Forex Trading Basics

Forex Trading Basics

What is needed for Forex trading ?

A laptop or desktop or mobile, an Internet connection and a broker. These are the material needs, but there are other needs as well, such as knowledge and a good frame of mind.

It can help to have a rationale for actions taken in the market. At the beginning this may be hard to do, however education is still important before entering the market (and after).

What could be seen as a key piece of market information, especially in Forex, is that what is moving up or down, can stop doing this. After a Forex pair stops doing this, it may do other less directional moves, before it moves directionally again. Equally, it may also reverse back on itself. Or it may continue. But the fact the market is moving in a directional way, does not mean it will continue doing so.

Is a fast reliable Internet connection required ?

For short term and news trading, yes. Otherwise a connection is needed to get in and out, at a bare minimum. In practice, for a trading window, a reliable Internet connection is needed, because it is hard to trade without a good connection to execute one's trading wishes, or keep an eye on what is happening.

Can one trade at a public place ?

Trading can be a difficult emotional process and this may be worsened in a public place. In the case of trading, arguably the more privacy, the better, unless of course, one is trading with others.

Why is trading a difficult emotional process ?

It can feel like one's ego is on the line, again and again. One way out is to trade using automated methods. Otherwise, one can try and deal with the emotional side of trading.

Is it possible to achieve a cool state of mind where one can trade without or with less negative feelings ?

It can help to be logical. A good thing to know is that when one loses one tends to learn. When one wins, one tends not to, so much. But the more logical one is, the more one can learn from wins as well. The emotional element of trading can be a positive, as the feeling of winning can be a motivator. It is the case that negative feelings have their place, as they can teach lessons about the market.

The key is managing both positive and negative feelings, so they do not lead into unrealistic trading decisions. This is where logic can help and even more, something to be logical with, that is knowledge of the markets and how they behave.

Fundamentally this is the key, the secret, if there is one, to trading: the more there is a rationale for each move in the market, consistent with what is actually happening, then the easier it is to make decisions and accept them and develop from them.

One should always though use a stop-loss. A stop-loss needs to give a pair room to move, including retracements, and also needs to take into account how far this will take it from the entry.

Trades can be manually exited long before the stop-loss is reached. But, it is always possible the market may suddenly move at any time, for example on a surprise news release and here the logic of that move may overcome any move it may already be in. Which is a good reason to place the stop-loss in the first place. A stop-loss needs a rationale, though. Badly placed stop-losses can prove counter productive.

What is a past support or resistance level ?

When a Forex pair (e.g. Euro, EUR/USD) earlier tried to make a move in a direction it may have been stopped at or around a certain value a few times before proceeding to break through, to get to where it is. If it was stopped below, it may be support, if it was stopped from above, it may be resistance. Breakthroughs may take a series of moves to happen, thus the first move may not work, but it still may, of course.

Forex moves in complex ways and to breakthrough the pair may need to make retracements back. So the moves opposite to the breakthrough may be part of the breakthrough. This is a reason for caution in assuming directional moves.

While Forex can have moves which begin from a time of low volatility and then become trends, it can also have volatile move which bounce back and forth, perhaps around big figures or past support or resistance. Because reactive moves can be volatile, then it needs to be considered that they may reverse.

Support and resistance can be useful in Forex for making sense of a chart, but it should not be assumed that the market will respect them.

Can support and resistance help to set a stop-loss in Forex trading ?

There are a number of methods which can be used to set a stop-loss. In Forex, one method which may be helpful, is to use support and resistance, from examination of the charts. This is because of the way the market moves in retracements and off support and resistance. Even though the pair is moving up or down, it may still move considerably, or retrace, in the opposite direction for a time.

While entering a trade and getting a strongly directional move is possible, it is also quite possible to get a more complex set of moves, before the pair finds the required direction, assuming it does this at all.

But support and resistance can help identify areas of the chart where if the move exceeds them, it may no longer be a valid move. The pair may continue opposite to the desired direction or make moves other than returning back to the point of entry.

Because the market takes out stops, then placing them at support or resistance can be problematic. The pair may dip or push through support and resistance, before returning back.

A stop-loss can work to protect. It may be the case that the trade will be closed well before this protection is needed. But the stop-loss can protect, just in case.

If the trade is long, a region of support which the move came from may be identified. If the trade is short, then a region of resistance needs to be identified, from which the move came. This will tend to be clearer from inspection of the chart, but it can be useful also to look at longer time frames to get a better idea of what the overall context of this move is. This can help indicate how significant that support or resistance may be.

