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Lesson 1 – What Exactly Is Forex?
With a daily trade volume of up to 4 trillion USD, forex is the largest financial market in the world. In comparison, the daily trade volume of the New York Stock Exchange is only USD 25 billion. There is an evident disparity in the trade volumes between forex and stock markets. Its actual trade volume is more than 3 times the total trade volume of the stock and futures market!
What is Traded in the Forex Market?
The answer is simple, money. Forex trading is the buying of one currency and the selling of another simultaneously. Forex trades can be carried out through foreign exchange brokers or dealers. Trading of foreign currency is done in pairs, e.g. Euro against US Dollars (EUR/USD) or British Pounds against Japanese Yen (GBP/JPY). Buying and selling foreign currencies is like investing in a country’s stock. When you buy Japanese Yen, for example, you are actually acquiring a stake in Japanese economy. The pricing of the currency is a direct reflection of the immediate and future outcome of the Japanese economy.
• Margin addition.
• When you open a forex trading account, you will need to inject capital into this account. This will be your trading capital.
• The dealer will use a leverage ratio to determine the margin required.
• Your trades will be carried out based on this margin requirement.
• In summary, forex refers to various means of payments in the settlement of international claims and liabilities with foreign currencies.
• Another major difference between stocks and forex.
• Unlike in general stock trading, the balance in your trading account need not be greater than the nominal you invest in the foreign currency.
• Using stocks as an example, if the share price for Bank of China is HKD 4, you must have at least HKD 8,000 in your trading account in order to buy 1 lot (2,000 shares) of shares.
• This is the main reason why forex is attractive.
• Similar to futures trading, the trader can trade with a pre-determined proportion of the margin.
• This is the leverage ratio.
• In forex trading, many brokers provide traders with a leverage ratio of 200:1.
• If the price of 1 standard contract is USD 100,000, and the leverage ratio is 200:1, then one can trade with only USD 500 in his account (100,000/200).
• Some brokers also refer to the initial margin as the required margin.
Broker’s Policy on Insufficient Fund (Take Note!)
• Different brokers have different policies on insufficient margin balance in the trader’s account.
• Some brokers will square your open position when the unrealized profit and loss falls below the required margin, resulting in a zero balance in your account.
• Other brokers may open a corresponding opposite position on your behalf to ‘lock in’ your losses. In this way, your account balance will not be reduced to zero.
• Most brokers will require clients to top up the margin in their trading accounts within a specific deadline. If the margin is not topped up by the deadline, the broker will square the client’s open position, even if the client’s realized profit and loss may be lower than the current balance.
• In forex trading, pip is the smallest unit in the fluctuation of currencies.
• 1 pip is 1% or 1/100.
• Most currencies are quoted with 4 decimal places, e.g. EUR/USD. If the EUR/USD rises from 1.3514 to 1.3515, the difference of 0.0001 is called 1 pip.
• If trading is done in the standard unit of USD 100,000 per contract, then 1 pip would be worth USD 10.
Pip in Currency Pairs
Refers to the last digit in the quote.
EUR/USD @ 1.3512
GBP/USD @ 1.5085
USD/JPY @ 89.14
USD/CHF @ 1.0810
Lesson 2 – Foreign Exchange Rates and Quotation Methods
1. Concept of Foreign Exchange Rate
We have an expert understanding of domestic trading. When you are in Germany and you buy rice from a shop, you will naturally pay in Euros, and of course, the shop will be willing to accept Euros. This trade can be conducted in Euros. Trading of goods within a country is relatively simple.
However, things get complicated if you want to buy a US-made computer. You might have paid in Euros at the shop. However, through transactions in banks and financial institutions, the final payment will be made in US dollars and not Euros. Similarly, when Americans want to buy German products, they will have to eventually pay in Euros.
From this example of international trading, we introduce the concept of foreign exchange rate. Foreign exchange rate is the value at which a country’s currency unit is exchanged for another country’s currency unit. For example, the current foreign exchange rate for Euros is: 100 EUR = USD 130.
