LEARN THE FOREX IN A WEEK

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FOREX 101

You’ve probably heard or read about bid and ask or bid and offer. What are those? Price quotes for a currency pair are double, one for buying and the other for selling. The difference between the two prices is called  the spread,which will be discussed later on. 

As a side note, the opposite is meant when using the same word in a news release. For example, when there is a considerable number of pending orders awaiting for the price to reach a lower value to buy,it is said that there are many bids on  the  market,  but  when  sellers  have  pending orders at a certain price higher, it is said that there are many offers sitting at that price.This happens because the bid price is actually the end-value price of a long position, which is purchased at the ask price to allow for the spread to be paid. The same occurs in the inverse situation; the end-value price of a

short position is the actual offer price, and it is purchased at the 

bid price,so the spread is paid at the moment the particular position is closed.

OPENING A POSITION

The reason for trading the FOREX market is to make money and to diversify your current portfolio. You do this through the positions you take by means of buying and selling a different set of currencies. When a currency rises in value after you have bought it at a lower price, you realize a profit when you close the position at a higher price. At the moment you close the working order, you are selling back the base currency and buying its counterpart  currency.  This  operation  implies  a  relationship  of  relative  worth because  the  value  of  one  of  the  components  of  the  currency  pair  will  be compared with the value of the other one; thus any currency will only have value  as  a  result  of  its  comparison  with  another  currency  of  a  different country.

The position,or order,represents the net amount of exposure in a particular currency and in its counterpart currency because they always work in pairs. The position is said to be flat when there is no exposure, 

long if more currency has been bought than sold,and short if more currency has been sold than bought. When you perform currency trading, you are in fact exchanging one currency for another,expecting that the currency that you buy will see its value rise in comparison with the currency you sell in the operation.In the FOREX market,currencies always trade in pairs. We are  constantly and simultaneously buying one currency (the  base  currency,mentioned first in the pair quote) and selling the other(the quote currency,mentioned second in the pair quote). If we decide to realize the profit,then we need to sell back the currency that we bought earlier at the higher current price. If we decide to hold and do not realize the profit for a while,the amount  of  a  particular  currency  bought  or  sold  is  not  being  sold  to or bought back from the market and thus is said to be an open position.Purchasing a  particular currency pair,where you are  also acquiring a certain  amount  of  the  base  currency and  selling the same amount of the quote currency, is also called going long or longing the market.

If we go long 10,000 units, for example, in the EUR/USD pair, we are purchasing 10,000 units of the euro, which is the base currency, and selling the equivalent sum

in U.S.dollars,  which  is  the  quote  currency,  which  at  a  rate  of  1.40  for

EUR/USD would represent 14,000 units of U.S. dollars. The selling of USD

units guarantees the buying of the EUR counterpart.The  same  rules  apply  in  the  inverse position,where we are then shorting the market or going  short in  a  particular base currency,when you see that its value is decreasing with respect to the quote currency.

Now we would be selling, for example, the 10,000 euro units and buying back the 14,000 units of U.S. dollars because we expect the euro value to decrease, and we would buy it back at a lower dollar price thereafter to realize the profit.One is said to be long in one currency when we buy it and short in that currency when we sell it. Long, or buy, positions use the offer or ask price of the quotes.For example, if you acquire one lot of GBP/USD at a rate of 1.4722 bid/1.4727 ask,this means that you’ll be buying 100,000 GBP units at 1.4727 USD.Short,  or  sell, positions  use  the  bid  price  of  the  quotes. Thus, in the preceding situation,we would be selling 100,000 GBP units at 1.4722 USD.

Trading currency pairs is simultaneous and symmetrical; this implies that we will always be long in one currency and short in another at the same time. In the previous example, if we exchange those 100,000 GBP units at 1.47220 USD, we will be short in pounds sterling and long in U.S. dollars.A position that is running and active will be called an open position. Its value  will  change  depending on fluctuations in market rates. Profits and losses will be influence the margin account but will not be official until the position has been closed.

TRADING ON MARGIN

Trading on margin is equivalent to borrowing money from a bank or a broker to purchase a particular security or currency pair. The margin needed depends on the leverage offered by the financial institution and represents the guarantee needed to control a certain quantity of units.

For example, when using a 100:1 leverage, the trader controls a $100,000

lot with only $1000 on margin in the account. Smaller lot sizes of $10,000 may be controlled with only $100 on margin.

Higher-leveraged  accounts  may  allow  control  of  greater  amounts  of

money in the market with less margin, but this also can be dangerous when

losses are experienced. A lower margin requirement can induce the trader

to risk more than is wise.

