Trading forex is similar to the equity market because individuals interested in trading need to open up a trading account. Like the equity market, each forex account and the services it provides differ, so it is important that you find the right one. Below we will talk about some of the factors that should be considered when selecting a forex account.
Leverage
Leverage is basically the ability to control large amounts of capital, using very little of your own capital; the higher the leverage, the higher the level of risk. The amount of leverage on an account differs depending on the account itself, but most use a factor of at least 50:1, with some being as high as 250:1. A leverage factor of 50:1 means that for every dollar you have in your account you control up to $50. For example, if a trader has $1,000 in his or her account, the broker will lend that person $50,000 to trade in the market. This leverage also makes your margin, or the amount you have to have in the account to trade a certain amount, very low. In equities, margin is usually at least 50%, while the leverage of 50:1 is equivalent to 2%.
Leverage is seen as a major benefit of forex trading, as it allows you to make large gains with a small investment. However, leverage can also be an extreme negative if a trade moves against you because your losses also are amplified by the leverage. With this kind of leverage, there is the real possibility that you can lose more than you invested - although most firms have protective stops preventing an account from going negative. For this reason, it is vital that you remember this when opening an account and that when you determine your desired leverage you understand the risks involved.
Commissions and Fees
Another major benefit of forex accounts is that trading within them is done on a commission-free basis. This is unlike equity accounts, in which you pay the broker a fee for each trade. The reason for this is that you are dealing directly with market makers and do not have to go through other parties like brokers.
This may sound too good to be true, but rest assured that market makers are still making money each time you trade. Remember the bid and ask from the previous section? Each time a trade is made, it is the market makers that capture the spread between these two. Therefore, if the bid/ask for a foreign currency is 1.5200/50, the market maker captures the difference (50 basis points).
If you are planning on opening a forex account, it is important to know that each firm has different spreads on foreign currency pairs traded through them. While they will often differ by only a few pips (0.0001), this can be meaningful if you trade a lot over time. So when opening an account make sure to find out the pip spread that it has on foreign currency pairs you are looking to trade.
Other Factors
There are a lot of differences between each forex firm and the accounts they offer, so it is important to review each before making a commitment. Each company will offer different levels of services and programs along with fees above and beyond actual trading costs. Also, due to the less regulated nature of the forex market, it is important to go with a reputable company. (For more information on what to look for when opening an account, read Wading Into The Currency Market. If you are not ready to open a "real money" account but want to try your hand at forex trading, read Demo Before You Dive In.)
Friday, August 7, 2009
Forex Trading of Technical Indicators and analized
There are many large players in the forex market, such as hedge funds and large banks, that all have advanced computer systems to constantly monitor any inconsistencies between the different currency pairs. Given these programs, it is rare to see any major inconsistency last longer than a matter of seconds. Many traders turn to forex technical analysis because it presumes that all the factors that influence a price - economic, political, social and psychological - have already been factored into the current exchange rate by the market. With so many investors and so much money exchanging hands each day, the trend and flow of capital is what becomes important, rather than attempting to identify a mispriced rate.
Trend or Range
One of the greatest goals of technical traders in the FX market is to determine whether a given pair will trend in a certain direction, or if it will travel sideways and remain range-bound. The most common method to determine these characteristics is to draw trend lines that connect historical levels that have prevented a rate from heading higher or lower. These levels of support and resistance are used by technical traders to determine whether or not the given trend, or lack of trend, will continue.
Generally, the major currency pairs - such as the EUR/USD, USD/JPY, USD/CHF and GBP/USD - have shown the greatest characteristics of trend, while the currency pairs that have historically shown a higher probability of becoming range-bound have been the currency crosses (pairs not involving the U.S. dollar). The two charts below show the strong trending nature of USD/JPY in contrast to the range-bound nature of EUR/CHF. It is important for every trader to be aware of the characteristics of trend and range, because they will not only affect what pairs are traded, but also what type of strategy should be used. (To learn more about this subject, see Trading Trend Or Range?)
