Forex Trading Tips

What is Forex Trading?

Forex trading refers to buying and selling currencies in the foreign exchange market. Currency is always measured in relative terms. Currencies are traded in the forex market that operates 24hrs a day, 5 days a week. Individuals can participate in the forex market through retail brokers. Exchange rate gives the worth of a currency in terms of another. Simply put, forex trading is a means of earning money by taking advantage of exchange rate movements.

Making Money with Forex Trading

Let us assume that at present 1 USD = .71585 EURO (1 EUR = 1.39694 USD) and a trader has $100,000. He decides to buy EUR at the current price and ends up getting 71,585 EURO. After a few days, the euro appreciates and the new exchange rate is 1 EUR = 1.40101 USD. The trader sells his EURO for USD and in turn makes a profit. This is because on selling EUROs, he gets $100,291.30085; whereas, he started off with $100,000. In other words, in a span of a few days the trader earns $291.30085, which is approximately a return of .29% on his investment. Since 1 pip = .0001 (for EUR/USD pair), the trader made 29 pips.

In case the trader had only $10,000 to begin with, he could have obtained the remaining $90,000 from the retail broker. This is known as margin trading. Had he traded on margin his return would have been 2.91% instead of .29%! This is why leveraging is desirable. Had the trader made a mistake in assessing the direction of the currency movement he might have ended up losing his margin account because of huge losses. This is one of the drawbacks of employing excessive leverage.

Forex Trading Strategies

Theoretically, currency trading appears to be the easiest way of making money. However, in order to profit one needs to assess the direction of currency movements. Extreme volatility in the foreign exchange market makes this a formidable task and discourages people from trading. In order to assess the market one can use fundamental and technical analysis.

Fundamental Analysis: Fundamental analysis is the method of determining the price of the currency by evaluating factors that have a direct bearing on the value of the currency. For instance, if the European economy shows signs of recovery, the EURO would appreciate. Using this information one can trade profitably. This is an example of fundamental analysis.

Technical Analysis: Technical analysis involves studying charts and graphs and comparing past trends and repetitive patterns with the present fluctuations in order to predict the direction of currency movements. Charts used in technical analysis are as follows:

Types of Charts

Line Chart: A line chart connects the opening price and the closing price with a line.
Bar Chart: A bar chart gives the opening price, the closing price, the highest price and the lowest price with the help of a vertical bar that shows the range of the currency for a given time period.
Candlestick Chart: In addition to providing the information that can be obtained from the bar chart, a candlestick chart shows the range between the opening and the closing value for the day, by representing it in the form of a vertical bar. In case the closing value is less than the opening value, the bar is colored.

Chart Indicators

Bollinger Bands: Bollinger bands are used to measure the volatility of the market. When the market is very volatile the bands expand. When the market is less volatile the bands contract. The currency values always tend to revert to the middle and this is the principal behind the Bollinger bounce. When the market is about to break out, a Bollinger squeeze is observed. A market is said to break out when the currency shifts from the narrow band within which it has been trading for some time.
Relative Strength Index: Relative Strength Index (RSI) is used to determine whether the market is overbought or oversold. On a scale of 0 to 100, any value below 20 would mean that the market is oversold; while a value above 80 would indicate an overbought market.

MACD, Parabolic SAR and Stochastics are a few other chart indicators.

Chart Time Frames

Depending on whether one is a day trader, a short term trader or a long term trader, one can use the 5 min/15 min chart, the 1hr chart or the 4hr chart, respectively.

Placing Orders: Just as in the case of stocks, the trader can place a market order, a limit order or a stop loss order in case of forex trading. In addition to these if a trader knows that a breakout is likely but is unsure about the direction of movement of the currency, he can place an OCO (one order cancels the other order) which would result in either buying or selling at a certain price depending on currency movement.

Forex trading can be a rewarding experience for a trader who knows how to use the tools and benefit from the trading platform provided to him by his online broker.