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Friday, January 11, 2008


Forex, also called "FX", is short for foreign exchange. The foreign exchange doesn't get the big press like stocks, options, and commodities. But the foreign exchange is the biggest market in the world and it offers investors an incredible opportunity for profit.

When you trade on the foreign exchange, you don't trade in stocks or bonds, but in currency, like Euro or Usd. Simply put, Forex trading is just the buying of one currency and the selling of another. As exchange rates go up and down, you either make or lose money.

With Forex, you're not investing in a single company or even a group of companies. You're investing in the economy of nation. You are betting that the overall economic health of one nation will improve in relation to that of a second nation.

For example, let's say you are analyzing the US Dollar and the Japanese Yen. Your research seems to indicate that the US dollar is undervalued and is due for a rise in price, and at the same time you expect the Japanese Yen to lose value. In this case you would execute a trade to buy US dollars and sell Japanese yen. If you are correct and the exchange rate rises, you make a profit!

So its a piece of cake, right? Well no, not really. Currency prices can be incredibly difficult to forecast because there are so many factors that can contribute to a change in exchange rates. And you must remember that in currency trading you always trade in pairs. You buy one currency and sell another. So you can't just look at one nation's economy; you must look at two.

Of course, you do not have to limit yourself to only one pair of currencies. There are dozens of different currencies to choose from. But if you are just starting out, I suggest sticking to the seven major currencies:

USD - US Dollar

EUR - the Euro

GBP - British Pound

JPY - Japanese Yen

CHF - Swiss Franc

AUD - Australian Dollar

CAD - Canadian Dollar

Most small investors concentrate their trading on just these seven currencies.

Forex Trading vs The Stock Market

Trading currencies on the foreign exchange has quite a few advantages over trading stocks.

A 24-hour market

The foreign exchange is open for business twenty-four hours a day. This is a major plus for small investors who are starting out trading in their spare time. Rather than having to juggle your schedule around your trading opportunities, you can schedule your trading when its convenient for you.

If you're a night owl in Manhattan and want to trade at 1:00 AM, no problem. Banks in Tokyo are open.

Low Transaction Costs

Forex brokers are not paid by traditional commission-based fees, and there are no hidden fees. The broker's fee is built directly into the trade in the form of the bid/ask spread. In simple terms, the spread is the difference in what you would buy a currency for and what you would sell it for. The spread is expressed in "pips".


The ability to trade on margin gives forex traders significant leverage in their trading and offers the potential to make extraordinary profits with relative small investments. For example, with a broker that allows margin of 100:1 you can purchase $100,000 in currency with only a $1,000 deposit. Of course, leverage goes both ways and can lead to large losses if you are not careful.

High Liquidity/Fast Trade Execution

When you trade in currencies you are trading in cash. There's no investment more liquid than cash, so trades are executed near instantaneously. There's no sitting around waiting for your trade to execute.

Not Easily Influenced

The foreign exchange market is so incredibly huge that no one individual, fund, bank, or government entity can influence it for long. This is the opposite of the stock market where one television analysts negative appraisal of a company's stock could send it into a tailspin.

A Small Sample to Study

There are thousands upon thousands of stocks available to trade. Large companies, small companies, international companies, newly issued IPOs. Its just not possible to follow them all.

In forex trading, there are only seven major currencies to follow, so you can devote a lot more time to each of them. And there are many successful forex traders who do not even trade in all seven major currencies. Some just pick three or four and stick with them.

Forex Trading vs The Stock Market (cont)

No Bear Markets

Since you can trade either short or long, you can make money whether the prices go up or down (assuming you guess correctly).

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Reading Forex Quotes

To a newcomer in the world of trading, forex quotes can be confusing. But they are actually quite simple to read.

Let's look at an example of what a foreign exchange rate quote looks like:

EUR/USD = 1.2526

Seems simple enough, right? This example shows the foreign exchange rate between the Euro and the US Dollar.

It helps to remember that in any forex quote, there will always be two currencies quoted. This is because when you make a trade on the foreign exchange you are in effect buying one currency and selling a second currency at the same time.

When reading forex quotes, the first currency listed is called the base currency. The second currency listed is called the quote currency. Forex quotes show us the price relationship between two currencies.