Trend or Range
One of the greatest goals of technical traders in the FX market is to determine whether a given pair will trend in a certain direction, or if it will travel sideways and remain range-bound. The most common method to determine these characteristics is to draw trend lines that connect historical levels that have prevented a rate from heading higher or lower. These levels of support and resistance are used by technical traders to determine whether or not the given trend, or lack of trend, will continue.
Generally, the major currency pairs - such as the EUR/USD, USD/JPY, USD/CHF and GBP/USD - have shown the greatest characteristics of trend, while the currency pairs that have historically shown a higher probability of becoming range-bound have been the currency crosses (pairs not involving the U.S. dollar). The two charts below show the strong trending nature of USD/JPY in contrast to the range-bound nature of EUR/CHF. It is important for every trader to be aware of the characteristics of trend and range, because they will not only affect what pairs are traded, but also what type of strategy should be used. (To learn more about this subject, see Trading Trend Or Range?)
Forex Strategies of Fundamental analysis
The currency carry trade is a strategy in which a trader sells a currency that is offering lower interest rates and purchases a currency that offers a higher interest rate. In other words, you borrow at a low rate, and then lend at a higher rate. The trader using the strategy captures the difference between the two rates. When highly leveraging the trade, even a small difference between two rates can make the trade highly profitable. Along with capturing the rate difference, investors also will often see the value of the higher currency rise as money flows into the higher-yielding currency, which bids up its value.
Real-life examples of a yen carry trade can be found starting in 1999, when Japan decreased its interest rates to almost zero. Investors would capitalize upon these lower interest rates and borrow a large sum of Japanese yen. The borrowed yen is then converted into U.S. dollars, which are used to buy U.S. Treasury bonds with yields and coupons at around 4.5-5%. Since the Japanese interest rate was essentially zero, the investor would be paying next to nothing to borrow the Japanese yen and earn almost all the yield on his or her U.S. Treasury bonds. But with leverage, you can greatly increase the return.
For example, 10 times leverage would create a return of 30% on a 3% yield. If you have $1,000 in your account and have access to 10 times leverage, you will control $10,000. If you implement the currency carry trade from the example above, you will earn 3% per year. At the end of the year, your $10,000 investment would equal $10,300, or a $300 gain. Because you only invested $1,000 of your own money, your real return would be 30% ($300/$1,000). However this strategy only works if the currency pair’s value remains unchanged or appreciates. Therefore, most forex carry traders look not only to earn the interest rate differential, but also capital appreciation. While we’ve greatly simplified this transaction, the key thing to remember here is that a small difference in interest rates can result in huge gains when leverage is applied. Most currency brokers require a minimum margin to earn interest for carry trades.
However, this transaction is complicated by changes to the exchange rate between the two countries. If the lower-yielding currency appreciates against the higher-yielding currency, the gain earned between the two yields could be eliminated. The major reason that this can happen is that the risks of the higher-yielding currency are too much for investors, so they choose to invest in the lower-yielding, safer currency. Because carry trades are longer term in nature, they are susceptible to a variety of changes over time, such as rising rates in the lower-yielding currency, which attracts more investors and can lead to currency appreciation, diminishing the returns of the carry trade. This makes the future direction of the currency pair just as important as the interest rate differential itself. (To read more about currency pairs, see Using Currency Correlations To Your Advantage, Making Sense Of The Euro/Swiss Franc Relationship and Forces Behind Exchange Rates.)
To clarify this further, imagine that the interest rate in the U.S. was 5%, while the same interest rate in Russia was 10%, providing a carry trade opportunity for traders to short the U.S. dollar and to long the Russian ruble. Assume the trader borrows $1,000 US at 5% for a year and converts it into Russian rubles at a rate of 25 USD/RUB (25,000 rubles), investing the proceeds for a year. Assuming no currency changes, the 25,000 rubles grows to 27,500 and, if converted back to U.S. dollars, will be worth $1,100 US. But because the trader borrowed $1,000 US at 5%, he or she owes $1,050 US, making the net proceeds of the trade only $50.