2. World Currency Symbols
USD : US Dollar
HKD : Hong Kong Dollar
EUR : Euro
JPY : Japanese Yen
GBP : British Pound
CHF : Swiss Franc
CAD : Canadian Dollar
SGD : Singapore Dollar
AUD : Australian Dollar
RMB : Chinese Renminbi
3. Methods of Quoting Foreign Exchange Rates
Currently, domestic banks will determine their exchange rates based on international financial markets. There are two common ways to quote exchange rates, direct and indirect quotation.
Direct quotation: This is also known as price quotation. The exchange rate of the domestic currency is expressed as equivalent to a certain number of units of a foreign currency. It is usually expressed as the amount of domestic currency that can be exchanged for 1 unit or 100 units of a foreign currency. The more valuable the domestic currency, the smaller the amount of domestic currency needed to exchange for a foreign currency unit and this gives a lower exchange rate. When the domestic currency becomes less valuable, a greater amount is needed to exchange for a foreign currency unit and the exchange rate becomes higher.
Under the direct quotation, the variation of the exchange rates are inversely related to the changes in the value of the domestic currency. When the value of the domestic currency rises, the exchange rates fall; and when the value of the domestic currency falls, the exchange rates rise. Most countries uses direct quotation. Most of the exchange rates in the market such as USD/JPY, USD/HKD and USD/RMD are also quoted using direct quotation.
Indirect quotation: This is also known as the quantity quotation. The exchange rate of a foreign currency is expressed as equivalent to a certain number of units of the domestic currency. This is usually expressed as the amount of foreign currency needed to exchange for 1 unit or 100 units of domestic currency. The more valuable the domestic currency, the greater the amount of foreign currency it can exchange for and the lower the exchange rate. When the domestic currency becomes less valuable, it can exchange for a smaller amount of foreign currency and the exchange rate drops.
Under indirect quotation, the rise and fall of exchange rates are directly related to the changes in value of the domestic currency. When the value of the domestic currency rises, the exchange rates also rise; and when the value of the domestic currency falls, the exchange rates fall as well.
Most Commonwealth countries such as the United Kingdom, Australia and New Zealand use indirect quotation. Exchange rates such as GBP/USD and AUD/USD are quoted indirectly.
Direct Quotation Indirect Quotation
USD/JPY = 134.56/61 EUR/USD = 0.8750/55
USD/HKD = 7.7940/50 GBP/USD = 1.4143/50
USD/CHF = 1.1580/90 AUD/USD = 0.5102/09
There are two implications for the above quotations:
(1) Currency A/Currency B means the units of Currency B needed to exchange for 1 unit of Currency A.
(2) Value A/Value B refers to the quoted buy price and sell price. Since the difference between the buy price and sell price is not large, only the last 2 digits of the sell price are shown. The two digits in front are the same as the buy price.
4. Defintion of “pip” in foreign exchange rates quotation
Based on the market practice, foreign exchange rates quotation normally consists of 5 significant figures. Starting from right to left, the first digit, is known as the “pip”. This is the smallest unit of movement in the exchange rate. The second digit is known as “10 pips”, so on and so forth.
For example: 1 EUR = 1.1011 USD; 1 USD = JPY 120.55
If EUR/USD changes from 1.1010 to 1.1015, we say that the EUR/USD has risen by 5 pips.
If USD/JPY changes from 120.50 to 120.00, we say that USD/JPY has dropped by 50 pips.
Lesson 3 – Characteristics of the Forex Market
Other than the weekends when it is closed, the forex market is open 24 hours a day. There is no need to wait for the market to open and you can trade anytime you like. This flexibility has enabled many working professionals to take on forex trading as a side job. They can trade in the morning, afternoon, night or whenever they are free. The best thing is that this also means that no one can monopolize the market!
The forex market is so huge that no single entity, be it an organization, a group, a central bank or even the government can control the market trend.
In forex trading, only a small margin is needed to purchase a contract of a much higher value. Leverage enables you to earn high returns while minimizing capital risks. For example, a leverage of 200:1 granted by a forex broker would allow a trader to buy or sell USD 10,000 worth of currency with a margin of USD 50. Similarly, you would be able to trade USD 100,000 with just USD 500. However, leverage can be a double-edged sword. Without proper risk management, such high leverage trading may result in huge losses or profits.
In view of the huge trading volume in the forex market, under normal conditions, you can buy or sell currency at your desired price in a mere matter of seconds with just a simple click of the mouse. You can even setup an online trading platform to buy and sell (place order) at the right price so that you can control your profit margin and cut losses. The trading platform will execute everything for you automatically. It is fast and simple.
