Welcome to the Investingoal course dedicated to Forex Market.
In the previous Investing For Dummies course we have studied all the basics you need to approach the investment practice. Before to find out how this is possible with Social Trading, you must first discover on what market Social Trading is developed.
The Social Trading market is primarly Forex.
Are you a beginner? Discover our list of the Best forex brokers for Beginners
Maybe you have already heard about it, maybe you’re already an expert, maybe you’re already trading in this market. Or maybe you’ve never heard of it.
As you will discover, you will not be required to become a professional in this industry to be able to invest in it. However, a basic level of knowledge on how Forex is structured, and what are its protagonists and its rules, can’t do anything but improve your investment with Social Trading.
Therefore, do not run straight to the next course, but read this one very carefully, so to strengthen your foundations right from the start.
The term FOREX is an abbreviation for Foreign Exchange Market.
With this term, or its abbreviation FX, is commonly identified the market in which currencies are traded through an exchange rate.
The Forex Market is an interbank money market, born in 1971 following the conclusion of the Bretton Woods system. Those agreements sanctioned the dollar’s convertibility into gold at a fixed price, and all other currencies to the dollar. Once those agreements were ended, it gave way to the free exchange of currency, for arriving later to the free movement of exchange rates.
From that date until today, thanks to the expansion of Internet and the information technology, the volume of transactions and the accessibility to this market have been always growing.
History of Forex Market and Forex Trading: from Pharaohs to Soros
Have you ever wondered how the Forex market is born?
What were the historical events through which today we can freely buy and sell currencies around the world?
It might seem obvious, but in reality the history of Forex is much more exciting than you might imagine.
In this post we will summarize in style all the events that led to the birth of the Forex market as we know it today (click the link to find out how it works), and the birth of forex trading.
The birth of the most important asset of all time
In order to tell the history of Forex, I see no better way to start telling the history of the protagonist of this market: money.
Some say China, others Egypt of the Pharaohs, the appearance of money is dated at least 3000 years before Christ. The first tangible form of money were coins, which from 1530 BC were provided with a distinctive mark to authenticate them. From 650 BC money took its current shape, and with the development of metallurgy, the usage increased more and more.
From the V century AD to the X, coins were predominantly used within their original kingdom. The expansion of commercial activity led exchanges to pass from national to international, and there was therefore the need to facilitate payments and transactions.
In 1291 AD the first letters of exchange were created in Florence, thus giving birth to exchange rates and interest rates, and greatly facilitating the business. Needless to say how this innovation led to the huge fortunes of banker families, one of which was the famous Florentine family of Medici.
The emergence of financial markets
The real financial markets made their first appearance in the sixteenth century.
They were simple markets, based on the trade balances of countries, and within these markets, some traders began to gain profit from the difference between exchange rates.
The use of money in the coming centuries intensified and expanded, but without having a real dominant currency, in relation to the others. One fact, however, set the stage for future change.
In 1866 it was completed the first transatlantic cable, that linked Europe and the US. It was an event of fundamental importance in the history of trading, and it led many European banks to settle in London, crowing the “City” the first financial center in the world.
CURIOSITY: it is because of this important cable that GBP/USD has been named “Cable”.
The pound became strong among world currencies, but there was always a good that was still recognized as the most reliable: gold.
The Gold Standard was a fully convertible gold to currency system. Each currency was convertible into gold, and central banks acted as guarantors of this convertibility by owning gold reserves. This system allowed the exchange rate to remain fairly stable over the decades.
The End of the Gold Standard
It was the First World War in 1914 to put an end to the gold standard, since countries, in order to meet the huge expenses, had to print money in large amounts, creating high inflation and making it impossible to guarantee convertibility.
After the First World War, a second attempt was made to return to the gold standard, albeit with some modifications, but the 1929 crisis put a definitive end to the attempts of monetary stability.
The supremacy of the dollar in the global financial landscape was enshrined in the Second World War, in 1944, with the Bretton Woods agreement, where was also created the International Monetary System (IMS), a control of currency fluctuations and economic stability organ. It was also determined that only the dollar could be converted into gold at a fixed rate of $ 35 an ounce, setting de facto dollar as the global currency basis.
Very important has been also the creation of the International Monetary Fund (IMF), which mission was to foster and support the weaker and developing economies, supporting and controlling the trade balances and global economic growth within a financial and currency system that was becoming every year more and more complex.
It was indeed this complexity, along with the need to find a new, more flexible currency system and the need to devalue the dollar, to ensure that in 1971 the US President Nixon, together with the IMF and the representatives of the 10 major states, decided to abandon the convertibility of currencies to dollar, and of the latter to gold, opening the doors to the world of free floating rates.
It was called Smithsonian Agreement,and was perhaps the most important element in the forthcoming developing of Forex as we know today.
The end of the Bretton Woods agreements gave free rein to the creation of money and the raising of capitals in the financial markets. In 1976 the agreements in Jamaica finally made official the beginning of a new era for the trading of currency, which were almost completely liberalized. Gold was no longer a reserve requirements and the banks had to just try to keep the exchange rate within a margin of +/- 2.5% from the central parity.
In 1978 EMS was born, i.e. the European Monetary System, along with the stabilization of the currency mechanism (ERM) against the ECU, the Euro ancestor.
Over the years, the advent of new technologies created the perfect landscape, and in the 90s the flows of capitals increased exponentially, finally breaking the wall that only allowed access to the Forex market to large financial institutions, primarily banks.
New investors and big traders could enter with their capital and expand the number of players.
The final act and the birth of the modern Forex market
Finally, hedge funds had the merit of giving the last push to the evolution of the Forex market as we know it today.
In 1992, the hedge fund of George Soros “attacked” the pound and the lira, causing a strong devaluation and forcing Italy and England to step out of EMS. This attack indeed made the containment of exchange rate policy fail.
This eventually create the awareness and acceptance of leaving exchange rates fluctuating without any restrictions.
That was the last piece.
Forex market was in fact liberalized. In the beginning large sums of money were needed in order to operate in it, but thanks to the expansion and evolution of the Internet and computers, Forex quickly opened its doors to all.
The brokerage companies flooded the market with their platforms and increasingly lowered (and still do) the minimum margin to operate, so much that today, every person with a PC, an internet connection and a few hundred dollars (even less ), can invest in this huge market.
Did you like our history of the Forex market?
Let us know what you think in the comments!
Forex Market: the world’s largest one
The Forex is universally recognized as the largest market in the world. Every day there are exchange of currencies for a volume of nearly 5,000 billion dollars (five thousand billion, or five trillion). To make a comparison and understand its magnitude, consider that the NYSE (New York Stocks Exchange), the largest in the world, where stocks and derivate are traded, every day on average there’s only a transaction volume of 22.4 billions of dollars.
We must however specify 5 trillion is the volume generated by Forex in its entirety, but as we will see, this market is divided into different sub-markets, and what we are interested in is the SPOT market only. Here we have so many players dealing with each other, banks, forex brokers, money transfer services, institutional and corporate traders, and also retail traders (private traders and speculators) that we’re going to learn more about and take advantage of in the next course.
The SPOT Forex market is still huge compared to all the others, recording an average daily transaction volume amounted to $ 1,500 billion. The retail traders (private traders or small speculators) are a small part of this market and to participate they need intermediaries, who in the world of finance are represented by the Brokers.
How forex market works
Let’s then start to say in simple terms how Forex works.
The Forex market is called OTC (Over The Counter). OTC simply means that this market doesn’t have an official negotiation place, such as the NYSE in New York, the LSE in London, or the TSE a Tokyo, etc. Forex is spread over an interbank circuit, without having a specific location, and participants in this circuit are free to trade with each other without having a registered office.
This inherent flexibility of Forex market, and the exponential increase in the number of participants, have ensured that the entry barriers in this market were completely demolished.
Today the Forex market is truly accessible to everyone. If once you could have problem with initial capital, even that problem no longer exists. Now you can open an account paying just a few tens of dollars of initial capital.
