Forex trading for beginners
Forex trading for beginners analyses the basics of Forex, how macroeconomics and other factors move currencies and advanced trading strategies.
Successful forex trading uses systematic processes to predict future currency moves by analyzing macroeconomic and global financial market dynamics.
Int this guide we will cover the basics of Forex, how to find forex trading opportunities by screening the currencies using specific forex trading strategies, the factors used to predict currencies, technical analysis used to time a specific trade and risk management methods to protect your investment portfolio while achieving consistent returns.
Forex trading involves the systematic analysis of countries’ economies and global financial markets to predict currency moves and generate consistent returns with low risk.
Never lose money
Warren Buffet’s first rule in investing is never lose money. Unfortunately, most forex trading advice floating on the internet is generated by brokers and educators whose only purpose is to convince you that forex trading is easy and then get your money.
The 90/90/90 rule: This rule means that 90% of new traders lose 90% of their capital within 90 days.
The truth is that forex Trading is one of the most competitive markets. Hence, only sophisticated traders are profitable. The rest of amateur traders get wiped out.
If you are serious about learning how to trade currencies continue reading. Else, stop reading right now and do not waste your money trying to trade forex.
The main reasons new traders lose their capital so fast are the following:
1. Get Rich quickly / Guaranteed income: Brokers and educators try to convince new traders that they can become rich quickly or can earn $1,000 per month following a specific forex strategy. These are all lies.
Professional traders and fund managers take prudent risks to generate steady returns without exposing their trading accounts to huge risks. They also acknowledge that investing and trading is not for income. They have a constant income stream from other income generating assets, and they use investing and trading strategies for long-term growth of their wealth.
2. Small overleveraged trading accounts: They trade a small overleveraged account. The minimum forex requirement is 1%. Hence, new traders deposit $1,000 and use 100x leverage (borrowing from the broker). This means that they use $1,000 to borrow another $99,000 from the broker and trade a $100,000 account. If they lose 1% of the account, their account is wiped out since a 1% loss of a $100,000 account is their initial capital of $1,000.
3. Losing Trading Strategies: They follow stupid losing forex trading strategies provided by brokers. Brokers aim to convince foolish traders that trading is easy. As a result, they teach them simple rules to buy or sell currencies using charts. Traders follow these stupid strategies, and in the process lose all their capital while brokers generate commissions and other fees.
4. Broker is your enemy: Brokers try to convince you to trade as frequently as possible, using the maximum leverage, liquid currencies which offer no trading opportunities. You are wiped out as fast as possible while they earn revenue with 1. wide bid-ask spreads, 2. execution commissions, 3. Interest cost charged for your leverage, 4. Taking the other side of your trades.
Professional forex traders
Professional forex traders and fund managers also called smart money aim firstly to protect the capital of their investors and secondly to generate steady returns in both rising and falling markets.
What is the Forex Market?
The forex market is a global marketplace for exchanging currencies. It is one of the largest global markets with a daily trading volume of over five trillion us dollars. The market opens in New Zealand every Sunday at 5pm EST and closes every Friday at 5pm EST. 20% of the trading volume is for real business transactions whereas 80% is for pure speculation conducted by forex traders.
The G10 currencies are the US Dollar, Euro, Japanese Yen, British Pound, Swiss Franc, Australian Dollar, New Zealand Dollar, Canadian Dollar, Swedish Krona, Norwegian Krona. The G10 currencies and their symbol is listed below:
- US Dollar (USD)
- Euro (EUR)
- Japanese Yen (JPY)
- British Pound (GBP)
- Swiss Franc (CHF)
- Australian Dollar (AUD)
- New Zealand Dollar (NZD)
- Canadian Dollar (CAD)
- Swedish Krona (SEK)
- Norwegian Krona (NOK)
The G10 currencies are the ten most heavily traded currencies in the world and are very liquid. However, they have low volatility hence they rarely offer good trading opportunities.
Professional traders focus on the currencies presented below grouped using three main factors: 1. Floating vs fixed exchange rates, 2. safe versus high risk currencies, 3. Commodity related currencies versus independent currencies.