Other methods include identifying support and resistance with indicators, or setting a percentage of a move which will be tolerated, or letting a broker set the stop loss, which can include setting a trailing stop-loss.

Because it is important how much the distance between the entry and stop-loss is, then it may be helpful to combine any technique with a percentage stop-loss as well. It is a good idea to assume that the stop-loss is needed, thus the consequences of it being activated need to be considered.

A stop-loss is a protection, not a way of exiting a trade, assuming of course, that the stop-loss is honoured.

What is a retracement ?

The instrument is moving back through the territory it just gained, in the opposite direction. This happens a lot in Forex and can happen for many reasons, for example, support or resistance can result in a retracement. While a retracement is supposed to be temporary within a larger directional move, it can always also be exactly what it looks like, namely a reversal of direction.

This said, directional trends tend to have an end, where they move in volatile ranges. The next trend may not take place for a while after this. However, it is always possible for a pair simply to reverse, because, for example of news or perhaps because it bounces, or just because it reached a low or a high.

What is a trend ?

A direction up or down the market is or was moving in. In essence, trend are moves which have an overall direction which continues, but there will usually be directional variation of some kind within the move, for example retracements in the other direction.

If a market isn't trending it may be in a range of moves, roughly between an upper and a lower limit, or it may be very quiet. It may be possible to classify reactions to news events as something else, but after they happen, they may fit into a trend, or into another trend, or a range, as a volatile set of moves, for example.

On different time frames the market may be doing different kinds of moves. Trends have beginnings and ends, but this is only known for sure, after the event.

If a trend is happening in a pair like USD/JPY or EUR/USD, it may be helpful to see what is happening in the US stock market, if it is open, as surges in this market can show up in Forex trends. It is important also to look out for potential obstacles to the trend within the path of the Forex pair, such as big figures or half way between a big figure.

But, while moving through a big figure may stall a pair for a bit, it may also add to the directional momentum, when it gets over. Halfway between can be implicated in stalling or ending trends. It can thus be helpful to always check and see what the value of a pair actually is, at least from time to time.

Movement between big figures is one of the features of the Forex market which can show repeated events, or regularities. But knowing there is a possible repetition, is not the same as knowing that it will happen.

It is easy to get caught up in what an indicator is saying, or what patterns are happening, while not noticing what the chart is all about, namely the movement of value through time.

What can trends in Forex look like ?

A trend can be seen as a pattern in Forex and the following kind of pattern may be seen. But of course different variations on it, or entirely different outcomes can happen as well.

A trend can be seen as having a beginning, a middle and an end. It may begin from a time of low volatility. As it begins, it may start up slowly, dropping back but perhaps holding its lows away from the beginning region. Then it may pick up steam. It may be seen as having strong directional candles.

However once it gets into its stride, it may tend to retracements. Thus, an entry into a trend may result in moves against the position. It may evidence a final push towards the end, which can trap those who enter here, expecting the move to continue.

Then it may end, and it may end by falling back and rising again, but unable to get above the earlier highs and perhaps keeping off the low of the initial reversal (so it may not reverse back at this stage). This is a time of volatility and with moves which oscillate to some extent up and down. The power to move in its original direction is still there, but it cannot sustain these moves. It may then quieten again and then enter ranges or it may not.

Trend could be seen as positive trading patterns, but they contain traps and can turn into something else. For example, a retracement could turn into a reversal, undoing the trend. It is impossible to know what is going on, until it has already happened.

What is a Forex pair ?

Two currencies written like this: EUR/USD, USD/JPY, or GBP/CHF and so on. The first currency in the pair is known as the base currency, the second as the quote currency. One way to remember this is, in the case of EUR/USD: "I'll give you a quote in dollars for the base (euro)".

Value in Forex is based on relative valuations of currencies. In the example of EUR/USD: the euro, the currency of the eurozone and dollars, the currency of the United States.

If the price of the pair is 1.2, for example, this means that euro has a value of 1.2 dollars: the price of 1 euro is 1.2 dollars. If the price is 1, then this is known as parity, it means they have equal valuations. In trading parity can be important, an event which may result in alterations in the way prices are moving, even before it is reached, or after it is reached.

Are some currencies better to trade ?

Popular currencies with good sustained volumes across markets may tend to move at least relatively more smoothly. Less popular pairs may tend to move in more volatile ways. As a rule of thumb, volatile is hard to trade, as one may get what is knows as whipsawed trying to follow the directional changes.

Popular pairs can move in volatile ways as well and volatility may be an indicator of increased ranges in moves. To give a few examples where volatility may occur: when a trends ends all pairs can be subject to volatility; near market closes, particularly at the end of the trading week; around a major news release and in times of market turmoil. Approaches to and bounces around big figures can be volatile as well.