Free! Free! Free!
In addition to free simulation accounts, many trading platforms also provide , charts and analyses free of charge. Market movements in a simulation account are the same as those in the actual forex market. Use a simulation account to build up your trading experience and confidence and find your way to success.
What are the tools needed?
You will only need a computer with Internet access. It is that simple! There is no need for you to spend thousands of dollars in training and courses that cannot guarantee you success. We believe that you can find your pathway to wealth creation by using the free resources available in our trade simulation system!
Lesson 4 – Players in the Forex Market
In general, anyone who carries out a transaction in the forex market can be considered as a player. However, the key players in the forex market largely include the following groups: foreign exchange banks, government or central banks, forex brokers and clients.
1. Foreign Exchange Banks
Foreign exchange banks are the primary players in the forex market. They specifically include professional foreign exchange banks and large commercial banks without foreign exchange departments that are
designated by the central bank.
2. Central Bank
The central bank is the governing body or regulator in the forex market.
3. Forex Brokers
Forex brokers are the middleman between the clients and the central or foreign exchange banks. They have very close contacts with both the banks and the clients.
In the forex market, any company or individual who participates in forex trading with a foreign exchange bank is considered a client of the bank.
Lesson 5 – Major Forex Markets of the World
Currently, forex markets with global influence are generally from the western industrialized countries. The major forex markets of the world include London, New York, Zurich, Frankfurt, Paris, Tokyo, Hong Kong and Singapore. In addition to these 8 locations, the forex markets in Bahrain, Milan, Amsterdam and Montreal also have considerable influence.
The table below sets out the trading hours of major forex markets and their corresponding time in GMT:
|Forex Market||Local Time||GMT|
|NZ Wellington||9:00 – 17:00||20:00 – 04:00|
|AU Sydney||9:00 – 17:00||21:00 – 05:00|
|JP Tokyo||9:00 – 15:30||23:00 – 05:30|
|Singapore||9:00 – 16:00||01:00 – 09:00|
|GM Frankfurt||8:30 – 17:30||07:30 – 16:30|
|UK London||08:30 – 17:30||8:30 – 17:30|
|US New York||9:00 – 16:00||13:00 – 20:00|
Lesson 6 – Key Factors Affecting Exchange Rate
All forex trading involves the exchange of one currency with another. At any one time, the actual exchange rate is determined by the supply and demand of the corresponding currencies. Keep in mind that the demand of a certain currency is directly linked to the supply of another. Likewise, when you supply a certain currency, it would mean that you have the demand for another currency. The following factors affect the supply and demand of currencies and would therefore influence their exchange rates.
1. Monetary Policy
When a central bank believes that intervention in the forex market is effective and the results would be consistent with the government’s monetary policy, it will participate in forex trading and influence the exchange rates. A central bank generally participates by buying or selling the domestic currency so as to stabilize it at a level that it deems realistic and ideal. Judgment on the possible impact of government’s monetary policy and prediction on future policy by other market players will affect the exchange rates as well.
2. Political Situation
Growing global tension will result in instability in the forex market. Irregular inflow or outflow of currencies may result in significant fluctuations in exchange rates.
The stability of a foreign currency is closely related to the political situation of that place. In general, the more stable the country is, the more stable its currency will be.
We will illustrate how political factors influence exchange rates with some actual examples. At the end of 1987, the US Dollar was suffering from continuous depreciation. In order to stabilize the US Dollar, the G7 Finance Ministers and central bank governors released a joint statement on 23 December 1987 announcing plans for a large-scale intervention in the forex market. On 4 January 1988, the group started to dump Japanese Yen and Deutsche Mark in huge volumes while buying US Dollars. This resulted in a rebound of the US Dollar and maintained its exchange rate at a stable level.
For our second example, if you have been observing the Euro, you would have noticed that for three consecutive months during the Kosovo War, the Euro fell by about 10% against the US Dollar. One of the reasons was the downward pressure on the Euro caused by the Kosovo War.
3. Balance of Payments
Balance of payments of a country will cause the exchange rate of its domestic currency to fluctuate. The balance of payments is a summary of all economic and financial transactions between the country and the rest of the world. It reflects the country’s international economic standing and influences its macroeconomic and microeconomic operations.
