What Is Forex?
FOREX stands for FOReign EXchange. The Foreign Exchange market is the biggest financial market in the world; with a daily turnover of over $5 trillion dollars (that’s a whopping $5,000,000,000,000!). Almost all forex trades are of speculative nature; without physical delivery of currency, it’s basically numbers flickering around on computer screens. Chances are your currency trades will be of the speculative kind, too. So what is forex exactly? Forex trading is the simultaneous buying of one currency and selling of another. Every deal goes through intermediaries called brokers or dealers. Currencies are traded in pairs, for example euro vs. US dollar (EUR/USD), US dollar vs. Japanese yen (USD/JPY), US dollar vs. Canadian dollar (USD/CAD) and so on and so forth.
As you are not buying anything physical really, forex trading can be somewhat confusing. So, assume that when you buy a currency, it’s like you’re buying a piece of a country as the rate of exchange of a given currency against the other currencies is a reflection of the state of the economy of this given country in comparison with the economies of the other countries. As opposed to other financial markets such as, for instance, the New York Stock Exchange, the London Stock Exchange, Bolsa de Madrid or Bursa Malaysia, the forex market is not based in any particular headquarters. It has no particular central exchange. The forex market is an over-the-counter (OTC) market – an interbank market, meaning that all the trades are executed electronically in a network of banks. The forex market “is open” non-stop for over 5 days a week, from late Sunday until the end of Friday.
ABOUT THE FINANCIAL MARKETS – SESSION 1
Every country is built on a certain economy; controlling, managing, sustaining is the main major role of an economy; Economy means the largest set of inter-related economic production and consumption activities which aid in determining how scarce resources are allocated. Each economy must encompass every single detail that is related to the production and consumption of goods and services in a certain allocated area, trying to sustain it in a way that might help to prosper and develop certain sectors.
In each economy there are two different types of policies; fiscal and monetary policy:
The Fiscal Policy: is a policy stimulated by the policy makers, it is divided into taxation law and government spending; the government can adjust these laws in order to modify the amount of non-refundable income available to its tax payers, for example a government could ask more taxes from individual which makes them have less amount of money used in spending on goods and services, then the government could use those money to inject it back again into certain companies and markets by something called Government Spending. The higher the government spending means that they are going to demand more taxes from individuals in the economy; but the major disadvantage of this policy is that it might take time in order to achieve all that.
The Monetary Policy: is the second type of polices used in managing a certain economy, this type of policy is mainly controlled by central banks, meaning that they control the supply of money into the economy, by putting cost on the borrowing of these money with something called Interest Rates. Interest rates are defined as the percentage amount of money charged on borrowed or lent money, as it could be variable or fixed.
Another classification to an economy is, Open and Closed Economy; an Open Economy means that it has bilateral trade with other economies all around the world for example the United States. A Closed Economy has a limited regulated trade with other world economies like China. Inside each economy there is a Financial System; Financial System is “found to organize the settlement of payments, to raise and allocate finance and to manage the risks associated with financing and exchange; developed to secure efficient payment system, security markets and financial intermediaries that arrange financing and derivative markets and financial institutions that provide access to risk management instruments”.
There are two major roles of a Financial System; the first one is to organize surplus funds from people and organizations, and to reallocate them into deficit facing organizations or people; as those mobilized funds are used to generate returns for the surplus entities, by enabling deficit entities to augment their productive and purchasing capacities.
A Financial System contains something called financial markets; a financial market is a mechanism that allows people to easily buy and sell financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect efficient market hypothesis.
Securities: “essentially a contract that can be assigned a value and traded”.
Commodities: “a tangible good or product that are subject of sale or barter, such as grains, metals, and foods traded on commodities exchange or on spot market”.
Transaction Cost: “cost incurred when buying or selling securities, which includes commission and spreads (the difference between the prices the dealer paid for a security and the prices at which it can be sold)”.
Efficient Market Hypothesis: “means that each share price in a market must reflect all relevant information”.
ABOUT THE FINANCIAL MARKETS – SESSION 2
An Investor is a person who invests in any different type of markets, for example equities, commodities derivatives, currencies, real estate; as this term is connected with the individual who is looking for profit from a certain investment. Types of Investors’ can be classified on certain criterion which is known by risk (the possibility of suffering damage or loss). Risk is calculated by dividing the standard deviation over the historical average returns. Risk = Standard Deviation /Average Returns
Are type of investors’ who take higher than average risks, seeking for abnormal profits, as they are mainly concerned about speculating which might be the futuristic prices of a certain asset e.g. currency or a commodity; mainly they are involved in buying and selling future and option contracts in the short term, as they represent almost 70% if investors’; which might be known by “Risk Seekers”.
