Forex Trading Explained

What is Forex Trading ?

Forex Trading could be seen as having a basis for believing that a pair will change its value, resulting in moves in a given direction. This change in value can then be traded on. That is, a pair can be bought with the belief that it will attain a higher value or sold with the belief that it will attain a lower value.

The past in a trade provides the basis for this belief, the present determines the entry and the future determines the outcome. For options trading, this can simplified to a belief that a pair will have a given value at a certain date or over a certain time period.

The past is right there, it is written on charts, so they need to be read. It may be helpful to ground the entry in the present, as much as is possible, thus entry on 1 minute can be helpful. As for the future, indicators can be used to do precisely this, indicate what the future direction may be.

The problem is this indication may not be correct. It can be important to keep an eye on what the market continues to say, as time progresses in a trade. That is, the present becomes the past and this should be read on an ongoing basis to inform the expected outcome and even provide a basis for changing it.

Is Forex hard to trade ?

Forex can be seen as technically friendly, as it has patterns appearing across time frames, from short to long term, with frequency. This makes trading Forex seem relatively easy. Yet these clear patterns will tend to be seen as have an uncertainty factor, making them unreliable.

Patterns which may seem like they are showing one outcome, end up having a different outcome, which can mean a different direction or very little direction at all. And after the event, the pattern which happened makes sense, just as the pattern which might have happened would make sense as well.

This makes trading Forex, especially for beginners, hard and risky. It makes learning from experience hard as well, as it is difficult to apply templates of behavior to the market. What it may tend to do is to push one into looking for anything which might constrain the uncertainty. This means regularities of all kinds and constraints on the market such as news releases.

What are good strategies to use for Forex trading ?

The market retraces, trends end, ranges turn, change and end, and volatility changes, sometimes rapidly. All these factors may work against a simple continuation of a trend or a range.

So Forex strategies may need to take into account these factors and look for indications these changes are taking place in the market. A basic strategy is to look for signs of momentum changes taking place, either from outside sources, such as news events or from patterns playing out.

Three rules of trading

  • Localise: taking time before entry to check the chart on 5 minute, 30 minute, 2 hour, daily and monthly (or short, medium and long term), to find a sense of where the pair is and what kind of movement may be possible.
  • Enter: on 1 minute (or a short term time frame), to get a sense of what the pair is doing.
  • Manage: setting a stop-loss and be aware of changing value, to keep on top of where the pair is going (such as approaching big figures).

Is a 5 minute time frame better to enter on than a 1 minute time frame ?

5 minute can be better to enter than 1 minute, because 1 minute can show too much detail. An entry should preferably be linked with longer term action. This is arguably even the case with intentionally short term trades.

However a good survey of time frames can help link longer term to 1 minute. For example, if 1 minute is showing a pattern of repeating failures to get past an apparent support or resistance, longer term views may indicate that this was a past area of support or resistance.

This is also the problem with 1 minute, as these moves may only make sense on other short term time frames. If the aim is a short term trade, it may succumb to unpredictable moves back and forth, but some sense of what is happening may come from longer term awareness.

In the case of a news trade which can be very quick, this may be seen in some cases as a longer term move sped up, so it can be important to be aware of longer term features on a chart.

A reason to pick 1 minute for Forex, is the uncertainty in the market, the way it can turn so easily and 1 minute can show signs of these changes, first, so it becomes an indicator in and of itself, potentially.

Is it necessary to learn technical analysis ?

It can be helpful to do so in that it permeates Forex trading. Thus it may be hard to understand many things written or said about Forex without it. More than this though, it provides tools and approaches to trading and can provide representations of the market (which is just a set of price movements).

But, because the market may behave in a matter contrary to technical indications, then it may be helpful to try and combine an ongoing reading of the market with any technical approach.

Moving averages (and indicators which use moving averages such as the Ichimoku Cloud) are a possible way to see why a pair may be moving back and forth, because Forex pairs do tend to respect these indicators, at least to an extent.

