Many people have asked me “what is this forex thing?” People are generally familiar with stock markets, either because they have money in it or simply because they hear about it in the news all the time. Yet the FOREX market is much bigger, more easily accessible for everyday people, much more interesting, and more liquid. To fill the knowledge gap, I decided to provide an “introductory overview” with some value-added insights for people in the general public who are curious about financial markets and investments. Ready? GO!
What is it and how does it work?
The FOREX market is not really a physical place like the New York Stock Exchange or a Wall Mart. It is simply a collection of people, institutions, intermediaries, and technology that allows all participants to buy or sell currencies online. Anyone can participate in this market: you, me, billionnaires, major hedge funds, multinationals, financial institutions, central banks, etc. We as individuals would not be able to trade in this market without the pooling of funds and intermediation services of broker/dealers.
Retail traders (ordinary people like you and me) are a very small fraction of the massive global FOREX market, which is the largest financial market in the world. Other than central bank interventions and special government interventions, the market is not manipulated by any one player because it simply is too big to be impacted by individual players, even large institutions, especially over periods of several months and years. This means that if I find a “winning strategy” and I tell 5000 of my friends, it won’t even make a dent in the market. This is actually a very good aspect of the FOREX market: almost each player is negligible and the market moves based on various market forces that are too long to explain in a blog article. But be warned: never fight the market... follow the direction of the big players, which as a whole DO move the market. Knowing how to do this is part of any good forex training program.
The FOREX market is special for most retail traders, because you never actually buy or sell currencies “for real”: if you “trade” a currency pair (buy or sell – details further below), you are simply taking a “long” position on one currency and a “short” position on the other. Period. You do not actually “get” a currency when you buy and you do not have to “deliver” a specific currency to anyone when you sell. It IS possible to ask for the transfer of the foreign currency funds to your account if you want, but that rarely happens and is done more often by financial institutions and multinationals who actually need various currencies of the world in their business.
You take a long position on one currency when you expect it to appreciate over time, and you take a short position on a currency when you expect it to depreciate over time. It is of course this specific knowledge of markets and the capacity to understand markets and currency fluctuations that is the challenge, and also what makes FOREX trading fascinating and fun. Your trading strategy can be very short term (a few hours) to a few months.
When the currencies of your long positions indeed appreciate (as you expected), you make a profit and when the currencies of your short positions depreciate (as you expected), you make a profit. Otherwise you make a loss (negative profit). You also receive interest payments on the currencies on which you are long, and you must pay interest on currencies on which you are short. The total proceeds (profits/losses + net interest payments) are deposited in the account you have with your chosen broker/dealer. The interest payments are very close to the central bank rate of the currencies. Beware: if you think the Brazilian Real is attractive for interest payments and you go long on the BRL to get that 14% rate, you must be careful of the BRL not depreciating more than 14% ;) ... if you get appropriate training and you practice enough, this will all become crystal clear.
The FOREX market is accessible to you within approximately a few hours from now: open an account with one of the big and trustworthy “forex broker/dealers” (more on this further below) and you are good to go with “fake funds” that they give you without having to deposit a penny.
You can trade as little as one hour per week and as much as you want. Some make a full living off of online FOREX trading, which can be done from anywhere in the world, which is very cool! Many people who discover FOREX trading become passionate and fascinated about it because... well... it IS fascinating! I even know people who essentially do it just for fun: they mostly use the demo account with fake money to “play”, and they never risk more than 1000$ per year of their own real money, just because they find it so interesting and fun!
Once you are comfortable with the practice account (and I INSIST you practice first for several weeks or months AND get appropriate training and knowledge!), you can start trading with real money such as 1000$ that you deposit in your account with your chosen broker/dealer. Depending on various aspects of your profile, the 1000$ can give you access to as much as 100 000$ to actually trade, which is leverage... a double-edged sword that should be used with great caution.
Although the demo account is essentially exactly like the real world experience, it differs in a few fundamental ways, 2 of which are 1) “psychology, emotional control, and strategies” and 2) slippage of stops and market volatility issues (I don’t want to explain this here). These can be managed with a gradual, step-by-step approach and appropriate training and knowledge.
The problems that most people new to FOREX have are typically:
Remember the trading classic: bulls make money, bears make money, pigs get slaughtered!
FOREX trading is done in a simple manner: you buy and sell “currency pairs”:
EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, etc.
It is of no importance where you live or what your actual personal currency is (the currency origin of your bank account and the currency you are paid with at your job). All you need is a good Internet connection and normal intelligence. There are differences in rules and regulations by country, which you will discover as you start trading. The “doing” is very easy and straightforward. You simply open an account and “setup a trade”:
Suppose I expect the USD to appreciate against the CAD (Canadian dollar) over the next month. I enter a “buy” on the USD/CAD pair... and if things turn out as I expected after a month, I can close the position and pocket the profit.
