the other. A common Latin phrase is “pro rata” from “pro rata parte,” meaning “in proportion.” The word “rate” in English comes from the Latin “rata.”What Is Being Exchanged?Since foreign exchange refers to two baskets of money, each with its own denomination, a foreign exchange transaction can be as simple as buying a basket of 165 dollars in return for £100 at an airport kiosk. The exchange rate is $1.65 per UK pound sterling.Why is the exchange rate not £0.6061 per dollar? This the same exchange rate, just expressed differently (it is the reciprocal, or 1 divided by 1.65). The answer lies in the historical convention of quoting the price of other currencies in terms of what they cost in pounds. The pound sterling was the benchmark currency for centuries until just after World War II, meaning the central currency against which all other currencies were judged and priced.After World War II, the US dollar became the benchmark currency and most other currencies were priced in terms of how many units of the foreign currency you could get for one dollar.As a rule, any money not issued by your home government is “foreign.” The natural way to look at foreign exchange is to ask: “How many units of the foreign currency can I get for a fixed amount of my home currency?” This is how a tourist or an importer looks at foreign exchange. But because the dollar is currently the benchmark currency against which almost all others are priced, the dollar comes first in the name of many currency pairs, although not all. The first name in a currency pair is generally the important name and the second is the secondary or less important one.Putting a name first is to assume that the fixed amount is denominated in that currency and the variable amount will be the other currency. In other words, the first currency is the base and you are applying a ratio to derive the price of second currency. When the European Monetary Union decided to quote the euro in the format “Euro/USD” and “Euro/JPY,” etc. it was a deliberate choice to make the euro the more important of the two currencies in every pair.The rule is that whichever name comes first is the one that is getting stronger on higher numbers and weaker on lower numbers. If the number goes up in the pound, for example, from 1.6000 to 1.6500, it means the pound is getting stronger and by definition, the dollar is getting weaker because in this pair, the full quote should read GBP/USD. It is accurate to express the quote as $1.6000 to $1.6500, meaning the pound used to cost $1.6000 but now it costs $1.6500. Journalists usually apply the convention of putting the dollar sign in front of the price quote, although brokers and analysts tend not to insert the currency symbol.This is also true of the euro (EUR/USD) so a higher number always means the euro is getting stronger vis-à-vis the dollar. You could say the EUR/USD moved from 1.3200 to 1.3900, meaning it got more expensive in dollar terms. If you are new to Forex, you can place an imaginary currency symbol in front to the first-named currency to get your bearings. Therefore, the price quote now looks like $1.3200 to $1.3900.The pound, euro, Australian dollar, and New Zealand dollar are the top key currencies in which the dollar does not come first, because of historic convention. All other currencies are quoted in terms of dollars, such as USD/CHF = US dollar against the Swiss franc.Below is the Yahoo! Finance’s list of major currencies. Yahoo! Finance is one of many providers of market information in the professional and retail Forex market. Other providers, including brokers, have their own version of this list.Major currency pairs by Yahoo! FinanceCross-ratesA few decades ago, a cross-rate was any currency pair that did not include your home currency. The US dollar/Japanese yen exchange rate would be a cross-rate for someone in the UK or Europe, for example.Today, however, the common definition of a cross-rate is any currency pair that does not include the dollar. Therefore, the USD/JPY exchange rate is a “major” exchange rate and not seen as a cross-rate by people in the UK or Europe, while the AUD/CAD would be seen as a cross-rate by everyone, including Australians and Canadians, even though the rate includes their home currencies.This convention for defining a cross-rate is not accepted everywhere and you will see lists in newspapers and websites that define cross-rates differently. The US dollar accounts for about 70% of global government money reserves and 70% of world trade, so placing the dollar as a component in all the major exchange rates is not without justification. In fact, there are more dollars in banknotes and bank deposit accounts outside the US than inside the US, so it may be accurate to say the dollar is the most-used currency in some places even though it is not the home currency. However, when someone says "the euro," he is always talking about EUR/USD and never talking about EUR/GBP, in which case the second currency must be named.See the list of Yahoo! Finance's