Caution needs to be observed, because more significant directionality may be separated from reactions around and on technical indicators. This also applies to movements around big figures values. However using indicators with an eye on value on the chart can provide some way to interpret the movement of a Forex pair.

Is it necessary to use technical analysis ?

They do tend to be the tools on offer. It is possible to trade using minimal technical tools. For example, a candlestick chart and RSI. Time frame analysis of the chart can indicate where potential stalling or changes in direction may occur. RSI can act as an indicator of indicators.

There is a presumption that indicators, whether they are valid or not, move the market, as they are used so much. This can be true, but in Forex any effect such as this can get absorbed quickly.

An indicator can show what it believes are states where the pair can stall or change direction, which can be used in conjunction with the way the market seems to be moving, to indicate a possible exit, for example. The candle can indicate whether the pair can and may continue moving, by enlarging it and seeing how much upward or downward pressure is in it.

There are limitations to this approach, but nonetheless it is a simple approach which combines technical approaches with market movement. The idea here is to try and let the market indicate what may be possible, within possible technical constraints and time factors.

In a trading system, typically, there are clear rules, such as using RSI to make, close or change a trade when a certain value is reached, filtered perhaps by other indicators or market conditions. Here, RSI can be used to indicate that a stall may occur because it is indicating overbought or oversold market conditions, for example. It is more like a potential guide.

Technical approaches can become overloaded by a complexity issue, as they become like a set of rules covering various conditions, leading into a necessity to use automated methods. But keeping technical methods as guides in a moving market can potentially alleviate this issue. But it requires decisions making during the trade and potentially other factors.

Is it possible to trade without using technical analysis ?

It may be in news trading. Taking a guess on direction and placing a trade, for example. This is essentially a fundamentalist approach, as the guess will presumably be informed by economic data. However even here one may need to make charting analysis, to indicate where the pair may stall after it may have moved, as sharp reversals are very possible in news events. No matter what the data may say, the pair might react in unexpected ways, or not really react at all.

What is RSI ?

It is an indicator which is said to indicate whether a pair is at a state where it may stall or change direction, namely overbought or oversold. It also is said to indicate other things, based on referencing the present value of an asset to past values and giving a value to express this. It can be useful for indicating stalling.

This is because whether its judgement that the pair is over or under valued is correct or incorrect, traders and computer programs may react to this judgement. This may then produce a market reaction, which may not follow through, but may at least stall the present move, with a temporary change in direction. While it may indicate a change of direction which continues, the fact it can also get this wrong, makes for caution in this use.

RSI divergence patterns can be useful in Forex, as the market moves up and down. It may be some market conditions are more suited to this than others, for example, in the crisis in 2008, the market seemed well attuned to this kind of pattern formation, as indeed it was filled with retracements, within a strong directional momentum.

What is meant by RSI going wrong ?

It can show, for example, an oversold state of the market, and the market takes it lower and lower.

What does oversold mean ?

It means that the pair has been sold to such an extent a correction is potentially imminent. Overbought means it has been bought to such an extent a correction is potentially imminent.

Why do indicators not always work ?

Leaving aside a discussion of the effectiveness of the indicator, in Forex there is unpredictability, moves take place which have range outside of what one may expect. This unpredictability is everywhere, from news events to sudden trends appearing and disappearing in the market.

So an expected outcome, turns easily into an unexpected outcome, for example oversold going lower and lower. However one can expect that at some stage the market will reverse. That is indeed a feature of Forex. But like everything in leveraged trading, it is the 'when' that counts.

Why is time important in leveraged trading ?

Because in leveraged trading, there is usually a limit to how much of a reverse can be taken, as the cost of sustaining it rises. Even if the market does reverse back, it may not go all the way back to even the entry point of the trade let alone beyond it.

How can leverage affect trade size ?

Value in Forex is determined by changes in pips. The amount made or lost is determined by the value of each pip. Leverage can be used to determine how much each pip value is worth because as leverage increases, the amount of money which is needed to determine the worth of each pip, decreases. So effectively, smaller account sizes can behave like larger account sizes. But this can put unrealistic expectations on the behavior of the market.