However, the fact that it is easy to access does not mean that it is also easy to invest and make money out of it. This is the lever that many operators have used to obtain many customers, misleading them into believing that Forex trading was a no-brainer.
I’ll tell you now and clearly: it’s not easy.
Forex trading is very difficult, complicated, and requires years of training and experience.
Anyone who says otherwise does not know what he’s talking about.
“But then, if it’s so difficult and challenging, why is it also so famous?”
The answer is simple: because with Forex you can make a lot of money, even having just a few at the beginning. There is a good news for you. You won’t need to go through the long and difficult journey to become a forex trader, but you can exploit to your advantage those who already have been traders for some time, as we shall see in the next course “What is Social Trading”.
In this course we won’t discuss technical or operational strategies for trading in the Forex, but we will see step by step all the main characteristics of this market, so that you’ll have the necessary knowledge to deal with the Social Trading course with the right foundation (here you can deepen the subject anyway). So, don’t waste any more time, and dive in the first lesson of this 12 chapter course.
Forex is a market, then it’s, by definition, a place where goods are exchanged. Let’s start by understanding first which goods are traded in the largest and most used market on earth.
What are Forex Market’s currencies and how they work
In the Forex market we trade the most famous good: money, or to put it in a more technical term, currencies.
Unlike the other markets, where the absolute values of singular assets, companies or index are shown, in the Forex market the representation of the currency value is made in a combined form. Here’s an example to clarify this concept:
In case of a company: Apple $ 600.00 (price that identifies the share’s value)
In the case of a commodity: Gold $ 1,662.15 per ounce (price that indicates the value of the commodity)
In the case of Index: Dow Jones 16,500 points (points that represent the value of the index)
In the currency market the values are always determined from a rapport between the value that a particular currency has in relation to another one. In Forex the value of a currency will never be expressed in absolute terms, but always in relation to another.
Currency pair: EUR/USD 1.3000
The value 1.3000 represents the value of the Euro currency against the Dollar currency. In the specific case we are saying that we need 1.3000 USD (one point three dollars) to have 1 Euro.
Base and Quote currencies
Let’s continue with the previous example: EUR / USD 1.3000.
If we say that we need $ 1.3000 for 1 euro, in reverse we can say that we need 0.7692 euro (1/1.3000 = 0.7692) for 1 usd. We are saying the same thing.
The numerator currency (left, Euro in our example) is defined as “base currency“, because its amount never varies in the ratio, and it always corresponds to a value of 1. The denominator (on the right, USD in our example) is called “quote currency”, and its amount varies with the exchange price.
A very important agreement states that the ratio between the currencies must be represented the same way all over the world, and for any intermediary. If we see EUR / USD (and we will always see EUR/USD, because this is the convention) we will never find the contrary USD/EUR.
The symbols of the major currencies
Here’s how to read the the currencies’ symbols:
USD: United States Dollar
JPY: Japan Yen
CHF: Swiss Franc (form the latin name “Confoederatio Helvetica”)
GBP: Great Britain pound
AUD: Australian Dollar
CAD: Canadian Dollar
Usually, the first two letters identifies the country, while the third corresponds to the first letter of the currency. An exception of course is EUR!
Opening hours of the Forex Market
Forex treats the currencies of all the markets around the world, and it’s very rare (except for worldwide holidays) that all the markets around the world are closed simultaneously. When a market is closed in one part of the world, another one is open in another part (for example, if the U.S. market is closed, the Japanese one is open).
For this reason, the Forex market is open 24 hours a day, 5 days a week, unlike other markets, again like the NYSE for example, that open in the morning and close in the afternoon (local time).
n the Forex market, trading of currencies usually begin at 22:00 GMT of Sunday, to end on Friday at 22:00 GMT.
How a Forex currency exchanges works in practice
If I say that EUR/USD at the moment on the market is trading at 1.3500, it means that 1 euro (base currency) corresponds to 1.3500 dollars (quote currency), or, in other words, that if you want to buy 1 euro, you need 1.3500 dollars.
It goes without saying that when the Euro currency appreciates in the EUR/USD exchange, it does so at the expense of the Dollar currency, so if Euro appreciate Dollar depreciates, and vice versa.
EUR/USD at 1.5000 indicates that it will take 1.5000 U.S. Dollars for 1 Euro, that means more dollars compared to the previous example. In fact, the EUR/USD exchange rate in this example has risen in favor of the Euro currency, leading to a depreciation of the Dollar currency.
A EUR/USD 1.1000 means that to buy 1 Euro you need 1.1000 U.S. Dollars, so less dollars than the two previous examples.
In fact, in this example, EUR/USD dropped at the expense of Euro, encouraging the appreciation of the Dollar.
Currency exchange: a life example for a better understanding
Our friend Marco from Italy recently completed his studies and decided to have a good working holiday in the US, to have a great experience and learn a new language while working. Since his parents can afford it, they gave Marco a bonus of € 10,000 for the trip that, added to the other € 10,000 that Mark has put aside over the years, made a total of € 20,000.
So, Marco left his home, and once arrived in America he changed its 20,000 Euros in U.S. Dollars. At the moment he changes his money, EUR/USD was quoting 1.5000, and consequently he took $ 30,000 U.S.
Marco spent 6 months in America, traveling, having fun, knowing a lot of people and learning English. But, contrary to the initial good intentions, Marco didn’t work a single day, spending in six months of vacation the sum of 6,000 usd.
On his return to Italy, he had 24,000 U.S. dollars, which he promptly changed in Euros at the EUR/USD exchange rate of 1.1000 (as you can see, within 6 months of vacation, the euro has depreciated a lot, causing an appreciation of the dollar).
Marco was very surprised and pleased with what he sees, because the clerk handed him 21,816 euro. That is € 1.816 more than the sum he had when he left Italy.
How is that possible? Marco left with 20,000 euro and came back with 21,816 euro, after living in America for 6 months without working, therefore using his own financial resources.
Marco unknowingly has exploited the Forex market, he has done in 6 months what investors, speculators and traders, very often do daily.
The currency market mathematically
Let’s analyze mathematically the situation, in order to understand in practice what it means to be a Forex trader and an investor or the foreign exchange market.
We have said that Marco started with 20,000 euro, changing them once arrived in the United States. Therefore, the operation he has done was to use the 20,000 euro to buy Dollars.
We said that, at the time of the transaction, the EUR / USD rate exchange stood at 1.5000, which is like saying that to buy 1 euro you need 1.5000 U.S. dollars, or that with 1 euro you can get 1.5000 U.S. dollars.
1 euro x 1,5000 = 1,5000 dollars
20.0000 euro x 1,5000 = 30.000 dollars
On the way back, after spending 6,000 dollars, our friend Marco had 24,000 dollars left, which he changed in euro at the exchange rate of EUR/USD 1.1000.
Therefore, an exchange rate with a much weaker Euro against the Dollar, if compared with the rate at the time of Marco’s departure.
1 euro x 1,1000 = 1,1000 dollars
1 dollar x (1/1,1000) = 0,9090 euro
Therefore 24,000 Dollars x 0,9090 = 21,818 Euro
(or, to simplify the calculation, you can make 24,000 dollars DIVIDED by the exchange, so 24,000 / 1.1000 = 21,818 euro)
There you have it.
Trading on the currency market means buying a currency pair, or a currency exchange, when it has a low value to sell it when it has a higher value, or selling it (I’ll explain what that means) when it has a high value and then buy it back on the market when it has a lower value.
In the world of trading we use two specific terms to describe the two scenarios, and these are LONG and SHORT.
- “To go long” means buying the base currency (on the left) and selling the quote currency (on the right), hoping that the base currency will rise in value, and then sell it to collect the difference. In other words, the exchange rate is rising.
- “To go short” instead means to sell the base currency and buying the quote currency, hoping that the base currency will lose value, so to buy it at a lower price and collect the difference. In other words, the exchange rate is going down.