MANAGING A POSITION

The  position  can  be  set  up  from  the  start  of  the  trade,  with  its  individual

stop-loss and target-profit levels, or it can be managed as it develops. Set-

ting and trailing the stops, balancing partial profits, and shifting entry prices

in pending stop or limit orders are other ways of managing your trades.

CLOSING A POSITION

A position will be closed automatically when it reaches either the target-

profit or stop-loss set price resulting in a loss. Positions also can be closed

manually through specific controls on the platform or by calling the broker

directly. When you close a position manually, you are subject to the same

conditions as when opening at market price, such as requotes if the prices

have changed.

Positions also can be closed by opening a matching and opposite trade in the same currency pair(a limit order,a stop-loss order, or simply a market order can be used).For example,if you have gone long in one lot of GBP/USD at the offer price,you may close out that position by going short in one GBP/USD lot at the actual bid price. However, this is not possible with brokers that permit hedging through opening long and short positions on the same currency pair. Hedging has been halted in the United States in

the FOREX by recent rule changes enacted with the farm bill in October 2008.You still can use hedging strategies via different accounts and different futures commission  merchants(FCMs),although not quite  with the same affect.You also can open an offshore account, which some FCMs in the  United  States will allow you to do so that you can still hedge your FOREX trades.

PIPS AND LOTS

The pip or point(percentage in point)is the minimum unit of movement of a currency. It symbolizes a 0.0001 variation in four-decimal-based currency pairs, and a 0.01 increase or a decrease in two-decimal-based pairs. In this way,assuming that the previous price is,for example, 1.2750 on the EUR/USD and it rises to 1.2799,you will have a difference of 49 pips.

Each pair can have a different pip value, which is based on the relationship between the varying currency rates. It would not be calculated by the  same  method  for  pairs  where USD is the base currency as for pairs where USD is the quote currency. This is also true in the case of crossedrate currency pairs.

A currency’s price moves are usually measured by the number of pips.Every pip a currency moves will equal a specific amount of profit or loss in real USD on every trade. Often the value of a pip changes based on which currency  pair  is  being  traded.Only if currency pair includes USD as the quote currency, listed second in the pair,will the value of a pip consistently stay the same. This happens because it is how much of the base currency you can buy or sell for the USD that fluctuates.

To determine the amount of loss or gain on a particular trade, you first should set up the value of a pip and then multiply it by the number of pips the currency has changed for or against your position since the trade began.

If the base currency is increasing in relation to the quote currency,each pip above  the price at which you purchased it will be counted as profit. And vice versa, every pip that is lower than the price at which you purchased it would increase your loss.

It’s extremely important to remember that if the counter currency is USD (e.g., the pair is EUR/USD),the value always remains 1 pip $0.0001 USD(1/100 of a cent) for every dollar traded.This is a value of US $10 per pip for every usual lot amount of US $100,000 traded and is US $1 for mini lots of US $10,000.Most other currency pairs will have a pip value that changes constantly between US $0.00006 and US  $0.00009 per pip depending on the current rate of exchange. This is US $6 to US $9 per pip for every US $100,000 lot traded or US $0.60 to US $0.90 per pip for every US $10,000 lot traded.Here are some more examples of the calculations to be made depending on which are the base and quote currencies:

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The  pip  values in these examples are calculated to show a result in U.S. dollars  because this is the main currency used in most trading accounts. However,many brokers permit traders to open and retain their accounts in local and foreign principal currencies, such as euros, pounds sterling, Japanese yen, Swiss francs,etc. In these cases, the calculations must be made taking the different rates  into  account with  respect to the deposit currency.The following  table of equivalences  illustrates the pip value for each type of contract,from standard lot to nano lot,based on the preceding examples and rates.

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THE LOt

The contract amount that a bank or brokerage firm allows a currency to be traded in is called a lot.Usually, brokerages recommend two different kinds of accounts: standard and mini. A standard lot size is $100,000, and a mini account lot size is $10,000. There are also smaller retail institutions than offer micro account and nano account lots, equivalent to $1000 and $100,respectively.

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 ORDER TYPES

BUY/SELL MARKET ORDERS 

A market order is an order to buy or sell at the current market price and can

be used to enter or exit a trade. Market orders should be used carefully because in fast-moving markets there may be a difference between the price seen at the time a market order is given and the actual price of the transaction. This is due to 

slippage the amount the market moves in the few seconds between issuing an order and having it executed. Slippage potentially could result in the loss or gain of several pips.

