Getting Started in Currency Trading

Winning in Today's Forex Market

Michael D. Archer

• Publisher: Wiley
• Year: 2010
• Print ISBN: 9780470602126
• eBook ISBN: 9780470609279
• Edition: 3
• Topic: Business
• Subtopic: Foreign Exchange
• Index: Business

An accessible introduction to trading currencies

While the Foreign Exchange (Forex) market can be a very profitable place, you must have a firm understanding of how to operate within this environment if you intend on achieving any success.

That's why you need Getting Started in Currency Trading, Third Edition. This reliable resource-written for both newcomers and those with some Forex experience-puts trading world currencies in perspective, and shows you exactly what it takes to make it in this field.

• Guides you through the process of opening your own account as well as the actual placing and managing of currency orders
• Offers specific trading strategies and tactics
• A companion Web site will provide updates on brokers and FOREX services; an author's Blog will answer your questions about all aspects of trading
• Includes a new chapter on Forex trading platforms
• The often confusing FOREX calculations are reduced to handy computer-side tables

On the heels of the recent market crash, this fully revised Third Edition is filled with in-depth insights and practical advice that takes into account all of the recent changes in the currency market and shows you how to profit from them.

Part 1

The Foreign Exchange Markets

Chapter 1

The FOREX Landscape

Introduction—What Is FOREX?

Foreign exchange is the simultaneous buying of one currency and selling of another. Currencies are traded through a broker or dealer and are executed in currency pairs; for example, the Euro Dollar and the U.S. Dollar (EUR/USD) or the British Pound and the Japanese Yen (GBP/JPY).

The FOReign EXchange Market (FOREX) is the largest financial market in the world, with a volume of more than $2 trillion daily. This is more than three times the total amount of the stocks and futures markets combined.

Unlike other financial markets, the FOREX spot market has neither a physical location nor a central exchange. It operates through an electronic network of banks, corporations, and individuals trading one currency for another. The lack of a physical exchange enables the FOREX market to operate on a 24-hour basis, spanning from one time zone to another across the major financial centers. This fact—that there is no centralized exchange—is important to keep in mind as it permeates all aspects of the FOREX experience.

What Is a Spot Market?

A spot market is any market that deals in the current price of a financial instrument. Futures markets, such as the Chicago Board of Trade, offer commodity contracts whose delivery date may span several months into the future. Settlement of FOREX spot transactions usually occurs within two business days. There are also futures and forwards in FOREX, but the overwhelming majority of traders use the spot market. I discuss the opportunities to trade FOREX futures on the International Monetary Market.

TABLE 1.1 Major FOREX Currencies

Symbol	Country	Currency
USD	United States	Dollar
EUR	Euro members	Euro
JPY	Japan	Yen
GBP	Great Britain	Pound
CHF	Switzerland	Franc
CAD	Canada	Dollar
AUD	Australia	Dollar

Which Currencies Are Traded?

Any currency backed by an existing nation can be traded at the larger brokers. The trading volume of the major currencies (along with their symbols) is given in descending order: the U.S. Dollar (USD), the Euro Dollar (EUR), the Japanese Yen (JPY), the British Pound Sterling (GBP), the Swiss Franc (CHF), the Canadian Dollar (CAD), and the Australian Dollar (AUD). See Table 1.1. All other currencies are referred to as minors and those from smaller countries, exotics.

FOREX currency symbols are always three letters, where the first two letters identify the name of the country and the third letter identifies the name of that country’s currency. (The “CH” in the Swiss Franc acronym stands for Confederation Helvetica.)

A FOREX transaction is always between two currencies. This often confuses new traders coming from the stock or futures markets where every trade is denominated in dollars. The price of a pair is the ratio between their respective values. Pairs, crosses, majors, minors, and exotics are terms referencing specific combinations of currencies. I discuss these terms in Chapter 5, “The FOREX Lexicon.” They are defined in the Glossary.

Who Trades on the Foreign Exchange?

There are two main groups that trade currencies. A minority percentage of daily volume is from companies and governments that buy or sell products and services in a foreign country and must subsequently convert profits made in foreign currencies into their own domestic currency in the course of doing business. This is primarily hedging activity. The majority now consists of investors trading for profit, or speculation. Speculators range from large banks trading 10,000,000 currency units or more and the home-based operator trading perhaps 10,000 units or less. Retail FOREX, as much as it has grown in the past 10 years, still represents a small percentage of the total daily volume but its numbers and significance are growing rapidly.

Today, importers and exporters, international portfolio managers, multinational corporations, high-frequency traders, speculators, day traders, long-term holders, and hedge funds all use the FOREX market to pay for goods and services, to transact in financial assets, or to reduce the risk of currency movements by hedging their exposure in other markets.

A producer of widgets in the United Kingdom is intrinsically long the British Pound (GBP). If they sign a long-term sales contract with a company in the United States, they may wish to buy some quantity of the USD and sell an equal quantity of the GBP to hedge their margins from a fall in the GBP.