The Pip: How the Forex unit of measurement works
You have seen previously that the exchange rate value between Euro and Dollar was expressed with a 5 digit number, one before, and four after the comma, for example 1.3020.
But how do we express the value changes of a currency exchange in Forex? Do we use the usual mathematical terms such as tenths, hundredths and thousandths? The answer is no, in Forex, unlike other markets where the unit of measurement is the tick, we use PIPS. Let’s talk about Pip measurement.
What is a pip in forex
The pip is the minimum price deviation of an exchange rate. We can say it’s the base unit of measurement of the movements in the foreign exchange market.
Let’s make an example to better illustrate the idea of pip unit:
If I say that EUR/USD is at 1.3020 + 1 pip, then EUR/USD is at 1.3021.
If, on the contrary, I say that the EUR/USD is at 1.3020 – 1 pips, then EUR/USD is at 1.3019.
So, as you understand, the pip is nothing more than the fourth decimal number after the comma.
So, in order to measure the quantity we have:
0.0001 = 1 pip;
0.0010 = 10 pips;
0.0100 = 100 pips;
0.1000 = 1000 pips.
The first thing to pay attention is not to confuse 1 pip with 0.1 pip (or tenth of a pip). Some brokers offer prices that are up to 5 decimal figures after the comma (much more accurate), but the pip always remains the fourth digit.
The fifth digit is instead commonly called “Pippete“, or tenth of a pip. Therefore:
– if we say that if EUR/USD moves from 1.3020 to 1.3021, the deviation is of 1 pip;
– if EUR/USD goes from 1.30201 to 1.30202, the deviation is of 0.1 pips; that is 0.00001 or one pippete.
Forex pips and its exceptions
Some currency pairs, among which the most famous are those with the Yen as the denominator (quote currency), have only 2 decimal figures after the comma. Therefore, the forex pip is no longer the fourth, but the second decimal place, and the pipette becomes the third.
Let’s examine the most representative two decimal place currency pair.
The currency pair Dollar against Yen is represented with only 2 digits after the comma, for example, USD/JPY 103.25.
In this case:
– if USD/JPY rose from 103.25 to 103.26, the deviation was of 1 pip;
– if USD/JPY rose from 103.251 to 103.252 deviation was 0.1 pips
What do we use forex PIPS for?
We have said that Pip acts as a measurement unit of the movements in the forex market.
The use of pips also facilitates communication between the parties, as it’s more convenient and quick to say that EUR/USD moved 150 pips, rather than saying that he moved 150 thousandths.
But we haven’t said yet what is the most important use. Pips are used by traders, or by any operator that make a transaction on the Forex market, to calculate the profits and losses of their operation.
Once he has decided how much a pip is worth for that operation, the trader has just to see how many pips has been able to accumulate, or otherwise to lose. However, when the transaction is closed, the gain or loss won’t be anything else but the multiplication of the pip value decided by the trader for the number of pips gained or lost.
Nothing could be easier.
This is one among the several elements that has driven hundreds of thousands of people to experiment Forex market, that is its ease of use. The other, as we’ll see now, is the fact that Forex market moves every day of many pips, or as they say in the jargon, is very volatile.
Pips variations generate volatility
The variations in terms of pips in the Forex market are very frequent and widespread.
This is one of the main reasons why this market is loved by many Trader, whether independent or not. If a financial instrument moves a lot and very often it’s said to be very volatile.
Very often we hear people and media talking about volatility in negative terms only, describing it as a strong component of risk. But the truth is that if an instrument is not volatile at all, it would make no sense to use it for trading or investing.
If the price of any goods, being it is stocks or exchange rate, does not move, it becomes very difficult to find investment and profit opportunities, both in the long term, and especially in the medium and short term.
The fact that in Forex the movements in terms of pips are frequent and widespread means that in this market the traders will have many occasions to try to take profit. It’s also true that the chances of losses will increases, but it’s precisely the high number of opportunities and possibilities that ensures that traders can use statistical and profitable methods to operate professionally.
As we will see later, in the Forex market a trader’s profit is calculated directly on the number of pips that can earn.
However, given the volatility, it’s obvious that traders must first be able to defend from possible movements against themselves, which means being able to manage the risk properly.
What is and How Forex Spread works
One of the word you often hear in the finance, investment and market fields is definitely the term “Spread”.
This word doesn’t mean anything but “difference” or “differential”, but based on the scope in which it’s used, it assumes a lot of specific meanings. Let’s see what we usually mean when we talk of forex spread.
Forex Bid Ask Spread
We have seen how the value of the exchange rate between two currencies is expressed, however, when we approach a broker to ask him to buy or sell one currency in exchange for another, the broker doesn’t show us a single price, but rather two, one a little higher than the current value of the exchange, one a little lower.
These two values represent the demand and supply of that particular currency pair, or the Bid price and Ask price. So, let’s see how spread works.
The Bid price is always lower than the Ask price. To make things easier, let’s start from the Ask one.
– The Ask Price is the price you can find to your right in a classic book. Let’s suppose you want to buy the EUR/USD cross, that is you want to go LONG on that currency exchange.
You go to your broker and you ask him what is the price at which you can make this purchase. The broker looks at the listing, and says that on the market, at that time, the best seller, that is the one willing to sell you EUR/USD at the lowest therefore most convenient price (so to be SHORT on the same exchange) offers it at a price of 1.3001.
In other terms, he ASKs you 1.3001 for selling you the exchange, so your price to buy EUR/USD is 1.3001.
– Let’s pass to the the Bid price, that one you can find on your left in classic book. Let’s suppose on the contrary you wish to place an offer to sell EUR/USD, that is you want to go short on the currency pair.
The broker tells you that, to conclude the operation now, the best buyer, that is the one willing to buy at the higher price, would buy the EUR/USD at a price of 1.2999. So your price to sell EUR/USD is 1.2999.
The difference between your purchase price 1.3001, and your sales price 1.2999, which in this case is 2 pip, is called in jargon “spread”, which is the difference between the best seller and the best buyer.
The spread as the broker’s profit
To get their profits many brokers, of which the majority don’t operates in the Forex markets, take a small percentage of the volume of any transactions made by their customers.
For example, if the client opens a purchase transaction on Apple’s shares for a volume of $ 10,000, the broker will earn a small percentage of those $ 10,000, generally 0.05%, or 5 basis points.
Most of the Forex brokers instead do not charge commission like that, but they simply widen the spread of the market, perceiving this way their self-interest.
At this point we have created two types of spreads. There’s the real spread, based on the quoted market prices and its actual levels of supply and demand; and then there’s the broker spread, determined by the broker, who will take the real one from the market, will add a small amount in terms of pips, and finally will propose it to you for your operations.
The difference between the real spread and the broker’s one is precisely what the broker will gain from every client transaction. It means that the broker, for the fact of providing this trading service, asks you in exchange a small amount on the transaction you are about to carry out.
Taking the example above, if the market bid-ask quotes of EUR/USD were 1.2999 and 1.3001 respectively, the broker will place a further spread in both prices, for example 1 pip each, making you no longer see the previous values, but instead 1.2998 and 1.3002.
So you will see directly a price for the sale of 1.2998 and not 1.2999, and a price for the purchase of 1.3002, and not 1.3001. So, for you the bid and ask spread will be of 4 pips.
As said before, the Forex market is continuously evolving and it’s becoming even more efficient, and in addition to this, the competition among brokers is getting always more fierce.
What does it mean? It means that the additional spreads charged by the brokers are becoming smaller, for the benefit of the users’ and investors’ earnings.
What is a Forex Broker and How it works
Let’s suppose you’re ready to take your first step on the Forex market.
Before you decide which particular currency exchange to use for the transaction, before you even decide whether to want to buy or sell, first of all you need two things.
Now, all you need is a capital to start with, but above all you need is a broker (check out our list of the best forex broker for beginners).