The exchange rate tells you how many units of the quote currency you have to pay in order to get one unit of the base currency.

In the example above, the base currency is the Euro and the quote currency is the US dollar. The price quote tells us how each currency is trading relative to the other. In order to buy one unit of Euros you will have to sell 1.2526 units of US Dollars.

Still with me? Ok, just one more thing to add to our example: the Bid/Ask spread.

There are no commissions charged on any trades placed in the forex market. But brokers do get paid for their work through the bid/ask spread.

Let's add the spread to our example and I'll explain:

EUR/USD = 1.2526/1.2528

Or, this can be simplified to:

EUR/USD = 1.2526/8

Brokers make their money by selling currencies at a slightly higher rate than they buy them. This is perfectly legal and all brokers do it, though the amount of the spread can vary.

As a trader, you will buy the at bid price, which is the first price quoted. You will sell at the ask price, which is the second price. The difference between the prices is called the spread, which is retained by the broker as their profit on the trade.

In our example, you would buy at 1.2526 and sell at 1.2528. The 0.0002 (2 pips) would go to the broker as payment for executing the trade.

The bid/ask spread is a simple and straightforward way to calculate trading fees and expenses.

Understanding Pips

To forex traders, everything revolves around pips.

"I'm up 35 pips for the day."

"I made a 127 pip profit on my last trade."

That's great, but what's a pip?

Pip is short for "percentage in point" and you may sometimes hear people refer to pips as points.

Put simply, a pip is the smallest unit of price for a currency. It's the last decimal point in every exchange rate or currency pair.

For most currencies its 0.0001. So if you bought USD/CHF 1.2475 and sold at 1.2489 you made 14 pips.

One common exception is USD/JPY. In this currency pair there are only two decimal places so a pip is equal to 0.01.

The reason pips are so important is because they are the basis for calculating profit or loss.

Pip Value.

With all these different currency pairs to deal with and with prices fluctuating all the time, how do you know the value of a pip?

It's a simple calculation. For currency pairs in which USD is the base currency, just divide a pip (usually 0.0001) by the exchange rate.

For currency pairs in which USD is the quote currency, its even simpler. The pip value is always one pip (for example, 0.0001).

So in our example above, when the exchange rate for USD.CHF is 1.2489:

0.0001 / 1.2489 = 0.0000800704

That's a pretty tiny number. But remember that in forex trading you are able to leverage small sums of money to move large quantities of currency.

In other words, you can use leverage to make big profits off of that tiny number.

Let's say your broker allows you to trade with leverage of 100:1. This means that in order to buy a standard lot of $100,000, you only need to put up $1,000.

You can see how trading in larger lots affects the pip value, and therefore your profit or loss:

If you are only trading $1,000 in currency, the pip value is calculated as follows:

0.0000800704 X 1000 = $0.08 per pip.

The price would have to go up by a whole lot of pips in order to make a significant profit at that rate. That 14 pip profit only made you $1.12.

But by using leverage to buy a lot size of $100,000 your profit increases.

0.0000800704 X 100,000 = $8.01 per pip.

That's a profit of $112.14. Now you're talking.

Understanding Margin and Leverage

Being able to trade on margin is one of the greatest advantages of forex trading. You can purchase large quantities of currency while only putting up a small fraction of the full value.

You may hear some people refer to "leverage trading" and other to "trading on margin". In forex trading, they refer to the same thing, just in different terms.

Leverage is usually quoted as a ratio such as 100:1.

This simply means that you can trade 100 units of currency while only putting up 1 unit. In other words you would only need to put up $1,000 in order to trade $100,000.

Margin is the same thing, just from a different point of view. Margin is generally quoted as a percentage such as 10%. In this example you would be able to trade $10,000 of currency while only putting $1,000 down.

Successful forex traders use margin to explode their profits. Since the value of a single pip is quite low, you have to trade large lots of currency to make a profit.

Being able to make leveraged trades enables small investors without a lot of capital to make big profits. However, margin cuts both ways and you must use it wisely or you'll find yourself broke in no time.

When you first open an account with a forex broker you will be required a minimum amount of funds into the account before you can trade. The minimum account value varies from one broker to the next.

