The Basics of The Forex Market

The foreign-exchange market, or forex, is the largest market in the world by volume. That is, more money exchanges hands on the foreign exchange than in any market in the world. Some $1.5 Trillion is exchanged daily, compared to $25 billion on the New York Stock Exchange. Across the world, the daily volume of stock exchanges is till just one third of the volume of the foreign exchange market! It’s easy to see why the foreign exchange market has grown to be so big, brought about by greater interest in the market by retail investors like you and I.

So What is the Foreign Exchange?
The foreign exchange market is simply a market for money. Currency pairs, such as GBP/USD and USD/JPY are simply the value of one currency against another, in effect the exchange rate of the currencies. In the pairs above, the pairs represent the value of the Great British Pound against the Dollar (GBP/USD) and the US Dollar against the Japanese Yen (USD/JPY).

A Uncentralized Market
There is no central processing market for the foreign exchange. Instead, the market is made up of interbanks, which operate the foreign exchange market by processing orders to trade one currency for another. The market exists only among banks, it does not exist as a market itself. This makes the foreign-exchange market a over-the-counter (OTC) marketplace.

Until the internet opened up online trading for people like you and I, the foreign exchange market was dominated by the banks and other larger players. Small investors could not easily trade the forex market, and could not access leverage and other tools which make it so profitable. In fact, in order to trade the foreign exchange market, you would have to have as much as $10 to $50 million dollars. Today, many brokers allow investors to open up an account for as little as $500, and some even $1!

Tools of the Trade
Today’s investors need little more than a high speed internet connection, a computer and a willingness to learn the foreign exchange market. In the next many pages, we’ll explain everything you need to know about trading the market. From opening an account, to making your first trade, we’ll cover it all at ForexOnlineLearning.com

Related Articles

Forex Market Trading Times

The foreign exchange market is the only market in the world that is open 24/7. Investors are able to place trades every single day of the week, however, most pairs will move very little on the weekends as very few investors stick around to trade.

When Various Markets Open
When one market closes, another one opens, allowing traders to trade the market 24/7. Below is a list of the various open and closing times for the Tokyo, London, and New York forex markets.

The Best Times to Trade Forex
The best times to trade the foreign exchange market is when the most traders are trading. As such, investors should look to trade when more than one major market is open. As you can see in the chart above, the Tokyo and London markets overlap for 1 hour each day, and the London and New York markets overlap for 4 hours each day. This is when the most currency is traded, as more than one location is actively buying and selling different currency pairs.

Different Times, Different Currencies
Though anyone can trade any currency regardless of their country of origin, some currencies are more often traded during certain periods of the day. During the London trading session, the US Dollar (USD), the Great British Pound (GBP), and the Euro (EUR) are the most actively traded currencies. During the Tokyo session, the Japanese Yen (JPY) grows in volume. If your broker offers sliding spreads, those that change depending on volume, your best bet is to place trades during these market times in order to pay the lowest price in spreads and maintain the highest amount of market movements.

Related Articles

How Money is Made With Forex

So, you know how the forex market works, now its time to find out how investors make money with forex. The premise of the foreign exchange market is simple, to exchange one currency for another currency which you believe will go up in value. The basics are much like the stock market, so anyone with any financial experience should pick up the foreign exchange market rather quickly.

Making Money With Forex
You make money in the foreign exchange market when one currency rises in value against another. For this portion of the tutorial, we’ll use the pair GBP/USD as our example.

We’ll start with 1 lot, or 100,000 units of GBP/USD. We think the Pound will strengthen against the US Dollar, so we buy one lot at 50:1 leverage and a price of 1.60. This means that we are buying $160,000 of the Pound, and staking $3200 and “borrowing” the other $156,200 through leverage. In the backend, our forex broker is moving $160,000 from a US bank account to a Pound denominated account. We’ve essentially sold, or traded, $160,000 for 100,000 pounds.

