Chapter 1
What is the Forex?
• Forex = Foreign Currency Exchange
• You can trade 24 hours a day
• The Forex is larger than all other financial markets COMBINED
The Foreign Exchange (Forex) Market is a cash, or “spot”, interbank market established in 1971 when
floating exchange rates began to materialize. This market is the arena in which the currency of one
country is exchanged for those of another, and where international business is settled.
The Forex is a group of approximately 4,500 currency trading institutions that include international
banks, government central banks, and commercial companies. Payments for exports and imports flow
through the Foreign Exchange Market, as well as payments for purchases and sales of assets. This is
called the “Consumer Foreign Exchange Market.” There is also a “speculator” segment in the Forex
Market. Speculators have great financial exposure to overseas economies participating in the Forex to
offset the risks of international investing.
Historically, the Forex Interbank Market was not open to small speculators. With a previous, minimum
transaction size, and often stringent financial requirements, the small trader was excluded from
participation in this market. Today, Market Maker brokers are allowed to break down the larger
interbank units and offer small traders the opportunity to buy or sell any number of these smaller units
(lots).
Commercial Banks play two roles in the Forex Market:
(1) They facilitate transactions between two parties. For example, two companies wishing to exchange
different currencies would seek the help of a commercial bank.
(2) They speculate by buying and selling currencies. The banks take positions on certain currencies
because they believe they will be worth more if, “long”, or less if, “short”, in the future. It has been
estimated that international banks generate up to 70% of their revenues from currency speculation.
“Other” speculators include many of the worlds’ most successful traders, like George Soros.
The Forex also includes central banks from various countries, like the U.S. Federal Reserve. They
participate in the Forex to serve the financial interests of their country. When a central bank buys and
sells its own or a foreign currency, the purpose is to stabilize their own country’s currency value.
The Forex is so large and is composed of so many participants, that no one player, not even the
government central banks, can control the market. In comparison to the daily trading volume averages
6
of the $300 billion U.S. Treasury Bond market and the approximately $100 billion exchanged in the U.S.
stock markets, the Forex is huge, and has grown in excess of $3 trillion daily.
The word “market” is a misnomer describing Forex trading. There is no centralized location for trading
activity as there is in the other markets. Currency trading occurs over the phone and through computer
terminals at hundreds of worldwide locations. The bulk of the trading is between approximately 300,
large, international banks that process transactions for large companies, governments, and their own
accounts. These banks are continually providing prices (“bid” to buy and “ask” to sell) for each other and
the broader market. The most recent quotation from one of these banks is considered the market’s
current price for that currency. Various private data reporting services provide this “live” price
information via the Internet.
There are numerous advantages to trading on the Forex.
Liquidity
In the Forex Market, there is always a buyer and a seller! The Forex absorbs trading volumes and per
trade sizes which dwarf the capacity of any other market. On the simplest level, liquidity is a powerful
attraction to any investor. It suggests the freedom to open or close a position at will, 24 hours a day.
Once purchased, many other, high‐return investments are difficult to sell at will. Forex traders never
have to worry about being “stuck” in a position due to lack of market interest. In the nearly $3.5 trillion
U.S. per day market, major international banks always have “bid” (buying) and “ask” (selling) prices for
currencies.
Access
The Forex is open 24 hours a day from about 6:00 P.M. Sunday to about 4:00 P.M. Friday. An individual
trader can react to news when it breaks, rather than having to wait for the opening bell of other markets
when everyone else has the same information. This timeliness allows traders to take positions before
the news details are fully factored into the exchange rates. High liquidity and 24 hour trading permit
market participants to take positions, or exit, regardless of the hour. There are Forex dealers in every
time zone and in every major market center; Tokyo, Hong Kong, Sydney, Paris, London, United States, et
al. willing to continually quote "buy" and "sell" prices.
Since no money is left on the market table‐referred to as a “Zero Sum Game” or “Zero‐Sum Gain”‐ and
providing the trader picks the right side, money can always be made.
Two‐Way Market
Currencies are traded in pairs–for example, Dollar/Yen, or Dollar/Swiss Franc. Every position involves the
selling of one currency and the buying of another. If a trader believes the Swiss Franc will appreciate
against the Dollar, the trader can sell Dollars and buy Francs. This position is called "selling short".
If one holds the opposite belief, that trader can buy Dollars and sell Swiss Francs–“buying long”. The
potential for profit exists because there is always movement in the exchange rates (prices). Forex
7
trading permits profit taking from both rising and falling currency values in relation to the Dollar. In
every currency trading transaction, one side of the pair is always gaining, and the other side is always
losing.
Leverage
Trading on the Forex is done in currency “lots.” Each lot is approximately 100,000 U.S. dollars worth of a
foreign currency. To trade on the Forex market, a Margin Account must be established with a currency
broker. This is, in effect, a bank account into which profits may be deposited and losses may be
deducted. These deposits and deductions are made instantly upon exiting a position.