The balance of payments can affect the supply and demand for foreign currencies as well as their exchange rates.
An economic transaction, such as export, or capital transaction, such as inflow of foreign investment, will result in foreign revenue. Since foreign currencies are normally not allowed to circulate in the domestic market, there is a need to exchange these currencies into the domestic currency before circulation. This in turn creates a supply of foreign currencies in the forex market. On the other hand, an economic transaction, such as import, or capital transaction, such as outflow of investment to a foreign country, will result in foreign payments. In order to meet a country’s economic needs, it is necessary to convert the domestic currency into foreign currencies. This creates a demand for foreign currencies in the forex market. When all these transactions are consolidated into a table of international balance of payments, this would become the country’s foreign exchange balance of payments. If the foreign revenue is larger than payment, there will be a larger supply of foreign currencies. If the foreign payment is larger than revenue, then the demand for foreign currencies will be higher. When the supply of a foreign currency increases but its demand remains constant, it will directly drive the price of that foreign currency down and increase the value of the domestic currency. On the other hand, when the demand for a foreign currency increases but its supply remains constant, it will drive the price of the foreign currency up and decrease the value of the domestic currency.
4. Interest Rates
When a country’s key interest rate rises higher or falls lower than that of another country, the currency of the nation with lower interest rate will be sold and the other currency will be bought so as to achieve higher returns. Given this increase in demand for the currency with higher interest rate, the value of that currency will rise against other currencies.
Let us use an example to illustrate how interest rates affect exchange rates. Assume there are two countries, A and B. Both countries do not exercise foreign exchange control and capital funds can flow freely between them. As part of its monetary policy, Country A raises its interest rate by 1% while the interest rate of Country B remains unchanged. There is a huge volume of liquid capital in the market that flows freely between these two countries, seeking out the best possible interest rate. With all other conditions remaining unchanged, as Country A’s key interest rate rises, a large portion of the liquid capital will flow into Country A. When the liquid capital flows out from Country B to Country A, a large amount of Country B’s currency will be sold in exchange for Country A’s currency. In this way, the demand for Country A’s currency will increase, strengthening it against Country B’s currency.
In fact, in today’s globalized market, this scenario applies to the whole world. Over the years, the market trend has been shifting towards free capital mobility and elimination of foreign exchange restrictions.
This enables liquid capitals(also known as “hot money”) to flow freely in the international market. A point to note though is that such capital will only be moved to a region or country with higher interest rate if their investors believe that the change in exchange rate will not nullify the returns gained with higher interest rate.
5. Market Judgment
The forex market does not always follow a logical pattern of change. Exchange rates are also influenced by intangible factors such as emotions, judgments as well as analysis and comprehension of political and economic events. Market operators must be able to interpret reports and data such as balance of payments, inflation indicators and economic growth rates accurately.
In reality, before these reports and data become available to the public, the market would have already made its own predictions and judgments, and these will be reflected in the prices. In the event that the actual reports and data deviate too much from the predictions and judgments of the market, huge fluctuations in exchange rates will occur.
Accurate interpretation of reports and data alone is not adequate, a good forex trader must also be able to determine market reactions before the information becomes publicly available.
Speculation by major market operators is another crucial factor that influences exchange rates. In the forex market, the proportion of transactions that are directly related to international trade activities is relatively low. Most of the transactions are actually speculative tradings which cause currency movement and influence exchange rates. When the market predicts that a certain currency will rise in value, it may spark a buying frenzy that pushes the currency up and fulfill the prediction. Conversely, if the market expects a drop in value of a certain currency, people will start selling it away and the currency will depreciate.
For example, after World War II, the United States enjoyed a period of political stability, well-managed economy, low inflation rate and an average annual economic growth of about 5% in the early 1960s. At that time, all the other countries in the world were willing to use US Dollar as the mode of payment to safeguard their wealth. This causes acontinuous rise in value of the US Dollar. However, from the end of 1960s to early 1970s, the Vietnam War, Watergate scandal, serious inflation, increased tax burden, trade deficit and declining economic growth caused the US Dollar to plunge in value.
