The Fundamentals of Forex Trading
Gregory: “Draw thy tool . . .”
Sampson: “My naked weapon is out.”
—Shakespeare, Romeo and Juliet
Welcome to the world of forex trading. Forex is the largest market in the world. Forex traders exchange $4 trillion each day, but is forex the best market for you? The answer depends on what you
are looking for. If you want a market that never sleeps, if you want the opportunity to trade at any time of the day, if you would like to make a boatload of money in a short amount of time, forex may be for you (it should be noted that you may also lose an incredible amount of money in a short amount of time). Traders with very little money can begin trading forex. In forex, you may take relatively large trades with small amounts of money because of the favorable leverage requirements. There are many reasons to become a forex trader, but before jumping into the reasons, perhaps we should take a closer look at the characteristics of a forex trade.
A QUICK LESSON IN CURRENCIES
“Forex” is simply an abbreviation for “foreign exchange.” All foreign exchange transactions involve two currencies. If an individual trader, a bank, a government, a corporation, or a tourist in a Hawaiian print shirt on a tropical island decides to exchange one currency for another, a forex trade takes place. In every instance, one currency is being bought and, simultaneously, another currency is being sold. Currencies must be compared to something else in order to establish value; this is why forex trading involves two currencies.
If you and I go to the beach and I tell you the tide is low right now, how do you know this is true? You may decide to compare the current water level to the pier. If there are starfish and mussels exposed on the pier, you may believe me because you can compare the current water level to the previous water level. In forex, we compare currencies in much the same way, currencies are traded in pairs and, thus, one currency is always compared to another currency.
An example may be helpful to illustrate how currencies are traded. If you are a hotshot forex trader, and you believe that the EUR/USD is going go up, you may decide to buy the EUR/USD. Thus, you think that the Euro currency will get stronger, and the U.S. dollar will weaken. You are buying the EUR/USD currency pair, another way to look at this is to say you are buying Euros and simultaneously selling U.S. dollars. The unique (and often difficult to understand) aspect of forex trading to keep in mind is this: Each forex transaction involves the buying of one currency pair and simultaneously the selling of another currency pair.
If you have experience buying or selling in any market—the stock market, a futures market, an options market, the baseball card market, or the used car market—then you understand markets. For any market transaction a buyer wants to buy something and a seller wants to get rid of something.
The forex market is simply amoney market, the place where speculators exchange one currency for another. In many ways, the forex market is no different from the stock market. The major differences between forex and the stock market are as follows: A forex transaction involves buying one currency pair and selling another, also, the symbols to identify forex pairs are consistent and systematic, unlike the symbols used to identify companies listed on a stock exchange.
Forex traders buy and sell countries. It is true: Forex traders are basically buying “shares” in a country, just as a stock trader buys shares in a company. For example, if forex trader Emma decides to sell the EUR/USD, she is essentially selling the European Union (and buying the United States). To be even more specific, we might suggest Emma is buying the economy of the United States, and selling the economy of the European Union. Does this mean that Emma must keep tabs on all the economic data for all the countries that she is trading? The short answer is no, but we will
talk more about news and trading based on economic news and data a bit further on in this book.
Just as a stock has a symbol, so do currencies. Table 1.1 illustrates the most popular currencies and their symbols. Do you notice a pattern? There is a secret code for currencies. The three-letter code for each currency pair is composed of the country (first two letters) and the name of the currency (last letter). So, for example, the Japanese yen is JPY, the “JP” stands for Japan, and the “Y” stands for Yen. The currencies listed in Table 1.1 are the major currencies; these are the most widely traded currencies.