The first thing that I would like to point out is that this article is not the book. I am not giving an overview of the book, either, but there may be some references. We have already mentioned the Currency trading for dummies in the Forex books for beginners article if you would like to look at that. Instead, I am going to give you some general thoughts and processes that would fall under the Forex trading for dummies umbrella, and hopefully give you a little bit of a different view. If you would like to buy the book, click here.
Forex Trading For Dummies - Understanding Forex
- 1 Forex Trading For Dummies - Understanding Forex
- 2 Your Personal Forex
- 3 Major Forex Trading Pairs
- 4 Minor Pairs
- 5 Exotic Forex Trading Pairs
- 6 Major Vs. Minor Vs. Exotic Pairs
- 7 Forex Trading For Dummies - Forex Quotes
- 8 Indirect And Direct Quotes
- 9 Forex Terminology
- 10 PIP
- 11 Spread
- 12 Leverage
- 13 Margin
- 14 Slippage
- 15 Forex Trading For Dummies - Conclusion
Forex is otherwise known as FX, currency exchange, or currency exchange is a global, decentralized market of trading currencies. It is a vast market that is difficult to comprehend the scale, unless you already have experience in it, or you have something to compare it to. So, here is a comparison:
- In 2019, the total value of all stocks traded for the whole year totaled $60.359 Trillion. Even that is an amount of money that is difficult to understand to someone who has not got a background in stocks. So, to break it down a little bit, it is equal to $1,913,971 every second of every day.
- On the other hand, the global Forex market had a daily transaction of $6.6 Trillion, which is equal to $76,388,888 every second of every day. Not trying to do simple math for you here, but so that you don’t have to, that is 38x the size of all stocks in the world.
Those numbers have probably lead you in one of two directions of thought:
- That is a huge amount, and pretty scary, I don’t know if I am ready.
- That is a vast amount, loads of people must do it, so I can too.
Your Personal Forex
The truth is, if you have ever traveled abroad, you have already taken part in a Forex transaction. In the past, you may have gone to a bank to change your money from USD to Euros. That is not necessarily the way you have to do it now. However, when you did go to the bank, you would have checked the exchange rate, and maybe wait for a day or two to see if you could get a better price. Even though you may not go to the bank and hand over an envelope of money now, the principle is precisely the same.
Because of supply and demand, the exchange rate of all currencies, when compares to another, will differ from minute to minute and day to day. A month ago today (July 17th), the USD to EUR exchange rate was 0.88 USD to the Euro. Yesterday it closed at 0.84. While that doesn’t seem like a considerable amount, if you were taking $1000 on holiday with you and changed it on July 17th, you would have had €880. If you changed it yesterday, you would have had €844.28.
However, if you start to think about large companies that send millions of dollars to European employees or other businesses, you may notice the difference a little more than the one meal you lost out on with your holiday exchange rate. $1,000,000 changes to €880,000 or €844,280, depending on the day; nearly €36,000 difference.
Major Forex Trading Pairs
While I have used USD to EUR as an example because it is the largest pair, they are not the only major currency pairs that people and businesses trade. Before we get into the other pairs, you need to understand why they are a major pair, and what makes them major. Simply put, the major pairs are the most traded in the world economy by volume. The four largest traded pairs in Forex are:
- EUR/USD. - 28% of the market volume.
- USD/JPY. - 13% Volume.
- GBP/USD. - 11%.
- USD/AUD. - 6%.
Of course, those numbers do change almost daily, so if you are looking at it now, it may not reflect the exact percentages. However, the pairs are likely to remain roughly where they are, especially until you get to the lower market shares, where a single percent will change the bottom pair.
What you may have noticed is that all of the major pairs have USD in them.
Minor trading pairs are a combination of any of the above, with the exclusion of the USD.
These pairs all have a lot lower market trading volume in comparison, but they all have more stability than the exotic pairs.
Exotic Forex Trading Pairs
Exotic currencies are some of the more volatile currencies for trading with. However, an exotic pair often includes one of the major, and one exotic currency, such as USD/HKD (Hong Kong Dollar). While there are nearly 200 exotic currencies that you can trade with, most brokers will only offer around sixteen of them. Here is an alphabetical list of them:
- Brazilian Real
- Chinese Yuan Renminbi
- Czech Koruna
- Hong Kong Dollar
- Hungarian Forint
- Indian Rupee
- Indonesian Rupiah
- Malay Ringgit
- Mexican Peso
- Norwegian Krone
- Polish Zloty
- Russian Ruble
- Singaporean Dollar
- South African Rand
- South Korean Won
- Thai Baht
- Turkish Lira
Some of them are a lot more volatile than others, so you will need to look into them a little bit before you decide to trade.
Major Vs. Minor Vs. Exotic Pairs
Knowing whether to trade with major, minor, or exotic pairs is one of the first steps that you will need to take before doing anything with Forex. There are two main advantages and disadvantages of trading any pair:
- They are more stable.
- There is less chance of making a significant profit.
- There is less chance of losing money (relatively).
- If you understand one of the minor currency pairs more, you will have more idea of the trades.
- Slightly less stable.
- There is slightly more chance of losing money.
- Less Stable
- More change of making a significant profit.
- More chance of losing money.
While exotic pairs may seem like a good starting point because of the more substantial profit that may be available, it is not recommended that you choose it to start with. That is because it is effortless to lose vast amounts of money, too. So, start with either a major or minor pair if you are beginning.