Are types of investors’ who tries to avoid or cancel any risks that can be accompanied with certain investment, they try to take positions that might prevent them from any potential losses, these types of investors’ are widely found in markets that are full of uncertainties and high volatility. There are many types of hedging positions like natural hedges, hedging credit risk, hedging currency risk, hedging equity and equity futures. Which are also known by “Risk Neutrals”.
Are types of investors’ who buy securities in one market then immediately resell it in another market in order to profit from prices divergence, as this type of dealing is only suggested only for well experienced investors’ as any delay in transactions could result of huge losses; the effect of these transaction would result in adjusting price differences between markets.
There are three types of markets:
Factor Market: it is the type of markets that include all features of production for example land, labor, capital.
Product Market: is the market that includes all distributing products like food, goods and services.
Types of Financial Markets: Primary Market: type of market that only sells the newly issued securities. Secondary Market: it’s a market where buyers buy from the seller rather than getting it from issuing company. Over the Counter Market (OTC): it’s a type of market that trades occur via phone or a network instead of a physical trading. Those types of markets are found for companies that do not meet the exchange listing requirements.
Inside the OTC Market there are:
Market Makers: it’s a type of firm that takes in a certain type and number of shares in order to ease the trading in this security, each market maker displays buy and sell quotations for a certain number of shares, when the order is set the market maker instantly sells from his inventory, as this transaction takes only a small amount of time; for example NASDAQ is considered to be a market maker. The market maker profits from the spread, which is the difference between the prices for buying and the prices at which they are willing to sell at.
Ask Prices: is the price the seller is willing to take for a certain type of security and besides the ask prices there will be the amount of securities the market maker is willing to sell; which are also known by the Bears.
Bid prices: the prices the buyer is willing to take, which is the opposite of the ask prices, the bulls in the markets are known by the bidders.
Money Market: is a type of market instruments that mature in less than one year as they are very liquid, the instruments involved in this market have fixed income and low risk for example treasury bills and commercial papers.
Capital Market: it’s a market of trading more risky instruments with a longer maturity date, as this market consists of the primary and the secondary markets.
Bond Market: “the place where the issuance and the trading of the debt securities occur”, as most bond market instruments are traded in the OTC market.
Stock Market: is the market in which shares are traded through exchange floor or over-the-counter, which is known by another name equity market, this market helps investors’ to have a partial ownership in a certain company, and some gains or dividends based on the company’s performance.
A Stock is defined as share of ownership in a certain company, and the more stocks you obtain the bigger your share in the company, which is confirmed by a certain piece of paper called a certificate. The managers of a company are supposed to increase the value of those investments to increase the confidence of investors’ in the company to raise its share price. There are two types of stocks, preferred and common stocks. A common stock are type of shares that are released to public were anybody can acquire; a preferred stocks are another type of stocks that are sold to certain people, not publicly available. The difference between both types of stocks is that preferred stocks have the priority in taking distributed dividends and in the liquidation of the company.
Functions of Financial Markets
Borrowing and lending: financial markets provides money to investors’, by giving out certain amount of money but with certain interests which is known by cost of borrowing.
Price Determination: sets or defines fixed or volatile prices for each type of instrument in the market.
Information Collection and Analysis: provides information for market participants to value or estimate prices of a certain instrument.
Risk Sharing: financial markets eliminate a type of risk known by systematic risk, by diversifying investments.
Liquidity: markets provide sufficient amount of buyers and sellers helping any investors’ to directly convert instruments into cash.
Efficiency: markets reflecting all the publicly available information on a certain instrument.
Major Market Participants
Broker: a broker’s job is to locate a buyer to the seller, as they involve in assets transformation.
Dealer: smoothes the process of matching the buyer with the seller.<br/>
Investment Banks: contributes in selling the newly issued securities.<br/>
Financial Intermediaries: They are foundations that act as mediator between investors and firms.
ABOUT THE FINANCIAL MARKETS – SESSION 3
Are type of securities that their value is abstracted from other financial instruments; these types of derivates are used as a hedging bargain to stop any losses from any reversal movement in the market, so the main use is to “Control Risk”; it is mainly used with currency and interest rates.
The Derivative is used by the three types of Investors:
Hedgers: the Hedger uses the derivates in order to minimize the losses by taking a position opposite to the transaction that he/she is having, so if the market reverse no major losses will occur.
Speculators: the speculator will get in market just looking for abnormal profits, with accepting higher risk, by taking an open position.
