Forex Trading - Tutorialspoint

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Forex Tradingi

Forex TradingAbout the TutorialForex Market is an exciting place. The one good thing about entering into the forex marketis that you can trade anytime as per your convenience.The forex market is enormous in size and is the largest market with millions of participants.Hundreds of thousands of individuals (like us), money exchangers, to banks, to hedgefund managers everybody participates in the forex market.This tutorial covers the fundamentals of forex trading.AudienceThis tutorial is prepared for beginners to gain some knowledge before they begin theirjourney with trading. Professional who are already into forex trading can also draw benefitfrom this tutorial.PrerequisitesWe assume that you know the essential terms related to forex trading and the basicstandards of currency trade.Copyright & Disclaimer Copyright 2018 by Tutorials Point (I) Pvt. Ltd.All the content and graphics published in this e-book are the property of Tutorials Point (I)Pvt. Ltd. The user of this e-book is prohibited to reuse, retain, copy, distribute or republishany contents or a part of contents of this e-book in any manner without written consentof the publisher.We strive to update the contents of our website and tutorials as timely and as precisely aspossible, however, the contents may contain inaccuracies or errors. Tutorials Point (I) Pvt.Ltd. provides no guarantee regarding the accuracy, timeliness or completeness of ourwebsite or its contents including this tutorial. If you discover any errors on our website orin this tutorial, please notify us at [email protected]

Forex TradingTable of ContentsAbout the Tutorial . iAudience . iPrerequisites . iCopyright & Disclaimer . iTable of Contents . ii1.Forex Trading – Introduction. 2What is Forex? . 2Why Trade Forex? . 2Who Trades Forex? . 3When can you trade forex? . 3Forex Market Hours . 32.Forex Trading – The structure of the forex market . 5Hierarchy of Participants . 6Market Participants . 6Currency pair . 7Commonly Used Currency Pair . 7The Bid-Ask Spread . 9What are Bullish and Bearish Markets? . 9What happens in a Bull Market? . 10What happens in a Bear Market? . 10What is Lot size? . 11What is long in forex trade? . 11What is short in forex trade? . 11What are Pending Orders in Forex Trade? . 11What is Leverage and Margin? . 12Hedging. 13ii

Forex Trading3.Forex Trading – Major Currencies and Trade Systems . 15Major Currencies . 15Different Trade systems on Forex . 174.Forex Trading – Types of Market Analysis . 19Fundamental Analysis. 19When to use fundamental analysis for the forex market? . 19Key factors influencing fundamental analysis . 20Technical Analysis . 21Dow Theory for Technical Analysis . 21Sentimental Analysis . 21What type of analysis is better? . 225.Forex Trading – Kinds of Foreign Exchange Market . 23Spot Market . 23Major Participants on the Spot Exchange Market . 23Forward Market . 24Future Markets . 25Option Market . 256.Forex Trading – Benefits of Trading Forex . 27UNIT 2: DRIVING FORCES BEHIND FOREX MARKET . 297.Forex Trading – Fundamental Market Forces . 31Economic Growth and Outlook . 31Capital Flows. 31Trade Flows and Trade Balance . 32The socio political environment of a country . 328.Forex Trading – Technical Indicators . 33What is a chart? . 33Types of Charts . 33iii

Forex Trading9.Forex Trading – Pattern Study of Trends, Support and Resistance . 38Kinds of Trends . 38Percentage Retracement . 42The Trendline. 4310. Forex Trading – Technical Strategy in Price Patterns . 46Price Action Patterns . 46Pattern Types. 46Building the Price Pattern Rules . 47Strength of a trend: length and steepness of trend-waves . 48Strength of trends: depth of pullbacks . 4911. Forex Trading – Oscillator Divergences . 50Categories of Indicators. 50Relative Strength Index (RSI) . 53Overbought and Oversold . 54Divergence . 54Estimating Price Targets . 5712. Forex Trading – The Role of Inflation . 58Higher and Lower Inflation . 58Gross National Product (GNP) . 59How GDP affects Forex market? . 59Producer Price Index . 59Consumer Price Index (CPI) . 6013. Forex Trading – The Commodity Connection . 61UNIT 3: PUTTING IT TOGETHER . 6214. Forex Trading – Position Sizing & Money Management . 63Determining your Position Size . 63Creating a Forex trading spreadsheet to track your performance . 64iv

