by V Gaucan · Cited by 13 — Keywords: forex market, forex currency trading, analysis, psychology The basic concept behind the foreign exchange (or forex) market is for trading
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INTRODUCTION TO THE FOREIGN EXCHANGE MARKET Violeta Gaucan, Titu Maiorescu University, Bucharest, Romania Abstract: Before I™ll describe forex market I™d like to say why I have choose this subject for this article. First of all I really think that still exi st people which don™t know about this activity and I strongly believe that in our days it™s a must, especially for those people how want to double or triple their profits from their own business. This article was created from a collection of structured data and I wish that through this article to familiarize yourself, more with the currency market. Keywords: forex market, forex currency trading, analysis, psychology Personally, like many others I was also mistaken that it is a business only for banks. I was surprised when a friend of mine told me that this business is not only for banks and companies. He was into this business and told me that is ear ning good money.Latter when logged on to my computer and searched for forex I was nearly shocked to see that 30% of forex industry was held by the indi viduals. 30% of $7 million industry means a big amount. I further searched about this fore x market and got to know that it is online business now. It means anyone can be a forex trader while sitting at home in front of computer. Apparently forex market doesn™t have any common points with what we study in school but to a closer look I can say that in forex mark et we can find informatical, economic, marketing, mathematical, psycholog ical and even geographical elements. What is forex market? History of the forex market Foreign exchange dates back to ancient times , when traders first began exchanging coins from different countries. However, the forei gn exchange it self is the newest of the financial markets. In the last hundred year s, the foreign exchange has undergone some dramatic transformations. The Bretton W oods Agreement, set up in 1944, remained intact until the early 1970s. Trading volume has increased ra pidly over time, especially after exchange rates were allowed to float freely in 1971. In 1971, the Bretton Woods Agreement was first tested because of uncont rollable currency rate fluctuations, by 1973 the gold standard was abandoned by president Richard Nixon, currencies where finally allowed to float freely. Thereafter, the forei gn exchange market quic kly established itself as the financial market. Before the year 1998, the foreign exchange market was only available to larger entities trading currenc ies for commercial a nd investment purposes through banks, now online currency trading platforms and the internet allow smaller financial institutions and retail investors acce ss a similar level of liquidity as the major foreign exchange banks, by offering a gateway to the primary (Interbank) market. The FOREX refers to the Foreign Currency Exchange Market in which over 4,600 International Banks and millions of small and large speculators participate worldwide. Every day this worldwide market exchanges mo re than $1.7 trillion in dozens of different currencies. With the current growth rate the market is projected to grow to more than $1.9 trillion per day by the year 2006. With such volume, one can assume that the forex
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market is extremely volatile, changing at a moment™s notice, depending on conditions within that country. Forex Exchange Compared to Other Finacial Markets So, what is forex trading ma rket, really? The answers are simple Œ and complex. Here, we will go over the basics so that you, the r eader, can decide if you wish to learn more. The basic concept behind the foreign exchange (or forex) market is for trading currencies, one pair against another. It™s the world™s larg est market, consisting of almost $2 trillion in daily volume and is growing rapidly. The value of one currency is determined by its comparison to an other currency via the exchange rate. The major currencies traded most often in the foreign exchange market are the euro (EUR), United States dollar (USD ), Japanese yen (JPY), British pound (GBP) and the Swiss franc (CHF). These combine to form the most commonly traded currency pairs: EUR/USD USD/JPY GBP/USD USD/CHF The first currency of a currency pair is the base currency; the second currency in the pair is the counter currency. One can think of currency pairs as a single unit. When buying a currency pair, the base currency is being bought, while the counter currency is being sold. The opposite is true when selling a currency pair. Foreign currency trading is conducted without a central exchange, but instead is traded over-the-counter (OTC). Unlike other markets, this decentralization allows traders to choose from a large number of different deal ers or brokers with which to place trades. This also provides the means to compare pri ces and pip spreads before buying or selling. A number of tools and charts are used in fo rex currency trading and the educated trader uses these tools extensively to perform accura te analysis to determ ine whether to buy or sell a given currency pair. The forex market is operated in Europe, Asia and the United States in overlapping shifts, so currencies are constantly traded 24 hours a day. No single entity has the capability of influencing the market Œ at least for very long. Currency trading Œ at its most basic definition Œ is the act of buying and selling (trading) different currencies of the world. A typical scenario might go something like th is: A trader is looking at the British pound (GBP) and U.S. dollar (USD). This is called a currency pair. The GBP is the base currency, and the USD is the secondary currency. News that the value of the GBP is up from previous reports creates a positive reaction and a spike in the value of the GBP. This, in turn, will cause a rally on the GBP/USD currency pair. If the opposite occurred, and a positive announcement for the USD was reported, then the GBP/USD currency pair will fall, or dip. Either scenario can offer up a profit, depending on which part of the currency pair is bought or sold. The price of each currency within the pair is determined by a number of factors, such as changes in political leadership, economic booms or busts, even natural disasters.
