What is Forex
Hello! This is video 3 of our Forex Boot Camp series. Now you have got to grips with what trading is, and what trading is not, we are ready to get into the meat of it.
You are still someway from being released onto the battlefield of trading and first we need to show you your trading weapon! Forex is, in our opinion, the best place to start your trading career.
We have touched on some of the reasons previously, and we will go into more detail in the next video. But first, now, we want to show you exactly what Forex is.
Forex, as you will no doubt remember, is a contraction of Foreign Exchange, otherwise known as currencies trading.
Currencies Explained
The traditional understanding of currencies is that each sovereign nation has its own currency. If you wish to buy something in that country you must use their national currency.
That idea still holds true but has begun to be challenged in recent decades.
So you have the USA with has the United States Dollar and you the United Kingdom which has the Pound Sterling.
The Euro is slightly different as it is used by 19 of the nations from the European Union and is not tied to single state
Historically, however, the price of the Euro is more impacted by Germany than other states in the EU, as Germany is the biggest country and economy in the Eurozone.
In the last year or two, traditional currencies, known as Fiat currencies (and which form the market of Foreign Exchange) have been challenged by the emergence of crypto currencies.
These are digital currencies, that do not exist in the physical world as coins and notes, and are not tied to a single nation.
Fiat Currencies, such as the British Pound are considered part of the forex market.
Cryptocurrencies are not considered part of the Forex market.
As such, they are outside the scope of this video series. We do both trade cryptos actively, so if there is demand maybe we will create a crypto series in the future!
The other thing you do need to be aware of is that currencies are always quoted in pairs.
That is because the only thing you can value a currency by, is another currency. For instance the British pound versus the US Dollar. Or in the example below EUR USD - the euro vs usd.
Although you do have things like the US Dollar index, which seeks to give an overall impression of the strength or weakness of the USD, you will almost always be trading currencies against each other.
There is a full video on this topic soon, as it is hugely important to understand fully.
The Forex Market
The Forex market is the name given to the party to party Over the Counter trading market, not on a centralised exchange, that handles currencies trading. You will hopefully remember the phrase over the counter, or OTC from video one.
There are big players in this market and there are small players.
The first to consider, as they often get forgotten, even by experienced traders are the companies that genuinely use the Forex market for business.
If a British business wants to buy goods from Japan it needs to turn British Pound Sterling into Japanese Yen. If it wants to sell those goods in America it will be paid in US dollars which it may want to send back to HQ in the UK and need to turn into Pounds Sterling again. All of this buying and selling drives the Forex market.
Companies may also want to ‘hedge’ using the Forex market. We will cover hedging in more detail in another video, but basically, if a company is worried that the value of the pound is going to go down, they may wish to sell sound pounds against the dollar. If the pound does go down (and assets they hold that are valued in pounds are now less valuable) then they have made money on the short selling of the pound against the dollar, and this offsets the loss in value of their goods that are valued in pounds.
Don’t worry We will cover that again later! It is very important!
Next is the big institutions, the banks, that speculate. The big ‘Tier 1’ banks play a very important role in creating the conditions to allow the Forex market to function. They are also active traders, both trading their own money and that of their clients.
They are the large speculators. They you have smaller speculators, these are often Hedge Funds or Proprietary Trading Funds, Prop Funds for short. These have mind boggling sums of money to the regular person, but to a bank like HSBC or Goldman Sachs, they are certainly a few tiers down!
Right at the bottom of the pile you have us, the retail trader. Once you click fire on your first trade you are a retail trader. Congratulations!
Well done, but sadly you are too small to remotely impact the market, and often an afterthought in the plans of the banks and other speculators.
But, if you play your cards right and get your knowledge and skill levels up, there’s no reason you can’t profit from their game, even if they make the rules.
Now, we also need to address the size of the market.
The Forex market, as you can see, is comfortably the largest financial market. The daily forex turnover is larger than the actual size of global GDP on that day.
Get your head around that!
That means that the market has liquidity.
Liquidity is the term given for the amount of trading activity in a given market and how easy it is to find a trader on the other side of your trade. Think about the housing market -It may only take a day to sell your house, but it may take months: it is an illiquid market.