What does a forex broker do?
A broker is an intermediary that execute the transaction orders on behalf of his client. They are called intermediaries because their job is to intercede between the market, on one hand, and investors and traders on the other. The tasks performed by the broker are:
- to provide customers the market prices of the various financial instruments (underlying), via trading platforms accessible via web or installed on the PC, or in some cases, by phone (a practice most used some years ago and currently in decline);
- to find a counterparty with which to satisfy the transaction request received from his client:
- to send to the market the trading orders executed by his clients via PC or phone;
- to return information about the order outcome, if it has been executed or rejected, or if it’s in the processing phase, or maybe stuck for some problem;
- some also act as withholding agent, calculating and paying taxes for the trader on the realized capital gains or on the generated capital gains, or by calculating and maintaining the capital losses if the trader has not yet made a profit with his work.
The two major broker families
Brokers can be divided into two large families: Dealing Desk and No Dealing Desk broker.
To tell the truth, nowadays many brokers, especially the larger, have the ability to offer their customers both the account management solutions (dealing desk or no dealing desk), depending on the type of deposit that is made or on the customer’s choice.
Usually the dealing desk option is given to the less consistent deposit, and the no-dealing desk to the more important. The thresholds that define when a deposit is more or less consistent depends on the business plan of the broker.
Obviously these different options have different conditions, in terms of commissions, spreads, orders execution times, and so on. But let’s see together in detail the main features of these two great families.
Dealing desk brokers (market makers)
These intermediaries are usually the smaller, or is the setting that is attributed to smaller accounts in the event that the broker possess multiple solutions.
In the case of dealing desk broker, in addition to performing the simple task of an intermediary, that is to send orders to the market and funding a counterpart, the broker can directly act itself as the counterpart (here’s our list of the best Market Maker brokers).
Usually brokers, when they receive orders from their customers, they go directly to the market through specific entities that represent the Forex circuit (discussed below), where they find a counterpart, and so the order is then executed. But it may happen that, if a counterparty is not found, or the situation is considered convenient, the broker acts himself as the counterparty for the operation of his client, without going through the market.
Therefore, when then the client will close the transaction, the broker will lose his own money if the operation of the client had been successful, or in the other case he will cash directly into his account the money lost by the customer. In fact, this type of broker make profits in two ways:
- With the spread (as we have seen widening the spread between bid and ask);
- by trading against their clients (playing as counterpart for transactions submitted by customers).
To be clear, there is nothing illegal about this activity (trading against customers), provided the market it’s not modified artificially by disguising prices with some subterfuge.
Given that, statistically, of the customers who decide to make Forex trading personally, the 90% fails (due to the difficulty of retail trading), they act as counterpart to their customers, knowing that in the short to medium term, almost all of off them will be found to be on the wrong side of the market, and will lose money, which instead will be earned by the broker that was the counterpart.
These brokers, also known as ‘market makers’, literally create an artificial market of Forex exchange rates for their customers. Given that the ‘market makers’ control both the supply and demand prices, it follows that for them to define fixed spreads is really not very risky.
An example to understand this better: let’s say you want to put through a dealing desk broker a purchase order on EUR/USD (that is buy euro and sell dollars).
In order to fulfill your request, the broker first of all will seek among its customers a sales order that coincides with your purchase order, or in the other case he will pass the order to his liquidity supplier, ie a large entity capable of quickly buying or selling large financial positions in block. Doing the latter, it minimizes the risk, as he gains from the spread without having the opposite side of the trading operation.
In the event, however, he cannot find orders that meet the other side of the client’s transaction, then the broker will take the opposite position to guarantee the order execution. At that point, if you earn, he lose, vice versa if you lose, he earns.
No Dealing Desk brokers
As the name suggests, a No Dealing Desk broker is a broker that does not pass the orders of their customers through their dealing desk (“brokerage office”).
This means that the broker will never take on charge the opposite side of his clients’ operations, but he will simply connect the two counterparties to each other by sending the order directly to the market. For this intermediation activities, these brokers may charge a small fee, or simply put a little surcharge by increasing the spread as already seen.
The No Dealing Desk brokers can be either STP or STP + ECN (we talk about them in several articles, included: best ECN STP Broker and best MT4 Ecn broker.)
– Broker Straight-Through Processing (STP)
The Forex broker who has a STP system directs his clients’ orders directly to his liquidity providers, who in turn have access to the interbank market.
The STP Broker usually has a lot of liquidity providers, and each provider determines its own ’ask’ and ‘bid’ values, which are communicated to the broker constantly. For example:
Let’s assume that a STP broker has three different liquidity providers.
In his STP system, the broker will see three different pairs of ’ask’ and ‘bid’ values. The system will sort these pairs of values in descending order, from the best to the worst. In this case, the best ‘bid’ value is 1.3000 (the highest for selling) and the best ‘ask’ value is 1.3001 (the lowest for buying). The best bid/ask couple is thus 1.3000 / 1.3001.
But those are not the quotes you will receive. Usually the broker will add a little fixed surcharge, which will be his gain. If he would add 1 pip, the quotation for you would be 1.2999 / 1.3002. So you’d see a spread of 3 pips, that is the difference between the bid and ask on which the broker will get his profit from.
The spread in this case is not fixed, like it was with the dealing desk, but it’s a variable spread. The broker, since he doesn’t create his own, must report the best prices he receives from its liquidity providers, and the latters, in order to determine their prices, follow specific formulas.
In particular, when the number of trades increased dramatically (in technical terms, “volatility increases”), the spreads can widen, even a lot.
– Broker ECN (Electronic Communication Network)
A true ECN broker allows the orders of his clients to interact directly with the orders of the other participants in the ECN (Electronic Communication Network).
Participants may be banks, individual traders, investment funds, as well as other brokers. In essence, the participants are trading against each other by offering their best bid and ask prices.
The ECN broker enables its customers to see the “Market Depth“. The “Market Depth” shows you where (and at what values) the purchase and sales orders of the other market participants are. The ECN broker is the only broker that can provide such a market book, precisely because it gives direct access to it.
Given the nature of the ECN, it’s very difficult to add an extra fixed cost, then the ECN brokers are usually compensated with a small commission deducted from each transaction, or from a total transactions volume.
PROS AND CON
|Being the broker itself the counterpart, he might be interested in working against your interest (only incorrect brokers do that, and usually you recognize them because the charts has spikes that other brokers charts are not present).
||Orders sent directly to market
|Easier and more frequent requotes (the broker cannot or is not willing to accept your quote request for the operation, and then asks you if you want the execution with a different quotation)
||Immediate execution of orders
|Possible execution of the order at a unfavorable price for the trader
||In case of no liquidity (rare but can happen), the orders execution can slow down
|Delays in the orders execution, with processing times that increase
||View of market depth
|High Spread but no commission
||Spread usually very tight, but that can enlarge in case of lack of liquidity or volatility explosion
|Possibility to enter the market with accounts of modest size
||Payment of a commission to the broker
How Forex leverage works and How much is risky
Now that we know how pips and spread work, and how we can buy or sell via brokers, we miss to understand how quantities work in Forex market.
For this topic we will go primarily to deepen the concept of forex leverage. Some of the next questions could be: “What type of quantities we use to trade on Forex?” and “How much the pip will be worth based on this quantities?”.
Let’s start from the beginning.
Leverage as a function of the lot
The standard quantity, or the unit of measurement of quantities, with which you trade in Forex is the forex Standard Lot. When you want to buy or sell a particular pair, what you do is to go long or short of a chosen number of lots, on that particular pair.
But how much is one lot in forex? A lot generally corresponds to 100,000 units (one hundred thousand) of the base currency (on the left, at the numerator). So, considering the most important base currency in the world, i.e. the U.S. dollar, a lot will have a value of 100,000 U.S. dollars.
“Does this mean that to trade on Forex I must have an account with at least 100,000 usd to be able to use a lot?!?“.