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Figure 1: How much value each market Figure 2: Average daily derivates, equity and Forex vo lume. Year 2000 Forex Myths Myths, rumors and legends are everywhere. The forex market is not immune. The new forex trader is likely to be inundated with a number of forex myths, legends and downright falsehoods, so it™s important to sepa rate fact from fiction before your money leaves your hands. Here is a list of just a few: Myth 1 – Forex can make you rich quick Think about forex as a journey, and not a destination. There is no final winning trade; no huge gains; no trade of the century. Advanced strategies like margin trading, options and futures require a great deal of analysis. Traders make money in the forex market by analyzing trends and making smart decisions. The gain on each trade is a small step in the direction of his or her long-term goals. Myth 2 Œ The forex market is rigged Sometimes you might hear a trader complaini ng that the market is against them. Every trade they make is a losing one. They blam e the broker, the interbank, the government, the timing. The truth is this: foreign exchange rates change often and are too volatile to be rigged. Forex trading is not for the fain t-hearted. Blaming everyone but yourself for bad trades will prevent you from learning an d growing as a trader. The only person responsible for your poor trade performance is you. Myth 3 Œ The markets move in a predictable, scientific way The junk emails you get from companies trying to sell their guaranteed, scientific formulas are just that Œ junk. Anyone who trie s to tell you that they have the market cornered with forex predictions or a single formula is just as crazy as those people who tell you that you can win the lottery by scientific method. Try doing some paper trading (simulated, such as with a demo) and find the pattern. It™s not there.
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Myth 4 Œ The experts know best (experts always win) This is probably the most e nduring myth. Tons of ‚experts™ abound with advice for the new trader, based on years of experience. News flash: even the world™s best traders are right only about half of the time. Think about it Œ a trader can literally be a loser 50 percent of the time and still be considered an expert in forex Forex trading systems A forex trading system is a tool used by trad ers to help automate the more mundane and intricate aspects of trading. There are hundreds of forex software programs out there and in order to find the best program, you need to do many things. Also called forex robots (or bots), these trading systems offer the trader a variety of automatic functions. Some are fully-featured platforms; others are bare bones robots. There are literally hundreds of forex trading systems out there Œ enough to confuse the most savvy trader. The poor newbie could go into vapor lock trying to evaluate automated forex trading software without a little help. We have listed a few of the more comprehensive and popular programs available for easy, automated syst ems trading. No guarantees here, and of course, your mileage may vary. 1) FAPTurbo FAPTurbo is one of the most popular forex bots, and the website boasts examples of real trading results with real deposits with high-profile brokerages. Fully automated, FAPTurbo is able to automate high-volume tr ade with tight stop loss routines, which minimize losses. Multiple currencies trading capability enables the trader to diversify. Short-term scalping strategy a nd safe filters help to maximize control. A Virtual Private Server (VPS) service is offered for a fee. 2) Forex Megadroid Forex Megadroid is a very popular robot that was completed and used by the developers for a number of years before its release in March of 2009. This is unusual, as many bot systems are on the market as soon as the last line of code is written. Forex Megadroid has an extremely robust interface, and the makers claim that it won™t fold under high- volatility conditions like some bots. Fore x Megadroid offers a 60-day money-back guarantee, tutorials, 24-hour phone and online support. 3) U$DBot The makers of U$DBot say that their aim is to take as much of the guesswork out of forex trading as possible. U$DBot is offered at a price somewhat less than other competitors and includes a 60-day money-back guarantee if not satisfied. If the user decides a strategy is not working, the program allows for switching on the fly, making this one of the most versatile forex robots on the market.