Cashing In
Four hours have passed and the GBP has strengthened against the USD by 50 pips. The forex broker’s quote is now 1.6050 and our 100,000 pounds are now worth $160,500, giving us a total profit of $500 on a $3200 investment. That’s not a bad return at all, it’s a gain of nearly 15% in just a few hours. Granted, we have used 50:1 leverage, but even then, results like these are more than typical!

Is Making Money in Forex Really That Easy?
Actually, it is. Making money on the foreign exchange market is as easy as knowing in which direction a currency pair is likely to travel. See, the difficulty is not in making money itself, but in knowing how to make money. In the following chapters we’ll reveal how to know in which direction a currency pair will go, but we still have a lot more to learn about the foreign exchange market itself.

Related Articles

The Spread, A Forex Brokers Profit

In our example from the previous article, we actually alluded to a few things. The first, is that there were a few costs in our example trade of 1 lot of GBP/USD. The hidden cost is the “spread” or the commission the broker earns for completing our trade.

How Forex Spreads Work
Unlike stocks or other tradeable securities, there is no set commission rate. With stocks, you may be accustomed to paying $6.95 to complete an online trade. In forex, we don’t pay commissions, instead the cost to trade is built into the forex bid and ask prices.

Bid and Ask
The bid and ask prices can be confusing, but we’ll make as much sense of the two prices as we can. The bid price is the price you would get when selling the pair. The ask price, is the price the market is asking for the pair. For instance, the pair GBP/USD may offer a bid price of 1.6101 and an ask price of 1.6104. If you bought the pair at 1.6104, you would immediately be able to sell the pair, at a loss, for 1.6101. Your net profit/loss would be negative 3 pips.

Why the Difference?
The difference between the bid and ask price is the illusive spread mentioned above. This spread is for the broker, for completing our trades. By selling to traders at one price, and buying from traders at another price, the broker is able to make money by completing our trades. A spread of 3 pips would create a profit of $30 for the broker, for each lot traded. This may seem to be horribly expensive, $30 a trade vs $6-7 for stocks, however the spread in forex is actually less than in the stock market.

Stock spreads vs. Forex Spreads
Spreads occur naturally in the stock market as well as in the foreign exchange market. The difference is that the forex market is not a centralized market like the stock markets. When you go to buy stock, there is a spread in the bid/ask price which is profit for the marketmaker, or the person who sits on an exchange and completes orders. In forex, the spread goes to the broker, who is a market maker in that they pair two orders to complete a trade.

All in all, spreads on the stock market are much, much higher than on the foreign exchange. The spread on the foreign exchange market adds up to roughly .03% of a trade. In the stock market, the spread is often 20 times greater, or about .6% of the cost of the trade PLUS the commission to complete the trade. All in all, the costs of trading the foreign exchange market are much cheaper than the stock market.

Related Articles

Rollovers and Carry Interest, The Money You Make For Making Money in Forex

Believe it or not, you can actually make money when a currency pair goes neither up nor down in price. Yes, that is right, you can make money for just holding a position in forex!

Carry Trade Interest
You remember from the third article of our comprehensive guide that when you buy or sell a currency pair, you’re essentially moving money from one currency denominated bank account to another. And the crazy thing about borrowing and lending money, is that you receive interest for it!

How Carry Trade Interest Works
Carry trade interest works by borrowing in one currency to buy another currency. Back to the original example, when you buy the GBP/USD at 1.6000, you are trading $160,000 for 100,000 British Pounds. In effect, you debited $160,000 from one account, in which you owe interest, and credited another with 100,000 British Pounds, in which you gain interest.

Let’s assume that the bid and ask interest rates for US Dollars and Great British Pounds are as follows:
GBP Bid 2.5% Ask 3%
USD Bid 1% Ask 1.25%

Just like the spreads, the bid price is the price you get paid for depositing. The ask price, is the price the lender asks in interest.