However, imagine that there was another crisis in Russia, such as the one that was seen in 1998 when the Russian government defaulted on its debt and there was large currency devaluation in Russia as market participants sold off their Russian currency positions. If, at the end of the year the exchange rate was 50 USD/RUB, your 27,500 rubles would now convert into only $550 US (27,500 RUB x 0.02 RUB/USD). Because the trader owes $1,050 US, he or she will have lost a significant percentage of the original investment on this carry trade because of the currency’s fluctuation - even though the interest rates in Russia were higher than the U.S.
Another good example of forex fundamental analysis is based on commodity prices. (To read more about this, see Commodity Prices And Currency Movements.)
You should now have an idea of some of the basic economic and fundamental ideas that underlie the forex and impact the movement of currencies. The most important thing that should be taken away from this section is that currencies and countries, like companies, are constantly changing in value based on fundamental factors such as economic growth and interest rates. You should also, based on the economic theories mentioned above, have an idea how certain economic factors impact a country's currency. We will now move on to technical analysis, the other school of analysis that can be used to pick trades in the forex market.
Real-life examples of a yen carry trade can be found starting in 1999, when Japan decreased its interest rates to almost zero. Investors would capitalize upon these lower interest rates and borrow a large sum of Japanese yen. The borrowed yen is then converted into U.S. dollars, which are used to buy U.S. Treasury bonds with yields and coupons at around 4.5-5%. Since the Japanese interest rate was essentially zero, the investor would be paying next to nothing to borrow the Japanese yen and earn almost all the yield on his or her U.S. Treasury bonds. But with leverage, you can greatly increase the return.
For example, 10 times leverage would create a return of 30% on a 3% yield. If you have $1,000 in your account and have access to 10 times leverage, you will control $10,000. If you implement the currency carry trade from the example above, you will earn 3% per year. At the end of the year, your $10,000 investment would equal $10,300, or a $300 gain. Because you only invested $1,000 of your own money, your real return would be 30% ($300/$1,000). However this strategy only works if the currency pair’s value remains unchanged or appreciates. Therefore, most forex carry traders look not only to earn the interest rate differential, but also capital appreciation. While we’ve greatly simplified this transaction, the key thing to remember here is that a small difference in interest rates can result in huge gains when leverage is applied. Most currency brokers require a minimum margin to earn interest for carry trades.
However, this transaction is complicated by changes to the exchange rate between the two countries. If the lower-yielding currency appreciates against the higher-yielding currency, the gain earned between the two yields could be eliminated. The major reason that this can happen is that the risks of the higher-yielding currency are too much for investors, so they choose to invest in the lower-yielding, safer currency. Because carry trades are longer term in nature, they are susceptible to a variety of changes over time, such as rising rates in the lower-yielding currency, which attracts more investors and can lead to currency appreciation, diminishing the returns of the carry trade. This makes the future direction of the currency pair just as important as the interest rate differential itself. (To read more about currency pairs, see Using Currency Correlations To Your Advantage, Making Sense Of The Euro/Swiss Franc Relationship and Forces Behind Exchange Rates.)
To clarify this further, imagine that the interest rate in the U.S. was 5%, while the same interest rate in Russia was 10%, providing a carry trade opportunity for traders to short the U.S. dollar and to long the Russian ruble. Assume the trader borrows $1,000 US at 5% for a year and converts it into Russian rubles at a rate of 25 USD/RUB (25,000 rubles), investing the proceeds for a year. Assuming no currency changes, the 25,000 rubles grows to 27,500 and, if converted back to U.S. dollars, will be worth $1,100 US. But because the trader borrowed $1,000 US at 5%, he or she owes $1,050 US, making the net proceeds of the trade only $50.
However, imagine that there was another crisis in Russia, such as the one that was seen in 1998 when the Russian government defaulted on its debt and there was large currency devaluation in Russia as market participants sold off their Russian currency positions. If, at the end of the year the exchange rate was 50 USD/RUB, your 27,500 rubles would now convert into only $550 US (27,500 RUB x 0.02 RUB/USD). Because the trader owes $1,050 US, he or she will have lost a significant percentage of the original investment on this carry trade because of the currency’s fluctuation - even though the interest rates in Russia were higher than the U.S.
Another good example of forex fundamental analysis is based on commodity prices. (To read more about this, see Commodity Prices And Currency Movements.)