Brokers have differing Margin Account regulations, with many requiring a $1,000 deposit to “day‐trade”
a currency lot. Day‐trading is entering and exiting positions during the same trading day. For longer‐term
positions, many require a $2,000 per lot deposit. In comparison to trading in stocks and other markets,
which may require a 50% margin account, a Forex speculators' excellent leverage of 1% to 2% of the
$100,000 lot value means the trader can control each lot for one to two cents on the dollar.
Execution Quality
Because the Forex is so liquid, most trades can be executed at the current market price. In all fast
moving markets (stocks, commodities, etc.), slippage is inevitable in all trading, but can be avoided with
some currency brokers' software that informs you of your exact entering price just prior to execution.
You are given the option of avoiding or accepting the slippage. The Forex Market's huge liquidity offers
the ability for high quality execution.
Confirmations of trades are immediate and the Internet trader has only to print a copy of their
computer screen for a written record of all trading activities. Many individuals feel these features of
Internet trading make it safer than using the telephone to trade. Respected firms such as Charles
Schwab, Quick & Reilly and T.D. Waterhouse offer Internet trading. These companies would not risk
their reputations by offering Internet service if it were not reliable and safe. In the event of a temporary
technical computer problem with the broker’s ordering system, the trader can telephone the broker 24
hours a day to immediately get in or out of a trade.
Internet brokers’ computer systems are protected by firewalls to keep account information from prying
eyes. Account security is a broker’s highest concern. They take multiple steps to eliminate any risk
associated with financial transactions on the Internet.
A Forex Internet trader does not have to speak with a broker by telephone. The elimination of the
middleman (broker/salesman) lowers expenses, makes the process of entering an order faster, and
decreases the possibility of miscommunication.
Execution Costs
Unlike other markets, the Forex does not charge commissions. The cost of a trade is represented in a
Bid/Ask spread established by the broker. (Approximately 4 pips)
8
Trendiness
Over long and short historical periods, currencies have demonstrated substantial and identifiable trends.
Each individual currency has its own “personality,” and offers a unique, historical pattern of trends that
provide diversified trading opportunities within the spot Forex market.
Focus
Instead of attempting to choose a stock, bond, mutual fund, or commodity from the tens of thousands
available in other markets, Forex traders generally focus on one to four currencies. The most common
and most liquid are the Japanese Yen, British Pound, Swiss Franc and the Euro. Highly successful traders
have always focused on a limited number of investment options. Beginning Forex traders will usually
focus on one currency and later incorporate one to three more into their trading activities.
Margin Accounts
Trading on the Forex requires a Margin Account. You are committing to trade and take positions today.
As a speculator trader you will not be taking delivery on the product that you are trading. As a Stock Day
Trader, you would only hold a trading position for a few minutes, up to a few hours, and then you would
need to close out your position by the end of the trading session.
All orders must be placed through a broker. To trade stocks you would need a stockbroker. To trade
currencies you will need a Forex currency broker. Most brokerage firms have different margin
requirements. You need to ask them their margin requirements to trade currencies.
A Margin Account is nothing more than a performance bond. All traders need a Margin Account to
trade. All accounts are settled daily. When you gain profits, they place your profits into your Margin
Account that same day. When you lose money, an account is needed to take out the losses you incurred
that day.
A very important part of trading is taking out some of your winnings or profits. When the time comes to
take out your personal gains from your margin account, all you need to do is contact your broker and
ask them to send you your requested dollar amount. They will send you a check or wire transfer your money.
Chapter 2
Reading Candlestick Charts
In the Seventeenth Century, the Japanese developed a method to analyze the price of rich contracts.
This technique was called "Candlestick Charting." Today, Steven Nison is credited with popularizing the
Candlestick Chart, and is recognized as the leading authority on interpretation of the system.
Candlesticks are graphical representations of the price fluctuations of a product. A candlestick can
represent any period of time. A currency trader’s software can provide charts representing time frames
from five minutes, up to one week per candlestick.
There are no calculations required to interpret Candlestick Charts. They are a simple visual aid
representing price movements in a given time period. Each candlestick reveals four vital pieces of
information; the opening price, the closing price, the highest price and the lowest price the fluctuations
during the time period of the candle. In much the same way as the familiar bar chart, a candle illustrates
a given measure of time. The advantage of candlesticks is that they clearly denote the relationship
between the opening and closing prices.
Because candlesticks display the relationship between the open, high, low and closing prices, they
cannot be used to chart securities that have only closing prices. Interpretation of Candlestick Charts is
based on the analysis of patterns. Currency traders predominantly use the relationship of the highs and
lows of the candlewicks over a given time period. However, Candlestick Charts offer identifiable patterns
that can be used to anticipate price movements.