Forex TradingForeign Exchange Risks . 6415. Forex Trading – Foreign Exchange Risks . 65Exchange Rate Risk . 65Credit Risk . 65Liquidity Risk . 66Operational Risk . 66Interest Rate Risk . 66Country Risk. 6616. Forex Trading – Trading Rules to Live By . 69v

Forex TradingUNIT 1: Welcome to the World’s LargestFinancial Market1

1. Forex Trading – IntroductionForex TradingForex Market is an exciting place. The one good thing about entering into the forex marketis that you can trade anytime as per your convenience.The global Foreign exchange market (‘FX’, ‘Forex’ or ‘FOREX’) is the largest market in theworld as measured by the daily turnover with more than US 5 trillion a day eclipsing thecombined turnover of the world’s stock and bond markets. The forex market measuring apropelling turnover is one of the many reasons why so many private investors andindividual traders have entered the market. The investors have discovered severaladvantages many of which are not available in the other markets.What is Forex?Forex (in simple terms, currency) is also called the foreign exchange, FX or currencytrading. It is a decentralized global market where all the world’s currencies trade with eachother. It is the largest liquid market in the world.The liquidity (more buyers and sellers) and competitive pricing (the spread is very smallbetween bid and ask price) available in this marked are great. With the irregularity in theperformance in other markets, the growth of forex trading, investing and management isin upward trajectory.Why Trade Forex?So, why trade Forex? There are many reasons to trade in Forex. If we ask four differentpeople, you might get more than four different answers. Primarily, making money is themost frequently cited reason for why trade Forex.Let us now consider the following reasons why so many people are choosing forex market:Forex market never sleepsThe Forex market works 24 hours and 5-1/2 days a week. Because governments,corporates and private individual who require currency exchange services are spreadaround the world, so trading on the forex market never stops. Activity on the forex marketfollows the sun around the world, so right from the Monday morning opening in Australiato the afternoon close in New York. At any point of the day you can find an active pair totrade.Long or ShortA trader in forex can trade both ways. It means a forex trader can play the market andmake profits irrespective of whether market is going up, down or is in tight range. Soirrespective of the event that has triggered the movement – forex traders do not care.Low transaction costMost forex accounts trade with little or no commission and there is no exchange or datalicense fees. Generally, the retail transaction fee (the bid/ask spread) is typically less than2

Forex Trading0.1% under normal market conditions. With larger dealers (where volumes are huge), thespread could be as low as 0.05%. Leverage plays a crucial role here.LeverageLeverage is the mechanism by which a trader can take position much larger than the initialinvestment. Leverage is one more reason why you should trade in forex. Few currencytraders realize the advantage of financial leverage available to them. For example, if youare trading in equity market, the maximum leverage a stock broker is offered is 1:2 butin case of forex market, you will get a leverage up to 1:50 and in many parts of the worldeven higher leverage is available. For this reason, it is not hard to see that why forextrading is so popular.High leverage allows a trader with small investment to trade higher volumes of currenciesand thus provide the opportunity to make significant profits from the small movement inthe market. However, if the market is against your assumption you might lose significantamount too. Therefore, like any other market, it is a two-way sword.High LiquidityThe size of forex market is enormous and liquid by nature. High liquidity means a tradercan trade with any type of currency. Timing is not a constraint as well; trading can bedone as per your convenience. The buyers and sellers across the world accept differenttypes of currencies. In addition, forex market is active 24 hours a day and is closed onlyon the weekends.AccessibilityGetting started as a currency trader would not cost a ton of money especially whencompared to trading stocks, option or future market. We have online forex brokers offering“mini” or “micro” trading accounts that let you open a trading account with a minimumaccount deposit of 25. This allows an average individual with very less trading capital toopen a forex trading account.Who Trades Forex?The forex market is enormous in size and is the largest market with millions of participants.Hundreds of thousands of individuals (like us), money exchangers, to banks, to hedgefund managers everybody participates in the forex market.When can you trade forex?Forex market is open 24 hours a day and 5 days a week. However, it does not mean it isalways active. Let us check what a 24-hour day in the forex world looks like.The forex market is divided into four major trading sessions: the Sydney session, theTokyo session, the London session and the New York session.Forex Market HoursThe following table shows the opening and closing time of each session.3