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4) Forex Auto Pilot System (FAPS) Developed by forex guru Marcus Leary, FAPS is designed to continuously monitor the forex market unaided, choosing and trading th e most profitable tr ansactions based on meticulously written algorithms. Clear and co ncise feedback by the program lets the trader know exactly what is taking place. The program offers a demo to test the program out before buying. Understanding Forex Trading When you are trading Forex you are trading on e currency against another. An example would be when you are trading your Dollars for Euros. Most people have experienced this when visiting another country with a different currency. Because the rate for which you can trade your money fluctuates over time, it is also possible to earn money with currency trading. The only rule you have to follow says ‚buy low, sell high™. Of course this is not as easy as it sounds as you never know in advance what would be considered ‚low™ and ‚high™. However, if you know which factors influence the rate of a currency, you can make predictions about the future rate of this currency. An important aspect to know when trading is called the ‚spread™ of the currency. This is the difference between the rate to buy and the rate to sell the currency. This is expressed in ‚pips™, which is the smallest unit of price of a currency: 0.0001 of a currency unit. For example: Tabel 1: The Bid/Ask of the EUR/USD Bid Ask EUR/USD 1.3507 1.3512 In this case the spread is 5 pips (1.3512 Œ 1.3507 = 0.0005). This means that if you want to buy US Dollars with Euros, you will receive $1.3507. In case you immediately trade this back for Euros you will only receive •0.9996. In this case you lost •0.0004 by only changing from one currency to another and bac k. This is why a low spread is important when trading, to make sure your money will not all get lost just by trading. Predicting the Forex market The Forex market is very complicated and affected by many factors. Nevertheless, the price is always a result of all supply and demand forces. The demand and supply is influenced by several elements whic h can be put into three categories: 1. Economic Factors This means the economic conditions and ec onomic policy of a currency zone. The economic policy includes fiscal policy a nd monetary policy. The economic conditions consist of government budget deficits or surplu ses, balance of trade levels and trends, inflation levels and trends a nd economic growth and health.
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Tabel 2: International Interest Rates Central Bank CurrencySymbolChange DateInterest Rate Previous Rate The Reserve Bank o f Australia Australian Dollar AUD 11/02/2010 4.75% 4.50% Bank of Canada Canadian Dollar CAD 09/08/2010 1.00% 0.75% European Central Bank Euro EUR 05/07/2009 1.00% 1.25% Bank of England British pound GBP 03/05/2009 7.00% 7.00% Bank of Japan Japanese yen JPY 10/05/2010 0.00% 0.10% Swiss National Bank Swiss franc CHF 03/12/2008 0.25% 0.50% Federal Reserve U.S. dollar USD 12/16/2008 0.25% 1.00% National Bank of Denmark Danish krone DKK 01/14/2010 1.05% 1.15% Hungarian National Bank Hungarian forint HUF 04/26/2010 5.25% 5.50% Bank of Israel Israeli shekel ILS 09/27/2010 2.00% 1.75% Bank of Mexico Mexican pesoMXN 07/17/2009 4.50% 4.75% Reserve Bank of New Zealand New Zealand dollar NZD 07/29/2010 3.00% 2.75% Bank of Norway Norwegian krone NOK 05/05/2010 2.00% 1.75% National Bank of Poland Polish zloty PLN 06/24/2009 3.50% 3.75% South African Reserve Bank South African rand ZAR 11/18/2010 5.50% 6.00% Bank of Sweden Swedish kronaSEK 10/26/2010 1.00% 0.75% Central Bank of the Republic of Turkey Turkish lira TRY 11/19/2009 6.50% 6.75% Let™s analize some of this indicators: 1) Interest Rate(IR) Every currency zone has an interest rate that is set by the central bank. This rate is the most influential number for the forex market. Higher rates makes it more attractive to possess a certain currency. The interest rate is a reflection of all other economic