Calculating Your Profit/Loss
Each year, you will pay $2,000 in interest to borrow the US Dollars, and you will gain 2,500 Pounds ($4000) in interest for depositing. Your net gain, even if the currency prices go absolutely nowhere, will be $2000 each and every year. Per day, it equates to $5.48, or about ½ pip per day.

It Really Adds Up
The cost of carry, or in some cases, the gain of carrying, really adds up over time. In the example above, an investor would have made $2000 with a leveraged investment of $160,000. In real terms, at 50:1 leverage, the profit would have been $2000 on a $3200 investment, not too shabby! Many investors have started trading forex just to make money from carry trades, but we’ll get to that later.

Related Articles

Types of Forex Market Orders: Market and Limit

Now that we know what goes into a trade, we need to also know how to enter the trade to a broker. There are two main types of orders to buy currency, the first of which is a market order, the second is a limit order.

Market Orders
A market order is an order at the current market ask price for a certain currency pair. This type of order is filled instantaneously at whatever price the broker can match up with your entry. Market orders are used by virtually every trader, but are more often used by traders that want to buy at a certain time (now) rather than a certain price.

Limit Orders
A limit order is a special order put into a broker to buy a currency pair at a predetermined price. Let’s say that the current value of the GBP/USD pair is 1.5050 and you want to buy the pair, but at a price lower or higher than the current price. For the sake of discussion, we’ll say you’re interested in buying GBPUSD only at a price of $1.5025 and do not wish to buy it at the current price.

By entering a limit order, you are able to enter the price at which you’d like to buy ($1.5025) and how long you’re willing to wait for the order to be filled. If at any time the price falls to $1.5025, your broker will automatically enter the trade, choosing to buy X number of lots at this predetermined price.

Limit Order Operations
Most brokers will not require you, or your platform, to be logged into your account to execute a limit order. This is both a benefit and a negative, as you’ll be able to log out of your account and still have your orders in place, but should you forget, you might find yourself holding a position that you forgot about. Holding positions unknowingly is dangerous, due to the fact that the market may move wildly without you to close the position either for a profit or loss.

Related Articles

Forex Stop Loss and Take Profit

Arguably, the stop loss and take profit orders are the two most important order types for foreign exchange traders. The two orders are essentially orders on top of another order. The stop loss allows you to determine at what price you want to cut your losing trades and the take profit allows you to enter what price you’d like to close a position for a profit.

The Stop Loss
A stop loss should be entered for each and every trade you ever make on the foreign exchange market. A stop loss prevents you from runaway losers, due to the fact that it will automatically close a losing position before your account balance is depleted. It would never be recommended to trade without a stop loss as doing so is like risking your entire account balance on one trade.

If you were to buy a lot of GBP/USD but wished not to lose more than $250 on this single trade, you would set your stop loss 25 pips below the price at which you entered the trade. If you bought GBP/USD at $1.50, you’d want to enter a stop loss at $1.4975, thus preventing a loss greater than $250.

The Trailing Stop
The trailing stop is a different kind of stop loss order offered by a few brokerage accounts. Many investors, particularly momentum traders, like to use trailing stops to both limit their losses, and also to lock in gains. The trailing stop lags the current price by the amount set. For instance, if you were to buy EUR/USD at 1.3150, and wish to lose no more than 50 pips, your trailing stop would sit at 1.3100. If the price were to advance to 1.3175, your trailing stop would then move to 1.3125, lagging the market by the 50 pip differential that you set.

The trailing stop is a more advanced type of stop loss but can be used by any trader. Ultimately, the trailing stop will activate at a price that is X number of pips lower than the price you set. If the EUR/USD was to advance from 1.3150 to 1.3350 without ever dipping more than 50 pips at any given time, you would be in the position all the way to 1.3350. If it had dipped deeper than 50 pips, your stop loss would have been executed.

Take Profits
Take profit orders are the opposite of a stop loss. The take profit is a price at which you would like to close your position for a profit, above or below the current price of the currency. Just like a stop loss, you can enter this order either during your initial entry to buy a currency, or after, and it can be changed at any time.

Related Articles