Market dynamics

The breadth, depth, and liquidity of the market are truly impressive. It has been estimated that the world's most active exchange rates like EURUSD and USDJPY can change up to 18,000 times during a single day.

Somewhere on the planet, financial centers are open for business, and banks and other institutions are trading the dollar and other currencies, every hour of the day and night, aside from possible minor gaps on weekends. In financial centers around the world, business hours overlap; as some centers close, others open and begin to trade.

The foreign exchange market follows the sun around the earth. Each business day arrives first in the Asia-Pacific financial centers; first Wellington, New Zealand, then Sydney, Australia, followed by Tokyo, Hong Kong, and Singapore. A few hours later, while markets remain active in those Asian centers, trading begins in Bahrain and elsewhere in the Middle East. Later still, when it is late in the business day in Tokyo, markets in Europe open for business. Subsequently, when it is early afternoon in Europe, trading in New York and other U.S. centers starts. Finally, completing the circle, when it is middle or late afternoon in the United States, the next day has arrived in the Asia-Pacific area, the first markets there have opened, and the process begins again.

The graph underneath displays not only the currency trading time cycle but also the average 'depth' of trading at different times during the day in the various business hours.

1. Spot rate

A spot transaction is a straightforward (or outright) exchange of one currency for another. The spot rate is the current market price or 'cash' rate. Spot transactions do not require immediate settlement, or payment 'on the spot'. By convention, the settlement date, or value date, is the second business day after the deal date on which the transaction is made by the two parties.

2. Bid & ask

In the foreign exchange market (and essentially in all markets) there is a buying and selling price. It is important to perceive these prices as a reflection of market condition.

A market maker is expected to quote simultaneously for his customers both a price at which he is willing to buy (the bid) and a price at which he is willing to sell (the ask) standard amounts of any currency for which he is making a market.

ACM quotes very competitive spreads to customers, to site an example if a trader is interested in a transaction in EURUSD then he can trade on a bid/ask of say 0.9150 / 0.9153. This means that ACM is willing to buy from him a pre-determined amount at 0.9150 or inversely to sell to him at 0.9153.

Generally speaking the difference between the bid and ask rates reflect the level of liquidity in a certain instrument. On a normal trading day, the major currency pairs EURUSD, USDJPY, USDCHF and GBPUSD are traded by a multitude of market participant every few seconds. High liquidity means that there is always a seller for your buy and a buyer for your sell at actual prices.

3. Base currency and counter currency

Every foreign exchange transaction involves two currencies. It is important to keep straight which is the base currency and which is the counter currency. The counter currency is the numerator and the base currency is the denominator. When the counter currency increases, the base currency strengthens and becomes more expensive. When the counter currency decreases, the base currency weakens and becomes cheaper. In telephone trading communications, the base currency is always stated first. For example, a quotation for USDJPY means the US dollar is the base and the yen is the counter currency. In the case of GBPUSD (usually called 'cable') the British pound is the base and the US dollar is the counter currency.

4. Quotes in terms of base currency

Traders always think in terms of how much it costs to buy or sell the base currency. When a quote of 0.9150 / 53 is given that means that a trader can buy EUR against USD at 0.9153. If he is buying EURUSD for 1'000'000 at that rate he would have USD 915'300 in exchange for his million Euro. Of course traders are not actually interested in exchanging large amounts of different currency, their main focus is to buy at a low rate and sell at higher one.

5. Basis points or 'pips'

For most currencies, bid and offer quotes are carried down to the fourth decimal place. That represents one-hundredth of one percent, or 1/10,000th of the counter currency unit, usually called a 'pip'. However, for a few currency units that are relatively small in absolute value, such as the Japanese yen, quotes may be carried down to two decimal places and a 'pip' is 1/100th of the terms currency unit. In foreign exchange, a 'pip' is the smallest amount by which a price may fluctuate in that market.

6. Euro cross & cross rates

Euro cross rates are currency pairs that involve the Euro currency versus another currency. Examples of Euro crosses are EURJPY, EURCHF and GBPEUR. Currency pairs that involve neither the Euro nor the US dollar are called cross rates. Examples of cross rates are GBPJPY and CHFJPY. Of course hundreds of cross rates exist involving exotic currency pairs but they are often plagued by low liquidity. Ever since the Euro the number of liquid cross rates have decreased and have been replaced (to a certain extent) by Euro crosses.

How To Choose a Forex Trading System That Works and Suits You

There are so many different trading systems you could use to trade the forex market, some better suited to certain people than others. For example some people may find it easier to comprehend and take into account fundamental factors as opposed to looking at a screen covered in technical indicators, and vice-versa.

The first logical step in determining what type of trading system would best suit you is actually being aware and understand the widely known methods of analysis used in trading the currency market. Once you are aware of the tools that are available, you can generally tell what type of analysis suits you. For example some of the main technical analysis methods which are popular include:

Pivot points

Chart patterns

Fibonacci retracements

Candlestick patterns

And some fundamental factors which are widely used include analyzing:

Interest rates

Trade balances

Unemployment rates

Gross domestic product (GDP)

You may now actually be able to develop your own system by combining certain methods of analysis together, giving you a method which you are comfortable with. On the other hand you may decide that you would like to trade someone else’s system, either way, that brings us to the next step which is determining the profitability of a trading system.

