What is forex? – 4 tips to invest and trade on the Forex

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Today you are going to learn what Forex is and why it is such an important market.

And not only that, but I will also give you four tips on how to trade in this fascinating market.

A market that has many peculiarities and is not as easy to operate as it is believed.

Let us begin.

What is Forex and how does it work?

The forex (“foreign exchange”) refers to the international currency market , which is so necessary for the normal functioning of the increasingly interconnected world markets.

Let’s see a simple example.

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A European insurer buys dollars for its operations in the American market and a European importer needs to buy yen to do business with a Japanese company.

As we see this means that there is a constant demand for the currencies of the different countries of the world.

We can draw ten thousand examples like the previous one and we will realize the importance and extension of this market.

Who manages the Forex market then?

Not surprisingly, this is a world-class, transnational market run by the world’s largest banks.

It is in them where the large volumes of currencies are traded and it is somewhat easy to understand if we look at the previous example, or whatever we can think of.

For example , Bank X has one branch in England and one in Mexico.

If an English company buys a batch of Mexican beans, it will have to pay in Mexican pesos, the currency of that country.

On the contrary, if a Mexican company buys financial services in the London city, it will have to pay in British pounds.

If both companies work with bank X, then it will be in charge of exchanging the Mexican pesos of one company for the pounds of the other, and along the way a commission is taken to facilitate the task.

As we see, the Forex market is a natural business of the banks, so to speak.

Trying to make these types of changes outside of banks was previously quite complicated and therefore they were – and continue to be – the matrix of the global currency market: where large corporations and institutions go to find and sell foreign currency necessary for their activities.

However, in recent years the market has been opening up more and more to new technologies and more and more services have been achieved bypassing “bank surveillance”.

Discover which are the best brokers on the market
Services like Oanda pioneered the possibility of making currency exchange operations online, both for companies and individuals

How did Forex trading evolve?

This is a market that used to be closed to the retail public and was only operated on the interbank by banks and large institutions.

However, trading was not offered to the masses of the world.

For this the advent of the “digital age” had to come.

Currency futures were first introduced into the CME back in 1971.

The possibility of trading leveraged forex was already closer to the public, but it was still restricted to being large contracts (100,000 units of currency), and depending on trading by phone. Day trading was not as easy as it is today, of course.

Over the years, the possibility of trading forex for the retail market was created.

They started to create market- type brokers that offered quotes in the main currency pairs.

This was back in 1996, with the first brokers of this type, although it took a few years to achieve the great popularity that it ended up obtaining in the first decades of the 2000s.

Brokers like Oanda, FXCM , Forex.com, IG markets and others were pioneers in this market.

But do not believe from these opinions that the retail Forex market is the most important in the world in this sector.

The market is still dominated by large international businesses and banks. The latter is easy to understand if we get an idea of ​​the volume of international trade . Imagine the transactions between German companies and the United States, to give an example.

In a 2016 report by the Bank for International Settlements ( report ), the retail market volume accounted for 5.5% of retail trading within the total volume of the world Forex, with a figure of $ 282 billion daily trading, which which is not bad, when it comes to trading between individuals.

To get an idea of ​​how popular this type of trading is, let’s see a comparison with what occurs in other classic online trading markets: futures and stocks.

Now, as you can see from the graph there is a very big difference between the retail Forex market and the true volume of the Forex market.

When people talk about the volume of the Forex market they always mean the total Forex market trading.

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But from my point of view this is wrong.

The Forex figure that would have to be taken for that trading volume would be that of retail trading, which as we see is more similar to the other great world trading markets: stocks and futures.

In fact, according to this point of view, futures would be the most traded markets in the world when it comes to pure trading. While the Forex and stocks would follow.

Surely you have heard that Forex is the most liquid market in the world.

As we have just seen, it is a half truth.

Yes, it is the most traded market, but not from an online trading point of view, but rather from business commerce. When we measure trading activity, things are already quite equal and we see how stocks and futures are at the height of the currency markets.

In fact, I tell you another secret , and that is that in reality the Forex is not as liquid as they paint it. Because it is one thing for so many billions to be traded and another for us to have access to that liquidity.

What is the Forex market?

Let’s see:

The forex is a market that is not centralized, unlike futures or stocks, but is quoted 24 hours on the interbank, where the activity reaches a few trillion dollars a day.

The brokers retailers try to offer the real prices of the market according to data provided by their liquidity providers, banks.

Some of those brokers will be market makers, and others will be ECN brokers .

The basic difference between one and the other is that the former will take the counterpart to the trader’s operations and do not send them to the real market.

The latter send the operations through their liquidity provider, being their neutral position with respect to the client.

Although it is likely that the orders sent by some of these ECNs are to other providers, market makers, which in the end is the same.