When you make a trade, part of your account balance is earmarked as the initial margin requirement for that trade. Let's look at an example.

You open an account and deposit $10,000 into it. You then make a trade at 100:1 leverage. You buy $100,000 of currency, but are only required to put up $1,000. So you now have $1,000 in used margin and another $9,000 in available margin.

It's important to keep track of how much margin you have available. If prices move against you, some of the $9,000 you have as usable margin will be used to compensate for your losses. If your balance falls too low, the broker will liquidate your positions and you will be hit with a big loss. This does however prevent you from losing more than you could if they left your position open and prices continued to go against you.

No one wants to receive the dreaded margin call. But you can effectively eliminate it by using stop-loss orders to cut your losses before they near the point of liquidation.

Types of Orders

When your broker buys or sells a currency for you, it is called 'executing an order'.

Depending on your trading system, your objectives, and your analysis of where you think prices are going to go there are different types of orders that you can place with a broker.

Here are the most common types of orders that any broker should be able to make for you:

Market Orders

A market order is the simplest type of order, and the most common order used in day trading. It is simply an order to buy or sell a currency at the current market price. A trader places a market order by specifying the currency pair he wishes to trade, as well as the number of lots to trade.

With most online brokers this can easily be done in seconds with just a click of the mouse. The order is executed almost immediately at the price shown.

Limit Orders

A limit order is an order places to buy or sell a currency when it reaches a certain price. For example, say USD/JPY is currently trading at 117.50. The price has been in a downtrend, and your analysis shows that it will drop to about 117.25 and then bounce back up.

You could sit at your computer waiting for it to drop to 117.25 and then place a market order to buy. Or you can place a limit order at 117.25 and when the price hits that point the order will automatically be executed.

If your analysis is wrong and the price only drops to 117.30 before bouncing back up, the trade will never be executed and it will usually be canceled at the end of
the day.

Stop-Loss Orders

Savvy traders use stop-loss orders to minimize their losses. Say you expect the price of GBP/USD to go up and you place a buy order at 1.8255 with a stop-loss order at 1.8235. Your analysis was way off and the price drops all the way to 1.8185.

The stop-loss order protects you by automatically selling at 1.8235. Instead of losing 70 pips, you only lost 30.


This stands for "one order cancels the other order." Two orders are placed with at prices above and below the current price. When one trade is triggered, the other trade is canceled.

For example, say the price of USD/CHF has been hovering around 1.2435 for some time. You know its going to break out soon but you're not sure which way. You place an OCO order to buy at 1.2445 or sell at 1.2455. This way as soon as the breakout starts you can jump on board. The second trade is canceled as soon as the first is executed.

Forex Market Analysis

Any smart trader knows that in order to be successful they must be able to analyze the market and predict price movement. This is true whether you trade in stocks, bonds, commodities, currency, or any other type of security.

When it comes to analyzing the forex market, there are two basic schools of thought. One is called fundamental analysis, which is the study of a nation's overall economy. Proponents of this big-picture view believe that price trends can be predicted by analyzing various economic indicators which give an overall picture of an economy's health.

The other school of thought is called technical analysis. The core belief behind technical analysis is that prices tend to follow patterns, and that by analyzing past price patterns one can predict what the price will be in the future.

Fundamental Analysis

Fundamental analysis is the study of a nation's overall economic health. I like to think of this as "Big Picture" analysis. The idea is that the strength of a nation's economy will affect the supply and demand for its currency, which will in turn affect the price of the currency.

For example, let's assume that the US economy is in a major upswing. Since the economy is strong, the value of the dollar will be expected to rise and currency traders will invest heavily in the dollar. This bullish behavior becomes a self-fulfilling prophecy and the dollar rises in value.

That's a pretty simple concept, but judging the health of a nation's economy is no easy task. There are many factors to consider, and two traders may look at the same figures and interpret the data differently.

Fundamental analysts look at various economic indicators for signs of an economies strength. Some of the indicators they analyze are the interest rate, unemployment rate, consumer price index, and gross domestic product (GDP).

These reports are released regularly by various government agencies and non-government entities. You should find the latest schedule of upcoming releases and put them on your calendar. Keep an eye on them for a few months and see what effect they have on currency prices.