Forex Trading For Dummies - Forex Quotes
When you start looking at a trading account, the first thing that you should do is to look at a demo account. I cannot stress that enough.
When you do, you will start to see different quotes on different currency pairs. They will look different depending on the broker, and they will also vary in cost, too. However, here is an example quote:
Here you can see a sell and buy price.
- The “sell” price, sometimes called the “bid” price, is the price that you can sell the FX for.
- The “buy” price sometimes called the “ask” price, is the price you can buy FX for.
There are two basic concepts of buying and selling Forex, but they both end, hopefully, in the same result.
- Buy low - sell high. - If you see that the price is low, you may want to buy it and wait for the price to rise before selling.
- Sell high - buy low. - If you see the price is high, you may want to sell it and wait till the price drops to repurchase it.
As you can see, the idea is precisely the same; only the beginning step of buying or selling is the other way round.
The buying price is almost always higher than the sale price, and the difference is called a spread. That spread is where the broker will earn their money for completing the trade for you. In the image above, you can see that there is not a lot of spread. Some will be bigger, and some will be smaller, so keep an eye on that to ensure you are not going to lose too much money on fees.
Indirect And Direct Quotes
Usually, the price that you see will be in the currency that the trader resides in. If you live in the US and want to buy Euros, you will see the quote as USD/EUR. In the image above, you can see that it is GBP/USD, which gives you a price of one GBP in USD. Therefore, it is an indirect quote. A lot of brokers will do the same format as this, as you can see below:
In this image, you can see the price of one USD in GBP.
The best way to think about this is you are buying USD in GBP or visa versa, as in the previous image where you were buying GBP with USD. Another way to see it is if the change rate is lower, a direct quote will be appreciating in value, and an indirect quote will mean that the domestic currency is lower in value to the foreign currency.
There are a lot of words that traders and brokers alike are using, that when you look at them for the first time, they can be very confusing. In this section, we will try to run through some of the more common ones that you are likely to see so that you have a little bit more understanding when you see them. While this list is not expected to cover everything, you will undoubtedly know the basics.
A Pip, PIP, or pip (capitalization is not something that people stick to in this area), stands for Percentage In Point. All a PIP is is a numeric unit that people use to measure a small percentage of any currency, wither in profit or loss. No matter which currency you are using, a PIP is 0.0001 of the currency. For example, if you are looking at a quote for the USD, with a lot size of 50,000, a PIP will be $5.
You will always see a buy and sell price with five decimal places, the last two of which are the PIPs.
A spread is a difference between the buying and selling price of a single currency pair.
As you can see from the image above, the spread at the time of the image, was 1.3 pips (1.32405-1.32392 = 0.00013). Knowing what the spread is is essential to all traders, as that is the cost of making a trade, decided by the broker. Some brokers provide lower spreads; others are higher. Do not think that they will all be the same, and they will all change for different currency pairs, too.
Some trading platforms will show the number of pips between the sell and buy price, and others, you will need to work it out.
You may see a lot of brokers and traders talking about leverage, and some of the statements and conversations that you see make it seem like a great thing to have. While it may be something good for some people, it is very, very dangerous to others. To talk about everything that is involved in leverage would need its own article, so I will try to keep this as simple as possible.
Forex leverage is a ratio of a trade that you need to put into a trade. The rest of the money comes from the broker. In theory, a 100:1 leverage means that you can put $2,000 into a trade and potentially earn profits from a trade that is equivalent to a $200,000 trade. Or a 10:1 means you can make profits from a $20,000 trade. Sounds great, doesn’t it?
The problem is, unless you are very careful with which broker you choose, you could also make a loss of a $200,000 trade, which could be significantly more than the $2,000 you had to start with. Thus, you are in debt with the broker.
The bottom line of leverage is to look carefully at the fine print that you agree to before committing.
Margin is similar to leverage, in the sense that you can amplify the profits and losses of your trades depending on the margin. The significant difference is that a margin is expressed as a percentage. In the UK, most brokers will start their margin requirements at 3.3%. What that means in real money, is that you only need $3,300 to open a position that is worth $100,000.
Again, this may seem like a good thing; the remaining 96.7% is not plucked out of thin air. The broker provides it. That means you can get the profit, or the loss, from a much larger trade than you actually have the cash for.
Your skill level, and the stance that you have with a particular broker, will change your margin. That can be either up or down - down if you are new, up if you are more experienced.
Slippage is the difference between when you decide to trade, and when the trade actually occurs. If you are looking at all of the data and choose to trade a lot (a certain amount of money) at the buy price of 1.32405 as seen above, you would expect to execute the trade at the same price. However, sometimes, with the volatility of the market, within that second, the price may have changed dramatically. For example, look at the image below:
If you planned to buy the lot at the bottom arrow, you might find that the time it takes to execute the trade takes you to the higher arrow. That would be a negative slippage, as you essentially paid more than you wanted to and missed out on the rise.
The same works the other way, though. If you buy it at a price that then falls, you will get a positive slippage, where you spend less money on the trade than you thought.
Forex Trading For Dummies - Conclusion
I have tried to keep this Forex trading for dummies article to the basics, as there is a lot to go through. Things like how to trade Forex will come later. Therefore, my suggestion is that you go and make a few demo accounts with different brokers and look out for the things that we have gone through in this article.
One thing that I would suggest, though, is that you look for brokers that are compatible with the MT4 platform. The reason is that you only have to learn one platform for all of your trading. Only because it can be quite tricky learning all of the terms and even the layouts of different platforms when you are starting in Forex.