Forex Trading Introduction

The forex market in its most basic sense is a market created in order to facilitate trade between different currencies.
Most people neglect the importance of currencies in regards to business, virtually every company in the world participates in the forex market, not with the aim of making money but with the aim of buying products or services.

One example is Sony.

At the end of 2014 Sony estimated that it was going to lose 230 billion yen by the end of 2015.

In February 2015 it revised this forecast to 170 billion yen (about 1.4 billion dollars) one of the main reasons for this revision were partly due to the declining value of the yen in relation to the other currencies.

Here’s what Sony said in its letter to shareholders. “due to the favorable impact of foreign exchange rates, a significant increase in mobile communication segment sales reflecting an increase in unit sales of smartphones” – Sony

Source: http://www.industryweek.com/supply-chain/sony-revises-forecast-big-losses-2015

Here’s another example: Lets say Toyota wanted to buy some aluminum for the production of their cars, if the only country which has aluminum available is the United States then what they are going to have to do is convert their currency (the Japanese yen ) into US dollars in order to buy it.

How much this will cost them depends on the exchange rate of  Japanese Yen to the US Dollar, if they find its going to cost them too much to buy the aluminum they might choose to wait until things are more favorable for them.

 

People don’t realize that these big companies all have economists and forecasters analyzing the financial markets, they employ these people to understand the current market environment so they can buy and sell materials and products at the most favorable times.

When Toyota finally do decide to by the aluminum the transaction will have an effect on the exchange rate of JPY/USD, we will not be able to identify this on our charts however.

The reason why is down to how many transactions take place in the market everyday. Because there is so many companies and people participating in the forex market all at various different times throughout the day it would be impossible for us to figure out when and where these companies are placing trades without having access to inside information.

This is not a problem for us though, because the opinion of everyone who participates in the forex market will be reflected in the charts we have on our computer, allowing us to make judgments as to where the price of the exchange rate will likely go in the future.

Theses two examples just go to show how important the forex market is for companies around the world, in the Toyota example we saw how they have to exchange different currencies in order to manufacture cars, in the Sony example we saw how their yearly losses shrunk due to the exchange rate of the yen decreasing.

 

Largest Market In The World

 

If you were to do a survey of what the most commonly known financial market was then the majority vote would probably go to the stock market.

I mean it’s what you mainly hear about in the news and what you also see in many films.

The funny thing is though is because people hear about it and see it on the news they tend to believe that it’s the only financial market in the world.
Amazingly it happens to be  there are lots of financial markets operating in our world today, the commodities market which is where things like gold and silver get exchanged, the bond market, and finally the currency exchange i.e. the Forex market.

Now if you were to add up all of the trading that takes place daily in all of these markets it would amount to about a third of what gets traded on a daily basis in the forex market.

Every single day around 4.5 trillion Dollas! and yes you did read that right, gets exchanged over the forex market, this makes it by far the largest market in the world.

One unique aspect of the forex market and also where it differs slightly from other markets is that trading takes place 24 hours a day 5 days a week.

In the stock market trading begins at 8.00am and ends 3.00pm each day so you can see choosing to trade the forex market has a clear advantage, I mean if you have commitments during the day such as work then you can place a trade the night before, go to work come back home later and you might find you have made some money, you wouldn’t be able to do that trading other markets.

When it comes to learning about the Forex market many new traders find that there are lots of trading terms  and slang which they don’t understand.

In this next section I’ll  explain some of the frequently heard trading terms.

 

Currency Quotes

 

Currency quotes are basically what the price of one currency is in relation to another.

For example, lets say that you wanted to place a trade on the exchange rate of the Euro to the Dollar, this will be represented on your trading broker as EUR/USD, next to this there will be a number.

This number is the current market price of how much one euro will get you in dollars.

If the current market price is 1.11600 then that means one euro will get you 1.11600 (basically a dollar and 11 cents)

The first currency listed is known as the base currency, the base currency is always equivalent to 1 unit of that currency, in the example above its 1 euro, if the base currency was dollars then it would be 1 dollar.

 

Cross Currencies

 

Most currencies in the Forex market are traded against the dollar meaning that the base currency of most of the exchange rates contain the dollar as the first currency.
The reason for this is because the dollar is seen as the worlds reserve currency and America is identified as the largest economy in the world, all the exchange rates which do not have the US dollar as the base currency are known as cross currencies.

CHF/JPY – EUR/GBP – GBP/JPY along with many more are all considered cross currencies.

 

Bid Price And Ask Price

 

Because trading in the forex market takes place 24 hours a day there is no central exchange where all the trading takes place, instead there are many different exchanges all over the word

What this means is there always a price at which you can buy at and a price at which you can sell at.

If you go on to your trading platform next to the current market price you’ll see there are two prices .

One will be labelled Ask and the other labeled Bid, these represent what price you can buy or sell the base currency at.

The Ask price is what price your trade will be placed at if you decide to place a sell trade.

The Bid on the other hand, is what price your trade will be placed at if you decide to place a sell trade.

You may notice there is a difference between the price you can buy at and the price you can sell at, this difference is commonly refereed to as the spread.

The Spread

 

So as an example if you wanted to place a trade on USD/JPY you will probably see it quoted like this:

USD/JPY 119.681 This is the current market price, next to it you will see this:

ASK 119.680

BID 119.683

So the spread for USD/JPY in this example would be 0.3 pips because that’s the difference between you can place a buy trade at and the price you can place a sell trade.

 

What Does This Mean For You?

 

The main purpose of having a spread is so the trading broker you use can make money.

You see every time you place a trade whether it be a buy trade or sell trade when that trade gets placed you automatically pay the spread to the broker.

How much you pay is dependent on two things.

  1. The size of the trade your placing.
  2. How big the spread is on the currency you have chosen to trade.

The size of the spread differs between currencies. The four most traded currencies EUR/USD – USD/JPY – GBP/USD – USD/JPY have the lowest spread due most of the trading activity in the market taking place on them, currencies which are not highly traded can have much higher spreads.

If your just getting started in the markets it’s probably best if you stick to trading the 4 currencies i mentioned above in order for you to keep trading costs down.

At the end of the day the spread isn’t really something to be to conceded about, the amount of money you have to pay will be minuscule if you trade the 4 major currencies i listed above, the size of the trades your taking should be small as well because your only a beginner

 

Pips

 

If you noticed when I was talking about the spread I mentioned something called pips.

Pips are smallest increment of movement in the Forex market.

When the market moves its measured in terms of pips.

It the USD/JPY moved from 119.800 to 119.900 then that would be 10 pips,  if it went from 119.800 to 119.810 then that would be 1 pip.

 

A full list of trading terms is available in my Beginner’s Guide To Currency Trading

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1 comment

  1. Master of Pips

    Hi, I am new to this site and so far it looks very interesting.

    I have been studying Forex for about 4 months now, and look forward to reading all the material you have on your site.

    Something I picked up in this article: it says: “The Ask price is what price your trade will be placed at if you decide to place a sell trade.” But Ask price is the price you BUY at? (Small mistake I think).

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