The answer is obviously NO. There’s no need. Soon I will explain the concept of leverage and margin. Meanwhile, consider the fact that with the evolution and expansion of Forex, in addition to lots, other smaller figures have appeared:
- mini lots, corresponding to 10,000 units, or 1/10 of a lot
- micro lots, corresponding to 1,000 units, or 1/100 of a lot
- nano lots, corresponding to 100 units, or 1/1000 of a lot
So, how much is a pip worth when I will open a transaction with one of these quantities? The calculation is very simple.
If a pip corresponds to 0.0001, just multiply it by the base unit, which is the lot, to find its value.
0.0001 x 100,000 = usd 10 usd.
When I open a transaction with a lot, my pip will be worth 10 usd. With the same calculation:
- mini lots: the pip is worth 1 usd
- Micro lots: the pip is worth 0.1 usd (or 10 cents)
- nano lots: the pip is worth 0.01 usd (or 1 cent)
Obviously, I am not obliged to use a single lot, or just a micro lot at a time. I can simply use the quantities I want. With 3 lots my pip will be worth 30 usd, with 5 mini lots my pip will be worth 5 usd, with 8 micro lots my pip will be worth 0.8 usd, etc.
Forex Leverage according to currency
However, if we want to be more precise, since the value of a pip in Forex refers to a rappot between two currencies, it goes without saying that if this rapport changes, the pip value also can vary:
- Let’s assume the USD / CAD is 1.1030. The formula for the correct value of a pip is: (0.0001 / 1.1030) x 100,000 = 9.06 usd
- Let’s assume that the USD / JPY is 102.70. The formula is: (0.01 / 102.70) x 100,000 = 9.73 usd
In the case of non-dollar base currency (in the numerator), we should add another step obtain always the dollar value.
- Let’s use EUR / USD at 1.2530. The formula is: (0.0001 / 1.2530) x 100,000 = 7.98 eur x 1.2530 = 9.99 usd.
As you can see, the pip value always ends up being around 10 usd. In any case, don’t worry, you will never have to do all these calculations by yourself for trading, there will always be your broker to do them for you and present you the results automatically. In addition, you can easily find on the internet some automated pip value calculator.
However, if you want to practice and discover by yourself the exact values of pips, now that you know the calculations, here’s a useful forex pip value table which shows the number of units per lot according to the pair and the position of the pip:
What is and how forex leverage works
We have seen all the quantities that are used to make Forex trading. The question at this point should be:
“If I want to use a mini lot, should I have 10,000 usd on the account?”.
The answer again is NO. Now we can talk about the concept of leverage.
The famous Archimedes said
“Give me a lever and I will move the world.”
The reason behind this statement is very simple. The lever is a tool that allows you, using a series of basic physics principles, to get great results doing a little effort. Let’s say that we can move large weights using a precise technique with little force.
Forex is one of the many markets where you can use leverage. Speaking about the world of trading and investing, quite simply, the financial leverage is the ability to operate in the markets and move large amounts of capital despite having much less consistent funds.
In other words, the broker acts as guarantor in respect of the market for your operations. So even if you don’t have the required amount in your account to open a specific transaction, the broker will let you open it anyway, because he himself will cover it with the necessary capital.
We will see shortly which are the calculations, but above all what are the guarantees that the broker will ask to allow you to operate with leverage.
Let’s take for example what professional traders and fund managers do. They usually trade with maximum 1 standard lot for each $ 50,000 they have on their account.
So, to think in terms of leverage, the proportion to apply is:
100,000 usd of equivalent on the market, and 50,000 usd of real fund on the account.
$ 100,000: $ 50,000
That is 2:1
According to this example, the leverage with which the professional traders and managers usually operate is 2 to 1. It would be like saying that when they make a transaction in the market, they do it with twice the money they have. This, in practical terms, means that they can achieve, for each transaction, a gain or loss equal to the double of what they could achieve if they would have access only to the capital in their account.
Obviously, for those who know how to do their job well, leverage is a very effective and very powerful tool. We must, however, make a clear distinction, always using the latest example.
Let’s suppose that our trader or manager opens a transaction with a lot, and that this begins to lose. The fact that the broker has guaranteed the market for 100,000 usd does not mean that he will keep the operation open on his behalf until it loses up to 100,000 usd. Absolutely not.
The broker will provide coverage as long as there will be funds on his client’s account, in this case up to 50,000 usd of loss. This is important to understand, because leverage can be a great ally, but also a potential enemy. The important thing is to know what it is and how to use it.
Brokers and leverage today
Most Forex brokers today offer leverage up to 100:1, some even more higher, even 400:1 or 1000:1. Let’s see some calculations with a 100:1 leverage.
100:1 means that I can move a hundred times more than what I actually have on the account. So, with only 1,000 usd on the account I can use a whole lot (1,000 x 100 = 100,000 usd = 1 lot).
To see it from another perspective, always with a 100:1 leverage:
- to use a lot are necessary 1,000 usd
- to use a mini lot are necessary 100 usd
- to use a micro lot are necessary 10 usd
- to use a nano lot is necessary 1 usd
Let’s make an extreme example to make you understand the risks of overdoing with leverage.
Some brokers offer leverage up to 1000:1 (one thousand to one). This way you can use a lot even having only 100 usd on the account. But remember, the pip, with a lot, is worth 10 usd.
If you were to open a position with one lot with only 100 usd on your account (and you can do it, because the leverage allows it), if the price would go against your operation for only 10 pips (consider that in the foreign exchange markets in a few minutes there may be oscillations of hundreds of pips), you would have completely burned out your account.
Therefore, pay attention to leverage. Treat it as an ally, but don’t push it too much, otherwise it will turn into your worst enemy.
But that’s not all. In fact the broker, to allow you to operate with leverage, obviously will ask you some guarantees. In the next lesson I will show you how these guarantees work in a market like Forex.
What is and How margin works in Forex
Forex is a market where there’s not the actual delivery of the purchased goods, or to put it in technical terms of the underlying. In Forex you operate with margin.
Margin or delivery of the underlying
For instance, in a normal purchase where there is the underlying asset delivery, such as in the stock market, when you purchase some shares this is what happens:
Suppose you have 10,000 usd on the account and you buy 1,000 shares of the XYZ inc. at € 5, for a total of 5,000 usd (1,000 shares x 5 usd).
What it will happen on a practical level?
On a practical level, of the 10,000 usd stored on your account, 5,000 usd would end up in the market for the purchase of the XYZ inc., and 5,000 usd would remain on the account. The 1,000 XYZ inc. would be loaded into your deposit (securities portfolio), linked to the account with which you are trading in securities (delivery of the underlying). So right after your purchase, you’d be left with 5,000 usd on the account and 1,000 shares of XYZ inc. on the portfolio, for an equivalent, at the purchase price of the market at that time, of 5,000 usd.
At this point, the value of your investment, that has been delivered within your securities portfolio, will fluctuate depending on the increasing or decreasing of the market value of the XYZ inc. shares.
If the market value of the XYZ inc. shares would increase, also the value of the deposit would increase, and once the shares would been sold, you will find yourself again with an empty security portfolio, as before the purchase, and your account would be increased by the difference between the sales price and the initial purchase price.
This is what happens when you work in a market that involves the delivery of the underlying. In a market in which this delivery is not provided, just as in Forex, you will work with margin.
But what is margin?
The margin is the amount of money needed as a “good faith deposit” that the broker asks for letting you open an operation.
The broker takes your margin deposit and puts it together with all the other margin deposits (those of other customers who are operating in the meantime), thus creating a “super margin deposit” with which he is able to place large orders on the interbank network.
The amount of margin required for each transaction is inversely related to the leverage allowed by the broker. The higher the leverage, the smaller the margin requirement (the capital locked into the account as a guarantee).
Having a leverage of 100:1, the margin required by the broker will be nothing but the hundredth part of the investment you’re making.
