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ForexTV Education – Forex 101

ForexTV Education – Forex 101

  • What is Forex? (back to top)
    1. Forex is the largest market in the world and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The average daily trade in the global forex and related markets currently is over USD $3 trillion
    2. Does not have a central location, it is traded through banks, financial institutions, and individuals,
  • Representations of different currencies (USD, CAD, etc.) (back to top)
    1. Major currencies include the US Dollar (USD), the Euro (EUR), the Great Britain Pound (GBP), Japan Yen (JPY), and the Swiss Franc (CHF)
    2. Minor currencies include Canadian Dollar (CAD), Australian Dollar (AUD), New Zealand Dollar (NZD)
    3. A cross currency is any currency that does not include the USD
  • Why trade forex? (most liquid, money is constantly changing, 24-hour trade) (back to top)
    1. Most liquid and most traded market because it is dealing with money (cash or cash equivalents)
    2. Leverage – can control and move a lot of money with a small amount of money
    3. Trade is 24 hours a day (ie. when the London market is closing, the New York market is still open, then as the NY market closes, the Japan market is opening)
    4. Market is volatile so the conversion rates are constantly trading, constantly creating opportunities to make money.
    5. Low transaction fees/no commissions
    6. No fixed lot size, can trade any amount of money
  • Simultaneous buying/selling of currencies (back to top)
    1. For every transaction there is 2 transactions taking place, the selling of one currency for the purchase of another
  •  How to read bid/ask prices, what is spread? Long/short (back to top)
    1. The base currency is the first currency shown in the pair (ie. GPB/USD the GPB is the base currency)
    2. A bid price is the price you can sell the base currency (at the same time buying the counter currency)
    3. An ask price is the price you can buy the base currency (at the same time selling the counter currency)
    4. Spread is the difference between the bid price and the ask price
    5. Going long is when you stand to make money if the currency rate will rise (ie. buying first, as the market is low and when it rises you would sell)
    6. Going short is when you stand to make money if the currency rate will fall (ie. selling first, as the market is high and as it drops you buy)
    7. “If a currency quote goes higher, that increases the value of the base currency. A lower quote means the base currency is weakening”

Leverage, Margin, Pips

  • Leverage
    1. A small amount of capital will give you allow you to control a large position because it will be multiplied a number of times. A common leverage is 100:1, so if you have an account with USD$1000 in it, and it was leveraged 100:1, you would be able to trade up to USD$100,000
    2. It is used to increase buying/selling power because the market shifts in a given day are often very small, typically only around 1%, so it is necessary to trade large sums of money to make any substantial profits
  • Margin
    1. Margin is minimum required to make a trade (ie. if you want to trade $100,000 and your leverage is 100:1, you need to put up only $1000
    2. In trading stocks, you need to put up least 50% of price of stocks, the rest of the money is borrowed and interest is paid back on the money that is borrowed.
    3. In trading forex, you only need to put up 1% make the money that is made on the trade, “extra” 99% of money is collateral
  • Pips
    1. Pips are the smallest unit in a currency quote or 1/100th of 1%, which is 3 decimal places out in all currencies except for the JPY
    2. In EUR/USD, a 3 pip spread would be from 1.2500 to 1.2503
    3. In JPY, a pip is only taken out to 2 decimal places (ie. 3 pips would be 114.00 to 114.03)
  • Mini/Micro Accounts
    1. Smaller amount of money, good for starters, test skills, get experience
    2. Mini account – about USD$10,000
    3. Micro account – about USD$1,000

Types of Orders (Back to top)

  • Market Order - order placed to enter or exit the market at the market price, either bid/sell price or ask/buy price
  • Limit Order - order placed to enter or exit the market at an exact placed price or better with no slippage
  • Stop Loss Order - order placed to enter or exit the market at an exact price that turns into a market order when that price is reached
    1. A buy order above the market is a stop order
    2. A buy order below the market is a limit order
    3. A sell order above the market is a limit order
    4. A sell order below the market is a stop order
  • * Key Principle * 
    1. With a long position for profit, you would sell at a limit order
    2. At a long position for a loss, you sell at a stop order
  • Order Execution Procedures
    1. One Cancels the other (OCO) – when either the limit or the stop order is reached, it will cancel out the other order. “Set it and forget it”
    2. Stop/Reverse Order – order that has been placed to stop at a certain price. At the same time, a new order is made in the opposite direction and reverse position by re-entering the market
    3. Cancel/replace orders – any order that is cancelled and/or replaced