Online trading platforms may differ a little in the manner in which they initiate a trade,but a trade normally is accomplished through a form that shows the current bid and ask prices. Some platforms ask for a confirmation of the order;others have a direct one-click order capability.Usually execution of the order is instantaneous or,at the very most, it takes just a few seconds to appear as executed.

Sometimes market orders also can be placed over the telephone at the

broker’s dealing desk.The etiquette  to  follow  this  procedure  should  be  

verified with your broker.

BUY/SELL LIMIT ORDERS

A limit order is an order to buy or sell at a certain limit. It can be used to buy a currency below the market price or sell a currency above the market price. When buying, your order is executed when the market falls to your set limit-order price. When selling, your order is executed when the market rises to your set limit-order price. Normally, there is no slippage with limit orders. The order essentially contains two variables, price and duration. The trader identifies the price to buy/sell a certain currency pair and also specifies the amount of time the order should remain active.

A common use of limit orders is when a trader anticipates the price to bounce  back  from a given resistance or support area after a rally or fall.This is especially true when the currency pair has been trending.

BUY/SELL STOP-LOSS ORDERS

Astop-loss order is an order to buy above the market value or to sell below the  market  value.This type order is used  most commonly as stop-loss orders  to  limit  losses  if  the  market  moves  opposite  that  which  the  trader expected. A stop-loss order will sell the currency if the market falls below the point set by the trader. The order contains the same two variables,price and  duration.  The  main  difference  between a limit  order  and  a  stop-loss order is that stop-loss orders are used frequently to limit loss potential on a transaction, whereas limit orders are used to enter the market, add to a preexisting position, and/or engage in profit taking.

A trader uses a stop-loss order when he or she expects a price breakout to happen and wants to seize the opportunity to “ride” the breakout on any side if it develops.

OCO (ONE CANCELS THE OTHER) ORDERS

This type of order is used when placing a limit order and a stop-loss order

simultaneously.If either order is executed,the other is canceled,which allows the trader to make a transaction without monitoring the market. If the  market  falls,  the  stop-loss  order  will  be  executed,but if the market increases to the level of the limit order, the currency is sold at a profit. This is used in a straddle when trading news, a type of trading strategy used.An OCO order is a mixture of two limit and/or  stop-loss  orders.Two orders with price and duration variables are placed above and below the current price. When one of the orders is executed, the other order is canceled.

IFD(IF DONE)ORDERS Using  an IFD order  allows a trader to program  particular  strategies  in which there can be a sequence of trades. These trades will not be executed until the first one is accomplished.

TIMED ORDERS

GTC (Good Till Canceled) Orders A GTC order will remain active in the market until the trader decides to cancel it. It will not be terminated by the dealer. For this reason, it is very important to remember open pending orders after a strategy is executed because any of them can become a market order at any moment when the market price matches the order price. GFD (Good for the Day) Orders A GFD order remains active in the market until the end of the trading day. This will have some deviations depending on the server time of your broker.

Good until Date/Time Orders This is another timed order in which the trader can specify the exact time of the day and the date on which he or she desires to keep the order active.

WHERE IS THE MARKET GOING?

This depends on a number of factors. The market is always in a perfect equilibrium,  which it succeeds in holding thanks to the periodic variations related to interactions between the elements of which it is composed(currencies, people, events, traders, etc.).

If you monitor using a very big time frame, you will notice something very interesting: In almost all cases, the currency pairs move upwards or,at least,relatively sideways.

Many long term operators,namely,hedge funds and large capital investors, don’t constantly open and close positions, but they use a strategy with several elements that allows them to achieve a constant growth,slow but safe, and almost as important, with nominal risk. However, if you look at inter a day or inter a week  trading,a very diverse and opposing scenario is seen. If you fail to match them up and understand them from their individual perspectives, they will bring you to a tremendous amount of confusion because it will seem to you that the market isn’t going up or down. When you see the market rising and you decide to open a position, that could be the precise moment the market goes against you, and you end up dazed and frustrated.

It has been said that it is appropriate to use at least two time frames.However, to combine them is not the same as mixing them. You should use one longer time frame and one shorter time frame. This is the safest way to work  because  you  will  find  more precise entry and exit points for every trade  you  make.  In  this  way,  you  can  better assure yourself of entering a trade on time and exiting it without leaving too much on the table.