In forex you can usually place your trade and get it paired with another trade virtually instantly - known as being filled. When prices move very fast it may take a few seconds, or longer, and the price you get may be vastly different from the one you wanted when a HUGE price movement occurs, but these events are rare. Think Brexit vote if you want an example.
24 hour market
Forex truly is a global 24 hour marketplace. There isn’t the UK forex market or the German Forex market like there is for shares trading.
Although there are a number of different electronic trading venues that you may be able to access, it is best to think of it as a single, unified worldwide market.
There are regional Forex trading centres around the world but they all trade in the global market. From the minute traders in Sydney are at the desk on Monday morning, to the moment New York shuts down on a Friday night, the Forex market is open.
If you are in London but want to trade in the middle of the night, then you can trade what we call the ‘Asian Session’ - when traders in Tokyo and Sydney are at the desks, trading and providing activity in the market.
After the Asian session, as the UK and Europe wakes up, you have the London session, sometimes called the European session.
Then the USA gets out of bed, eats it pancakes and the New York session starts. Before they knock off for the day, Tokyo takes back over and the Asian session starts again.
The London session is typically the most active and liquid, then the New York Session and then the Tokyo, or Asian session.
What Moves Currencies
Currencies, like any other financial product, are moved by the laws of supply and demand. If there is more Euro buying activity than selling activity then the Euro will go up in value.
What influences those buying and selling decisions, and thus the price, is what concerns us here.
Essentially, the national currency of a country can be seen as the barometer of that country. If the trading world is positive on that country, then the price is likely to go up and if negative then the price is likely to go down.
But it is not quite so simple as this metaphor suggests.
In the first case, simple buying and selling for commercial purposes will affect the currency of the country. That is hard to measure, predict or profit from so in some senses, traders may be right to largely forget about the activity of companies and businesses in their buying and selling.
Then you have what traders will call the Fundamentals. These are the hard facts that underly a currency and it’s relationship with other currencies, and are rooted in what the home nation of that currency is doing.
Historically, when interest rates rise, that will lead to a rise in the value of the currency. If interest rates go down, the value of the currency is likely to go down too. Explaining why is a video or two in itself so don’t worry too much for now!
Aside from interest rates, there is a slew of economic data that comes out about each country that traders look to to inform their Forex trading.
Good data is good for a currency, bad data is bad.
So if positive economic data is released, that show a lot of jobs creating or an increase in GDP in, say, Japan, then the Japanese Yen will likely be positively impacted by that. If the data is negative then it will likely be negatively impacted by that.
Outside of the fundamentals, we have technical trading. This refers to trading just based on what you can see on a price chart. This is such a popular way of trading that it actively moves the value of the currency.
If the price goes up to a point that many technical traders believe means it will reverse, then there is a possibility of self fulfilling prophesy - the price will then reverse as many traders sell at that level.
Technical trading ideas will form the backbone of this course, and it is something that every trader needs to understand and ideally master, even if they don’t end up being a technical trader in the long term.
The short term opinion of the market, either based on fundamental ideas, economic data, political news or technical trading ideas forms what is known as the sentiment.
The market sentiment is the current, short term, cumulative view of all of the traders engaged in that market. The sentiment can be positive, negative or neutral. Often prices don’t move in one currency because there is no real sentiment and Forex traders are busy trading other currencies
Then maybe there is an unemployment report released, or a statement by a political leader and suddenly there is a hugely positive or negative sentiment and the price moves significantly.
This is the drama of the Forex market!
Understanding what moves currency prices and learning how to anticipate that and be positioned before most of the move happens is the key skill in trading. That is how you make money.
Most of the videos in this course will be dedicated to this, as it is fundamentally what the activity of trading is.
This was a 30,000 feet fly past overview of what moves markets, but I hope it has started sparking some ideas in your mind!
This completes video three. In this video we learned more about what Forex actually is. We covered currencies, and how they are quoted, the basics of the Forex market structure, who trades in the market and why, and the sheer global scope of Forex trading. We then finished up with some discussion of what it is that makes currency prices move - ultimately the heart of all trading endeavour!
In the next video we will be looking at Currency Pairs in a bit more detail.