Reading Charts

  • Line Chart (back to top)
    1. Draws line from one closing price to another closing price. Shows a general price movement over a period of time

    Example:
    Line Chart

  • Bar/Open High Low Close (OHLC) Charts (back to top)
    1. Shows opening and closing prices as well as the highs and lows of that time period. (one “bar” is one period of time, minute, hour, day, etc.)
    2. The bottom of the vertical bar indicates the lowest traded price for that time period, while the top of the bar indicates the highest price paid. So, the vertical bar indicates the currency pair’s trading range as a whole. The horizontal hash on the left side of the bar is the opening price, and the right-side horizontal hash is the closing price.

    1 Bar
    Bar Chart

  • [Japanese] Candlestick Chart
    1. Indicate the high-to-low range with a vertical line.  The larger block in the middle indicates the range between the opening and closing prices. Traditionally, if the block in the middle is filled or colored in, then the currency closed lower than it opened. If it is not filled in, the currency closed higher than it opened
      Japanese Candle
    2. Shadows are the “wicks” of the candle, showing the highs and lows of that period

      Example of Candlestick Chart: (click image to enlarge)
      candle chart

  • Prosticks
    1. Utilizes basic candlestick chart, but adds more information

      Example of a Prostick:
      Prosticks candle

       

      • Modal Point (dot) represents the most traded price of that period of time.
      • “Body” represents where 67% of all of the period’s trades occurred.
      • “Tails” are extreme 5% of the data, where smaller amounts of trading occur.

        Example of Prosticks Chart: (click image to enlarge)
        Prosticks Chart

  • Fundamental Analysis

    • Introduction
      1. Looking at the market from the angle of supply and demand, focusing on the forces that drive them (social, economic, political factors)
      2. Currency is a gauge of how well an economy is doing. Strong economy equals strong currency and vice-versa
      3. Whose economy is doing well? Whose economy is doing poorly?
      4. Can give insight to market conditions, not necessarily market prices
      5. Generally create models to formulate a trading strategy.
        1. These models typically use empirical data and attempt to forecast market behavior and estimate future values or prices by using past values of core economic indicators. This information is then used to derive specific trades that best exploit this information.
        2. Models often very subjective, can mean different things to different people.
            • Effects
              1. Interest Rate Effect
                1. As country’s interest rates ↑, strength of that country’s currency ↑
                2. A higher interest rate in a country entices foreign investors to put their money into that country. The higher interest rate will give the investor a return of that interest rate percentage before the currency even moves.
              2. Gold Effect
                1. Inverse Relationship between gold price and USD, so as gold price ↑, USD will ↓ or as gold ↓, USD↑
                2.  This inverse relationship is due to gold being seen as a solid, safe commodity. If there is instability in another commodity or currency, the amount of gold purchased will rise because it is a strong commodity to have in times of instability
                3. Example: If gold were to drop below a price level, or support, the price would be expected to keep dropping. If gold is expected to drop, the USD would be expected to rise because of the inverse relationship.
                4. Also, the change in the price of gold can be an indicator of the direction of change in the currencies whose countries are large producers and exporters of gold (Australia, Canada)
              3. Oil Effect
                  1.  As oil prices ↑, price of currency of oil-dependent country more likely to ↓, due to the sensitivity of the country’s market to oil (ie. USD)
      6. Triangulation – Looking at other currencies