You might object that this method of combining two or more time frames.Many people believe that this can distract the trader’s focus on what is being done because at a certain point during the trade the shorter period will go in an opposite direction from the longer time frame.However,when applying this approach in real time, you may observe that the shorter period doesn’t impede the longer one when the trade is in progress;instead,the smaller time frame allows you to better pinpoint a suitable exit.You should use a combination with which you feel comfortable, but there are particular combinations that I find more harmonic: Two time frames(the longer one for watching the trend and following the position,the smaller one for entries and exits):

●5 minutes and 1 hour

●15 minutes and 4 hours

●1 hour and daily

●4 hours and weekly

Three time frames

(trading the intermediate time frame and using the

longer one for the trend and the smaller for entries and exits)

●1 minute, 5 minutes, and 30 minutes (for extreme scalping; not

recommended for starters)

●15 minutes, 1 hour, and 4 hours (intraday operation)

●1 hour, 4 hours, and daily (intraweek or swing trading)

●4 hours, daily, and weekly (longer term or position trading)

Something  that  increases  the  confusion  when  you  are  analyzing  and observing market movements is the overcrowding of charts with trendlines and indicators that later overlap each other if you change the time frame. It would be more efficient to use a single chart for each time frame and then choose one that will be used only to perform the actual analysis.

Another confusion arises when you try to trade in a shorter time frame (5 or 15 minutes) but you pretend with this to make a 100- or even 200-pip-long run (and in a few hours, too).This is not impossible, but this is what usually  happens:  The  risk  management  is  proportional.Let’s say that,on average, the relationship is 2:1 (reward to risk) or, ideally, 3:1. More often than not, it is 1:1 (or less) if the entries haven’t been studied with precision.There  is  an  average  time/trade  relationship  that  is  about four or five times  greater  than  the  time  frame  incrementally.  For  example,  a position opened on a five-minute chart, if it has potential, shouldn’t last much more than half an hour or up to an hour if there is not much volatility. For a position  opened on the 15-minute chart,one or two hours is a maximum.  If,after the time has elapsed,there are no results,it would be better to close the position and wait for the  next  breakout.On the other hand,a position opened on a four-hour chart can last for the entire day or even two days,and a position opened on a daily chart can last up to a week.

Another very important issue to take into account when switching time frames is the  size of the stops.You can use a fairly dependable tool, the average true range(ATR),to  measure the actual volatility and potential scope in that time frame. Features of the ATR will be discussed in detail under“Technical versus Fundamental”below.

You can’t afford to open a medium-term position with targets that call for the trade to“breathe,”that is, perform its logical wave fluctuation inside the particular range of each pair,with a 7 or10-pip stop loss that will close the position much earlier than desired; maybe after half an hour or a few hours later,unless you get extremely lucky and are able to pick the top or bottom of the price.

The ATR offers the exact measure for an adequate stop loss (you should add the spread and, if your risk level allows it, some additional pips to  achieve  increased  safety).Based on this,you could expect double or triple the ATR value as a target profit if the position is successful and more so if it happens to be the bottom or top of a longer run and is followed up with trailing stops, especially if you are trading in the same direction as the higher-time-frame trend.

For a 15-pip stop loss,a target  profit  of  45  pips is fine (risk-reward ratio 1:3). It’s not wise to place a stop loss much higher than the target you expect unless your  strategy will give you a 90 percent record of winning trades,which is possible but probably won’t last for very long because the markets change and change quite a bit. The best option is not to go lower than 1:2 or at a minimum 1:1.5 (stop loss: 15 pips; target profit:22 pips,or 30/45,  etc.). A 1:1 ratio also works if the performance of  the  strategy is above 50 percent. 

STOPS AND TARGETS

HOW TO SET A STOP LOSS

I have already mentioned ATR based stop-loss sizing. There are other ways to define the level at which keeping a specific position open is no longer useful.

Support/Resistance-Based Stops These are stops that are usually set at the most recent swing high or low or at a specific price that the market has bounced off of repeatedly. It is recommended to set the stops a couple of pips higher or lower than the area to allow for more safety.

The  parabolic stop and  reverse(SAR)is another technical  indicator that can help you set and trail a relatively safe stop loss, especially when the currency pair is trending. Be advised that  this is not recommended in choppy or sideways markets.Trailing Stops There are two kinds of trailing stops. One is set automatically at a given distance from the  price  and is initiated at a set level,increasing thereafter every time the price advances in the direction set. The other way of using a trailing stop loss is manually,changing its price level as the trade develops.Automatic trailing stops can be set on the server side of the platform,which is the better option in case of a connection failure, or on the client side.A stop loss order is always used to exit a trade while at the same time limiting the eventual amount of loss. Some traders use them all the time as a regular exit strategy, whereas others will have“emergency stops”only,to be used in the event that something unpredictable occurs. A normal or regular stop usually is close to the price, depending on the time frame,and represents the maximum amount of loss the trader will allow himself or herself to lose on a single trade just in case it goes the wrong way.Backup and emergency stops are set up much farther out because the trader doesn’t expect them to be filled. They are set only to mitigate that unplanned power outage or connection issue that could harm the account financially and are seen as a last resort.A stop-loss order always should be used because it allows a quick and automatic exit on bad trades, even if it the trader is not actively watching the trade. Some traders do not use stops because  they  fear  that  if  their orders are visible in the market, they are more prone to be swept away by“stop  hunting"or that they might get caught by unusual price spikes in moments of  high  volatility before the trade continues in the appropriate direction.