Suppose I expect the GBP (British Pound) to depeciate against the USD over the next week. I enter a “sell” on the GBP/USD pair... and if things turn out as I expected after a week, I can close the position and pocket the profit.
I can also control risk by telling the platform (the environment for trading) to exit the trade if the price of the pair hits a certain value. I evaluate the “critical values” by estimating the value of a change of a certain amount of the currency pair and what that represents for me (in absolute $ terms and in % of my account balance). This is part of risk management, which also has other considerations I don’t have the place to cover here.
If you “buy” a pair (long position for the pair), you are long on the first currency and short on the second one. That means you expect the first currency to appreciate against the second one.
If you “sell” a pair (short position for the pair), you are short on the first currency and long on the second one. That means you expect the first currency to depreciate against the second one.
When you hold for long periods of time, you collect the interest payments on the currency you are long and you pay interest on the currency you are short.
Understanding currency fluctuations and predicting their evolution over time is possible, but requires some knowledge and training in an organized way. Good training helps to get the knowledge to do this appropriately and without excessive risk. Perfect foresight is of course impossible – if you have that gift, you should be a billionnaire by now! But increasing the probability of a good decision and decreasing the probability of a bad decision is possible – that’s the slogan of my website!
PIPS and spreads
When you buy one dozen eggs, you buy 12 eggs. The same principle applies in FOREX trading: you can buy or sell “big chunks”, “medium chunks”, “small chunks”, etc. For example, a standard “lot” is 100 000 units of a currency, a mini lot is 10 000 units of a currency, and a micro lot is 1000 units of a currency. Keep reading, you will see where this is going...
Exchange rates in FOREX trading are expressed with 4 digits, for example: if EUR/USD is 1.1325, it means that it takes 1.1325 USD to buy 1 EUR. An increase in the price of this pair means an appreciation of the Euro (it is more expensive in USD).
To simplify a bit, you can essentially take this :
1 pip = lot size /10 000
For example if you buy one standard lot (100 000 units) of EUR/USD, one pip is worth 100 000/10 000 = 10$. If you buy one mini lot (10 000 units) of EUR/USD, one pip is worth 10 000 / 10 000 = 1$... and if you buy a micro lot (1000 units), one pip is 10 cents.
So if you are long on the EUR/USD pair (buy) for a standard lot and the pair goes from 1.1325 to 1.1326, your account balance increases by 10$, and if the pair goes from 1.1325 to 1.1324, your account balance decreases by 10$. If you had a mini lot, your account balance would change by 1$, and if you had a micro lot, your account balance would change by 10 cents.
A 1% appreciation of the Euro against the US dollar in this situation would mean that the pair would go from 1.1325 to 1.01*1.1325 = 1.1438, or 113 pips = 1130$ for a standard lot, 113$ for a mini lot, and approx 11$ for a micro lot.
So if you were long on the EUR/USD from 2002 to 2005, the pair went from 0.9000 to 1.3000, or 4000 pips, which is 40 000$ for one standard lot or 4000$ for a mini lot with a long EUR/USD position over that period.
A last word about spreads. You will notice one thing once you start trading: there is a difference between the bid and the ask price: the ask price (buyers) is higher than the bid price (sellers). This is because each trade has 2 parties: a buyer and a seller, but you really are always buying from the broker and selling to the broker, which is the intermediary in the exchange. You sell the EUR/USD at 1.1325 and you buy at 1.1327 – a 2 pip difference, or 20$ on a standard lot. This is the profit of the broker.
If you enter a buy trade on a standard lot and the spread is 2 pips, you are automatically down 20$ in your account, because to exit the trade you will close it, which is equivalent to entering an opposing trade (not quite, but lets skip the details) and that means that if you buy now and sell immediately one micro second after, you make a negative profit, because you bought at a higher price than you sold. The cost of this transaction would be 20$. This is one of the many reasons I am not a fan of high-frequency trading such as what is often done in day trading: you pay lots of transactions fees with all those in-and-out strategies and trades...
A word about leverage
FOREX traders often have access to and use levarage, which means that you can buy or sell pairs for 100 000$ with only 1000$ of your own money. Yes, you read that correctly: if you had 1000$ in 2002 and you went long on EUR/USD for 3 years with a 100:1 leverage, your 1000$ transformed into 40 000$ in 2005, less margin interest, etc (but still good profit)... not bad! And if you had 10 000$ in 2002, well, you know...
Leverage is very attractive, but risky if you don’t use appropriate risk management and if you don’t know what you’re doing, which is the sad case of many retail traders. Because suppose you go long on EUR/USD with your 1000$ at 100:1 leverage, and the Euro depreciates, say, 200 pips (very possible!), which is 2000$... this means you are at -1000$ (you lost your initial 1000$, and an extra 1000$, plus interest payments)... OUPS!