          1. By looking at other currencies, one can formulate possible ideas of the currency in question
            1. “ie. if the USD is having a low period, there will be an underlying bid for the EUR. This will open up the market for less liquid dollar pairs (e.g. USD/CHF) to be sold through the more liquid Euro crosses, in this case resulting in EUR/CHF selling, which introduces a Euro offer into the EUR/USD market.”
            2.  Looking at technical levels may result in inconclusive results because the levels will fluctuate. This suggests breakout traders need to allow for a greater margin of error: 20-30 pips.
            3. “Another way to gauge whether EUR/USD is breaking out is to look to the less liquid USD/CHF and GBP/USD. If these pairs have broken equivalent technical levels, for example recent daily highs, then EUR/USD is likely to do the same after a lag. If “Swissy” and “Cable” (popular name for British pound) are stalling at those levels, then EUR/USD will likely fail as well.”
          2. USD/JPY most politically sensitive currency conversion
            1. USD/JPY trends
              1. Japanese investors’ tendency to cluster prices
              2. Support/resistance at numerically round numbers
      7. Economic Indicators
        1. Major Indicators
          1. The Gross Domestic Product (GDP), Industrial Production, Purchasing Managers Index (PMI), Producer Price Index (PPI), Consumer Price Index (CPI), Durable Goods, Employment Cost Index (ECI), Retail Sales, Housing Starts
        2. Information on the economy published by governmental agencies or the private sector
        3. Many people follow these indicators, so they have the ability to move prices and volume in huge amountsExample: If the market for the USD is bearish and has been holding in a bearish position, but there is a key piece of economic data coming out toward the end of the week, such as the Gross Domestic Product (GDP), it may have a positive effect on the market and drive the currency prices up, (if the GDP is better than predicted) or a negative effect, driving prices further down (if the GDP comes out lower than expected)
        4. Knowledge of when to use each indicator, where it is important in its respective country.
          1. en markets will move in anticipation of a certain indicator or report due to be released at a later time (anticipating a lower Unemployment report).
          2. Importance of economic indicators in the current For example, when the U.S. dollar is weak, inflation is often one of the most watched indicators.
          3.  Importance of market expectations for the data, and whether or not the expectations are met. Occasionally, there is a drastic difference between the expectations and actual results and this may affect the market greatly
          4. Initial reports often have revisions which may change the market substantially. Oftentimes, numbers are released and then revised, and things can change quickly. Pay attention to these revisions, as they may be a useful tool for seeing the trends and reacting more accurately to future reports.
        5. Technical Analysis

          Introduction

            1. Forecasting price movements by looking solely at market-generated data
            2. Price data from a particular market is most commonly the type of information analyzed by a technician, though most will also keep a close watch on volume and open interest in futures contracts.
            3. Stick to the basics, which are methodologies with a proven track record over a long period. After finding a trading system that works for you, the more advanced fields of study can then be incorporated into your trading repertoire
            4. Assumes that market fundamentals are already included in the market data

              ie. “a technical trader will tell you that all of the fundamentals are already represented in the price. They are not so much concerned that a natural disaster or an awful inflation number caused a recent spike in prices as much as how that price action fits into a pattern or trend. And much more to the point, how that pattern can be used to predict future prices.”

            5. Markets move in fairly predictable, quantifiable patterns called signals. Goal is to identify signals by examining past markets
            6. Prices move in trends, either up, down or sideways. Once a trend is established, it will continue that way for a period of time

Basic Concepts

                                                    1. Support and Resistance
                                                      1. When the market moves up and then pulls back, the highest point reached before it pulled back is now resistance. As the market continues up again, the lowest point reached before it started back is now support. In this way resistance and support are continually formed as the market oscillates over time.Example of Support and Resistance: (click image to enlarge)
                                                        Support/resistance chart
                                                      2. Trend Lines
                                                        1. An uptrend line is drawn along the bottom of easily identifiable support areas (valleys). In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks)Example of Trend Lines: (click image to enlarge)Trend Lines
                                                      3. Channels
                                                  1. Add a parallel line to the trend line indicators so that each trend direction now consists of two lines
                                                    1. Use – When prices hit the bottom trend line this may be used as a buying area. When prices hit the upper trend line this may be used as a selling area.Example of Channels: (click image to enlarge)
                                                      Channels

 

Types of Technical Indicators

                                                    1. Trend IndicatorsTrend is a term used to describe the continuity of price movement in one direction over time. Trends will move either up, down, or sideways. Trend indicators smooth variable price data to create a composite of market direction. (Examples: Moving Averages, Trend lines)
                                                    2. Strength IndicatorsMarket strength describes the intensity of market opinion with reference to a price by examining the market positions taken by various market participants. Volume or open interests are the basic ingredients of this indicator. Their signals are coincident or leading the market. (Example: Volume)