Scalpers often trade without stop-loss orders because trades might be held for only a few seconds. However, there is still potential for trouble,and at least an emergency stop should be set up to avoid ending up with a margin call.

TARGETS

Targets(or take-profit levels)are represented  by the number of  points or pips a trader believes a currency pair will rise or fall depending on his or her strategy and time frame. Calculations can be made using several tools,supports and resistance, or the ATR and depend heavily on the time frame being traded. A higher time frame will allow the setting of wider targets,but this also will require a wider stop loss.

SPREADS AND  SWAPS SPREAD The spread

is the difference between the bid and ask prices and typically constitutes the broker’s or financial institution’s profit on a transaction. The size of the spread is normally a measure of the volatility of a given market,but some brokers also offer fixed spreads. Most often spreads are widened at the moment of a news release, when higher volatility is expected.For example, if you want to exchange euros into dollars (selling euros and buying dollars), you will receive $1.2825 for each euro sold. Inversely,when you buy euros, you will have to pay $1.2827 each, assuming that the value of the spread at that moment is 2 points.

SWAP

The swap,also called the overnight or rollover interest,is the fee that is charged by the banks at the end of a 24-hour trading day on open positions and is calculated according to the respective interest rates of the currencies involved. In the FOREX, banks have determined that all trades must be setled  within  two  business  days.  Traders  who  desire  to  keep  their  positions open must “close” the positions  before  5 p.m. Eastern Time (ET) on  the settlement  day  and  reopen them at the start of  the next trading day.This rolls  over  the  settlement by another  two  trading  days.  This  strategy  is  created through a swap agreement, and depending on the position’s direction  and  the  interest  rates  of  the  currencies; it will generate a positive or negative amount.

The trader is  in fact borrowing  money to sell one currency and purchasing the other, so the trader pays interest on the borrowed currency and earns on the purchased currency, the rollover interest being the net result of the different rate calculations.

Although  the  interest  rate  for  each  currency  is  identical,  swap  rates may vary from broker to broker. Some have fixed rates on long and short positions until  a  rate change issued by the central banks,whereas others may vary the rates every day depending on the liquidity and volume of transactions.

To be able to calculate a swap  for a given currency pair,you need the short-term interest rates of both currencies, the actual price or exchange rate of  the currency pair,and the amount of lots purchased.For example,let’s assume that a trader has an open position of 10,000 units long of EUR/USD.

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The interest is earned on the currency that is owned (long  side) and paid on the currency that is being borrowed (short side).

TECHNICAL VERSUS FUNDAMENTAL

There are two types of analysis that can be applied  to  FOREX  trading fundamental and technical and traditionally they are thought of as“opposed” views. There has always been a controversy about which one is better or which one is the “truest” one. The truth is that both are an important gauge and a reflection of the markets. Each one has its own methodology and rules.

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FUNDAMENTAL ANALYSIS

Fundamental analysis helps you to understand the macroeconomic indicators and political decisions of every government. It provides you with an indication of  the  economic  situation  in  a  given  country that  results from  political decisions that quite possibly have an effect on currency value.When a trader studies the global economic environment and the political situation of the day,he or she will be able to develop a perception of the world situation  and it influence on the various markets involved. Unlike technical analysis, fundamental analysis focuses on the  cause and not the effect.

TECHNICAL ANALYSIS

Technical analysis  is used to interpret price charts. You can see what is happening in real time and react instantly. You also can study past prices and

volumes and, based on that information, make projections of the probable

levels to be attained.

With several technical analysis tools, you can identify trends and patterns  that  reflect  the  buy  and  sell  operations  being  made  by  all  market participants at any given moment. Those trends and patterns can be seen on short, medium, and longer time frames, allowing the study of recur-

ring patterns or particular conditions that are related to specific economic situations.

You must be able to understand and apply both types of analysis because the  best-studied  technical  strategy  based  on  past  action  can  go  horribly wrong if fundamental events are not part of the equation.

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