For example, if a small account is highly leveraged, it may not be able to take moves against it, even triggering a margin call. While the idea of a move which adds dollars instead of cents with each move in the trader's favor using a relatively small stake as margin may be attractive, the reality that this trade may involve moves which detract dollars instead of cents from the account can make for a risky and negative experience.

Whilst accounts come in standard lot sizes and mini lot sizes, they also may come in micro lot sizes. Using a micro lot account may help produce more realistic expectations, for smaller account sizes. And when opportunity presents itself, higher leverage can still be taken advantage of, rather than relied upon. So instead of trying to force opportunity on the market, one can look for where there is opportunity.

Going back to Forex pairs, are some better to trade than others ?

Different pairs may have different characteristics. For example some may react in more volatile ways, some may tend to have a greater range of movements, some can move in structured ways, others less structured ways. This can affect how the pair may move.

Give an example of ways a pair might move ?

EUR/USD after its low in 2000, moved high, then following the crisis drop, moved down in waves which had lower tops and less intense drops and were supported on a longer term floor around 1.2, which it later fell out of, to find new support.

Since 1998, USD/JPY was in a long move down, with drawn out waves and lowering tops and also support around 100, which it also fell out of, to reach a low from where it has risen upwards again, to find resistance.

From 2008, Spot Silver (XAG/USD) moved around and below 20 for a few years, then powered up towards 50. After failing below 50, it began dropping and also rising as well, but the drops outweighed the rises. Then volatility faded as the metal continued down, dropping back below 20, then below 15 and rising again.

Does the way a pair is moving in the long term make a difference ?

It may be that awareness of how a pair is moving can be helpful for longer term trades, and it could affect pairs all the way down time frames in terms of potential support and resistance, but that unpredictability should always be borne in mind. With a sense of how the pair has moved then major events can be seen in this context, for example how the Brexit vote interacted with the movement of the pair.

Are there regularities in Forex ?

Regularities could be seen as repeated types of changes in value, usually based around some market event. News trading does not tend to produce regularities, as the event tends to change (if it does not, the market does not tend to react so much). However, the outcome of approaching significant valuation levels may produce regularities, as can changes in liquidity happening around market open and closes, as these events do not change.

The uncertainty in the market, the way potential outcomes can have have various possible results at a given time, makes for difficulties in sustaining repeated patterns in this market. Trading Regularities in Forex with Agility deals with the topic of market regularities in Forex in more detail, presenting and analysing a list of some regularities.

How did the crisis of 2008 affect Forex pairs ?

It tended to affect some pairs in similar ways. Looking across markets one can see the tell-tale, unusually strong directional momentum, large strong drops, with bounces. The US stock market did recover from the crisis. In pairs the moves of the crisis can perhaps also be looked at in the context of longer term moves.

Does trading Forex help with other markets ?

It may, in this way: it can help give a feel for charting action and for the likelihood of value altering momentum, back indeed to stalling and reversal. Put simply, Forex has an intensity to it that may make action in other less intense markets at least seem easier to read.

What is meant by 'value' in this article ?

The shifting weight given to the actual price of a pair. It is not specifically value in terms of the highness or lowness of the number, but how important that value is in terms of changes which may happen when it takes it again, or for more directional assets, for the first time and then if it returns to it.

For example, what was the potential imminence of 20,000 in the stock market, or in Forex, the effect of 120 on USD/JPY. In Forex, complex moves can be seen coming to and around value and beyond it. Value in Forex is relative, so what was a value or range of value which saw things happening, may not be so significant the next time the pair gets there. However, because something happened there, may predispose those values to creating some effect next time. For example, past support and resistance may result in changes in direction, when these values are returned to.

Because Forex, to put it simply, moves around rather than tending to have a clear direction, then values do tend to be returned to again and again, unlike, in some cases, the stock market or indeed commodities, which may have longer cyclical moves up and down, or in the case of metals may go high and return to base much later. But more than this, certain kinds of value do tend to create an effect, for example, big figures, irrespective of the way the pair is moving. However having an idea that something may happen, is different from knowing what this will be.

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