                                                    3. Volatility IndicatorsVolatility is a general term used to describe the size, of day-to-day price fluctuations independent of their direction. Generally, changes in volatility tend to lead changes in prices. (Example: Bollinger Bands)

                                                    4. Cycle IndicatorsA cycle is a term to indicate repeating patterns of market movement, specific to recurrent events, such as seasons, elections, etc. Many markets have a tendency to move in cyclical patterns. Cycle indicators determine the timing of a particular market patterns. (Example: Elliott Wave)

                                                    5. Support/Resistance IndicatorsSupport and resistance describes the price levels where markets repeatedly rise or fall and then reverse. This phenomenon is attributed to basic supply and demand. (Example: Trend Lines)

                                                    6. Momentum IndicatorsMomentum is a general term used to describe the speed at which prices move over a given time period. Momentum indicators determine the strength or weakness of a trend as it progresses over time. Momentum is highest at the beginning of a trend and lowest at trend turning points. Any divergence of directions in price and momentum is a warning of weakness; if price extremes occur with weak momentum, it signals an end of movement in that direction. If momentum is trending strongly and prices are flat, it signals a potential change in price direction. (Example: Stochastic, MACD, RSI)

 

Using Technical Indicators

                                • Fibonacci
                                    • Fibonacci Retracement Levels – used as support and resistance levels (0.236, 0.382, 0.500, 0.618, 0.764)
                                    • Fibonacci Extension Levels – used as profit-taking levels (0, 0.382, 0.618, 1.000, 1.382, 1.618)] how important?
                                    • After a significant price move (either up or down), prices will often retrace a significant portion (if not all) of the original move. As prices retrace, support and resistance levels often occur at or near the Fibonacci Retracement levels.
                                    • In the currency markets, the commonly used sequence of ratios is 23.6 %, 38.2%, 50% and 61.8%. Fibonacci retracement levels can easily be displayed by connecting a trend line from a perceived high point to a perceived low point. By taking the difference between the high and low, the user can apply the % ratios to achieve the desired pullbacks.
                                      • Swing High is a candlestick with at least two lower highs on both the left and right of itself
                                      • Swing Low is a candlestick with at least two higher lows on both the left and right of itself

                                          Example of Fibonacci: (click image to enlarge)

                                        Fibonacci





                                       

                                       

                                                  1. Moving AveragesTaking the average closing price of a currency for the last ‘X’ number of periods. Help traders verify existing trends, identify emerging trends, and view overextended trends about to reverse. Moving averages are lines overlaid on a chart indicating long term price trends with short term fluctuations smoothed out.

                                       

                                                        1. A “smooth” moving average has many days factored into its average, so the line will be more of a trend line, and will react slower to price movements. A “choppy” moving average has few days factored into its average, so will be a better indicator line and will react more quickly to price movements.
                                                        2. Simple Moving Average (SMA) - gives equal weight to each price point over the specified period. The user defines whether the high, low, or close is used and these price points are added together and averaged. This average price point is then added to the existing string and a line is formed. With the addition of each new price point the sample set drops off the oldest point. The simple moving average is probably the most widely used moving average. However, susceptible to price spikes because it is a basic average where everything is weighted equally.

                                      Example of Simple Moving Averages: (click image to enlarge)
                                      SMA







                                                  • Pros: Displays a smooth chart, which eliminates most fake outs.
                                                  • Cons: Slow moving, this may cause a lag in buying and selling signals.

                                       

                                                        1. Exponential Moving Average(EMA)An exponential moving average is another type of moving average. In a simple moving average, the price data has an equal weight in the computation of the average. Also, the oldest price data is removed from the moving average as a new price is added to the computation. The exponential moving average assigns a weight to the price data as the average is calculated. Thus, the oldest price data in the exponential moving average is never removed, but it has only a minimal impact on the moving average.

