Lessons from the Pros

The Global Forex Market

Yesterday, I was doing Hour With the Pros, our weekly free webinar that covers a vast variety of topics. I chose to share the basics of the Futures and Forex markets. I lead the Extended Learning Track (XLT) – Forex Trading program for Online Trading Academy. In the program, I teach through trading, analysis, and lessons four days a week, four weeks per month. Being very active in the Forex market each day in the XLT and knowing all the marketing out there for trading Forex, I am guilty of assuming that most people know and understand what Forex trading is and also know a little about how these markets work. In yesterday’s Hour With the Pros, I realized I was wrong to assume that, as there were many basic questions on Forex trading. During this piece, I will cover the basics of what the Forex market is, how it works, and some important information you should know before getting started.

What is the Forex Market?

The Foreign Currency (Forex or Spot) market is where global exchange rates are derived for everyone including market speculators and end users of currency. It is the largest and least regulated financial market in the world. There are pros and cons to this which I will discuss in a bit. This cash-bank market was established around 1971 when floating exchange rates began to materialize. The daily turnover has increased from around $5 billion in 1977 to around $2 trillion today. This market is open 24 hours per day – 6 days per week.

How Does it All Work?

In the simplest terms, supply and demand for currencies determine global exchange rates. Strong economies have strong currencies. When we trade the Forex markets, we are trading economies.

Therefore…

Supply and demand for currency depends on the current and expected future health of a country’s economy. We can see and assess the demand and supply for a country’s currency through fundamental and technical analysis. Let’s take a look at fundamental analysis first. Here is an example of how it works:

As the example shows, when global investors perceive a strong economy, they buy that country’s currency to take advantage of strong investments within that country’s stock and bond markets. To buy into a country’s markets however, you first need to buy that country’s currency. Next, let’s take a look at how to assess supply and demand for currency from the technical analysis perspective. I will use a trade I made this week in the Japanese Yen (Forex Futures) for the XLT members to explain.

Trade Risk: $225.00

Trade Reward: $737.50

Notice area "A". We call that an objective supply (resistance) level. Why? Because price declined from area "A" which can only happen if supply exceeds demand at that level (more sellers than buyers). "C" was the first time price revisited "A" which was the low risk/high reward time to sell short. Why? Because when price reaches a price level where there are more willing sellers than buyers, it declines. This is where I sold short as the risk was low, reward was high, and the probability of price falling was strong. Area "B" on the chart is an objective demand (support) level. Why? Because price rallied from area "B" which can only happen if demand exceeds supply at that level (more buyers than sellers). "D" was the first time price revisited "B" which was the low risk/high reward time to buy back the short position (take profit). Why? Because when price reaches a price level where there are more willing buyers than sellers, price goes up. This is where I took profit on the short position as the probability of price advancing at "D" was strong. These turning points where the trade was sold and bought happen because of a major supply and demand imbalance. Supply and demand are so out of balance that price simply can’t stay at these levels. We simply identify the supply and demand imbalance and trade that market back to balance. We can and do quantify supply and demand on the charts in the smaller time frames for day trading the Forex market and the larger times frames for swing and position trading the Forex market.

More Information You Should Know

There are two ways to trade the Forex market. While I go into this topic in much detail in the XLT program, here is some basic but important information you should be aware of.

The foreign exchange (Forex) market is where I began my trading career; specifically, on the floor of the Chicago Mercantile Exchange handling large order flow for institutions, banks, and retail traders around the world. The Forex market is far and away the largest market in the world for banks and institutions (not retail). One of the reasons for this is because of all the other markets: stocks, bonds, and options. For example, for the Japanese investor, institution, or bank who wants to buy into the US stock or bond market, they can’t use YEN to do it. They must buy US Dollars first. Perhaps you didn’t know the majority of the world settles oil purchases in US dollars. Importers and exporters are always involved in the currency markets as well. I could go on forever with information on the fantastic Forex markets but this piece would get way too long. If you have any questions or comments, feel free to email anytime.

Have a great day.

Sam Seiden – sseiden@tradingacademy.com