That is, in the end, what the world’s traders are negotiating are decentralized partial markets from different suppliers that will depend on the broker.

Come on, you are not going to a market where there are 280 billion dollars a day traded on the same platform.

On the contrary, there are tens of thousands of platforms from thousands of brokers and dealers with obviously much smaller markets.

In some small market maker brokers you can be sure that the liquidity is quite low. So small that you are basically betting against the broker, who is the one who puts the counterparty of the operation.

I will give you an example so that you can see it more clearly.

In the case of futures, since they are centralized markets, when we operate the ES, the S & P500 contract, we are trading in the same market of that future that is the same for all brokers. In other words, if you have an account with Interactive Brokers and you operate that future, those orders go to the same market as if you have an account with the Tradestation broker.

On the contrary, if you are negotiating with the Forex broker X and you send orders to the market, you are going to operate in the “broker market” which is the one that provides the same as a dealer, and the liquidity providers that it may have.

Do you see why the claim that Forex is the largest market in the world and the most liquid does not honor 100% of the truth?

What you have to do in case you start trading Forex is to try to find a broker with good liquidity, and for this it is better to find a broker with a good reputation.

But rest assured, there are many very reputable brokers in the market with enough liquidity so that we can trade Forex with guarantees.

Forex markets and main assets

There is a huge amount of foreign exchange in the world. Almost as many as countries.

Although some sites like the European Union have monetary unions, this is not the usual.

The logical thing is that the largest volume of currency trading is in those of the main world economies: the United States, the Eurozone, China, Japan, Great Britain, India, Brazil, Canada, South Korea or Russia.

However, the reality is different, or at least when we are looking for data related to “Forex trading volume”.

So we will find something like this:

Approximate volume in% by currency pair in 2019

As we see, the EURUSD is the highest volume pair in the world, followed by the USDJPY and the GBPUSD.

Come on, only EURUSD and USDJPY account for 40% of world Forex trading

But if China is so important in the world economy, why is the yuan so far away?

That is, the Chinese economy being at least 5 times higher than the British economy, why is the volume of the pound-dollar twice that of the dollar-yuan?

And why don’t the Russian ruble or the Brazilian real appear as some of the most traded pairs in the world?

Well, because this list refers to trading in the OTC markets, that is, to the trading and investment markets.

Another different thing is the actual volume of currency exchange between the Indian and Chinese economies, for example.

Major currencies in world Forex trading

As a general rule, the most traded pairs in the world will become those of the most developed countries, regardless of their size as an economy. The main currencies of the world in Forex trading are:

  • USD (US dollar)
  • EUR (Euro)
  • JPY (Japanese yen)
  • GBP (pound sterling)
  • AUD (Australian dollar)
  • CAD (Canadian dollar)
  • CNY (Chinese yuan)
  • CHF (Swiss franc)
  • NZD (New Zealand dollar)

I include the yuan due to its size but in terms of retail trading, that is, the one we do from home, the vast majority of it will be in the previous currencies without counting the yuan.

For example, in Europe the most popular pairs for trading are all related to the euro, the pound and the Swiss franc.

Pairs like: EURUSD, EURJPY, EURGBP, EURCHF, GBPUSD, GBPJPY, EURAUD, EURNZD, GBPCAD, etc.

What are the most important markets for retail Forex?

Well, I suppose if we ask the majority of people they will answer that the biggest Forex markets are in the United States, the most important economy in the world.

But not so fast, because it turns out that in the field of retail Forex trading there is another more important contender.

Who is it about?

From the London city , which becomes the world capital of Forex trading. London is the place in the world with more brokers and companies related to Forex trading.

The United Kingdom would be followed by the United States and third by Singapore, followed by Hong Kong and Japan.

Approximate volume of Forex trading in different countries (approximate ):

  • United Kingdom: 37
  • United States: 19
  • Singapore: 7
  • Hong Kong: 6
  • Japan: 5.5
  • Switzerland: 2
  • Others: 23.5

As we see, the leadership of London (United Kingdom) in the world Forex market is indisputable . And this despite the introduction of ESMA regulations that greatly limited the trading conditions of European brokers and clients, the main clients of the London city.

What is Forex trading?

Forex trading is the activity in which we negotiate the price crossings of the different currencies.

This is possible because these price crosses (exchange rates) are constantly fluctuating, or at least most of them.

Why do they do it?

Well, by the law of supply and demand.

Different economies have different offers and demands, which causes the value of their currencies to change with respect to others.

In this sense, it is very important to take into account the different economic policies of the countries.

If they are countries with policies favorable to business activity or if they are policies unfavorable to it.

Let’s see a clear example of this: 

For example, a country with favorable business and investment policies for decades (and centuries), Switzerland, has the strongest Forex currency (FIAT) in the world.

