Introduction to Forex

by Admin
Updated: August 8, 2020

A simple introduction to Forex (Foreign Exchange) currency trading for insight and profit

If you have a lot of money but then discover your currency has become devalued compared to other world currencies, how much wealth do you really have? If you invest in a currency that increases in value compared to your primary currency, you’ll protect and increase your wealth. Being aware of how one currency’s value is changing compared to another can give you insight into economic developments and reveal opportunities.

The TradingView widget below shows prices for some important currency pairs. Click anywhere on the appropriate row to change the mini-chart. If you click on the actual symbol, it will also take you to the Advanced chart in a new browser tab:

Currency abbreviations

Each currency is abbreviated to three capital letters, e.g. USD for US dollars, CAD for Canadian dollars, EUR for Euros and so on.

Currency pairs & prices

The price of a currency can only be determined in relation to some other currency.

Individual currencies are defined by three capital letters (USD for US dollars, CAD for Canadian dollars, GBP for British pounds etc.) and currency pairs are thus defined by six (USDCAD, GBPUSD etc.)

Currency pairs are sometimes expanded using a slash e.g. “USD/CAD” but this is misleading because the / looks like it could represent a division (1/2 is a half = 0.5, 1/3 = 0.333 etc.) whereas the value of the currency pair is actually the second divided by the first, i.e. CAD/USD (CAD÷USD).

When trading a currency pair there are three possible outcomes:

  1. Nothing changes, so you don’t make a profit (in fact you’ll make a loss due to other costs).
  2. The pair goes up, so the first currency is able to buy more & more of the second.
  3. The pair goes down, so the second currency is able to buy more & more of the first.

Trading a currency pair is easy to understand if you’re starting out with one or other of the currencies of that pair: If the pair is going up the first currency is the one to have and if the pair is going down the second currency is the one to have.

If you have USD and USDCAD goes up you can buy a lot of CAD. If the pair then goes down you’ll be able to get back more USD than you started with.

It can be a little trickier to understand when your source currency is not one of the pair. Consider, for example, buying GBPEUR:

Firstly, it’s essential to understand that the process involves two simultaneous trades: Buying GBP and selling EUR.

Secondly, since the currency you are selling, EUR, is one you don’t actually have, you effectively borrow it from your broker.

So, although the most obvious meaning of “GBPEUR” is how many EUR would be received in exchange for one GBP, it can be more helpful to think of it in terms of how many EUR have to be paid to get one GBP.

Now if you buy GBPEUR and it goes up and you then sell it to close your position, you’ll get back more EUR than you borrowed which can then be converted back into USD. Profit!

Jargon

  • Long - Buy. Going long means to buy with the expectation that the price will go up. It doesn’t necessarily mean staying in it for a long time.
  • Short - Sell what you don’t have. To “short” means to sell what you have effectively borrowed with the expectation that the price will go down and you can effectively buy it back for less, keeping the difference as your profit.
  • Slippage - The difference between the price you thought you were getting when you entered a trade and the price you actually got when it went through. Supposedly caused by extremely rapid changes in the market, it is the hidden evil in many trading platforms.
  • Paper trading - Calculating how much you would have won or lost had if you had made a particular trade without actually making the trade. You can do it yourself or try a demo account. It almost always misleads you about how well you’ll do in real trading.

Fundamental vs Technical analysis

Technical analysis uses historical data to predict future behavior. For example, you notice that after falling 3 days in a row the price always picks back up and today is the 3rd day of continuous fall so you decide to buy. Technical analysis can get very complicated.

Fundamentals refers to the possible underlying reasons for the price action. For example, you believe a growth in global demand for a particular country’s products will strengthen its economy and therefore its currency.

Both approaches are subject to negation.

Should I trade in forex?

It is not easy to make a lot money from forex even if you are a professional. That doesn’t mean it can’t be done, but I recommend extreme caution and lots of study.

Whether or not speculative forex trading is ultimately what you want to be doing, I highly recommend having an account with a peer-to-peer exchange. With such a system you can sensibly float 3-6 figures with clear fees & rates and no leverage. It will force you to pay attention to macroeconomic indicators, plus you should be able to beat inflation (and savings accounts) with minimal activity.

More info

“Introduction to Forex Trading” at nerdwallet.com.

“What is Slippage? Is it Always a Bad Thing?” at dailyfx.com.

“Reducing Order Slippage While Trading” at thebalance.com.

Getting stopped out: “How Professionals Trade Forex and Hunt Stops” at forexschoolonline.com and “Do forex brokers hunt stop losses?” at financialsource.co.

“Fundamental Analysis vs Technical Analysis” at forexfraud.com.

Internal links

Forex peer trading Recording your trades AUD as an alternative to gold Fallacy fallacies Go to Articles
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