Determining Profitability

Most people would think that back testing is the best way to determine a systems profitability. However back testing doesn’t always give you a true idea of how profitable a system is. The reason for this is because when you’re back testing your system on historical charts, you are only seeing the obvious setups which have occurred, and not always seeing the ones that are less obvious. These less obvious ones sometimes can produce losses, which is why back testing isn’t always the best method to implement.

A better method of determining profitability is by trading your system in real-time with a demo account. This would give you a true understanding of what your system is capable of. This would also allow you to familiarize yourself with your trading platform at the same time. When determining profitability you must look at it in terms of expectancy and opportunity.

Expectancy & Opportunity

These two factors together will be able to tell you what you could expect to make over a period of time. Expectancy is calculated with the following formula:

(Probability of winning × average win) – (Probability of losing × average loss)

This will give you a figure which is the average amount you can expect to make per trade. This shouldn’t be a negative amount, if it is you should look at some other method of trading since you cannot make money on a system that produces a negative expectancy. Obviously the higher this figure is the better. Now to the opportunity factor.

The opportunity factor is how often you are able to trade using your system. By multiplying your expectancy figure with your opportunity factor it will tell you how much you could expect to make over a period of time. The more opportunity you have to trade, the more money you should expect to make. This now brings us to the last component of a trading system, money management.

Money Management

Without proper money management you will end up as a statistic. In other words one of those 90%+ of traders who loose their money. Money management tells you how much of your account balance to risk per trade. The whole point of money management is to ensure your survival over the long term, and to preserve your capital.

The most common form of money management is the percent risk model which tells you not to risk more than x percent of your account balance on any one trade. A range between 1-3% is generally an accepted amount which has been a reliable percentage to use in order to make money in the long term.

Conclusion

By taking into consideration the above factors you will be able to determine if a trading system best suits you, and with some simple mathematical calculations you will be able to determine its profitability

Main forex markets

Foreign exchange is traded essentially in two distinctive ways. Over an organized exchange and 'over the counter'. Exchange traded foreign exchange represents a very small portion of the total foreign exchange market the great majority of foreign exchange deals being traded between banks and other market participants 'over the counter'.

1. Exchange traded currencies

In the case of an organized exchange like the Chicago Mercantile exchange (CME) in the US, standardized currency contract sizes that represent a certain monetary value are traded in the International money market (IMM). A central clearing house organizes matching of transactions between counter-parties. There are various disadvantages to trading currency futures as outlined in the chapter Advantages of trading FX.

2. Forex market

In comparison the over the counter market is traded around the world by a multitude of participants and price quality, reputation and trading conditions determine who a participant wishes to trade with. It is probably the most competitive market in the world and brokers like ACM must insure they live up to the highest standards of service and be compliant with market standards and practices if they want to acquire new customers and retain their existing ones. In 1998 a survey under the auspices of the Bank for International Settlements (BIS), global turnover of reporting dealers was estimated at about USD 1.49 trillion per day. In comparison, currency futures turnover was estimated at USD 12 billion.

Among the various financial centers around the world, the largest amount of foreign exchange trading takes place in the United Kingdom, even though that nation's currency, the British pound is less widely traded in the market than several others. As shown in the graph underneath, the United Kingdom accounts for about 32 percent of the global total; the United States ranks a distant second with about 18 percent, and Japan is third with 8 percent.

About Forex

To buy foreign goods or services, or to invest in other countries, companies and individuals may need to first buy the currency of the country with which they are doing business. Generally, exporters prefer to be paid in their country's currency or in U.S. dollars, which are accepted all over the world.

The foreign exchange market, or the "FX" market, is where the buying and selling of different currencies takes place. The price of one currency in terms of another is called an exchange rate.



The market itself is actually a worldwide network of traders, connected by telephone lines and computer screens there is no central headquarters. There are three main centers of trading, which handle the majority of all FX transactions United Kingdom, United States, and Japan .