Therefore, if you have a 1,000 usd account you can open maximum a position of 1 lot. The equivalent in the market of 1 lot is 100,000 usd and 1,000 usd is the hundredth part that, it is said, will be blocked as margin.
Following this logic, we can also say that you can open at the same time a maximum of 10 positions of a minilot (0.1 lot). A minilot corresponds to an equivalent value on the market of 10,000 usd. If for each position will be frozen on the account the hundredth part, 100 usd per position will be blocked as margin, which for 10 positions will always do our maximum of 1,000 usd.
Following this reasoning, it goes without saying that you can open at the same time up to 100 positions of a microlot (0.01 lot).
The margining is often expressed as a percentage value relative to the total amount of the position.
For example, most of the brokers on the Forex market will tell you that they require a margin of 2%, 1%, 0.5% or 0.25%.
Using the percentage margin required by your broker, you can calculate the value of the maximum leverage with which you can manage your trading account.
We often hear about it, but to be precise, we must say that in Forex the Margin Call does not exist. In other markets the Margin Call is the request to the client by the Broker of a payment of additional funds in order to cover the minimum margin requirement for the maintenance of losing positions.
In Forex the brokers calculate at any moment what are your margin requirements, and if by chance, even for a few seconds, your losing operations should go beyond that level, the broker would close them automatically. In Forex market the Brokers do not “call” you to let you know, in Forex the Brokers closed them directly.
Knowing leverage and margin is useful for you to understand the correct lot size that the open positions should have. For this reason, there are a number of logical and mathematical reasoning that I suggest you to do now with me, because it will help you get well acquainted with the weights to give to your positions.
Margin in practice
If you know:
- The account balance: 3,000.00 usd
- The maximum leverage that the broker gives you: 400:1
You can discover:
– The maximum lot size that you can use:
$ 3,000.00 of capital on the account x 400 of maximum leverage allowed by the broker
3000 X 400 = $ 1,200,000
$ 1.2 million of capital / $ 100,000 of capital that corresponds to 1 lot = 12 lots
So, under these conditions, with an account of $ 3,000, you can open transactions for a total maximum lot size of 12 lots.
– The percentage of margin that is required by the broker for each transaction will be:
$ 3,000.00 of capital on the account / $ 1,200,000 maximum equivalent on the market
(3,000 / 1,200,000) x 100 = 0.25%
Another example of the calculation. If you know:
- The account balance: $ 3,000.00
- The percentage of margin required by the broker for each transaction: 0.25%
You can discover:
– The margin of capital that the broker will immobilize for each transaction:
for example, for a transaction of one minilot, that is equivalent on the market to
$ 10,000.00 x 0.25% (percentage of margin required by the broker)
10,000 * 0.25 = 25
$ 25 is the amount of capital that the broker will block on the account in the event of input of an order of 0.1 lot ($ 10,000 equivalent) on the market.
– Using the sample data of the previous calculation, you can find also the maximum leverage allowed by the broker for the account:
$ 10,000.00 of equivalent on the market for a position of one minilot (0.1 lots) / $ 25 of margin required by the broker in the form of capital
10,000 / 25 = 400
That is, a leverage of 400:1. A leverage of 400 times the capital held on the account, for the single transaction.
So hypothetically having $ 500 on the account you can operate up to a maximum of $ 200,000, or 2 lots.
– The maximum lot size allowed by the broker for the capital in your account
$ 3,000.00 on capital on the account x 400 that is the maximum amount of leverage granted by the broker
3,000 x 400 = 1,200,000
That is 12 LOTS
If your broker will require a margin of 2%, you will have a 50:1 leverage. And here is the other most popular types of levers offered by most brokers:
All the ways you can trade the Forex Market
As mentioned in previous lessons, Forex is the market where you trade with currencies. In Forex, the financial instruments used to invest are:
- The spot;
- The Future;
- The Options;
- The ETFs (Exchange-Trade Funds).
Trading in the SPOT Market
The SPOT Forex market is that where there are the traders who are also Signal Providers in Social Trading.
Therefore, it’s the market that, from an operational standpoint, we are most interested in, in order to better understand how it works and then be a more conscious investor.
Characteristics of the spot market
The Forex Spot Market is OTC (Over the counter). As we have already seen, OTC indicates that it has not a specific trading venue. The liquidity, the correctness and the security of the transactions are guaranteed by each party engaged in the trade, including all major international banking groups.
As there is no headquarter, there are no official prices of the market, but the trading exchanges are communicated by all the major players in the international telematic networks such as Reuters and Bloomberg, that spread them instantly and globally.
It’s a “spot” market, i.e. a market where the trading price is fixed instantly by the two parties and the exchange of the treated products is regulated at the end of the same execution day. However, with the mechanism of “rollover” you can postpone indefinitely the date of closing of the transaction, in front of a payment of a small interest called “swap”, which can be paid or received (If the interest rate of the currency you buy is greater than the interest rate of the currency you sold, then you will have a gain of swap, or vice versa a loss of swap).
The spot market is by far the most liquid, flexible and accessible among all the markets we are going to analyze, where brokers give to their users most of the services for free.
Forex spot: the world’s most popular currencies market. Why is that?
Let us briefly analyze some of the reasons that led Forex Spot to be the most liquid market in the world and the most widely used by banks, large investment funds, small traders, in addition to being the market in which Social Trading is developed.
It’s a market open 24 hours and this makes the charts very smooth and linear, given the absence of gaps (in the markets closing in the afternoon and reopening in the morning we often find “holes” in the prices quotation among the closing price and the reopening price), a very positive thing for those who work using technical analysis. For this reason, the analysis are much easier and profitable. Small gap may arise, however, over the weekend, that is the only moment in which Forex is closed.
Being the most liquid market in the world also means never having problems running a particular order. In other words, if we want to buy there will always be someone willing to sell, and vice versa. We will never find ourselves in the position of not being able to close a transaction for the absence of a counterpart.
These two characteristics alone, the 24 hours opening and the immense liquidity, give the opportunity for programmers to design automated trading systems, more or less professional, which can operate in automatic mode, 24 hours a day, relying on the fact that the market has always a price for those who want to buy, and one for those who want to sell.
As we have seen in previous lessons, the user has the ability to operate by margin, being able to exploit even very large margin, together with the freedom to operate with leverage, ranging from nano lots (newly invented, for the less capacious pockets) to micro and mini lots, getting also to the most professional and known standard lots.
In this market brokers usually do not take commissions, but their earnings are based mainly on the payment of the spread by the users, for each transaction open.
The operations can be handled with a MT4 trading platform (the most common for trading on the forex spot and the one that made possible the evolution and the rise of forex autotrading), very stable and light and that, at no cost, gives the possibility to operate on the market with real or demo money. All of these accessibility characteristics have made Forex Spot one of the favorite markets among retail investors.
Trading on the FUTURE market
The futures market, on the contrary of the spot, is a regulated market.
The future, as the name itself said, is an future trading instrument, and is also derivate (its price is based on an underlying). It’s a contract by which a person is committed to buy or sell at a specified future date, a specified underlying asset at a specified price.
In the case of Forex, we talk of financial futures, which as underlying have currencies themselves.
These contracts have quarterly deadlines (March, June, September, December). The value of a futures contract is Euro 125,000.00 and the minimum variation is 0.0001 tick, then € 12.50 per tick.
Trading with OPTIONS
Options are trading instruments that in Forex are fairly recent. They are listed on regulated markets, and the contract characteristics are standardized.
They give to the purchaser, upon payment of a premium, the right, but not the obligation, to buy (call) or sell (put) a specified quantity of the underlying asset at a specified price at a specified future date. The seller of an option instead sells the right described above.
The disadvantages of this instrument, compared to the usual and famous Spot activity, are determined by the much more limited trading hours and the lack of liquidity.
But there is an advantage that offsets the previous disadvantages, that is the flexibility given by the possibility to build strategies, even very complex, which give way to earn even in markets that maintain lateral price range. Options are definitely the latest tools that are used for the operation on currencies.