You should now have an idea of some of the basic economic and fundamental ideas that underlie the forex and impact the movement of currencies. The most important thing that should be taken away from this section is that currencies and countries, like companies, are constantly changing in value based on fundamental factors such as economic growth and interest rates. You should also, based on the economic theories mentioned above, have an idea how certain economic factors impact a country's currency. We will now move on to technical analysis, the other school of analysis that can be used to pick trades in the forex market.
Forex Trading theries and feed data
The main economic theories found in the foreign exchange deal with parity conditions. A parity condition is an economic explanation of the price at which two currencies should be exchanged, based on factors such as inflation and interest rates. The economic theories suggest that when the parity condition does not hold, an arbitrage opportunity exists for market participants. However, arbitrage opportunities, as in many other markets, are quickly discovered and eliminated before even giving the individual investor an opportunity to capitalize on them. Other theories are based on economic factors such as trade, capital flows and the way a country runs its operations. We review each of them briefly below.
Major Theories: Purchasing Power Parity
Purchasing Power Parity (PPP) is the economic theory that price levels between two countries should be equivalent to one another after exchange-rate adjustment. The basis of this theory is the law of one price, where the cost of an identical good should be the same around the world. Based on the theory, if there is a large difference in price between two countries for the same product after exchange rate adjustment, an arbitrage opportunity is created, because the product can be obtained from the country that sells it for the lowest price.
Major Theories: Purchasing Power Parity
Purchasing Power Parity (PPP) is the economic theory that price levels between two countries should be equivalent to one another after exchange-rate adjustment. The basis of this theory is the law of one price, where the cost of an identical good should be the same around the world. Based on the theory, if there is a large difference in price between two countries for the same product after exchange rate adjustment, an arbitrage opportunity is created, because the product can be obtained from the country that sells it for the lowest price.
Forex History
The creation of the gold standard monetary system in 1875 marks one of the most important events in the history of the forex market. Before the gold standard was implemented, countries would commonly use gold and silver as means of international payment. The main issue with using gold and silver for payment is that their value is affected by external supply and demand. For example, the discovery of a new gold mine would drive gold prices down.
The underlying idea behind the gold standard was that governments guaranteed the conversion of currency into a specific amount of gold, and vice versa. In other words, a currency would be backed by gold. Obviously, governments needed a fairly substantial gold reserve in order to meet the demand for currency exchanges. During the late nineteenth century, all of the major economic countries had defined an amount of currency to an ounce of gold. Over time, the difference in price of an ounce of gold between two currencies became the exchange rate for those two currencies.
The underlying idea behind the gold standard was that governments guaranteed the conversion of currency into a specific amount of gold, and vice versa. In other words, a currency would be backed by gold. Obviously, governments needed a fairly substantial gold reserve in order to meet the demand for currency exchanges. During the late nineteenth century, all of the major economic countries had defined an amount of currency to an ounce of gold. Over time, the difference in price of an ounce of gold between two currencies became the exchange rate for those two currencies.
Forex market
Unlike the equity market - where investors often only trade with institutional investors (such as mutual funds) or other individual investors - there are additional participants that trade on the forex market for entirely different reasons than those on the equity market. Therefore, it is important to identify and understand the functions and motivations of the main players of the forex market.
Governments and Central Banks
Arguably, some of the most influential participants involved with currency exchange are the central banks and federal governments. In most countries, the central bank is an extension of the government and conducts its policy in tandem with the government. However, some governments feel that a more independent central bank would be more effective in balancing the goals of curbing inflation and keeping interest rates low, which tends to increase economic growth. Regardless of the degree of independence that a central bank possesses, government representatives typically have regular consultations with central bank representatives to discuss monetary policy. Thus, central banks and governments are usually on the same page when it comes to monetary policy.
Central banks are often involved in manipulating reserve volumes in order to meet certain economic goals. For example, ever since pegging its currency (the yuan) to the U.S. dollar, China has been buying up millions of dollars worth of U.S. treasury bills in order to keep the yuan at its target exchange rate. Central banks use the foreign exchange market to adjust their reserve volumes. With extremely deep pockets, they yield significant influence on the currency markets.