What are the major currencies ?

The four majors are EUR/USD, USD/JPY, GBP/USD and USD/CHF. One could also in practice include AUD/USD, USD/CAD and NZD/USD, known as commodity pairs because their value tends to be related to the value of commodities, for example Gold and Oil.

Some pairs may become more popular to trade. For example, EUR/CHF, which is known as a cross pair (no USD in it), when the Swiss National Bank imposed a peg on it, restricting its movements in effect to a range. When the peg was removed the pair moved very strongly indeed, initially.

What is news trading ?

Waiting for a market moving piece of Government data to be released at a certain time, or other market moving news and trading around this release. The market may move in this time period, but there can be intense volatility. One way of approaching a news trade is to have an informed guess of the number of the release.

For example, in the important monthly Non-Farm Payrolls release, guessing the size of the figure, or at least a range for it. The problem is that even if this is correct, the market may react in unexpected ways.

What may be looked for is something which can have the effect of making the market move, like a surprise. Guesses which are expected and then borne out, may not result in much of a market move as this expectation may have been priced in, in the run up to the move.

Situations where it is hard to know what the figure may be and where there is then a result which has some kind of surprise effect, for example an unexpected, strong, good or bad jobs figure, may have a greater predisposition to move the market, but the market needs to be predisposed to move as well.

What is news trading like ?

It can be exciting and it is risky and therefore potentially a painful experience. But it can be over quickly. The author began just as EUR/USD was making its all time high in 2008, which was certainly exciting, but what happened next, showed as well, the risk. When a market turns, it especially risky, because the expectation that it will continue somehow in the other direction, remains.

If a trade goes wrong, is there anything that can be done ?

If a move is happening opposite to the traded direction, then the pair may bounce at a past support or resistance level. This is a rationale for placing stop-losses near but away from these values. This bounce may stall or fall back though. Examining higher time frames may enlighten one as to the context of the move.

What is a time frame ?

The length of each unit representing prices in a chart. For example, the 1 minute candlestick chart has a series of candles each covering a one minute time frame. The 1 hour chart has a series of candles each covering a one hour time frame.

What time frame is good to trade on ?

It depends on the intention of the length of the trade. As all trades may become short term trades, 1 minute is can be worth keeping an eye on. While 1 minute can be subject to volatility, it can also show pattern formation like on higher time frames. There can be patterns forming which may not be evident on even 5 minute, which may affect momentum or direction on 5 or higher time frames.

1 minute, 5 minute, 30 minute, 2 hour (or 4 hour) and daily, can be examined to get a sense of where the market is at, when considering trade. This does not have to take a long time, as a quick search for support and resistance.

As this is done, it can be possible to see that a pair may, for example, seem to be in a downtrend, but is in fact a retracement on an uptrend, or that it is on a downtrend, but close to support.

There may not be hard and fast rules about which time frame to check, as the aim is not to go through a fixed set of time frames, rather to see what may be important in terms of the effect on the pair in the time to come. But like anything in trading one needs to start somewhere.

What is a candle ?

A unit of a candlestick chart and a popular kind of chart to use in Forex. There are other charts to use as well. Candles may be combined with multi-time frame analysis to see what is happening inside candles, as they may disguise structure, by the nature of their representation. This involves moving from a higher time frame to lower ones.

It is also possible to move from a lower to a higher time frame, which may be a wise idea, because it gives perspective on what is happening at a lower time frame. Like moving out on a map, and seeing where things fit in. But of course, in markets, the landscape is dynamic and changing, unlike maps.

What about candlestick patterns ?

Candlestick patterns can be used to look for turns in the market, but as with any patterns like this, the market seems quite happy to cut through the expectation.

What is meant by the context of the move ?

Forex moves can be seen as nested moves, to an extent, moves within moves, as one moves to different time frames. However as well as looking at higher time frames, lower times frames can also give more detail about what may be happening.

What is meant by moves in Forex being nested ?

Moves directionally moving within support and resistance, moving within support and resistance and so on, from a higher to a lower time frame. To trade it is necessary to have a belief that the market will have a certain value at a later time. However past support and resistance may give a way of interpreting what the market will be doing at a later time. And past support and resistance within multiple time frames may give a richer interpretation or context.

Once a trade is entered then the trade is at the mercy of the market. Indicators indicate what the market may do next. But they do not always work. However they can also be used to help interpret what the market will do, rather than relying on them to enter a trade.

This may help at least alleviate that sense of being lost in a strange land, once the trade is entered, and the market starts to do contrary things, relative to one's expectation.

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