I was recently leading an online Forex trading session. In the program, I was teaching through trading, analysis, and lessons. Being very active in the Forex market in the Extended Learning Track (XLT) and knowing all the marketing out there for trading Forex, I am guilty of assuming that most people know and understand what Forex trading is and also know a little about how these markets work. In the recent trading session, I realized I was wrong to assume that as there were many basic questions on Forex trading. During this piece, I will cover the basics of what the Forex market is, how it works, and some important information you should know before getting started.
What is the Forex Market?
The Foreign Currency (Forex or Spot) market is where global exchange rates are derived for everyone including market speculators and end users of currency. It is the largest and least regulated financial market in the world. There are pro’s and con’s to this which I will discuss in a bit. This cash-bank market was established around 1971 when floating exchange rates began to materialize. The daily turnover has increased from around $5 billion in 1977 to around $2 trillion today. This market is open 24 hours per day – 6 days per week.
And many, many more…
How Does it All Work?
In the simplest terms, supply and demand for currencies determine global exchange rates. Strong economies have strong currencies. When we trade the Forex markets, we are trading economies.
Supply and demand for currency depends on the current and expected future health of a country’s economy. We can see and assess the demand and supply for a country’s currency through fundamental and technical analysis. Let’s take a look at fundamental analysis first. Here is an example of how it works:
|The Stock Market|
|Company “A”||Company “B”|
|Weak earnings||Strong earnings|
|Weak management||Strong management|
|Little market share =||Strong market share =|
|Low Stock Valuation||High Stock Valuation|
|The Forex Market|
|Company “A”||Company “B”|
|Strong economy||Weak economy|
|Low taxes||High taxes|
|Growing GDP =||Declining GOP =|
|High Currency Valuation||Low Currency Valuation|
As the example shows, when global investors perceive a strong economy, they tend to buy that country’s currency to take advantage of strong investments within that country’s stock and bond markets. To buy into a country’s markets however, you first need to buy that country’s currency. Next, let’s take a look at how to assess supply and demand for currency from the charts supply and demand perspective. I will use a trade I made this week in the Japanese Yen (Forex Futures) for the XLT members to explain.
Notice area “A”. We call that an objective supply level. Why? Because price declined from area “A” which can only happen if supply exceeds demand at that level (more supply than demand). “B” was the first time price revisited “A” which was the low risk/high reward time to sell short. Why? Because when price reaches a price level where there is more willing supply than demand, it declines. This is where we sold short as the risk was low, reward was high, and the probability of price falling was strong. This turning point where the trade was entered happened because of a major supply and demand imbalance. Supply and demand are so out of balance that price simply can’t stay at that level. We simply identify the supply and demand imbalance and trade that market back to balance. We can and do quantify supply and demand on the charts in the smaller time frames for day trading the Forex market and the larger times frames for swing and position trading the Forex market.
More Information You Should Know
There are two ways to trade the Forex market. While we go into this topic in much detail in the XLT program, here is some basic but important information you should be aware of.
|Spot Forex (cash currencies)||Forex Futures (currency futures)|
|No central market||One central market (CME Exchange)|
|Largest market in the world||Very regulated market|
|Huge trends all the time||Volume good but not great|
|Big Leverage (can start with small account||Trends like spot market|
|Trades through CME Globex system|
The foreign exchange (Forex) market is where I began trading. Specifically, on the floor of the Chicago Mercantile Exchange handling large order flow for institutions, banks, and retail traders around the world. The Forex market is far and away the largest market in the world for banks and institutions. One of the reasons for this is because of all the other markets: stocks, bonds, and options. For example, for the Japanese investor, institution, or bank who wants to buy into the US stock or bond market, they can’t use YEN to do it. They must buy US Dollars first. Perhaps you didn’t know the majority of the world settles oil purchases in US dollars. Importers and exporters are always involved in the currency markets as well. I could go on forever with information on the fantastic Forex markets but this piece would get way too long. If you have any questions or comments, feel free to email anytime.
Have a great day.