Tradable Forex Markets
|Floating Currencies||Fixed Currencies|
|Diverse Currencies||Commodity Related||Diverse Currencies|
|US Dollar (USD)||Australian Dollar (AUD)||Chinese Yuan (CNH)|
|Euro (EUR)||Canadian Dollar (CAD)||Hong Kong Dollar (HKD)|
|Japanese Yen (JPY)||New Zealand Dollar (NZD)||Singapore Dollar (SGD)|
|British Pound (GBP)||Russian Rubble (RUB)||Danish Krone (DKK)|
|Swiss Franc (CHF)||Norwegian Krone (NOK)|
|Swedish Krona (SEK)||South African Rand (ZAR)|
|Czech Koruna (CZK)||Brazilian Real (BRL)|
|Hungarian Forint (HUF)||Mexican Peso (MXN|
|Polish Zloty (PLN)||Peruvian New Sol (PEN)|
|Indian Rupee (INR)|
|Turkish Lira (TRY)|
|Indonesian Rupiah (IDR)|
|Malaysian Ringgit (MYR)|
|Thai Baht (BHT)|
Currency Pair Definition
A currency pair is generically quotes against the US Dollar (USD). This is any currency in the world against the USD.
Example: USD/AUD = 1.43
This means that one U.S. dollar buys 1.43 Australian dollars. Alternatively, it means it takes 1.43 Australian dollars to buy 1 U.S. Dollar.
The currency on the left is known as the “base currency” and the currency on the right is the “quote currency”.
When we are long a currency pair we believe the currency pair will go (appreciate) up in value. When we are short the currency pair we believe the currency pair will go down (depreciate) in value.
Currency trading example
You can trade financial assets with two options. The first option is to buy the underlying asset itself whether it is a stock, bond, currency, or commodity future. The second option is to get exposure to a specific asset by trading a CFD (“contract for difference”). A CFD is a financial derivative whose price is determined by the price of the underlying asset.
CFD Trading example
You open an account with $1,000 and utilize 100x margin to trade a currency position of $100,000. You have only deposited 1% of the trading account. If you lose 1%, you lose your whole initial margin and you get wiped out.
If instead you open a trading account with $20,000 and you take a $100,000 position, your variable margin of 1% is $1,000 and is only 5% of your “initial margin” of $20,000 ($1,000/$20,000). Hence, your utilized margin is 5%. If you lose 1% of the $100,000 position, that is $1,000 and you only lost 5% of your initial margin.
Check more details on CFD trading
Volatility describes the degree to which an asset’s value moves up and down for a specific timeframe. Traders analyze the daily, weekly, monthly, and quarterly timeframes.
A financial asset with low volatility does not move up or down and hence it is difficult for a trader to capture the move and make money especially after taking into account the transaction costs involved and the probability of predicting the trend correctly.
During low market volatility environments which occurs 80% of the time in financial markets, traders extend their timeframes to weekly, monthly or quarterly horizons, in order to capture the asset’s larger price movements and make money after transaction costs.
When market volatility picks up, which occurs 20% of the time, traders reduce their timeframes to capture asset’s large price movements occurring on one to five-day time horizon.
Learn how to analyse Historical Volatility Definition – Historical Volatility Excel
ATR is a fast way to measure historical volatility. Check below how currencies rank up by daily ATR, weekly ATR and Monthly ATR.
|Tradable Currencies||Daily ATR (1yr average)||Weekly ATR (1yr average)||Monthly ATR (1yr average)|
Monthly volatility is high enough to make significant returns on a one to three month trading horizon. Alternative measures of volatility include the asset’s implied volatility which is forward looking.
Example: S&P 500 Day Trading Profitability profile
We analyse daily returns of S&P 500 for the last 40 years. The average negative return is -0.69% and average positive return is +0.68%. Negative return days occur 47% of the time while positive return days occur 52%. It is difficult to predict whether market will close positive or negative since it’s an almost 50-50 chance.