I don’t want to demonize leverage, but please use with caution, knowledge, and moderation. Just understand that the use of leverage requires a few conditions:
Who makes profits?
Many people lose in FOREX trading because they throw themselves into the market without appropriate knowledge and understanding of markets, thinking that they will make a quick fortune. Read my other blog posts on this. Yet, many others make very high profits... in the hundreds of % per year, even thousands of percent. I am not joking by the way. But they know what they are doing.
It is about gaining the knowledge, knowing yourself in terms of risk tolerance and desire for returns, and developing strategies to profit from the general ups and downs of currencies, which almost always happen, because currencies rarely stay flat for long – they either appreciate or depreciate against another currency. Look at the value of the USD versus the Yen below (quantity of USD for one yen – a drop is a depreciation of the USD against the Yen):
Notice the dramatic depreciation of the USD against the Yen from 1985 to 1987, then again more from 1988 to 1995, then a large appreciation of the USD from 1995 to 1998... a depreciation from 2008 to 2012, a strong appreciation from 2013 to late 2015... there is always quite dramatic movements in currencies, and THAT is the source of profits in the FOREX market. You just have to have the knowledge to understand and predict these swings with good success probabilities, which is what major hedge funds do well, using a combination of technical analysis and very good fundamental analysis, which is what I also provide in the program I offer on my website.
The average trade period for retail traders is short – most are day traders or “week traders”: they buy or sell for a few hours or days. High-return traders and hedge funds often use a 1-to-5 months period for their strategies, with an average of 2-3 months. I personally prefer this approach, as there is more logic in it for me, but there are winning strategies in every approach, from day trading to longer term strategies.
Broker/Dealers and FOREX market access for normal people
As explained earlier, the profits of brokers come from spreads – the difference between the bid (sell price) and the ask (buy price). Spreads are generally low and competitive. They make profits from the huge volume of trades. Although there are cases where brokers bet against you in trades, brokers generally don’t care about your trade decisions – they make a profit no matter what, because they buy at a lower price than what they sell, and that happens every time there is a trade.
There are literally hundreds of forex broker/dealers, but you should select one that is trustworthy, has solid capital to absorb shocks, and provides a good, reliable trading platform, with quality tools and a user-friendly trading environment. The bigger ones that are under regulatory supervision are generally trustworthy.
You go to their website and you open a practice account... you practice trading with the demo account for several weeks (or months), and when you start getting the hang of it, you open a real money account by depositing small funds in your account, like 1000$... then 2000$, 5000$, 10 000$... and beyond hahahaha! As I mentioned earlier, this is all fun to a point that some people (including people that took training with me) even develop this as a true “leasure activity” and may even not trade much “for real”, but they love the intellectual challenge of understanding markets and currency pair fluctuations, and the excitment of good trades.
There are 3 main “markets” for FOREX trading: Asia, Europe, America. All are served by all major broker/dealers, which means you can essentially trade 24 hours a day except weekends.
The broker/dealer acts as a “middle man” to allow trades to happen. You sell to the broker and you buy from the broker, but he really only acts as an intermediary (this is the preferable setup): for every sell order, the broker has a corresponding buy order and vice versa on the other side (this is not always actually the case, but you can keep this picture in mind so things stay simple and clear).
When many traders want to sell and less want to buy, there is temporary “excess selling pressure”, which drives the price down and attracts enough buyers to bring the market to equilibrium. Same logic the other way.
Everyone is allowed to trade in this market, which makes it very liquid: on most currency pairs, you will always find buyers when you want to sell, and sellers when you want to buy at the current market price. Large institutions participate in the FOREX market because they hedge balance sheet positions, because they actually need foreign currencies in their business and global operations, and because they also trade to turn a profit on fluctuations, just like us.
Some solid FOREX brokers are:
Note that there are MANY others and you simply need to research this and be sure to select one that is reputable, has no history of major “requoting” (changing the price at which you thought you closed a position!), no major “slippage” issues, has a good capital cushion, ideally does not itself take positions in trades (but that is hard to check for sure), provides enough currency pairs to trade and an easy trading environment with graphs and indicators, as well as a quality help service. They also differ by the minimum account deposit they require and allowed leverage, but most will accomodate the needs of ordinary people.
There is much more to say, but I see that I have written a bit too long already. The world of forex trading and currencies is fascinating and fun. Just be sure to get the appropriate knowledge before you jump in, and get it from a high-integrity source! If you want to join my online FOREX training program, feel free to do so – it is complete, transparent, fun, and honest. It is a good training program on its own, and also an excellent complement to other programs and knowledge sources you can find. It was build to be honest, clear, well structured, and accessible to anyone who wants to learn, regardless of background or experience.
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