Arbitragers: the arbitrager try’s to look for low risk profit, by taking advantage of difference in prices.
A derivative includes different types of instruments:
Forward Contracts: are negotiated between two parties, to buy a long position and sell a short position of a specified amount of a commodity, as the buyer hold the right to undertake the action but not obligated, and setting the price (known by the spot price) of the commodity at a specified date.
Future Contracts: are standardized contracts that are traded on a regulated floors, obligating the delivery of the agreed amount of commodity or a currency or an instrument for example treasury bonds, foreign currency. These types of contracts are considered to have low risk.
Options: is a contract that designed to specify in it the quantity of a certain commodity with the specified date of transaction, were options have the right to buy or sell but not the obligation.
There are two types of option contracts:
Call Option: gives the buyer the right to buy (but not the obligation) a specified amount of securities at a certain price at a set date.
Put Option: gives the buyer the right to sell (but not the obligation) to the writer of the option by a certain prices and a specified date.
Swaps: “is a flexible, private, forward-based contract or agreement, which is used to hedge against exchange risk from mismatched currencies on assets and liabilities”.
There are different types risk associated with Derivatives:
Basis Risk: it is the price of the hedged asset subtracted from it the price of the derivative contract.
Credit Risk: it’s the risk of the chance of one party offsetting the financial obligation under the contract.
Market Risk: it’s the loss due to changes in the value of the derivative, including different types of risks control, accounting and legal risks.
ABOUT THE FINANCIAL MARKETS – SESSION 4
Market Depth is defined as the capability of the market to generate enough or extra orders without having an effect on the price of a security, as it can be defined in another way, it is measured also with the liquidity, the more liquid the markets are the more depth it has; moving security prices in large markets is really hard, because of the depth of the markets large orders must be taken in order to change prices slightly.
There are certain factors which affect market depth:
- Tick Size
- Prices Movement Restriction
- Trading Restriction
- Allowable Leverage
- Market Transparency
- But there is a very big role that takes place in the markets that we can’t ignore, which is known by Investors’ rationality, or Market Psychology.
Markets in general are really built on speculations, forecasts and fears; if certain gossip spreads in markets average investors’ would really panic which at the end leads them to take irrational acts, that could really affect the trend that is going into markets, but let’s not forget the bigger influential which is known by attitude toward risk.
We all know a rational investor won’t really take into consideration any spread of rumors into markets they will concentrate more risk; but the enigma starts when the amount of average investors’ in markets gets bigger which would eventually affect the overall movement, obligating rational investors’ to take different actions to wipe away any extra risk that can be added on them.
PROFIT AND LOSS CALCULATION
Making profits in trading comes from expectations and speculations for prices. The concept is to buy a product hoping to sell it on a better/higher price or vice versa, and the difference is your profits – or losses if the market went against your trades and expectations.
As an investor, your net realized profits will be the total profit that your order/trade has made minus your broker’s spreads, commissions, and/ or any other deductions.
The equation to calculate profits or losses of a trade depends on the type of the traded instrument. For currencies, as an example, when you trade on a currency pair, the resulting profit amount is in the profit currency (second part of the currency pair). Therefore, in direct currencies where the profit currency is USD, profits are directly calculated in USD, while for indirect ones you need to exchange the resulting amount to USD according to the exchange rate at the time of closing the order.
Profit And Loss Calculation For Currencies
For Direct Currencies
Profit/Loss = (Bid Price – Ask Price) X Contract Size X Number of Lots
For Indirect Currencies
Profit/Loss = (Bid Price – Ask Price) X Contract Size X Number of Lots / Closing Price
For Cross Currencies (where the profit currency is denominated in a direct currency)
Profit/Loss = (Bid Price – Ask Price) X Contract Size X Number of Lots X USD Exchange Rate
For Cross Currencies (where the profit currency is denominated in an indirect currency)
Profit/Loss = (Bid Price – Ask Price) X Contract Size X Number of Lots / USD Exchange Rate
You bought 2 lots of EURGBP at price 0.8648, in few days, the price goes up and you close your position at price 0.8702. The resulting profit will be as follows:
Note: the exchange rate for GBPUSD at the time of closing the order is 1.5287
Profit = (Bid Price – Ask Price) X Contract Size X Number of Lots X Exchange Rate (USD)
= (0.8702 – 0.8648) X 100,000 X 2 X Exchange Rate for (GBPUSD) = 0.0054 X 200,000 X 1.5287 = 1,650.996 USD
And as you can trade in spot forex, so you can buy or sell futures contracts of currencies in the futures market for delivery on a specified future date.
