This is a fantastic quote in a small e-book I just read from robbooker.com and describes the forex market wonderfully. You can never beat the market, but you can beat other traders. To help you on that journey, here is an introduction to the very basics of trading Forex.

Forex, Foreign Exchange, FX ... whatever name it goes by it can be a daunting thing when you first encounter it. There are so many terms and concepts to understand that without some guidance it can become "all to hard". So in response to the requests I have received, here is a beginners guide to the basic concept of what Forex is.

Currency Pair

A currency pair is a representation of one currency against another. For example one currency pair is the EUR/USD, or the Euro to the US Dollar. If the EUR/USD is listed at 1.2150, you read this as 1 Euro will but 1.2150 US dollars.

Pip

Learn to love this word, because this is what you will be seeking for the rest of your forex career. A pip is the smallest denominator of a particular currency pair, so for the above example, if the EUR/USD moves from 1.2150 to 1.2155 then it has moved up 5 pips.

Leverage

This one I'll leave to robbooker.com:

Leverage is a simple concept. If you have $10,000 to trade with, your forex broker will let you borrow money from him so that you can trade in larger quantities. They will let you borrow as much as 400 times (400:1) what you put up in a trade. Most brokers allow between 50:1 and 100:1 margin. So, if you put up $1,000, and your broker allows 100:1 margin, then you'll be trading $100,000 worth of currency (instead of $1,000).

That's important, because every pip equals a certain dollar amount. When you trade $10,000, each pip movement equals $1. The chart below shows how it goes from there. If you trade 10,000 worth of currency, each movement would be equal to $1. So if you bought at 1.1445 and sold at 1.1545, you would make 100 x $1, or $100. If you trade $100,000, each pip movement would equal $10 and so on.

Going Long and Short

Now there is two different ways you can trade on the forex market, and many beginner traders are surprised to learn that you can actually make just as much money when a currencies price moves down as you can when it moves up. Let's start with the most logical movement, when the price moves up.

Most people are very familiar with the concept of buying something at a low price and selling it when the price increases. So the concept of buying the EUR/USD at 1.2150 and selling it at 1.2160 for a 10 pip gain should seem logical. This process is called going long.

However, you can also do this in reverse! If you think you know that a currencies price is going to go down rather than up, the you can go short. This is just the opposite of the above transaction, selling it first and buying it back later in the hope that the price will go down for you to make a profit.

This can be somewhat strange for those hearing this for the first time, but the concept remains the same either way, that being, that you always want to buy something at a low price, and sell it at a higher price than you bought it at. Which order you do it in doesn't matter, just that for a transaction to complete you must both buy and sell, as long as you sell at a higher price than you buy then you make profit.

Spread

The difference between the stock markets and the forex market brokers, is that in the forex market, broker commissions are either very low or zero. So how do the make money?, they make it from the "spread" or the difference between the actual price and the offered price through a broker.

To the right here you can see a typical board of currency pairs and their spreads. This one is taken from Marketiva this morning, and you can see for example the difference between the Offer (the price you can place a sell order) and the Bid (the price you can place a buy order) is 3 pips (the spread).

What does this mean to you though?, well, let's look at the board, if you bought the EUR/USD at 1.2158 as it is offered under the Offer column, and immediately sold it again before the price moved, you would only get 1.2155 as is shown in the Bid column. So the net result is -3 pips, or a loss to you, and a profit to the broker. Remember to always take the spread into account when placing a trade, setting targets and stop losses.

Stop Losses and Profit Targets

This is something I will go into much more in upcoming articles, but it is something that I view as vital for all beginners to understand. When placing a trade, the price has the potential to do three things, move up, move down or move sideways. If you are long in a trade and need the price to go up, what happens if you pop into the kitchen for a cup of tea and when you are gone the price drops dramatically? Remember, on a full forex account, each pip can equal $10, so any movement in the opposite direction can of course lose you money. A stop loss is your protection against big losses.

Placing a stop loss is like doing up the zipper of your pants ... you don't have to do it, but it is damn embarrasing when you get caught out!

The same applies for the other way around, if the price moves in your favour while you are away, before dropping again, if you are not there to close the trade at a profit, you may have missed your opportunity. A profit target is a place to take your profits.

When you place a trade you can set a price where, if it moves to that price, the trade will automatically be closed for you. Setting this price in the opposite direction of what you want the price movement to be is a "stop loss", or a level where your trade is "stopped" to minimise your losses. Now you may think "well how bad can it be" ... have a look at the below 15M chart from yesterdays GBP/USD.

Look at the two highlighter areas, if you had place a long trade (i.e. you think the price is going to continue up) as the price started to move upwards after the first initial drop (the first highlighted area), thinking "well that is the end of that move", then walked away without a stop loss, you would have been in some real mess 3 hours later when the price dropped again another 154 pips, or, on full account $1540!!

The Bears and the Bulls

You will constantly see the term "Bears" and "Bulls" in forex books and chat rooms. So why are we talking about animals when we are supposed to be trading? These are terms that describe the general mood of the market. A "bear" market, is when the general mood of the market is down, i.e. when there are more sellers than buyers in the marketplace. A "bull market" is the opposite, when there are more buyers than sellers and the general mood of the market is up.

Forex and any other marketplace, is just a struggle between the bulls and the bears, it if you can identify who is gaining the upper hand, then you can identify the direction of the price. Easier said than done of course.

Well that about covers the basics, there are so many more areas to cover of course but I hope it helps those starting out in this exciting marketplace. If I have missed something you wanted to read about please leave a comment below and I will be sure to add it to the article if I can.

Best of luck to you all!

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This entry was posted on Friday, September 23, 2005 at 1:37:00 AM. You can skip to the end and leave a response.