Forex TradingSummer Session (Around April – October)TIME ZONEEDTGMTSydney open6:00 PM10:00 PMSydney close3:00 AM07:00 AMTokyo Open7:00 PM11:00 PMTokyo Close4:00 AM08:00 AMLondon Open03:00 AM07:00 AMLondon Close12:00 PM04:00 PMNew York Open08:00 AM12:00 PMNew York Close05:00 PM09:00 PMWinter (Around October – April)TIME ZONEESTGMTSydney Open04:00 PM09:00 PMSydney Close01:00 AM06:00 AMTokyo Open06:00 PM11:00 PMTokyo Close03:00 AM08:00 AMLondon Open03:00 AM08:00 AMLondon Close12:00 PM05:00 PMNew York Open08:00 AM01:00 PMNew York Close05:00 PM10:00 PMNote: The actual opening and closing timing of forex market depends on local businesshours.We can see in the above chart that in between different forex trading session(region wise),there is a period of time where two sessions (region time) are open at the same time.There is always more volume of trade when two markets (in different regions) are openat the same time.4

2. Forex Trading – The structure of the forexmarketForex TradingIn this chapter, we will learn about the structure of the forex market.The structure of a typical stock market is as shown below:BuyersCentralisedExchanges (NSE,BSE, NYSE)SellerBut the structure of the forex market is rather unique because major volumes oftransactions are done in Over-The-Counter (OTC) market which is independent of anycentralized system (exchange) as in the case of stock markets.The participants in this market are: Central Banks Major commercial banks Investment banks Corporations for international business transactions Hedge funds Speculators Pension and mutual funds Insurance companies Forex brokers5

Forex TradingHierarchy of ParticipantsThe forex market structure may be represented as shown below:Major 3000-Spot MatchingMedium Size and Smaller banksRetail market makers\Retail ECNs\ HedgeFunds and commercial companiesRetail TradersMarket ParticipantsIn the above diagram, we can see that the major banks are the prominent players andsmaller or medium sized banks make up the interbank market. The participants of thismarket trade either directly with each other or electronically through the ElectronicBrokering Services (EBS) or the Reuters Dealing 3000-Spot Matching.The competition between the two companies – The EBS and the Reuters 3000-SpotMatching in forex market is similar to Pepsi and Coke in the consumer market.Some of the largest banks like HSBC, Citigroup, RBS, Deutsche Bank, BNP Paribas,Barclays Bank among others determine the FX rates through their operations. These largebanks are the key players for global FX transactions. The banks have the true overallpicture of the demand and supply in the overall market, and have the current scenario ofany current. The size of their operations effectively lay down the bid-ask spread thattrickles down to the lower end of the pyramid.The next tier of participants are the non-bank providers such as retail market makers,brokers, ECNs, hedge funds, pension and mutual funds, corporations, etc. Hedge fundsand technology companies have taken significant chunk of share in retail FX but very lessfoothold in corporate FX business. They access the FX market through banks, which arealso known as liquidity providers. The corporations are very important players as they areconstantly buying and selling FX for their cross-border (market) purchases or sales of raw6