Trading with ETF
ETF stands for Exchanged Traded Fund.
ETFs are, for the most part, passively managed funds, or funds that replicate the performance of an underlying.
These instruments are primarily used for a rapid creation of diversified investment portfolio, being this funds also built on different underlying gathered in one fund, or, as in the case of Forex, to allow investors to hedge and reduce the risk of their operations in other markets by investing easily on Forex market.
Order Types you can use when trading forex
The trading orders in Forex are those commands that are given to the broker via a telephone or, as is primarily done today, via a connected computer. The order family is divided into two major groups: market orders and pending orders.
The Forex Market orders
This is the most common type of order.
The characteristic of this order is to be unconditioned, ie when you enter this command, you confirm that you accept, without any conditions, to enter or exit the market at the price that is provided to you at that time by the broker.
Usually this type of orders are used for a “by ear” operation, ie when, being in front of the monitor, you recognize in that precise moment the perfect conditions for opening a positon in the market. A market order is in fact used when you want to perform an immediate purchase at the current market price.
This order is communicated directly to the broker who, without hesitation, will endeavor to give you back an executed order. In the case of forex, that price is what is expressed on the trading platform as the bid or ask price, or what is communicated orally via telephone. This order is then used to immediately open a new buy or sell position, or to close and exit from a position previously opened.
In the case of fast market (it is also said of high volatility) and depending on the characteristics of the broker, you may want to enable the maximum deviation from the quoted price, very useful in those phases of order process that take too long, or during exhausting re-quotes. This function allows you to set a maximum deviation in pips from the initial quoted price, that when you have given the order, to which you are still willing to accept that the buy or sell order is executed.
The Forex Pending orders
Pending orders are also called conditioned orders, because they are executed by the broker provided that certain conditions in the market are met. Obviously the conditions that must be met are those set by the trader.
Among conditional orders there are:
They are various type orders, of buy or sell, set by the traders and taken over by the broker, who automatically forwards them to the market upon the occurrence of a certain condition. Until this occurs, the order stays resident on the servers of the broker.
The most common use of Pending Orders is the setting of one or more levels of price protection for the operation (stop loss) or profit-taking (take profit), or of market entry at the achievement of certain price levels.
The two categories of pending orders
Pending orders for entering the market are divided into two major categories: limit (LMT) and stop (STP)
The LIMIT Pending Orders (LMT)
The limit order indicates that the trader is willing to buy or sell at a better price than what the market is “quoting” at that time.
It’s also widely used for the automatic exit from a position in profit and in that case it takes the name of Take Profit (TP)
current quotation of the price at 1.2500.
– Sell limit 1.2550 (sell condition at a higher price than the one the market quotes at this time, therefore better for a seller).
– Buy limit 1.2450 (buy conditions at a lower price than the one the market quotes at this time, so better for a buyer).
When you set a limit order, you imagine that the price, before making a move in a certain direction, retraces like a pull back, or that it performs an inversion movement, minor with respect to the main direction of the current trend, for then resuming the movement in favor of the main trend.
The STOP Pending Order (STP)
The Stop order indicates that the trader is willing to buy or sell at a worse price than what the market is “quoting” at that time.
When you enter a stop order, you imagine to enter or exit the market at the breaking of certain price levels (break out). Is much used for the exit from a position, when this comes against you, in an attempt to limit the losses. In this case it takes the name of Stop Loss (SL).
current market price at 1.2500
– Buy Stop 1.2550 (buy conditions at a higher price than the one the market quotes at this time, then worse for a buyer).
– Sell Stop 1.2450 (sell condition at a lower price than the one the market quotes at this time, then worse for the seller).
When you enter a stop order, you imagine that price, once get and broken certain levels, will continue and accelerate in that direction.
The various types of Forex Trader you can become
In Social Trading (or, as it was called at the beginning, Mirror or Copy Trading, discover the differences here) one of the main figures is the trader, also called Signal Provider, ie the person who provides the trading signals that are copied by the investors who follow him, called precisely followers.
A Signal Providers is nothing more than a trader who, in person or via an automated trading systems called Expert Advisor (EA), operates on the markets.
In this post we will see the various types of forex traders (or the forex trading types).
What is a trader?
A trader is any person who operates on the markets, for working, for passion or for living.
We can distinguish the types of forex traders in many ways. Many of the distinctions we will see are determined by the character of the trader, as well as the course of study and interests that led the person to becoming one.
Amount of underlyings on which they operate
There are traders who operate in many markets, dealing with many underlyings. Usually these traders, to follow them all, work with a long time horizon, in which the daily movements of the individual underlying will not affect particularly a singular transactions.
It’s certainly a very relaxed trading, and the trader has time to range between various markets and underlyings, and calmly decide when overweighting his investments and when underweighting them. Usually this type of trader has almost the connotation of investor.
Other traders instead prefer a more exclusive operation, choosing just a few markets, many times just one, and with few underlyings, very often only one. This makes them more similar to speculators, who invest and earn on every slightest price deviation of that single underlying.
The categories in this case are three.
Trend Follower: they have very long time horizons, they enter the market trying to guess very important movements of the underlying (not the individual daily fluctuations), which obviously don’t occur every day, and for this reason, they range between many markets and many underlyings, in order to increase the number of investment opportunities. The average duration of their operation could be weeks, months, even years in some cases.
Swing Trader: for swing trading is meant the type of trading that seeks to gain from those decided and sudden market movements, that can last one or several days, and that are called precisely swing. Usually the operations last more than one day but less than a week, but there can be exceptions of course.
Day traders: these are traders who try to gain from the daily price movements of the underlying they follow regularly. Their operations are almost always closed by the end of the day, rarely the next day. Given the time horizon of their operations, they usually prefer more underlyings, but remaining confined within a single general market, not to dissipate their energies; for example two, three or four pair of the Forex market.
A sub-category of the day traders is the Scalper. He’s definitely the most speculative and frantic figure of the market. These are traders who operate with very consistent leverage and very short timescales, in the order of minutes or seconds per transaction. Their goal is to close in profit a lot transactions with small gains during the course of the day.
Another thing that distinguishes traders is the type of study they have done before deciding whether to open a position in the market.
The two main categories in this case are:
– Traders who rely on fundamental analysis. They are usually the more long-term investors, who dedicate themselves to the study of fundamental, theoretic and global nature information.
Depending on the underlying asset, the relevant information may be different: We range from single company news, to forecasts on commodities, to countries economic conditions, to macro-economic analysis and monetary and political situation, rather than to the analysis of a segment of the market and the company’s competitors, and with regard to currencies, in particular to the decisions of central banks.
– Traders who entrust their operational decisions on technical analysis.
Usually swing, day traders and scalpers use a market approach of this kind (but also in the long term is much used). These traders claim that any news, event, geopolitical situation (and so on and so forth) is already showed, ie represented, in the price.
They think the price already includes and shows everything. According to these theories, all that remains to do is read the price, analyze the behavior and configurations with technical tools, and act accordingly.
The common denominator of every trader
In any case, distinctions aside, the lowest common denominator that brings together all the traders is that they are people who do their studies and their analysis usually in front of one or more PC monitors , dedicating their workday to this activity, which can be more or less longer compared to a traditional job.
With the evolution of computer science, some of them have managed to bring their decision-making patterns within a complex system of computing rules, creating automated trading systems, or Expert Advisor, which, thanks to a minimum or no supervision at all, operate on the market on behalf of the trader.
How the Buy long – Sell short operations work in Forex
When trading, a forex trader will buy or sell or, to put it in the jargon, will go long or short on a determined underlying, which for the foreign exchange market will be a currency pair.
With this lesson we will focus on both operations.
The Buy Long operation
The purchase of an underlying is a very easy and intuitive transaction.
Buying EUR / USD or going long on EUR / USD means buying that currency exchange.
