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Forex — what is it in simple words

Many of you have faced advertisements with the incomprehensible word "Forex". The first association with this word for an ordinary person is some kind of ephemeral concepts: stocks, stock exchange, Wall Street. The purpose of this material is to convey to people far from the economy what Forex is. Everything is not as difficult as it seems. It is better to learn such a thing as a forex topic step by step. So here we go.

Forex market — what is it and how it works

Forex stands for Foreign Exchange. It’s a currency exchange market. Like a regular exchange point on the street. The difference is that the Forex covers all the continents of the world. Traders are ones who need to make an exchange and brokers help them to make it.

Let's delve deeply into the forex topic. What is it and how does it work? The essence of earnings is the analysis and forecasting of a fall or rise in the price of a currency. The market is open 24 hours a day, 5 days a week. Because of the rotation of the earth around its axis. First the sun rises in Asia and the Asian market is trading. Then Europe's time comes after a while. The USA starts trading after that. Later the situation repeats again and again, except on weekends and holidays. And now we’ll add some termins, which help you to figure out what forex really is.

Basic concepts for a trader-beginner:

The main theses underlying Forex trading:

  • A unit of activity is a transaction. Selling or buying currency.
  • Each transaction is only within one currency pair. For example, the Euro-Dollar. Here the Euro is a base currency, and the Dollar is a quoted one.
  • We should consider the number of a quote up to the 5th symbol after the point. For example, 1 Euro is worth 1.2005 Dollars. The minimum step in this case is 0.00001. Or, more simply, — one point.
  • Earnings appear due to changes in the currency quote over a period of time. For example, we bought Euro for 1.2005 cheaper (one transaction), sold it an hour later for 1.20122 more expensive (another transaction).
  • In this EUR/USD=1.20005/1.20122 pair, the 1st value is the Ask price, the 2nd value is the Bid sell price. The difference between Ask and Bid is called Spread.
  • A trader is allowed to use leverage. Imagine that our target is buying 100,000 Euros for 107,000 USD (quote is 1.0700). In this case, the leverage is 1:100. So it’s enough for a trader to invest a 100th part of 107,000, namely $1,070 to open a transaction.
  • We call the one 100,000 of any currency the lot, to avoid piling up zeros.
  • You can earn in two cases: when the market grows or falls. In the first case, traders are called "bulls", in the second — "bears".

How can traders earn on Forex

We’ve managed with the forex market definition and its basic principles. But there is no ultimate answer to the question in a beginner's brain — how to really make money on Forex.

definition of the forex market

Of course, start-up capital is required to start trading. But before actually entering the market and spending real money, you should practice a lot on free demo accounts, monitoring the dynamics of the currency market, identifying trends and analyzing past periods. “So should I really look at the screen all the time, analyzing the charts” a beginner thinks. “I came here for a bag of money, and not for spoiled eyesight.” Everything is not so sad, you’ll be rewarded for spending time.

Pending Orders

In fact, after a novice investor develops the skill of analyzing and forecasting prices to a certain level, the cool tool “Pending orders” opens before him. It allows you to open a transaction in advance and set the maximum allowable values ​​of quotes, when the profit is as effective as possible, and the risks of losses are minimized. It means that we can open a transaction in advance and wait for profit. Forex can be turned into a relatively passive income.

Pending orders can be as follows:

  • To open transactions:

o   o   Buy limit

o   Sell limit

  • To close transactions:

o   Take Profit

o   Stop Loss

To effectively use pending orders, you should look at them using examples.

The first example is opening a transaction. Let's say the quote for the Euro/Dollar pair is 1.03000. We have indicated for ourselves that it is profitable for us to buy if the price falls to 1.02000 and sell if it rises to 1.04000. These numbers can be reached in one moment and then the market forces them to bounce in the opposite direction. We don’t want to miss that very moment, so we set a pending order “Buy limit” at 1.02000 and “Sell limit'' at 1.04000. Further, the transaction will automatically open when these values ​​are reached.

The 2nd example is closing a transaction. To effectively complete the "maneuver", the transaction should be automatically closed. Let's say we bought for 1.02000, and at the same time prices continue to change. We set a pending “Take Profit” order in advance. And when the profit grows to a certain level, the transaction is automatically closed. At the same time, a “Stop Loss” order was set. And with a price jump that leads you to a loss, the deal will automatically close when the maximum allowable loss is reached. Which you have set in advance.

In addition to pending orders, you can also adjust your trades manually. Trader’s level is in the successful combination of manual control and automation.

forex currency price analysis

So we have found out what forex is. And also we have considered the benefits of using pending orders. But all this is a consequence - the process of closing transactions directly, which takes 20% of mental activity. But the main 80% of brain work falls on price analysis. Let's figure out how to analyze currency quotes in the forex market.

Currency’s price analysis methods

There are 3 ways to predict the future currency quote:

  1. Fundamental analysis.
  2. Technical analysis.
  3. Computer analysis.

Let's consider step by step.

Fundamental analysis.

Let's return to the Euro/Dollar currency pair. We, as traders, are interested in what will happen to the price of the dollar in the future.

First of all, we look at the fundamental things that are happening and expected in the homeland of the currency — in the United States. These can be:

  • Political factors: presidential elections are expected, a referendum is being held, there are citizens’ strikes on the streets, changes in foreign military policy are expected.
  • Psychological triggers: rumors about a change in the financial situation in the media, oral bank CEO’s speech at a conference.
  • Other force majeure that occurs in America: hurricanes, tornadoes, tsunamis, impact on the work of oil rigs in the ocean, man-made disasters at industrial enterprises, etc.
  • The economic aspect, namely the publication of macroeconomic indicators. Whether it's GDP, tax rates, unemployment, inflation and interest rates in the country.