Futures contracts for currencies are all quoted in US Dollars. Therefore, your profits will be directly calculated in USD according to the following equation:
For Futures Currencies:
Profit/Loss = (Bid Price – Ask Price) X Contract Size X Number of Contracts
Profit And Loss Calculation For Metals
As for precious metals, gold and silver prices are in USD, the profits/ losses are directly calculated in USD according to the simple equation below:
For Precious Metals:
Profit/Loss = (Bid Price – Ask Price) X Contract Size X Number of Lots
Same equation applies to futures contracts of precious metals as they have the same contract size and denominated in USD as well.
Note that the contract size of 1 standard lot of sliver is 5,000 ounces, and for gold is 100 ounces.
You bought 3 contracts of Silver at price 19.86. In few days, the market goes up in your favor and you close your order at price 20.30.
Your profits will be as follows:
Profit/Loss = (Bid Price – Ask Price) X Contract Size X Number of Lots Profit/Loss = (20.30 – 19.86) X 5,000 Oz X 3.0 Lots Your Profit = 6,600 USD
Profit And Loss Calculation For Indices
Trading indices in futures contracts is to buy or sell an index in the futures market for delivery on a specified future date. An index is an imaginary portfolio of securities representing a particular market or a portion of it.
The most common indices that are made available for OTC trading by most brokers are the US indices: S&P 500, NASDAQ 100, and Dow Jones.
When an index price goes up or down, the difference in points will be your profits or losses. Profit/Loss is calculated for indices according to the following equation:
Profit/Loss = (Bid Price – Ask Price) X Index Point Value X Number of Contracts
Each index point has its determined value as in the indexes below:
S&P Point Value = $50 NASDAQ Point Value = $20 Dow Jones Point Value = $10
You placed a 2 contracts “Sell” order on S&P for Month September (SP13SEP) at price 1700.25. In two weeks period, SPJUN price is still going up, so you decide to cut your losses and close the order at price 1704.75.
Your losses will be calculated as follows:
Loss = (Bid Price – Ask Price) X Index Point Value X Number of Contracts = (1700.25 – 1704.75) X $50 X 2.0 Lots = -450.00 USD (Loss)
Profit And Loss Calculation For Energies
Trading in futures contracts of energies is to buy or sell a CFD on energy contract in the futures market for delivery on a specified future date.
The most common energy contracts that are made available for OTC trading by most brokers are Light Sweet Crude Oil, and Natural Gas.
Sweet crude future contracts are the most popular oil contracts traded on commodity markets. 1 standard contract of Light Sweet Crude Oil equals a 1000 Barrels.
Investors in the energy market can use Natural Gas futures contracts as well to profit from the changes in the underlying price. 1 standard contract of Natural Gas equals 10,000 MMbtu.
Oil and natural gas prices are quoted in US Dollars. Therefore, your profits will be directly calculated in USD according to the following equation:
Profit/Loss = (Bid Price – Ask Price) X Contract Size X Number of Contracts
You bought 5 mini contracts of Light Sweet Crude Oil for Month May (CL13MAY) at price 100.95 USD a Barrel. You close your order on price 103.10 USD a Barrel.
Your profits will be calculated as follows:
Profit = (Bid Price – Ask Price) X Contract Size X Number of Contracts = (103.10 – 100.95) X 1000 Barrels X 0.5 Lot = 1075.0 USD
When Day Trading, a trader makes the decision about what to trade, when to trade, and how to trade, using either fundamental or technical analysis. Both forms of analysis involve looking at the available information and making a decision about the future price of the market being traded, but the information that is used is completely different. It is possible to use both fundamental and technical analysis together, but it is more common for a trader to choose one or the other.
Technical analysis is a method of forecasting price movements by analyzing statistics generated by market activity, such as previous prices and trading volume using charts and mathematical indicators to identify patterns that can suggest future activity, as it is based on the belief that the historical performance of stocks and markets are indications of future performance.
Despite the technical tool that is used, technical analysis actually studies supply and demand in a market in an attempt to determine what direction or trend will continue in the future by studying the market itself.
Almost every trader uses some form of technical analysis. Even fundamental analysis traders are likely to glance at price charts before executing a trade, as these charts help traders determine ideal entry and exit points for a trade. They provide a visual representation of the historical price action of whatever is being studied.
Types of Charts
Studying charts patterns is the basic concept of technical analysis. There are a variety of charts that show price action. The most common are bar charts. Each bar represents one period of time and that period can be anything from one minute to one month to several years. These charts will show distinct price patterns that develop over time.