The probability of making more than 1% by going long or short the S&P 500 has a probability of 12% based on historical returns. Intraday returns can also be examined by calculating the high to low daily returns.
Day Trading Example
Trader X opens an account with $100,000 to day trade the S&P 500. He believes S&P 500 will go up by 1% and he will be able to capture it.
The trader arbitrarily places a target of 100 basis points target and 33 basis points stop loss. This accounts to $100 upside and $33 downside.
Net upside = $1000, Net downside = -$330
The trader believes his reward to risk ratio is = 3 to 1, he needs 1 profitable trade for every 3 trades to breakeven
The trader pays a 20 basis points trading commission for the round trip, i.e. 10bps for entering the trade and 10bps for exiting the trade. When adding trading commissions to the initial upside and downside:
Net upside = $800 ($1000-$200), Net Downside (-$330-$200) = -$530
Updated reward to risk = 1.5 to 1, he needs 1 profitable trade for every 2 trades to breakeven
Probability adjusted expected return
The S&P 500 daily returns analysis suggests that there is a 12% chance probability of making 1% when buying the S&P 500 on the open and selling it at the close. Hence, Net upside must be adjusted for 11%.
Net Upside = $80, Net Downside = -$530
The updated reward to risk is now 0.15 to 1, its 6.6 more probable to lose than make money.
This is the reason why professional traders use weekly, monthly, and quarterly trading horizons during low market volatility periods, to capture larger price movements.
Conversely, when market volatility or a specific asset’s volatility picks up professional traders reduce their timeframes to day trade.
Pips, Percentage Returns and basis points
Basis point definition: A basis point is 0.01%.
Currency pairs are quoted in unit sizes called pips. However, pips are useless since we as professional traders manage a broad portfolio of investments. Hence, we use percentages to compare returns and risk of currencies to other financial assets like stocks, bonds, and commodities.
Every currency pair except for JPY and INR pairs are quoted to 4 decimal places. 1 pip is equivalent to 0.0001
EUR/USD = 1.1254
JPY and INR pairs are quoted to 3 decimal places. 1 pip in this case is equivalent to 0.001
USD/JPY = 106.952
Basis points, percentage return
The size of one contract in a trading platform varies from broker to broker. There are 4 trading sizes.
Lot = 1 pip = 0.00001 = 100,000 (Base currency)
Mini Lot = 1 pip = 0.0001 = 10,000 (Base currency)
Micro Lot = 1 pip = 0.001 = 1,000 (Base currency)
Nano Lot = 1 pip = 0.01 = 100 (Base currency)
We use pips shown by the platform next to the price quote to estimate the broker’s unit size.
You see the following EURUSD Bid / Ask: 1.25435 / 1.25445
This is 0.0001 or 1 pip spread. Based on the table above this is a mini lot, hence 1 contract is equal to 10,000 or base currency. The trading size is the amount of the left currency bought and sold which in this case is the EUR.
When a trader opens a forex currency pair he goes long one currency while financing the purchase by shorting the other currency. The trader pays an interest on the currency shorted and receives interest from the currency he bought.
Each currency has two interest rates. The deposit rate which is received from investors who hold the specific currency and the lending rate which is the rate paid for borrowing the specific currency. The deposit rate is less than the lending rate.
Hence before opening a forex position it is important to consider the interest rate differential between the two currencies. If for example a trader goes long currency pair A/B where currency A has a deposit rate of 4% while currency B has a lending rate of 9%, the trader will have to pay 5% on an annual basis to keep this investment.
When a currency pair has a positive interest rate differential, it’s called positive carry. When a currency pair has a negative interest rate differential its called negative carry.
Rollover definition: The daily interest paid or received is called rollover.
A popular forex trading strategy is the carry trade strategy where investors buy high yielding currencies while selling short low yielding currencies. This is a risky strategy and if you want to learn more click the carry trade strategy details.
Now that you have learned the basics of Forex trading, you can move to MacroVar advanced Forex trading guide.