In the reality, in the currency market to buy EUR / USD means specifically buy Euros and sell Dollars, so, as they say in the jargon, be long on the Euro and short on the Dollar.
Ultimately, with a single operation you instead make two of them. In practice, however, the reasoning behind the mechanism is much easier if you imagine the transaction of purchasing EUR / USD as the purchase of any common underlying. Once you have purchased the underlying, in order to gain you just have to hope that the quotation, that is the market price, goes up, so you can resell your underlying asset at a price higher than that at which you bought it.
So, if you buy EUR / USD at a price of 1.3350, and the price would go up at 1.3400, you would have gained 50 pips when selling it. Then, we know that the value of the pips varies in function of the Lot Size used for the transaction.
If, however, after the purchase of EUR / USD at a price of 1.3350, the price had dropped to 1.3300, buy selling it on the market you would have lost 50 pips.
Let’s make a very practical example, that for the buying operation is not very useful, because I think you have easily understood it, but that will come in handy shortly for the comparison on the sell/short paragraph.
Let’s say that you have a shop of home appliances. Your goal will be to buy the goods at a lower price than that at which you will sell them.
You bought a washing machine for 300 euro, knowing that you can resell it at 550 Euros, making money on the difference. If everything goes smoothly and there are no unforeseen circumstances, you’ll be able to sell it at that price and you will get your profit, with the simple logic behind the purchase transactions.
Buy low, sell high.
If by chance, a few weeks after your purchase, the same washing machines brand or the competitor will present a clearly superior model, making yours looks obsolete, maybe you would find yourself having to sell your washing machine below cost, for example at 200 euro (cashing a loss of 100) in order to be able to find buyers on the market.
It is said that the buyer has a bullish view, ie he believes and hopes that the market price of what he has bought will go up.
The Sell Short operation
Let’s look at the opposite operation: the sell.
The sell is the other base operation for trading the forex market. The sale of the underlying is easy and intuitive if you already own the underlying. Quite simply, if you have the EUR / USD pair (because you have previously made a buy transaction), or the washing machine of the previous lesson, at some point you will decide to close your position by selling it. If you collect more than what you paid, then you will have a profit, otherwise a loss.
But this is a classic sale, it’s not the “short sell” that is made in Forex, which is the subject of this lesson. The short selling of the underlying transaction is less intuitive, but not so difficult. Sell short the EUR / USD or going short on EUR / USD means selling that currency pair.
The first question you’re probably making is, “How can I sell something I don’t have?“.
The reasoning behind the short sell is simple. You sell now to someone the EUR / USD pair at the price of 1.3350, in the hope that the price will drop to 1.3300, so to be able to buy it for those who you have already sold it and deliver it at the time of closing of the transaction, with the net gain of 50 pips.
If, once sold the EUR / USD at the price of 1.3350, the market price would go up to 1.3400, to close the transaction you should buy on the market at a higher price than what you previously sold, and you will take a loss of 50 pips.
To make things clearer, I’ll give you a more domestic example, and again I compare it to a dealer of home appliances.
Let’s say that in this case you still don’t have the washing machine in the store, and a housewife come to buy one. You let her see the catalog and she get convinced of brand and model. At that point you sell it, or you short sell it, because you do not have yet the washing machine. The lady pays for the washing machine 550 Euro.
Now what you need to do is go to your supplier and find that washing machine at a lower price than what you have sold it. If you will find at 300 euro, you will buy it and deliver it to the lady, profiting from the difference.
In the event that, after selling the machine to the lady at 550 €, there was a sudden increase in the value of the same, perhaps because of a particular news that had driven all the housewives to want that model, even the wholesale price probably would rise and you would not be able to find the washing machine from your suppliers for less than 600 Euros. In this case, in order to honor your contract, you should still buy it to deliver it to the lady, but in this case taking a loss.
It is said that those who sell short have a bearish view, ie they believes and hopes that the price will fall. Here you have explained the short selling operation.
We wanted to explain you what “Short selling” means because it’s a concepts that is often used in the finance and trading world, but always remember that in Forex, when you go Short on an exchange, you’re not short selling.
In Forex, when you are Short on a currency pair it means that you are buying the quote currency and selling the base currency, so we are always in the case of a normal transaction when you first purchase something and then sell it.
Forex Course: Summary and Conclusions
Now that you’ve learned all the technical characteristics of the Forex market, that you know its participants and what you can do within it, I would say we can conclude this course.
As you have discovered, the characteristics of the foreign exchange market called Forex are truly unique, and they are the reasons why it’s the market that is growing the most and is giving the greatest number of opportunities to anyone who wants to challenge themselves seriously with the investing activity.
Forex: let’s make a summary
Let’s summarize them here:
- ACCESSIBILITY: The Forex market is certainly the most accessible of all. The money needed to be able to open an account are now very few, and the tools to manage your own accounts are free and easy to use, plus the fact that internet is full of resources for learning.
- FLUIDITY: The Forex is open 24 hours a day, 5 days a week. This means that the price movements are fluid during the week, without interruption. Traders that take advantage of technical analysis appreciate this characteristic because it allows a precise and tidy analysis.
- SPEED: Opening an account is really easy. For a demo account an e-mail is sufficient, and it takes 1 minute to get it. For a live account instead, you just have to fill out the forms on the web page (1 minute) and send the photocopies of the requested documents, either by normal post mail, either much more simply using a scanner via web (5 minutes in this case). You must then obviously make a fund deposit, and the ways to do it are many, from the classic wire transfer, to the credit card, or PayPal, etc.. Times may vary, but with the fastest one it only takes from one to two days. Result: in 2 days you can be ready to go and use your account to invest in the Forex market.
- LIQUIDITY: Due to the participation of virtually any financial institution, primarily central banks, the liquidity of the Forex market has no equal. It’s by far the most liquid in the world, which means that buyers and sellers will always find a counterparty to perform the tasks they want. Illiquid markets may instead put you in the awkward position of wanting to buy and not finding anyone willing to sell, or even worse of wanting to sell (maybe to stop the losses of an operation) and don’t find anyone willing to buy.
- OFFER: brokers that offer the opportunity to get access to Forex are many and, given the competitiveness among them, the services they offer to the investor are significantly improved in quality and accuracy. But always be careful, do not trust too much the unknown names or the newcomers. Always entrust the well-known broker and those where you can find a sufficient number of feedback (check out our list of the best forex brokers for beginners).
- CONVENIENCE: competition among brokers has made sure that the costs for Forex trading would decrease drastically. We can say that the costs are represented in trading commissions, and we can say with certainty that the fees required to operate in the Forex market (spread) are the lowest ever. This means that your earnings are not affected by continuous reductions that progressively cut out your income.
- LONG / SHORT: as seen in the last lesson, we not only can buy, then gain if an instrument increases in value, with Forex we can also short selling and earn if something loses value. This means that there are double chance for a savvy trader to profit from these movements.
- SOCIAL TRADING: The last positive characteristic which distinguishes Forex it’s without doubt the possibility to invest in it with Social Trading. Very hardly this particular form of investment could have been able to develop and expand without the flexibility, accessibility and power of the largest market in the world.
Forex in conclusion
Forex is literally a goldmine of opportunities for those who know how to trade like a professional.
And now you also have Social Trading, that allows you to avoid to become a professional trader. You can, much more easily, choose the winning traders that you like, and do what they do, gaining in percentage as they gain. This is what is called financial progress.
The next course is dedicated precisely to Social Trading, from its birth, to its main features, to its hidden sides.
Your chance to start making money by investing is getting closer.
Forex Trading: What is Forex? – FAQs
How do I start trading forex?
Starting to trade, you should choose a broker first. A demo account that is free and ideally unlimited is a good place to start. When you feel ready, you will need to verify your account for live trading. You should prove your identity, residence, and answer KYC questions before making a deposit.
What is forex and how does it work?
Forex stands for “Foreign Exchange”. Trading forex is basically exchanging your money with other currencies and taking advantage of their changes in value to make a profit.