what is forex

FOREX (FOReign EXchange market) is an international foreign exchange market, where money is sold and bought freely. In its present condition FOREX was launched in the 1970s, when free exchange rates were introduced, and only the participants of the market determine the price of one currency against the other proceeding from supply and demand.As far as the freedom from any external control and free competition are concerned, FOREX is a perfect market. It is also the biggest liquid financial market. According to various assessments, money masses in the market constitute from 1 to 1.5 trillion US dollars a day. (It is impossible to determine an absolutely exact number because trading is not centralized on an exchange.) Transactions are conducted all over the world via telecommunications 24 hours a day from 00:00 GMT on Monday to 10:00 pm GMT on Friday. Practically in every time zone (that is, in Frankfurt-on-Main, London, New York, Tokyo, Hong Kong, etc.) there are dealers who will quote currencies.FOREX is a more objective market, because if some of its participants would like to change prices, for some manipulative purpose, they would have to operate with tens of billions dollars. That is why any influence by a single participants in the market is practically out of the question. The superior liquidity allows the traders to open and/or close positions within a few seconds. The time of keeping a position is arbitrary and has no limits: from several seconds to many years. It depends only on your trading strategies. Although the daily fluctuations of currencies are rather insignificant, you may use the credit lines, that are accessible even to currency speculators with small capitals ($ 1,000 - 5,000), where the profit may be impressive. (You can learn more about it in the section: The main principles of trading.)The idea of marginal trading stems from the fact that in FOREX speculative interests can be satisfied without a real money supply. This decreases overhead expenses for transferring money and gives an opportunity to open positions with a small account in US dollars, buying and selling a lot of other currencies. That is, on can conduct transactions very quickly, getting a big profit, when the exchange rates go up or down. Many speculative transactions in the international financial markets are made on the principles of marginal trading.Margin trading is trading with a borrowed capital. Marginal trading in an exchange market uses lots. 1 lot equals approximately $100,000, but to open it it is necessary to have only from 0.5% to 4% of the sum.For example, you have analyzed the situation in the market and come to the conclusion that the pound will go up against the dollar. You open 1 lot for buying the pound (GBP) with the margin 1% (1:1000 leverage) at the price of 1.49889 and wait for the exchange rate to go up. Some time later your expectations become true. You close the position at 1.5050 and earn 61 pips (about $ 405). For the calculation of 1 pip click here.Everyday fluctuations of currencies constitute about 100 to 150 pips, giving FX traders an opportunity to make money on these changes.In FOREX, it's not obligatory to buy some currency first in order to sell it later. It's possible to open positions for buying and selling any currency without actually having it. Usually Internet-brokers establish the minimum deposit such as $ 2000, for working in the FOREX market, and grant a leverage of 1:100. That is, opening the position at $100,000, a trader invests $1,000 and receives $99.000 as a credit. The major currencies traded in FOREX, are Euro (EUR), Japanese yen (JPY), British Pound (GBP), and Swiss Franc (CHF). All of them are traded against the US dollar (USD).In order to assess the situation in the market a trader has to be able to use fundamental and/or technical analysis, as well as to make decisions in the constantly changing current of information about political and economic character. Most small and medium players in financial markets use technical analysis. Technical analysis presupposes that all the information about the market and its further fluctuations is contained in the price chain. Any factor, that has some influence on the price, be it economic, political or psychological, has already been considered by the market and included in the price. The initial data for a technical analysis are prices: the highest and the lowest prices, the price of opening and closing within a certain period of time, and the volume of transactions.A technical analysis is founded on three suppositions:Movement of the market considers everything;Movement of prices is purposeful;History repeats itself. That is, technical analysis is a statistical and mathematical analysis of previous quotes and a prognosis of coming prices.A number of technical indicators have been installed into the PRO-CHARTS trading system. Analyzing the indicators one can come to the conclusion about further movements of the quoted currencies. For a more detailed description of the indicators, analyzing price charts and volumes of trading, click here.Fundamental analysis is an analysis of current situations in the country of the currency, such as its economy, political events, and rumors. The country's economy depends on the rate of inflation and unemployment, on the interest rate of its Central Bank, and on tax policy. Political stability also influences the exchange rate. Policy of the Central Bank has a special role, as concentrated interventions or refusal from them greatly influence the exchange rate.At the same time one should not consider fundamental analysis just as an analysis of the economic situation in the country itself. A far bigger role in the FOREX market belongs to the expectations of the market participants and their assessment of these expectations. Various prognoses and bulletins, issued by the participants, have a strong influence on the expectations. Very often an effect of the so-called self-filfilling prophecy occurs when market players raise or lower the exchange rates according to the prognosis. But a deep and thorough fundamental analysis is available only for big banks with a staff of professional analysts and constant access to a wide field of information.In spite of these different approaches, both forms of analyses complement one another. Traders who act on the basis of a fundamental analysis, have to consider some technical characteristics of the market (the main rates of support, such as resistance and resale), and supporters of the technical approach to the market must track the main news (interest rates, important political events).

Speculation vs investment

It is very important that the individual wanting to trade foreign exchange be aware of the very marked difference between speculation and investment. Forex trading is by nature a speculative occupation. Foreign exchange markets are amongst the most volatile markets in the world. When traded on a margined basis they effectively become the most volatile in the world. Day trading in foreign exchange can be extremely profitable and high-risk profile traders can generate huge percentage returns even overnight. Day trading is however a mentally and psychologically challenging activity and is by no means meant for everyone. Day trading is essentially speculation and day traders essentially only do that: day trading. Most people who trade foreign exchange are not professional day traders however.

Often the contractors of foreign exchange brokerage services are professionals in some capacity or other. These people do not day trade but take the occasional position from time to time. This is also speculation and should not be confused with making an investment.

The conclusion here is that the nature of foreign exchange trading not lend itself as much to investment as it does to speculation and hedging (hedging may be performed in forward instruments). It is possible in a sense to make an investment in foreign exchange over a long-term period but this necessitates a large account value and low leveraging.