One thing to keep in mind: it is not always the numbers contained in a report that have the greatest impact, but rather the relation of the numbers compared to what was forecasted.

In other words, a rise in interest rates may not have a significant impact if forecasters were expecting it. But if they were expecting interest rates to remain steady and there was an unexpected increase, there may be a large impact on currency prices.

A major disadvantage of fundamental analysis is that it can be a little too "big picture". It is great for predicting overall economic growth and price changes, but it doesn't offer enough details to target specific entry and exit points. This is where technical analysis comes in.

Technical Analysis

Technical Analysis is the study of price movement. You can use price charts to track the history of price movement and attempt to anticipate which way prices will go in the future.

Online forex brokers provide you with many different tools that are used in technical analysis. Some of the most common are listed below.

Bollinger Bands

Bollinger Bands are used to measure market volatility.

They consist of three lines:

1. A simple moving average in the middle.

2. An upper band which indicates the simple moving average plus 2 standard deviations.

3. A lower band which indicates the simple moving average minus 2 standard deviations.

When market volatility is high, the bands spread apart. When volatility is low, they come together.

The Bollinger Bounce

Most of the time, the middle band stay in between the outer bands. Think of the outer bands as the border patrol. When the middle brand approaches one
of the border guards, it gets bounced away and back towards the middle. Hence the name Bollinger Bounce. This is useful to know because if you see the middle band approaching an outer band, there's a good chance it will bounce off.

This strategy works best when prices are luctuating and there are no clear trends.

Bollinger Squeeze

A good way to spot a trend early is the Bollinger Squeeze. When the bands squeeze close together, it often means that a breakout is about to occur. If the middle band breaks through either the top or lower band, the trend will usually continue to go in that direction.

Parabolic SAR (Stop And Reversal)
The Parabolic SAR indicator is used to spot trend reversals. It is perhaps the easiest indicator to read, Dots are placed on the chart in positions either above or below the candles (the formula that calculates where the dots go is too complicated to get into).

Dots above the candles are a signal to sell.

Dots below the candles are a signal to buy.

Parabolic SAR works best when there are clear upward or downward trends. It does not work well when price movement is small.


Stochastics is an indicator that is used to measure overbought and oversold conditions in the market. It consists of a scale from 0-100. As the stochastics lines are above 80 it means that the market is overbought and a downward trend could be forming. When the lines fall below 20 it means the market is oversold and an upward trend may be forming.

Technical Analysis (cont)

Stochastics are useful in determining when to lock in profits and when to issue buy or sell orders. But you should never rely on only one indicator. Combine several and adjust them to your trading strategy.

Fundamental Analysis vs Technical Analysis

Fundamental Analysis vs Technical Analysis - which type is better?

Well, to be honest neither. You need to combine both types of analysis to become a successful trader. Limiting yourself to only one or the other is a recipe for disaster.

Why? Because by using only one method you're only looking at half of the picture. Let me use an example to make my point.

Let's say you're a strict technical analyst and you have no use for fundamental analysis. "What do I need to look at economic indicators for," you say. "I have my price charts and they shall never let me down!"

As you study your charts, you begin to see an opportunity forming. You've got 3 or 4 indicators showing that a huge breakout is about to occur. The US dollar is about to go on a rampage and rush to get in early. So you make the trade, sit back, put your feet, and wait for the price to soar.

But then something funny happens. The price drops 50 pips!

What the heck happened??

In disgust, you walk away from your computer and flip on the television just in time to see the financial report. It turns out that the latest Unemployment numbers were just released and the number is much higher than expected. At the same time, one of the world's largest corporations announced that their earnings were well under forecasted amounts, and they predicted sales would continue to be sluggish through the next quarter.

Those two variables through a major monkey wrench in the price rally you predicted. If only you had mixed a little fundamental analysis in with all of those price charts you were busy studying you may have seen this one coming.

Of course, using fundamental analysis alone is not the solution. The big-picture view of fundamental analysis is great at identifying general trends in price movement, but it does not give a detailed enough look to provide entry and exit points. Sure you may know that the Swiss franc is due for a price increase, but how much? When should you buy and then when should you sell?