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indicators. View a list of the interest rate of every major central bank.This is how it looks the worldwide IR. 2) The Gross Domestic Product (GDP) The GDP is an indicator that values the total market value of all goods and services produced in a country during a year. This makes it the broadest measure of the state of an economy. The Foreign Exchange (Forex) market is the biggest market on earth today. It has a daily turnover of more than 2.5 trillion US$, which is more than 100 ti mes greater than the NASDAQ. The Forex market is traded 24 hours a day, Monday to Friday. The market consists of trading between large banks, central banks, currency speculators, multinational corporations, governments and other financial markets and institutions. 3) Industrial Production The Industrial Production indicator measures the change in production of a nation™s factories, mines and utilities. The report also covers the capacity utilizations. It is important as production reacts quickly to the economic state of a nation. 4) Consumer Price Index (CPI) The CPI is derived from a basket of products over 200 categories. It signals inflation risks and will therefore influence central banks policy concern. 5) Discover the News Impact on Forex Market . Retail Sales The Retail Sales indicator measures the tota l amount spent in retail stores throughout a country. It is an important fundamental b ecause it signals consumer spending which accounts for a majority of overall economic ac tivity. Understanding the main aspects of the Fundamentals will help us to gain a bigger picture understanding of how these factors shape and influence the actions of willing buyers and sellers. Personally, I do not base my trading decisions on the economic factors alone , but that does not mean that I choose to ignore the fundamentals altogeth er either.It can be of great benefit to any market professional to understand such things and why certain markets have positive and negative correlations with others and why certain news releases have a greater impact on prices than others.Always use some kind of economic calenda r before placing your trades Œ I call this looking left and right before you cross the street. By far, it’s better to be safe than sorry. Technical Analysis The Technical analysis method focuses on unde rstanding the prevailing market trends and tries to pinpoint any reversal of this trend and predict how the Forex market is likely to behave in the future. It is more statistical in nature in the sense that this method relies heavily on historical data of prices and volumes traded using charts to understand and
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interpret the market™s behavior. There are many mathematical tools available for making such analysis like various indicators, Numb er Theory, waves, gaps and trends etc. Technical indicators for Technical Analysis help us in analyzing the following: Identification of the tr end for the currency pair Whether the trend for the currency pair is bul lish (uptrend) or bearish (downtrend). Or the currency pair is running sideways (range movement). Strength of the trend for the currency pair If there is a trend (up or down) then whether the trend has strength to continue or it’s weak, which may indicate that a correc tion or reversal may take place soon. Resistance and Support levels If the currency pair price is falling then at what levels we can exp ect support and expect a reversal to upward movement. And If the curren cy pair is having an uptrend then at what levels we can expect resistance and can e xpect a reversal to downward movement. For example let™s suppose a currency pair is havi ng a trend (up or down) and the trend slows down. Our analysis says that the trend should continue but a correction in opposite direction may take place but to what level? Technical analysis indicators like Fibonacci retracements indicates the possible retracem ent levels during a reversal or price correction during a trend.There are too many t echnical analysis indicators available with various online Forex trading platforms. Many theories exist and you will probably be familiar with Gann, Elliot wave and Fibonacci and many traders use them but there not scientific. We prefer to use a few popular ones. Let’s have an overview of some of those: SAR (Stop and Reversal) To determine whether a trend is e nding and/or a new trend may start. Bollinger Bands To measure market™s volatility. To Give buying /selling signals during non-trending /sideways market. To Have an idea when the market may en ter into a trend while running sideways. MACD (Moving Average Convergence Divergence) Identification of a new trend.
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Figure 3: Boolinger bands Figure 4: MACD Stochastic Oscillators To identify where a trend might be slowi ng / ending and/or a new trend may start (indicating over bought/over sold levels). RSI (Relative Strength Index) To identify whether a trend might be endi ng and/or a new trend may start (over bought /over sold levels). RSI also can be used to confirm trend formations.
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