Introduction to Trading Forex
The foreign exchange industry is the biggest industry in the world, with a daily turnover of more than 5 trillion dollars. In the past, you had to be an extreme high net worth individual, bank or institution in order to trade the foreign exchange market, but in 2017, anyone with an internet connection and phone or computer can speculate on this exciting and ever-evolving trading forex market.
So how does foreign exchange or trading forex work? Forex traders take positions on a pair of currencies based on their views for the prospect of each currency. For example, you may think the Australian Dollar is going to appreciate against the US Dollar, so you buy (go long) AUDUSD. In this example, the trader is buying Australian Dollars and selling US Dollars and if the Australian Dollar appreciates against the US Dollar, the trader will turn a profit.
Currencies are much less volatile than stocks and other financial markets, so forex traders will often use leverage to magnify potential gains and losses. Say you have $500 in an account with Vantage FX and your account is set to 100:1 leverage, this means you can open a $50 000 position on a currency pair like AUDUSD. If the Australian Dollar then moves up 1% against the US Dollar (0.7500 -> 0.7575), you make a 1% profit correct? No, as you have leveraged your original $500 and used that to open a much larger position of $50 000, you actually make a profit of 100%!
Note the above is just a very basic example using simple numbers for clarity, in reality a trader would not usually risk their whole account on a single trade or use all the available leverage. Also note that in the above example, AUDUSD could have easily traded from 0.7500 down to 0.7425, in which case our trader would have lost 100% … this is why it is unwise to risk so much on a single trade or use too much leverage. At Vantage FX, we offer our traders leverage up to 500:1, though if you are just starting out, it’s probably wiser to select a lower level of leverage such as 100:1 or 50:1.
Forecasting forex markets: technical analysis
So how do you correctly forecast movements in the forex markets? One of the most popular and relatively easy way to get started is using technical analysis. Technical analysis is the art (or science) of studying a chart of historical data and using this historical data in an attempt to correctly predict the next market move. Sound like wizardry? It’s really not and you’d be surprised at just how accurate some technical traders are – we’ve seen technical traders with win rates well exceeding 80%!
The most basic form of technical analysis is trend analysis, a trend trader takes a quick look at a forex chart, determines which direction the currency pair is currently moving and then looks for trading opportunities in the direction of the trend. For example, if AUDUSD is trending up, the trader would look for buying opportunities. On the other hand, if AUDUSD is trending down, the trader would look for selling opportunities. When we say trading opportunities, we mean relatively brief moments within a larger trend where the currency pair is temporarily moving in the other direction, also known as consolidation.
You’ve probably heard the popular trading forex adage ‘Buy low, sell high’? This is exactly what you want to do as trend analyst: in an uptrend (bull market), you are looking for opportunities to buy low. In a downtrend (bear market) you are looking for opportunities to sell high.
Trend analysis is by far the most simple form of technical analysis, though there is a huge variety of other technical methods traders use to correctly forecast currency markets too. You may want to do a little research on the Fibonacci tool, candlestick patterns, chart patterns and technical indicators. You’ll learn about these and more over at the Vantage FX website.
Forecasting forex markets: fundamental analysis
Fundamental analysis is a little more tricky, though getting a basic grasp of the concepts involved is not that difficult and this can even help you with your technical trading. Fundamental traders analyze the real world economic factors which are driving currency markets. If you own a home in Australia, you are probably aware that the Reserve Bank of Australia (RBA) sets interest rates on the first Tuesday of every month. Interest rates and more importantly, interest rate forecasts, are one of the biggest drivers in the currency markets. In general, if Country A has a higher interest rate than Country B, then Country A’s currency will be the more attractive investment. Note however that there are plenty of obvious exceptions for this rule as lots of developing nations will offer very high interest rates in order to attract investment and/or prevent declines in their currency. You’ll learn more about this as you progress on your trading journey.
As noted above, interest rate forecasts are actually more important than current interest rates themselves. Traders and investors are always trying to be one step ahead of the curve, as such they try to predict where interest rates are heading and take their trading decisions based on these forecasts. One of the best trading opportunities occurs when the central bank of Country A is planning on raising rates, while the central bank of Country B is planning on lowering rates. This phenomena is known as ‘monetary policy divergence’ in trading and economic circles and can lead to some truly astounding trades!
Sound difficult? Don’t worry, it’s a lot easier than it sounds at first and you will soon get the hang of what drives currency markets and the related jargon. Other fundamental factors that drive currency markets include GDP, jobs and inflation data. In general, if the data is good, or beats estimates, the country’s currency will rally.
Keen to get trading forex ?
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