Forex Tradingor finished products. Mergers and acquisitions (M&A) also create significant demand andsupply of currencies.Sometimes, governments and centralized banks like the RBI (in India) also intervene inthe Foreign Exchange market to stop too much volatility in the currency market. Forinstance, to support the pricing of rupees, the government and centralized banks buyrupees from the market and sell in different currencies such as dollars; conversely, toreduce the value of Indian rupees, they sell rupees and buy foreign currency (dollars).The speculators and retail traders that come at the bottom of the pyramid pay the largestspread, because their trades effectively get executed through two layers. The primarypurpose of these players are to make money trading the fluctuations in the currency prices.With the advancement of technology and internet, even a small trader can participate inthis huge forex market.Currency pairIf you are new to the forex market and have just started trading Forex online, you mayfind yourself overwhelmed and confused both at a time by the huge number of availablecurrency pairs inside your terminal (like the MetaTrader4, etc.). So what are the bestcurrency pairs to trade? The answers is not that straightforward as it varies with eachtrader and its terminal window or with what exchange (or OTC market) he is trading.Instead, you need to take the time to analyse different pairs of currencies against yourown strategy to determine the best forex pairs to trade on your accounts.The trade in Forex market occurs between two currencies, because one currency is beingbought (buyer/bid) and another sold (seller/ask) at the same time. There is aninternational code that specifies the setup of currency pairs we can trade. For example, aquote of EUR/USD 1.25 means that one Euro is worth 1.25. Here, the base currency isthe Euro(EUR), and the counter currency is the US dollar.Commonly Used Currency PairIn this section, we will learn about a few commonly used currency pair.The most traded, dominant and strongest currency is the US dollar. The primary reasonfor this is the size of the US economy, which is the world’s largest. The US dollar is thepreferred base or reference currency in most of the currency exchange transactionsworldwide. Below are some of the most traded (high liquidity) currency pairs in the globalforex market. These currencies are part of most of the foreign exchange transactions.However, this is not necessarily the best currency to trade for every trader, as this (whichcurrency pair to choose) depends on multiple factors: EUR/USD (Euro – US Dollar) GBP/USD (British Pound – US Dollar) USD/JPY (US Dollar – Japanese Yen) USD/CHF ( US Dollar – Swiss Franc) EUR/JPY ( Euro – Japanese Yen) USD/CAD (US Dollar – Canadian Dollar) AUD/USD (Australian Dollar – US Dollar)7

Forex TradingAs prices of these major currencies keep changing and so do the values of the currencypairs change. This leads to a change in trade volumes between two countries. These pairsalso represent countries that have financial power and are traded heavily worldwide. Thetrading of these currencies makes them volatile during the day and the spread tends tobe lower.EUR/USD Currency PairThe EUR/USD currency pair is considered to be the most popular currency pair and hasthe lowest spread among modern world forex brokers. This is also the most tradedcurrency pair in the world. About 1/3rd of all the trade in the market is done in this currencypair. Another important point is that this forex pair is not too volatile. Therefore, if you donot have that much risk appetite you can consider this currency pair to trade.The following diagram shows some of the major currency pairs and their values:Note: The above currency pair quotes were taken from www.finance.google.com.8

Forex TradingThe Bid-Ask SpreadThe spread is the difference between the bid price and the ask price. The bid price is therate at which you can sell a currency pair and the ask price is the rate at which you canbuy a currency pair (EUR/USD).Whenever you try to trade any currency pair, you will notice that there are two pricesshown, as shown in the image below:The following image shows the spread between USD and INR (US Dollar – Indian Rupees)pair.Bid PriceAsk Price(Source: Above data is taken from nseindia.com)The lower price (67.2600 in our example) is called the “Bid” and it is the price at yourbroker (through which you’re trading) is willing to pay for buying the base currency (USDin this example) in exchange for the counter currency (INR in our case). Inversely, if youwant to open a short trade (sell), you will do so at the price of 67.2625 in our example.The higher price (67.2625) is called the ‘Ask’ price and it is the price at which the brokeris willing to sell you the base currency (USD) against the counter currency (INR).What are Bullish and Bearish Markets?The term “bull” (bullish) and “bear” (bearish”) are often used to describe how the overallfinancial market is performing in general – whether there is an appreciation ordepreciation. Simply put, a bull (bullish) market is used to describe conditions where9

Forex Tradingmarket is rising and a bear (bearish) market is the one where market is going down. It isnot, a single day which describes if the market is in bullish or bearish form; it is a coupleof weeks or months which tell us if the market is in the bull(bullish) or the bear(bearish)grip.What happens in a Bull Market?In a bull market, the confidence of the investor or the traders is high. There is optimismand positive expectations that good results will continue. So in all, bull market occurs whenthe economy is performing well – unemployment is low, GDP is high and stocks marketsarerising.The bull market is generally related with the equity (stock) market but it applies to allfinancial markets like currencies, bonds, commodities, etc. Therefore, during a bull marketeverything in the economy looks great - the GDP is growing, there is less unemployment,the equity prices are rising, etc.All this leads to rises not only in stock market but also in FX currencies such as AustralianDollar (AUD), New Zealand Dollar (NZD), Canadian Dollar (CAD) and emerging marketcurrencies. Conversely, the bull market generally leads to a decline in safe-havencurrencies such as US dollar, th