This lesson explains how forex markets behave, and why prices fluctuate. You need to understand this basic information in order to develop your own trading system and to profitably trade in this market.
What is currency trading?
Forex traders make money by selling a currency position for more than they have bought it for. This is similar to other markets, such as the stock market.
One difference however, is that an FX trader can sell a position, and then buy it back later. This is called “short selling”, or going short. A trader would do this if the market will decline. Of course, a trader can also buy a position for sale later at a higher price. This is called “going long”.
It is therefore possible to make money in either up or down markets, as long as you can determine which direction the market will go in.
For every dollar in profit, someone else has lost a dollar. This is because when you “go long”, someone else has “gone short”, and they take the other side of your position. This is called a zero sum game. FX markets neither create or destroy wealth – they only move money from one party to another.
The minimum price movement in the FX market is called a “pip” and this generally represents 0.0001, where a price is quoted to four significant figures, or 0.01 where a price is quoted to two significant figures. This is usually between $8 and $10, depending on the currency pair you are trading.
Start Forex Trading
Most small FX traders lose money when they start forex trading. This is because their average profits are smaller than their average losses. There are several reasons for this:
- The trader may have selected a timeframe which results in brokerage expenses being too high as a proportion of profits. This usually means trying to trade very short term positions, which is difficult and costly.
- Not having a system that determines stop losses. The trader may use a stop loss which is too tight, and results in frequent exit from positions that end up being profitable, or stop losses that are too large and result in erosion of capital.
- Taking small profits instead of large profits. The tendency is to let losses go, but immediately realise small profits. Even professional traders are wrong in over 50% of positions so small profits will not compensate for losses.
- Focussing on predicting the market rather than managing risk. The trader’s efforts go into trying to forecast where the market is going rather than concentrating on identifying existing trends and determining stop losses.
It is very difficult to ALWAYS make a profit. Often a position will move against you, despite your best efforts. You need to know how much adverse movement you need to tolerate before deciding that you have got the direction wrong, and closing out your position at a loss. You need to rely on your trading system to get you out of losing positions without you having to exercise your own judgement. To be a successful trader, you will need to take losses – this is one of the most important currency trading basics. Losses will occur.
Spot Currency Trading
Sometimes traders refer to “Spot Currency trading” or “Spot Forex”. This simply means that you are trading forex in real time. An alternative to spot forex trading is currency futures. These are explained later.
Forex Trading Times
The Forex Market hours are from 5pm ET Sunday through until 5pm ET on Friday.
Trading Online currency
Trading online currencies involves high risk and only risk capital should be used.
Please see the next lessons in this category for more information.