The speculator trades to make a profit by purchasing one currency and simultaneously selling another. The hedger trades to protect his or her margin on an international transaction (for example) from adverse currency fluctuations. The hedger has an intrinsic interest in one side of the market or the other. The speculator does not. Speculation is not a bad word. Speculators add liquidity to a market, making it easier for everyone to transact business by setting efficient prices. They also absorb risks that exist in the marketplace. This latter differs from the gambler who creates risks in order to take them.

How Are Currency Prices Determined?

Currency prices are affected by a large matrix of constantly changing economic and political conditions, but probably the most important are interest rates, economic conditions, international trade, inflation or deflation, and political stability. Sometimes governments actually participate in the foreign exchange market to influence the value of their currencies. Governments do this by flooding the market with their domestic currency in an attempt to lower the price or, conversely, buying in order to raise the price. This process is known as central bank intervention. Any of these factors, as well as large market orders, can cause high volatility in currency prices. Reports of sudden changes in such factors as unemployment can drive currency prices sharply higher or lower for a short period of time. In fact, news traders specialize in attempting to capitalize on such surprises. Technical factors, such as a well-known chart pattern, may also influence currency prices for brief periods. However, the size and volume of the FOREX market make it impossible for any one entity to drive the market for any length of time. Crowd psychology and expectations also figure in the equation determining the price of a currency relative to another currency. There are an enormous number of correlations between all these factors and they are almost certainly nonlinear in nature. That means they are constantly changing and rearranging themselves, sometimes in nonpredictive ways. Now you see it, now you don’t. If you focus on one or a few of them, the others might change unnoticed. Quantum theory comes to mind.

Why Trade Foreign Currencies?

In today’s marketplace, the dollar constantly fluctuates against the other currencies of the world. Several factors, such as the decline of global equity markets and declining world interest rates, have forced investors to pursue new opportunities. The global increase in trade and foreign investments has led to many national economies becoming interconnected with one another. This interconnection, and the resulting fluctuations in exchange rates, has created a huge international market: FOREX. For many investors, this has created exciting opportunities and new profit potentials. The FOREX market offers unmatched potential for profitable trading in any market condition or any stage of the business cycle. These factors equate to the following advantages:

• No commissions. No clearing fees, no exchange fees, no government fees, no brokerage fees if you trade with a market maker.

• No middlemen. Spot currency trading does away with the middlemen and allows clients to interact directly with the market maker responsible for the pricing on a particular currency pair, if you trade with an Electronic Communications Network (ECN).

• No fixed lot size. In the futures markets, lot or contract sizes are determined by the exchanges. A standard-sized contract for silver futures is 5,000 ounces. Even a “mini-contract” of silver, 1,000 ounces, represents a value of approximately $17,000. In spot FOREX, you determine the lot size appropriate for your grubstake. This allows traders to effectively participate with accounts of well under $1,000. It also provides a significant money management tool for astute traders.

• Low transaction cost. The retail transaction cost (the bid/ask spread) is typically less than 0.1 percent under normal market conditions. At larger dealers, the spread could be as low as 0.07 percent. Prices are quoted in pips for currencies. Today pip spreads can be zero at some periods for the most actively traded pairs, but typically range from two to five pips.

• High liquidity. With an average trading volume of more than $4 trillion per day, FOREX is the most liquid market in the world. It means that a trader can enter or exit the market at will in almost any market condition. I must note that at the time of the first edition of Getting Started in Currency Trading in 2005, the daily volume was slightly less than $2 trillion.

• Almost instantaneous transactions. This is an advantageous byproduct of high liquidity.

• Low margin, high leverage. These factors increase the potential for higher profits (and losses) and are discussed later. Traders have access to leverage of up to 400 percent although 50 percent to 100 percent is most common. 400:1 leverage means $1 controls $400 of currency.

• A 24-hour market. A trader can take advantage of all profitable market conditions at any time. There is no waiting for the opening bell. Markets are closed from Friday afternoon to Sunday afternoon. As the markets transition to the Asian Session, they usually go quiet from 5 P.M. to 7 P.M. Eastern Standard Time.

• Not related to the stock market. Trading in the FOREX market involves selling or buying one currency against another. Thus, there is no hard correlation between the foreign currency market and the stock market although both are measures of economic activity in some way and may be correlated in specific respects for a limited period of time. A bull market or a bear market for a currency is defined in terms of the outlook f...

Table of contents

• Title Page
• Copyright Page
• Dedication
• Introduction
• Part 1 - The Foreign Exchange Markets
• Part 2 - Getting Started
• Part 3 - The Tools of the Trade
• Part 4 - The Complete FOREX Trader
• Part 5 - Extra for Experts
• Appendix A - How the FOREX Game Is Played
• Appendix B - List of World Currencies and Symbols
• Appendix C - Euro Currency Unit
• Appendix D - Time Zones and Global FX Trading Hours
• Appendix E - Central Banks and Regulatory Agencies
• Appendix F - Resources
• Appendix G - FX Calculation Scenarios
• Glossary
• Index