Governments and Central Banks
Arguably, some of the most influential participants involved with currency exchange are the central banks and federal governments. In most countries, the central bank is an extension of the government and conducts its policy in tandem with the government. However, some governments feel that a more independent central bank would be more effective in balancing the goals of curbing inflation and keeping interest rates low, which tends to increase economic growth. Regardless of the degree of independence that a central bank possesses, government representatives typically have regular consultations with central bank representatives to discuss monetary policy. Thus, central banks and governments are usually on the same page when it comes to monetary policy.
Central banks are often involved in manipulating reserve volumes in order to meet certain economic goals. For example, ever since pegging its currency (the yuan) to the U.S. dollar, China has been buying up millions of dollars worth of U.S. treasury bills in order to keep the yuan at its target exchange rate. Central banks use the foreign exchange market to adjust their reserve volumes. With extremely deep pockets, they yield significant influence on the currency markets.
Risk & Benefits of Trading Exchange
We already have mentioned that factors such as the size, volatility and global structure of the foreign exchange market have all contributed to its rapid success. Given the highly liquid nature of this market, investors are able to place extremely large trades without affecting any given exchange rate. These large positions are made available to forex traders because of the low margin requirements used by the majority of the industry's brokers. For example, it is possible for a trader to control a position of US$100,000 by putting down as little as US$1,000 up front and borrowing the remainder from his or her forex broker. This amount of leverage acts as a double-edged sword because investors can realize large gains when rates make a small favorable change, but they also run the risk of a massive loss when the rates move against them. Despite the foreign exchange risks, the amount of leverage available in the forex market is what makes it attractive for many speculators.
The currency market is also the only market that is truly open 24 hours a day with decent liquidity throughout the day. For traders who may have a day job or just a busy schedule, it is an optimal market to trade in. As you can see from the chart below, the major trading hubs are spread throughout many different time zones, eliminating the need to wait for an opening or closing bell. As the U.S. trading closes, other markets in the East are opening, making it possible to trade at any time during the day.
Time Zone Time (ET)
Tokyo Open 7:00 pm
Tokyo Close 4:00 am
London Open 3:00 am
London Close 12:00 pm
New York Open 8:00 am
New York Close 5:00 pm
While the forex market may offer more excitement to the investor, the risks are also higher in comparison to trading equities. The ultra-high leverage of the forex market means that huge gains can quickly turn to damaging losses and can wipe out the majority of your account in a matter of minutes. This is important for all new traders to understand, because in the forex market - due to the large amount of money involved and the number of players - traders will react quickly to information released into the market, leading to sharp moves in the price of the currency pair.
Though currencies don't tend to move as sharply as equities on a percentage basis (where a company's stock can lose a large portion of its value in a matter of minutes after a bad announcement), it is the leverage in the spot market that creates the volatility. For example, if you are using 100:1 leverage on $1,000 invested, you control $100,000 in capital. If you put $100,000 into a currency and the currency's price moves 1% against you, the value of the capital will have decreased to $99,000 - a loss of $1,000, or all of your invested capital, representing a 100% loss. In the equities market, most traders do not use leverage, therefore a 1% loss in the stock's value on a $1,000 investment, would only mean a loss of $10. Therefore, it is important to take into account the risks involved in the forex market before diving in
The currency market is also the only market that is truly open 24 hours a day with decent liquidity throughout the day. For traders who may have a day job or just a busy schedule, it is an optimal market to trade in. As you can see from the chart below, the major trading hubs are spread throughout many different time zones, eliminating the need to wait for an opening or closing bell. As the U.S. trading closes, other markets in the East are opening, making it possible to trade at any time during the day.
Time Zone Time (ET)
Tokyo Open 7:00 pm
Tokyo Close 4:00 am
London Open 3:00 am
London Close 12:00 pm
New York Open 8:00 am
New York Close 5:00 pm
While the forex market may offer more excitement to the investor, the risks are also higher in comparison to trading equities. The ultra-high leverage of the forex market means that huge gains can quickly turn to damaging losses and can wipe out the majority of your account in a matter of minutes. This is important for all new traders to understand, because in the forex market - due to the large amount of money involved and the number of players - traders will react quickly to information released into the market, leading to sharp moves in the price of the currency pair.