As it is a country that has not confiscated the assets of its citizens for hundreds of years and without radical communist or socialist policies, it is a country in which the world’s investors have been investing for a long time. This, together with the capital accumulation of the Swiss has made the currency highly valued in the markets, at least in the long term.

It is also a safe country in every way. Tourists can go and feel safe, so there is a strong demand for Swiss francs and because the products of the country’s companies are so good, there is a great world demand for the currency of that country, with companies from all corners of the country. world wanting to buy Swiss products.

On the other hand, if a country has governments with radical socialist policies like Venezuela, what happens is that the currency ends up being practically worth zero.

Think logically:

If the government announces that it is going to confiscate flats, to raise taxes on the wealthy by 90%, to close private companies and the media, to do price controls on products, etcetera. Who do you think wants to invest in such an economy?

Indeed: nobody.

That, coupled with the fact that the wealthy would take all the money out of the country, clearly explains why a nation’s currency can go to zero.

In such a scenario, the only thing there is is massive capital outflows from the country with the holders of bolivars buying anything, dollars, Swiss francs, pounds, yuan or mobiles.

In this scenario almost nobody in the world wants to buy bolivars because with them they can do nothing. That is, they are not worth anything.

It is what anyone would do when they see someone come to take their money.

Ok, I know that the example of comparing Switzerland with Venezuela is exaggerated, but I think it comes in handy enough to see the difference that can be in the behavior of two economies and, therefore, of two currencies.

So Forex is a market in which the pairs are going to move more or less because the economic policies of the countries are different.

In the case of developed countries, the differences in economic policies are not so great, but they are always significant.

One country may have the highest interest rates and another may have the lowest.

One government may have a more aggressive debt policy than the other.

Etc.

This is where the traders of the Forex market are going to try to find the opportunities: in those movements of the currencies.

Fundamental analysis in Forex

Therefore, it will be interesting that we have general notions of fundamental market analysis .

This type of analysis is well known in the stock markets.

In forex it is not as well known, but it can be useful since knowing what types of employment policies and others a country is undertaking can help us predict future long-term trends in the different Forex pairs.

This is different from the well-known news trading in this market that I will talk about later.

Forex features: advantages and disadvantages

Forex Advantages:

Leverage

It is a market that allows trading with great leverage. That is, we can multiply the power of our money up to the limit that the broker gives us (or the respective regulation).

For example, in Europe the leverage is 30: 1, in the United States 50: 1 and in Japan 40: 1. In most other countries in the world there are no limits, with brokers offering up to 1,000: 1.

Is leverage an advantage?

Well from the trader’s point of view yes, because we can earn more money when our strategy is good. If we have $ 1,000 and use a 20: 1 leverage, we can trade up to $ 20,000, so if the market goes in our favor, we can earn a lot of money faster.

Now, leverage is a double-edged sword because the problem for traders is being able to find that winning system in the long term. Since most systems turn out to be losers, in the end we have to lose our money much faster because of leverage.

The key: finding a good trading system (easier said than done)

Market without commissions

This is said by many but in reality it is something wrong.

There is no commission-free trading market and Forex is no different.

The fact is that many brokers have a policy of not charging classic commissions but the income they obtain is through the spread of the pair they are trading. This in the end is a “non-apparent commission”, but that does not mean that it is not a commission. You can learn more about the spread in this article .

Flexibility in the size of contracts

This is a very important advantage of Forex, at least from my point of view.

An advantage that favors us as retail traders.

The same is that in the Forex and most of its brokers we can use contract sizes of a thousand monetary units, which is known as a micro-lot, with a lot being 100,000 units.

In other words, we can buy positions of 1,000 EURUSD or GBPUSD or any other pair.

If we compare this to the size of a futures contract, which is usually around $ 100,000, we can understand that micro Forex contracts are much more suitable for trading in a more flexible way and suitable for small investors.

Of course, if you have an account with hundreds of dollars or a few thousand, don’t think about futures trading. Better trade and learn with Forex.

Open 24 hours

This is another great advantage of this market.

Why?

Well, because it allows us to operate with more confidence from one day to the next without having to be afraid because our orders are open at night with the market closed as it happens with the stock markets.

With Forex we can close the operation at the time we want.

If we want we can buy a position in the morning at the Frankfurt opening and sell it at night in the Tokyo opening. Or if we prefer we can leave the position open until the next day.

We can bet down

One of the fundamental characteristics of the Forex market is that we can play anywhere on the market.

As Jesse Livermore said, the important thing here is not to go bullish or bearish but to be on the right side of the market.

In any situation we can buy or sell the pair in which we are interested. If we think that the euro is going to fall, then we sell the EURUSD, and if we think that it is going to rise, we will place a purchase order. The market will pass judgment later.