Traders disagree on how important fundamental analysis is. Some of them say that it must be considered anyway. Others tend to trust technical analysis more. Let's take a look at it.

Technical Analysis

Trends

Supporters of technical analysis have a right to defend it. Because theoretically this tool already contains within itself the factors mentioned above.

Technical analysis in Forex is discovering currency rate changes using charts.

Based on them, the trader monitors the trend of price changes. One of three ones:

  1. Up-trend or "Bull trend" — the trend of rising currency prices.
  2. Down-trend or "Bearish trend" — a tendency for quotes to fall.
  3. Lateral trend — when prices are approximately in the same range during the period.

In this case, be sure to take into account the period within which the trend is formed. Is it a month, a week or an hour? Therefore, there are long-term, medium-term and short-term trends. Without reference to the period, the chart does not show us the real statement of things. For example, in the context of the day there may be an increase, for a week as a whole — a fall, and within a month — without changing. Finally it’s not clear which of the trends should be based on when forecasting.

Time frames

Therefore, for the correct analysis, all charts should be limited to time frames (trading periods). A detailed description of time frames is given in another material, now let's focus on the main theses.

What does this indicator show? As we know, the currency price chart is built in the coordinate system XY, and the Y-axis shows the values ​​of currency quotes, and the X-axis reflects the same time step — the time frame. Using it a trader figures out how often the price changed. Frames are marked. For example, H5 (Hour 5) reflects the price trend every 5 hours, and W2 (Week 2) — every 2 weeks.

Types of charts

We have already known that the timeline is a mandatory attribute of a chart. In this case, the type of chart can be different. Three main types are:

  1. Linear connection of points.
  2. Bars.
  3. Japanese candles.

More details about each of them can be found in the article about time frames.

Computer analysis

This type of analysis is auxiliary to fundamental and technical. With the special program, you can get additional indicators for analysis, such as:

  • Moving average (MA) price change for a period. For example, we see a price chart. In the trading terminal, select MA5 (with a period of 5). With a timeframe, for example, D1. This means that the price change is shown on average for each of the 5 days within a month. Then take MA with an older period, MA21. At the point where the line with a period of 5 days crosses the "bottom-up" line MA21, it is necessary to open transactions to buy. With a similar top-down intersection, it's time to sell.
  • Relative Strength Index (RSI) of the trend. It shows how much the market for a particular currency pair is overbought or oversold at the moment. In the terminal, limits are set in percentages (for example, 20% and 80%). Anything over 80 is overbought, anything under 20 is oversold. If we are in the area less than 20, then at the moment the level of sales for the currency pair significantly exceeds the level of buys. But this situation will not last long. The market will go up. And just at the intersection of 20%, the RSI indicator gives a “buy” signal. In a similar situation from top to bottom up to 80% — a signal to sell. 

More deeply description about indices is in the article about convergence and divergence.

Which analysis is better

There is no such thing as one method being better than another. Firstly, it is most effective to combine them. Secondly, everything works differently in different hands. It depends on the person himself, his mindset, temperament, level of excitement and logic of thinking.

As a rule, fundamental analysis is used for a long-term perspective, and technical analysis is used for opening/closing of transactions.

The key point in the market is money management. What is it in simple phrases

An important aspect in trading is the management of own capital — money-management. In order to effectively make transactions, while using various combinations and setting pending orders, you need a reserve of funds.

forex money management

You should also define acceptable limits for entering transactions. The standard is the use of 10% of the total deposit for transactions.

Risk assessment

It is advisable for a beginner trader to determine the amount of capital that he is ready to allocate for effective trading. Let's say it's $5,000. Next, you need to make a table and calculate three indicates:

  • Trade entry volumes. For instance, we work with one lot, each point of the fall/growth of the currency costs one dollar.
  • The maximum drawdown of the currency to our bankruptcy and the complete loss of the deposit. For example, we determine that a fall of 10,000 points will completely ruin us.
  • % of invested funds from total capital. As it was mentioned above, the ideal investment is 10% of the capital.

First, we describe the base scenario at 10%, and then we calculate similar numbers with a decrease or increase in indicators.

Finally, we get options to choose from - either a small entry volume, low profits, but minimal risks, or increased risks in the hope of boosting profits.

Summary — where new trader should start

Here is some advices for beginning traders:

  • Give yourself time for training. Today we live in the digital world. So it’s easy for a beginner to find some videos, seminars and master classes on the theory of Forex trading. The theory should not be neglected, you’ll be rewarded for your work.
  • Demo account. Search online or download platforms for demo and trial trading. Just keep trading and develop your skill. You can read more about working on a demo account in a new article.
  • Real account. The purpose of the whole event is to earn money, so after a short time using the demo account, it is worth opening your first deposit on real accounts. Well, go ahead — put the skills into real life.

At all stages, you should trust professional experts. They will also help buy forex leads from and start trading with the right knowledge and a high training level.

A bit about fraud

It is worth carefully approaching the choice of a broker. Entrust your capital to trusted companies that specialize specifically in forex trading and have the appropriate license.

Because in the market in recent years there are more and more so-called "forex kitchens" — companies that aim not to provide honest brokerage services, but to pull out as much money as possible from the client.

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