European cross-rates. This is a typical list for European countries:Cross-rates by Yahoo! FinanceEvolving PracticesYahoo!, one of the top news and data providers, chooses to include non-dollar crosses as “major world currencies.” As a practical matter, if you are trading euro/dollar, you can say “euro” without the word “dollar” and you will be understood. If what you really mean is “euro/yen”, though, you must say the name of the second currency.TradingWhen you go to the airport kiosk to exchange your home currency for another one, you are not trading. You are a price-taker. The kiosk sign tells you what exchange rate will be applied and you are stuck with it. You can take it or leave it.This is not trading. Trading is the process of going back and forth with the opposing party until you discover the price that makes each of you the least unhappy. Trading involves negotiating a price that satisfies both parties and can involve game-playing, deceit, and other tricks. You may be bidding on something the other person thinks is more valuable than you do, or you may be offering something you value more highly than other people out there who want to buy. When the final price is reached and both parties have agreed upon it, the result is a contract, whether by handshake or formal paperwork, that you will deliver your basket of currency to the other party and he will deliver his basket of his currency to you at some specified place and time. As a rule, in practice the actual exchange is a wire transfer from one checking account to another in the two countries of issuance of each currency.
FOREX — the foreign exchange market or currency market or Forex is the market where one currency is traded for another. It is one of the largest markets in the world.Some of the participants in this market are simply seeking to exchange a foreign currency for their own, like multinational corporations which must pay wages and other expenses in different nations than they sell products in. However, a large part of the market is made up of currency traders, who speculate on movements in exchange rates, much like others would speculate on movements of stock prices. Currency traders try to take advantage of even small fluctuations in exchange rates.In the foreign exchange market there is little or no 'inside information'. Exchange rate fluctuations are usually caused by actual monetary flows as well as anticipations on global macroeconomic conditions. Significant news is released publicly so, at least in theory, everyone in the world receives the same news at the same time.Currencies are traded against one another. Each pair of currencies thus constitutes an individual product and is traditionally noted XXX/YYY, where YYY is the ISO 4217 international three-letter code of the currency into which the price of one unit of XXX currency is expressed. For instance, EUR/USD is the price of the euro expressed in US dollars, as in 1 euro = 1.2045 dollar.Unlike stocks and futures exchange, foreign exchange is indeed an interbank, over-the-counter (OTC) market which means there is no single universal exchange for specific currency pair. The foreign exchange market operates 24 hours per day throughout the week between individuals with Forex brokers, brokers with banks, and banks with banks. If the European session is ended the Asian session or US session will start, so all world currencies can be continually in trade. Traders can react to news when it breaks, rather than waiting for the market to open, as is the case with most other markets.Average daily international foreign exchange trading volume was $6.6 trillion in April 2019 according to the BIS triennial report.Like any market there is a bid/offer spread (difference between buying price and selling price). On major currency crosses, the difference between the price at which a market maker will sell ("ask", or "offer") to a wholesale customer and the price at which the same market-maker will buy ("bid") from the same wholesale customer is minimal, usually only 1 or 2 pips. In the EUR/USD price of 1.4238 a pip would be the '8' at the end. So the bid/ask quote of EUR/USD might be 1.4238/1.4239.This, of course, does not apply to retail customers. Most individual currency speculators will trade using a broker which will typically have a spread marked up to say 3-20 pips (so in our example 1.4237/1.4239 or 1.423/1.425). The broker will give their clients often huge amounts of margin, thereby facilitating clients spending more money on the bid/ask spread. The brokers are not regulated by the U.S. Securities and Exchange Commission (since they do not sell securities), so they are not bound by the same margin limits as stock brokerages. They do not typically charge margin interest, however since currency trades must be settled in 2 days, they will "resettle" open positions (again collecting the bid/ask spread).Individual currency speculators can work during the day and trade in the evenings, taking advantage of the market's 24 hours long trading session.