An Introduction to Forex Trading

The popularity of foreign exchange trading has grown dramatically over the past decade. Originally the province of large banks and financial institutions, retail forex trading has come alive in tandem with the electronic revolution all around us. The Internet and advances in data management and telecommunications software have enabled anyone that has the talent and drive to trade currencies in the world’s largest global market, nearly $2.5 trillion a day. However, not everyone is cut out for the rough and tumble world of active currency trading. There are many options available to facilitate your becoming a successful trader, but a time commitment is required on the front end before any of them should be considered.

Beginner Terminology and Definitions when Dealing with Forex

Every newcomer to the world of forex is greeted with a host of confusing terminology and mountains of information to digest. Free forex tutorials advise that success depends on three factors: knowledge, experience and a disciplined approach to the market, free from emotional intervention. Forex trading is regarded as high risk, requiring specialized training and hours of practice to achieve the level of proficiency required by a very fickle market and before putting your real money at risk. There are no shortcuts around the time necessary for knowledge and experience. Preparation can start with perusing websites and forex articles, before enrolling in a formal training class.

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Your instructor will discuss technical analysis in depth. It is an important tool for forecasting financial market behavior. Financial markets move in trends like waves, and the study of past pricing movements often signals their future direction. Although the ability to use chart analysis has increased greatly over the past few years, it is anything but new. The art has evolved in complexity, but let’s keep it simple and use the figure below as our guide, courtesy of a free tutorial paper on the Internet.

Forex Trading Example

This chart from 2006 tracks the daily price activity for the British Pound (GBP) versus the U.S. Dollar (USD). The wave pattern of the red and blue “candlesticks” connotes the range of daily prices. The candlestick symbol presents the high, low, open and close for the day. The little rectangular box represents the open and close value range, and in this case, it is Blue if the closing price was higher than the opening, and just the opposite for Red. The price figures on the right of the chart represent the conversion from Pounds to the Dollar. The order of the currency pair, in this case “GBPUSD”, determines the axis scale.

The chart also illustrates a basic forex trading strategy that employs indicators to signal potentially profitable entry and exit points. The “RSI” blue line on the bottom portion of the chart is a favorite indicator for currency traders. The “Relative Strength Index” is one of a variety of “momentum” indicators. A momentum indicator applies mathematical formulas to previous price behavior to determine when the market is overbought, a “sell” signal, or oversold, a “buy” signal, by analyzing the magnitude of recent gains and losses.

Each indicator also has parameters that can be adjusted to align with the trader’s time preferences. This chart uses an 8-day prior period RSI, and also inserts an 8-day Moving Average curve, the red line, to confirm a trade signal. When these lines cross one another, as represented by the purple and green shaded areas, the algorithm suggests a buy or sell. It is up to the trader to interpret the voracity of this information, and then trade accordingly. Indicators are not infallible, but they give an edge to traders, which is all that is needed to achieve consistent results over time.

The trading strategy presented above is one of common sense, i.e., buy on the lows and sell on the highs. In forex, trading strategies often result from more complex analysis and familiarity with trending patterns in the marketplace. Trends move in predictable waveforms that repeat over time. A prudent and attentive trader is wise to these nuances and uses them to his advantage.

Foreign exchange trading is a popular, but high-risk business. Technical analysis helps a trader make sense of pricing information, detect trends, and achieve his main objective, making money.

This is a Guest Post by Michael from Forex Traders.  I asked him to write an introduction since I know absolutely nothing about Forex Trading.  If you have any questions…ask away!

5 Responses to An Introduction to Forex Trading

  1. I was very interested in Forex trading a few months back, and almost got into it. I have a question for you. How can you get started and what are typical minimums? Investors International is the company I was debating on starting my trading with, and they wanted some ridiculous amount of money to being, something like $5000 or so.. needless to say, I walked away…

    Are there easy ways to trade smaller amounts of cash? Much like a ShareBuilder, Scott Trade, etc. for stocks?

    Thanks!

    MFO

  2. Let me just state I believe FOREX is a zero sum game. You might as well go to Vegas and bet on 18 black at the roulette table. For the retail investor you are competing against companies with much more resources than you. There is a difference from FOREX and stock investing.

  3. @ investor junkie – totally not true. You can’t base real strategies on a roulette table. Forex and can will make you money if you take the time to learn what is needed to be learn and given the right mindset you can be rich.

    -BTW great blog.

  4. As a full time Forex trader I can say that before embarking on a Forex career do your homework, it’s not a quick fix and will take time to learn so gather a sound basic understanding of the Forex market and learn to understand supply and demand as this is a key element to any successful trading strategy without delving into money management etc. Now the trick is understanding and timing where the buyers and sellers are likely to be. Major areas of confluence give a high degree of success to any trading method, for example psych levels, trend lines, Fibonacci levels and pivot points to name a few that overlap. Pivot points are a major indicator in any professional traders arsenal if you’re unfamiliar with them check out this video http://www.youtube.com/watch?v=A6yrxMpXDRA and add them to your repertoire and watch your success skyrocket.

  5. Very True. Like the gentleman says above me this is not a get rich quick scheme. If you are planning to trade you should treat it as business not a hobby.

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