A simple bar chart shows opening and closing prices as well as highs and lows. The bottom of the vertical bar shows the lowest trade price for that time, while the top of the bar is the highest price that was paid. The vertical bar itself shows the instrument trading range in full. The horizontal line on the left is the opening price, while the horizontal line on the right is the closing price.
Like bar charts patterns, candlestick patterns can be used to forecast the market. Because of their colored bodies, candlesticks provide greater visual detail in their chart patterns than bar charts so they are easier to follow.
A candlestick chart indicates high to low with vertical line. The main body in the middle of this chart indicates the range between the opening and closing prices. If the block in the middle is colored in then the currency closed lower than it opened.
Line charts are one the most basic types of charts used in finance in general and forex in particular. This type of chart is formed through a line connecting a series of data points together; usually lines are drawn from one closing price to the next. Line charts provide a clear visualization of the general price fluctuation over a given period of time. One of the main reasons that make line charts so popular is that they record closing prices, one of the most important prices to keep track of.
Another unique charting technique used in technical analysis is the Point and figure patterns. They do not plot price against time as all other techniques do, but instead it plots price against changes in direction by plotting a column of Xs as the price rises and a column of Os as the price falls.
Besides studying chart patterns, there are other varied and more sophisticated technical tools and mathematical indicators available.
The most commonly used are technical indicators, measuring support and resistance, and using trendlines; although all three can be considered as technical indicators as they all rely on looking at the chart and reviewing recent history trying to spot whether a price is following a pattern or moving in a range. A Technical Indicator is a graphical representation resulting from calculations based on the price action and is usually displayed along the bottom of the chart. A wide range of technical indicators are widely used by many traders. They can be categorized according to what they describe and what they indicate.
Trend Indicators: trend is a term used to describe the persistence of price movement in one direction over time. Trends move in three directions: up, down and sideways. Trend indicators smooth variable price data to create a composite of market direction. (Example: Moving Averages, Trendlines).
Strength Indicators: Market strength describes the intensity of market opinion with reference to a price by examining the market positions taken by various market participants. Volume and open interest are the basic ingredients of this indicator. Their signals are coincident or leading the market. (Example: Volume).
Volatility Indicators: Volatility is a general term used to describe the magnitude, or size, of day-to-day price fluctuations independent of their direction. Generally, changes in volatility tend to lead changes in prices. (Example: Bollinger Bands).
Cycle Indicators: A cycle is a term to indicate repeating patterns of market movement, specific to recurrent events, such as seasons, elections, etc. Many markets have a tendency to move in cyclical patterns. Cycle indicators determine the timing of a particular market patterns. (Example: Elliott Wave).
Support & Resistance Indicators: Support and resistance describes the price levels where markets repeatedly rise or fall and then reverse. This phenomenon is attributed to basic supply and demand. (Example: Trendlines).
Momentum Indicators: Momentum is a general term used to describe the speed at which prices move over a given time period. Momentum indicators determine the strength or weakness of a trend as it progresses over time. Momentum is highest at the beginning of a trend and lowest at trend turning points. Any divergence of directions in price and momentum is a warning of weakness; if price extremes occur with weak momentum, it signals an end of movement in that direction. If momentum is trending strongly and prices are flat, it signals a potential change in price direction. (Example: Stochastic, MACD, RSI).
Benefits Of Technical Analysis
Technical Analysis focuses on price movement which is easily spotted at a glance through the charts.
Technical Analysis applies to all charts, whether they are 5-minute charts for day trading or daily charts for longer term trading.
Trends are easily found as some indicators can quickly display a currency or security that is exhibiting a trend.
Patterns are easily identified as charts displays previous patterns and help predicting future ones, as the market tends to repeat itself.
Charting is quick and inexpensive as such technical indicators and tools are available via the net and they are automatically represented according to built-in calculations. Most brokers nowadays offer them to clients as part of their package.
Charts and Indicators can provide a huge amount of information in only a few moments. There are more than fifty kinds of indicators and each provides information on different aspect of how a currency or a security is moving.
How Technical Analysis applies can be different for each trader. Every trader has their own interpretation of where they see trends and support. They also have their own ideas on setting up their indicators. The indicators and charts can be simple or sophisticated as they can provide only the most basic information on a trend or support and resistance, or go much deeper to provide information on the strength of a trend, how momentum is building, and whether formations are developing that the can be traded.
It is important to understand that technical analysis is not an exact science, and may not always give accurate predictions of the market movement; however, it is very useful in forex trading. It makes up only one portion of what you need to know when trading, but it is a very important thing to learn. Understanding technical analysis will give the charts some meaning when you look at them and help you understand why certain price movements occurred.