Conversely, in stocks, it is common to only be able to trade the bullish side. Although I also tell you that this in itself does not have to be bad.

Disadvantages of Forex

Decentralized market

As I said before, the fact that many say it is the “world’s largest market” does not do better than others. In fact, as I demonstrated, it is a false statement.

In addition there is another question to consider.

Being a decentralized market, the operations we do are only collected by our broker internally (or by one of its liquidity providers), while in a centralized market, such as New York oil futures, these operations are registered in the same market system.

Why is this so important?

Because the centralized market gives us enormous guarantees of being able to test our operations against the broker in case of problems (extremely unlikely by the way).

However, in the decentralized market, if we have problems we do not have an external official market where our operations were registered, so the broker has more possibilities of doing unfair activities, to put it one way.

This means that there can always be a broker that takes advantage of this decentralized nature and tries to take advantage of traders, especially in the case of some new and low-reputation brokers.

The good news is that established and reputable brokers do not do this type of practice.

4 tips to invest and trade on the Forex

Then seen, you are interested in trading Forex.

This is normal, as it is one of the most popular markets in the world, especially in retail trading and for small capital investors.

Let us begin.

Tip 1: Don’t do high frequency day trading

I know I know.

It is what you see recommended on all sites.

In fact you only see and hear about it.

The key is to become a great day trader.

Ok, I’m not telling you that he’s a bad target.

But honestly, it is a very complicated way to live from Forex trading.

My advice: if you do day trading that is as infrequent as possible and with large trades, and don’t be afraid to leave trades open for more than a day.

Which leads us to that: it is better to do swing trading, which is to make operations that can last up to several days or weeks, depending on how the operation has gone.

Tip 2: Learn chartism (technical analysis)

It is important that you learn to read the charts appropriately.

Technical analysis, even in its simplest form, for example looking for supports and resistances, is a very powerful weapon to be able to build our winning trading system in the future.

Therefore, it is important that we familiarize ourselves with the concepts of this type of analysis and begin to put it into practice in our operations.

In the end it will serve you a lot because the technical analysis of Forex is the same as that of any other market, be it stocks, cryptocurrencies, raw materials or indices.

If you want to learn more about Technical Analysis, you can also read some of the classic books on the market, such as the Technical Analysis of Financial Markets, by John Murphy ( see the price of the book on Amazon Spain)

Tip 3: Don’t trade the fundamental news

You may have seen people talking about Forex news trading somewhere.

If you have not done it, you will not take long, because it always was, is and will be (as long as the Forex exists) one of the favorite trading modalities in it.

It is not surprising.

It is in this news that the most important and explosive movements take place.

Why are we going to be operating almost all day if the market barely moves 5 or 10 pips every half hour if we can operate when there is an announcement of unemployment in the United States and the market moves 50 pips in minutes?

Well, despite how nice it sounds at first glance, I do not recommend that you do this type of trading.

The reason?

At those times you are going to find big liquidity problems and the vast majority of brokers are going to increase their spreads in a huge way, so that in the end you are going to “end up paying” in commissions.

Not only that, but also when we use stop orders on those occasions, we will see how the market surpasses them and we have slippages (known as slippages) of many pips, which almost always come against us, by the way .

Not to mention that entering to operate at those times will always be very difficult for us to do it at the desired price since there are also significant slips in the tickets.

In summary, that this radical decrease in liquidity is going to suppose a very high extra cost that we are hardly going to be able to compensate with our news trading strategies.

My advice on this subject: start trading news in demo format for a season and keep in mind that in real conditions you will have more execution problems.

In other words, if you manage to win overwhelmingly in the practice accounts, with a huge margin, then we could consider entering the real market.

And here we would consider the following advice:

Tip 4: start operating moderately

It does not occur to you to start trading the Forex with all the leverage they offer you, nor to put all your savings in the negotiation.

On the contrary, if you are going to start trading take a very small amount of money and start testing with it.

That’s where the advantage I said earlier is, of the “micro” type contract sizes.

As we can use 1,000 unit sizes we can trade without fear of ruining ourselves and thus we will be able to maintain control if we see that things do not go as planned in our system.

If we operate mini-batches of 10,000 units or batches of 100,000, then things get much more serious.

In other words, if you plan to open an account with $ 1,500, it would almost be better to open one with 150 and start operating micro-lots with it.

If after a considerable time, let’s say 6 months, things are going well, then increase the size of your account.

conclusion

Well, so far this post on the Forex market.

I hope it has helped you learn about what this popular online trading market is about.

Remember: go little by little, do not go in a hurry and do not believe everything they tell you.

The Forex market is fascinating but winning in the long term is much more difficult than it seems according to a good part of online advertising.

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