Only by incorporating both methods into your trading system do you have a chance to be a successful trader.

Calculating Profit and Loss

Pretty much any online forex broker you choose will have a trading platform that automatically calculates your profits and losses for you. But I think it's important to understand the basic math behind it. It's a good way to make sure your broker is honest, plus it's just good to know.

Besides, calculating profit and loss is really simple. There's only two simple formulas to remember.

When USD is the quote currency (the second currency in a pair), the formula is:

Profit = Price Change in Pips X Units Traded

When USD is the base currency (the first currency in a pair), the formula is:

Profit = Price Change in Pips X Units Traded / Exit Price

Let's look at some real-life examples to help you understand.

First we'll look at an example when USD is the quote currency. To keep things simple we'll assume the broker requires 1% margin, which means you can trade $100,000 in currency for only $1,000.

So let's say you are looking at EUR/USD which is currently trading at 1.2518/9. You predict the euro will rise in value against the euro so you execute a trade to buy euros, which means you also simultaneously sell USD.

You buy $100,000 units at 1.2519. Remember since you are buying you have to take the ask price, which is the second number in the quote.

Your calculations are correct and the price rises to 1.2532/3. You initiate a trade to sell EUR and buy USD. This time you use the bid price, which is 1.2532.

Since you bought at 1.2519 and sold at 1.2532 your profit was 17 pips, or 0.0017. Now we need to convert that into real money. So take your formula above:

Profit = Price Change in Pips X Units Traded


Profit = 0.0017 X 100,000 = $170.00

An easy rule to remember is that when trading a standard sized lot (100,000) of a currency pair in which USD is the quote currency, a pip is always equal to $10. 17 pips equals $170.

Now, let's look at an example where USD is the base currency. We'll execute a buy of 100,000 units of USD/JPY at 117.22. The price rises and we sell at 117.35. We just made 13 pips.

To calculate our profit we use the second formula:

Profit = Price Change in Pips X Units Traded / Exit Price

Or, Profit = .13 X 100,000 / 117.35 = $110.78.

Nice and simple.

Choosing a Forex Broker

In order to trade in the Forex market you will need to find yourself a broker. A broker is someone who executes trades according to your wishes and earns a commission
on each trade.

But there are so many brokers out there competing for your business it can be hard to figure out which one is best. This article will give you as idea of what to look

Transaction Costs

In the forex market, brokers are paid via the bid/ask spread. There should be no hidden fees or charges to trade. However, there may be additional charges to access certain reports and optional services.

Obviously the smaller the spread the better. Pip spreads vary by broker (and also by currency pairs), so shop around for competitive rates.

Currency Pairs Available

All brokers should at least have the big seven currencies ((AUD, CAD, CHF, EUR, GBP, JPY, and USD). But if you plan on trading New Zealand dollars or Danish krones, you should be sure that the broker is able to do so.

Immediate Execution of Orders

Currency prices are constantly moving up and down and any delay in the execution of your order can cut into your profits or add to your losses. Of course its possible a delay will help you, but it never seems to work out that way does it? Look for a broker that can consistently execute your trade at the price you see on your screen. An occasional delay is understandable, but if it happens frequently find yourself a new broker.

Free Tools

In order to analyze currency prices, spot trends, and plan entry and exit points you need access to charting and technical analysis tools. Most brokers offer basic services free of charge with an expanded array of tools for an added charge.

Minimum Account Balance

As a small investor you will need a broker that does not require a large balance to open an account. Many brokers today will let you open a mini-account with as little as $300.

Margin Requirement

The lower the margin requirement, the more leverage you have. If a broker allows you to use 100:1 leverage, that means you can trade $100,000 in currency for only $1,000. You can use margin to rack up huge profits. But don't margin yourself too much or you will find yourself wiped out fast.

Choosing a Forex Broker (cont)

Superior Customer Service

This is something traders often overlook when choosing a broker and later regret it when they need assistance. A quality broker should respond quickly to any question you have. They should have knowledgeable reps available 24 hours a day by phone and email.

A User-friendly Trading Platform

Some brokers require you to download a trading program to your PC in order to make trades. Others let you make trades directly over the web. Pick a few brokers out and sign up for a free demo account. You can trade with play money while you test out their software and see which one works best for you.