Though currencies don't tend to move as sharply as equities on a percentage basis (where a company's stock can lose a large portion of its value in a matter of minutes after a bad announcement), it is the leverage in the spot market that creates the volatility. For example, if you are using 100:1 leverage on $1,000 invested, you control $100,000 in capital. If you put $100,000 into a currency and the currency's price moves 1% against you, the value of the capital will have decreased to $99,000 - a loss of $1,000, or all of your invested capital, representing a 100% loss. In the equities market, most traders do not use leverage, therefore a 1% loss in the stock's value on a $1,000 investment, would only mean a loss of $10. Therefore, it is important to take into account the risks involved in the forex market before diving in
Introduction of Forex
The foreign exchange market is the "place" where currencies are traded. Currencies are important to most people around the world, whether they realize it or not, because currencies need to be exchanged in order to conduct foreign trade and business. If you are living in the U.S. and want to buy cheese from France, either you or the company that you buy the cheese from has to pay the French for the cheese in euros (EUR). This means that the U.S. importer would have to exchange the equivalent value of U.S. dollars (USD) into euros. The same goes for traveling. A French tourist in Egypt can't pay in euros to see the pyramids because it's not the locally accepted currency. As such, the tourist has to exchang at the current exchange rate.
Foreign Trading Summary
The forex market represents the electronic over-the-counter markets where currencies are traded worldwide 24 hours a day, five and a half days a week. The typical means of trading forex are on the spot, futures and forwards markets.
* Currencies are "priced" in currency pairs and are quoted either directly or indirectly.
* Currencies typically have two prices: bid (the amount that the market will buy the quote currency for in relation to the base currency); and ask (the amount the market will sell one unit of the base currency for in relation to the quote currency). The bid price is always smaller than the ask price.
* Unlike conventional equity and debt markets, forex investors have access to large amounts of leverage, which allows substantial positions to be taken without making a large initial investment.
* The adoption and elimination of several global currency systems over time led to the formation of the present currency exchange system, in which most countries use some measure of floating exchange rates.
* Governments, central banks, banks and other financial institutions, hedgers, and speculators are the main players in the forex market.
* The main economic theories found in the foreign exchange deal with parity conditions such as those involving interest rates and inflation. Overall, a country's qualitative and quantitative factors are seen as large influences on its currency in the forex market.
* Forex traders use fundamental analysis to view currencies and their countries like companies, thereby using economic announcements to gain an idea of the currency's true value.
* Forex traders use technical analysis to look at currencies the same way they would any other asset and, therefore, use technical tools such as trends, charts and indicators in their trading strategies.
* Unlike stock trades, forex trades have minimal commissions and related fees. But new forex traders should take a conservative approach and use orders, such as the take-profit or stop-loss, to minimize losses.
* Currencies are "priced" in currency pairs and are quoted either directly or indirectly.
* Currencies typically have two prices: bid (the amount that the market will buy the quote currency for in relation to the base currency); and ask (the amount the market will sell one unit of the base currency for in relation to the quote currency). The bid price is always smaller than the ask price.
* Unlike conventional equity and debt markets, forex investors have access to large amounts of leverage, which allows substantial positions to be taken without making a large initial investment.
* The adoption and elimination of several global currency systems over time led to the formation of the present currency exchange system, in which most countries use some measure of floating exchange rates.
* Governments, central banks, banks and other financial institutions, hedgers, and speculators are the main players in the forex market.
* The main economic theories found in the foreign exchange deal with parity conditions such as those involving interest rates and inflation. Overall, a country's qualitative and quantitative factors are seen as large influences on its currency in the forex market.
* Forex traders use fundamental analysis to view currencies and their countries like companies, thereby using economic announcements to gain an idea of the currency's true value.
* Forex traders use technical analysis to look at currencies the same way they would any other asset and, therefore, use technical tools such as trends, charts and indicators in their trading strategies.
* Unlike stock trades, forex trades have minimal commissions and related fees. But new forex traders should take a conservative approach and use orders, such as the take-profit or stop-loss, to minimize losses.
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