                                      Example of Exponential Moving Averages: (click image to enlarge)

                                                  • MACD







                                      • Pros: Quick moving, and is good at showing recent price swings
                                      • Cons: More prone to cause fake outs and give errant signals.

                                   

                                        1. Moving Average Convergence Divergence (MACD)Plots the difference between a 26-day exponential moving average and a 12-day exponential moving average. A 9-day moving average is generally used as a trigger line, meaning when the MACD crosses below this trigger it is a bearish signal and when it crosses above it, it’s a bullish signal.

                                   

                                            1. The two lines that are drawn are NOT moving averages of the price. They are the moving averages of the DIFFERENCE between two moving averages. A histogram is at the bottom, which measures the difference between the two moving averages
                                            2. Because there are two moving averages with different “speeds”, the faster one will be quicker to react to price movement than the slower one. When a new trend occurs, the fast line will react first and eventually cross the slower line. When this “crossover” occurs, and the fast line starts to “diverge” or move away from the slower line, it often indicates that a new trend has formed.Example of Moving Average Convergence Divergence (MACD) : (click image to enlarge)
                                              MACD
                                      • Bollinger Bands

                                        1. Because standard deviation is a measure of volatility, Bollinger Bands are indicators that adjust themselves based on the current levels of volatility in the market being studied. When prices hit the upper or lower boundaries of a given set of Bollinger Bands, this is not necessarily an indication of an imminent reversal in a trend. It simply means that prices have moved to the upper limits of the established parameters. Therefore, traders should use another study in conjunction with Bollinger Bands to help them determine the strength of a trend.
                                        2. Trader must specify the type and length of the moving average to be used, as well as the number of standard deviations from the mean that the Bollinger Band will measure (ie. 20 day SMA with 2 SD)
                                          1. Bollinger Bounce – the concept that price will typically return back to the middle of the two Bollinger Bands (so if the price hits the top Bollinger Band in one period of time, it will likely head back down and settle somewhere in the middle of the bands)Example of Bollinger Bounce: (click image to enlarge
                                            Bollinger Bounce
                                          2. Bollinger Squeeze - When the bands “squeeze” together, it usually means that a breakout is going to occur. If the candles start to break out above the top band, then the move will usually continue to go up. If the candles start to break out below the lower band, then the move will usually continue to go down.Example of Bollinger Squeeze: (click image to enlarge)
                                            Bollinger Squeeze
                                      • StochasticsAn oscillator (leading) that measures overbought and oversold conditions in the market.

                                        1. The %K line is the faster line, more sensitive, whereas the %D is the slower, less sensitive line
                                        2. Stochastics are scaled from 0 to 100. When the stochastic lines are above 80 (red dotted line), then it means the market is overbought, representing strong upward movement. When the stochastic lines are below 20 (blue dotted line), then it means that the market is oversold, with strong downward movement. Buy when the market is oversold, and sell when the market is overbought.
                                        3. When the %K line crosses over the %D line, this could be an indication that a market is about to reverse course.
                                        4. Many traders find that the best trading opportunity comes when their stochastic indicator is flattening out or moving in the opposite direction of prices. When these divergences occur, it’s time to book profits and/or to establish a position in the opposite direction of the prior trendExample of Stochstics: (click image to enlarge)
                                          Stochastic
                                      • Relative Strength Index (RSI)Measures the momentum of price movements. It is also plotted on a scale ranging from 0 to 100. Traders will tend to look at RSI readings over 80 as an indicator of a market that is overbought or susceptible to a downturn, and readings under 20 as a market that is oversold or ready to turn higher.
                                        1. This logic therefore implies that prices cannot rise or fall forever and that by using an RSI study, one can determine with a reasonable degree of certainty when a reversal will come about.
                                        2. In many instances, an RSI can remain at very lofty or sunken levels for quite a while without prices reversing course. At these times, the RSI is simply telling you that a market is quite strong or quite weak and shows no signs of changing course
                                        3. Look for divergences between prices and the RSI. If your RSI turns up in a slumping market or turns down during a bull run, this could be a good indication that a reversal is just around the corner. Wait for confirmation before you act on divergent indications from your RSI studiesExample of Relative Strength Index: (click image to enlarge)
                                          RSI