Avoiding Failure in the Forex Market

Forex trading can be an incredibly profitable way to make a living. The combination of margin leverage and a low minimum amount required for trading make forex trading ideal for small investors.

However, despite the opportunities for profit, the majority of forex traders lose all of their money within a year.

Why? Well I have found six root causes that can explain why so many new forex traders fail:

1. Unrealistic Expectations: Too many novice traders read about how easy it is to make money trading forex and they just jump in and lose everything before they even know what hit them.

Forex trading is not a get rich quick scheme. It requires hard work and research to be successful. And even then, you cannot expect every trade to be a winner. Even the best traders lose on trades. The key is knowing when to cut your losses and focus on the winners.

2. Not doing enough research: Forex trading is easy to learn, but difficult to master. Experienced traders make it seem so easy, but predicting currency prices is a complex endeavor. And as a small investor you are at a disadvantage. Large financial institutions have resources that you don't. They may have an entire staff analyzing
the most recent economic indicators while you just have yourself. You must be prepared to spend some solid time learning before you can expect to win big.

3. Gambling instead of investing: If you think you can beat the market without doing research and just picking currency trades based on a hunch, good luck. I've seen people do this and they usually pick a few winners and make some short-term profits, but in the end they just get slaughtered.

4. Lack of focus: Depending on which broker you use, there are likely dozens of currencies you can trade. But when you are just starting out, think small. Pick a few of the most popular currencies, such as the US Dollar, the Japanese Yen, and the Euro, and focus exclusively on them. The more currencies you trade, the more data you will have to analyze in order to spot trends. Better to know a few currencies really well than to know just a little about each.

5. Not having a trading system: There are literally hundreds, if not thousands, of different trading systems available. Some you will have to pay for, but many are free. Choose a system that is right for you based on your capital, your goals, and your personality. Without a system, you might as well be throwing darts.

Avoiding Failure in the Forex Market (cont)

6. Not sticking to your system: Having a trading system is not enough, you have to follow it through good times and bad. This is easier said than done. Its easy to get greedy and go for the big score or get nervous and get out too soon. You must follow your system to determine both entry and exit points. If you ignore them you risk missing out on a big upswing or being stuck in a trade as it goes sour.

The best forex traders know that knowing when to get out of a trade is even more important than knowing when to get in.

Traits of Successful Forex Traders

Forex trading is not for everyone. There are a lot of variables to take into account, and there is always the risk of losing money. Some people just aren't cut out for it. If you are considering becoming a forex trader, you'll want to read this article carefully. It contains the traits that set successful traders apart from those who fail.

If you don't possess most or all of these qualities forex trading may not be for you:

Discipline. Successful traders formulate a trading system that works and stick with it. They don't try to trade "on the fly".

The ability to accept risk. Despite what many will tell you, forex trading is not without risk. You can lose money by trading, and you must be willing to accept this risk.

The ability to accept failure. Even the best traders in the world lose money on some of their trades. It's the nature of the beast. But the difference between them and average traders is that they don't focus on their failure. They accept it, learn from it, and move on.

Confidence. Successful traders have confidence in their knowledge and in their ability to make winning trades. They don't doubt or second-guess their trades.

The ability to accept being wrong. Hey, no one is perfect. You're going to make mistakes and there will be times when your analysis will be way off. Don't stubbornly stay in trades gone bad just because you refuse to admit being wrong. Cut your losses and look for the next opportunity to make it up.

Patience. Smart traders follow their system and wait for good opportunities to present themselves. It's not necessary to have positions open at all times. You may go a day or two without any trades being made. Don't trade just for the sake of trading. You'll jump into many more bad trades than good ones.

Knowing when to get out. The key to trading is not just knowing when to get in, you need to know when to get out. Many a trader has gotten greedy and stayed in a trade too long only to see their profits wiped out by a sudden downtrend. When your trading system tells you to get out, listen to it.

Know your financial limitations. Don't over-leverage yourself, and don't trade with money you need to pay your mortgage. If you do you'll risk ending up on the street. Only trade with money that you can live without. If this means starting small with only a few hundred dollars, so be it.

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