Quoted from http://www.forextheory.com/:
Forex theory: technical and fundamental analysis, trading basics and money management
FOREX (Foreign Exchange Market) is a global currency market that exchanges currency from one country to the currency of another at a changing rate, subject to the date of exchange.
FOREX is a virtual network of currency dealers connected among themselves by means of telecommunications. FOREX currency dealers are connected to leading world financial centres, and round the clock workers. As a result, FOREX forms a united and very efficient system.
The foreign exchange market owes its existence to the 1971 abandonment of the Bretton Woods accord and the subsequent unwinding of the regime of universal fixed exchange rates.
The history of stock exchanges can be traced to 12th century France, when the first brokers are believed to have developed, trading in debt and government securities. Unofficial stock markets existed across Europe through the 1600s, where brokers would meet outside or in coffee houses to make trades. The Amsterdam Stock Exchange, created in 1602, became the first official stock exchange when it began trading shares of the Dutch East India Company. These were the first company shares ever issued.
The main participants of a foreign exchange market are:
- Commercial banks
- Exchange markets
- Central banks
- Firms that conduct foreign trade transactions
- Investment funds
- Broker companies
- Private persons
Access to foreign exchange (forex), the most extensive market on the planet, is generally through an intermediary known as a forex broker. Similar to a stock broker, these agents can also provide advice on forex trading strategies. This advice to clients often extends to technical analysis and research approaches designed to improve client forex trading performance.
Any company that conducts its business in another currency is exposed to currency risk (or foreign exchange risk, or exchange rate risk). However, this risk is present only if the company's sales currency differs from the company's cost currency – if a company's revenues and expenses are both denominated in the same foreign currency, there is no foreign exchange risk.
The most important forex market is the spot market as it has the largest volume. The market is called the spot market because trades are settled "immediately" or on the spot. In practice this means within two banking days.
There are some other types of Forex along with spot-market: swap contracts, forwards and futures. These called derivatives. Derivatives are powerful tools that can be used to hedge the risks normally associated with production, commerce and finance. Derivatives facilitate risk management by allowing a person to reduce his exposure to certain kinds of risk by transferring those risks to another person that is more willing and able to bear such risks.
But Forex offers a number of advantages over other types of forex trading, including:
- Powerful forex leverage
- Zero forex commissions
- Limited risk
- Guaranteed prices and Instantaneous Fills
- 24-hour market
As every successful Forex trader knows, it is not enough just to have the technical knowhow of the actual mechanics of trading the Forex (foreign currency exchange) market, but to recognise that to be a winner relies also on the psychology of trading.
A forex currency trade is the simultaneous buying of one currency and selling of another one. The currency combination used in the trade is called a cross (for example, the Euro/US Dollar, or the GB Pound/Japanese Yen.). The most commonly traded currencies are the so-called "majors" - EURUSD, USDJPY, USDCHF and GBPUSD.
Currencies are traded in dollar amounts called a "lot". One lot is equal to $1,000, which controls $100,000 in currency. This is what is known as the "margin". You can control $100,000 worth of currency for only 1,000 dollars. This is what is called High Leverage.
Currencies are always traded in pairs in the FOREX. The pairs have a unique notation that expresses what currencies are being traded. The symbol for a currency pair will always be in the form ABC/DEF. ABC/DEF is not a real currency pair, it is an example of a symbol for a currency pair. In this example ABC is the symbol for one countries currency and DEF is the symbol for another countries currency.
We know that the FX market is the largest in the world and that your broker or institution that you are trading with is collecting quotes from a centralized feed or individual quotes comprising of interbank rates.
So how are these quotes made up? Well, as we previously mentioned currencies are traded in pairs and are each assigned a symbol. For the Japanese Yen it is JPY, for the Pounds Sterling it is GBP, for Euro it is EUR and for the Swiss Frank it is CHF. So, EUR/USD would be Euro-Dollar pair. GBP/USD would be pounds Sterling-Dollar pair and USD/CHF would be Dollar-Swiss Franc pair and so on.
You will always see the USD quoted first with few exceptions such as Pounds Sterling, Euro Dollar, Australia Dollar and New Zealand Dollar. The first currency quoted is called the base currency. Have a look below for some example.
When you see FX quotes you will actually see two numbers. The first number is called the BID and the second number is called the offer (sometimes called the ASK).
When we trade currencies we open or close short or long position. A short position is where we have a greater outflow than inflow of a given currency. In FX short positions arise when the amount of a given currency sold is greater than the amount purchased. A long position is where we have greater inflows than outflows of a given currency. In FX long positions arise when the amount of a given currency purchased is greater than the amount sold.
Forex trading strategy begins with fundamental and technical analysis.
Fundamental analysis refers to political and economic conditions that may affect currency prices. FOREX traders using fundamental analysis rely on news reports to gather information about unemployment rates, economic policies, inflation, and growth rates.
Fundamental analysis is often used to get an overview of currency movements and to provide a broad picture of economic conditions affecting a specific currency. Most traders rely on technical analysis for plotting entry and exit points into the market and supplement their findings with fundamental analysis.
Currency prices on the FOREX are affected by the forces of supply and demand, which in turn are affected by economic conditions. The two most important economic factors affecting supply and demand are interest rates and the strength of the economy. The strength of the economy is affected by the Gross Domestic Product (GDP), foreign investment and trade balance.
Economic indicators are reports released by the government or a private organization that detail a country's economic performance. Economic reports are the means by which a country's economic health is directly measured, but do remember that a great deal of factors and policies will affect a nation's economic performance.
These reports are released at scheduled times, providing the market with an indication of whether a nation's economy has improved or declined. The effects of these reports are comparable to how earnings reports, SEC filings and other releases may affect securities. In forex, as in the stock market, any deviation from the norm can cause large price and volume movements.
Central banks as Forex participants play a great role in the economy of every country. Central bank is the principal monetary authority of a nation, controlled by the national government. It is responsible for issuing currency, setting monetary policy, interest rates, exchange rate policy and the regulation and supervision of the private banking sector. The Federal Reserve is the central bank of the United States. Others include the European Central Bank, Bank of England, and the Bank of Japan.
Other type of analysis is technical analysis. 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.
Categories of the technical analysis theory:
- Indicators (Oscillators, eg: Relative Strength Index RSI)
- Number theory (Fibonacci numbers, Gann numbers)
- Waves (Elliot wave theory)
- Gaps (High-Low, Open-Closing)
- Trends (Following Moving Average)
- Chart formations (Triangles, Head & Shoulders, Channels, Japanese candlesticks)
The Candlestick chart was actually created by a Japanese Rice merchant, named Munehisa Homma, in the middle ages. If you remember our history, Technical Analysis didn’t become popular until the 1900’s, however, Homma has to be considered one of the “Fathers” for his early work in tracking rice prices through charting. Homma created his candlesticks as “clear” and “shaded” to denote strength and weakness respectively. Today we use “green” (clear) and “red” (shaded) to represent the buying pressure and selling pressure respectively.