Lesson 7 – Concept of Positioning in Forex
Holding a position in which a currency is sold. In forex, when you sell a certain currency, you are going short on the currency. Hence, it is known as short position. A short position is maintained when a currency is sold in anticipation that it will depreciate in value so as to make a profit out of it.
Holding a position in which a currency is bought. In forex, when you buy a certain currency, you are going long on the currency. Hence, it is known as long position. A long position is maintained when a currency is bought in anticipation that it will appreciate in value so as to make a profit out of it.
In forex trading, when the currency trend of the market goes against your expectation and your assets begin to lose value, you may want to close the position to limit your losses. This is called stop loss.
For example, if you buy USD 10,000 worth of USD/EUR, you are long on USD and short on EUR. You have a short position on Euro and long position on US Dollar.
Lesson 8 – Types of Trading – Short-Term
Regardless of your trading style, “knowing how to trade” is the pre-requisite to trading in the futures market. Without actual trading, all forecasts, computations and analyses are meaningless. Therefore, making a trading transaction is a fundamental skill in any type of futures trading. Short-term trading is the best way for you to hone your trading skills. Even if you eventually adopt another trading style, it will still be beneficial to you.
Unlike other types of trading that rely on analyses and forecasts, short-term trading focuses mainly on your ability to trade. For a short-term trader, accurate judgment of market trend as well as amplitude of currency movements is not that crucial; rather, the ability to carry out a trading transaction efficiently is more important.
Regardless of your trading style, you must know the type of strategy to adopt in any given situation, the right speed and frequency of trading, the most favorable position and timing to buy and sell, the right time to enter the market, the right time to exit, how to limit losses, safeguard and maximize profits effectively, how to place orders to secure the best advantage as well as how to quickly recover yourself physically and psychologically when hit by losses.
Compared to other trading styles, short-term trading is the closest to market reality. It is an ability to react in real-time and does not require any other complementary or supplementary skills. Short-term trading is based on immediate situations of the market. There is no analysis to set trading zones and key trading positions, and waiting for the market to attain them before you start to trade. You do not wait for the market in short-term trading and there are trading opportunities any time.
Undeniably, short-term traders do sometimes define trading zones and positions and adjust their trades based on market observations. However, these settings are all secondary and can be modified or abandoned any time.
In terms of skill requirements, short-term trading requires the least amount of skill and is the simplest. You do not need to equip yourself with tons of knowledge (you do not even need to know or care about what you are trading) or rely on those traders who conduct trades based on forecasts. There is also no need for you to be equipped with the impossibly high skills of information gathering, analyses and consolidation (unfortunately these people always over-estimate their own capabilities, and willfully or unwittingly believe that they know so much more than others). In addition, you do not have to acquire in-depth knowledge of the products and possess insider information required of professional traders.
Short-term traders conduct trading based on immediate market situation.
They grasp the present moment and respond to current actions, rather than digest the overwhelming amount of information or try to predict how other people feel. All they do is to identify market reality, ride along closely and resonate with it. Recognizing market reality and trading accordingly are critical skills. Unfortunately, most traders (perhaps all traders) tend to trade with their own set of ideas rather than in line with the actual market situation. It may seem that they are watching the market, but in their minds they have already created another market of their own. They hope (and they are really just being hopeful) that the real market will move the same way as the market in their heads. We all know that this is impossible! However, many traders have this kind of wishful thinking and what follows is the same failure pattern that befalls these traders each day.
There is only one real type of trading – trading according to actual market situation. This is the essence of short-term trading.
Without the fundamental skill (also the most important skill) of recognizing real market situation, all the other skills are like building sand castles. Devoid of a strong foundation, everything will topple sooner or later. Traders who possess this skill normally do not require any other skills. However, there are exceptions. For example, traders with huge capital or large trading firms will need to go beyond such skill. They must build upon it to develop more techniques and comprehensive skills to play a trading game that is different from that of independent traders.
Their success is more likely attributed to other reasons rather than their powerful trading skills.
However, there are exceptions. There are people who succeed without this fundamental skill. Warren Buffett is a very good example. Buffett is not really a trader, but an expert in value judgment. He predetermines value deviations and enter the market in advance. This allows him to profit from contrarian trades before the mood of the market swings in the opposite direction. Most of us should not aspire to become an expert analyst like Warren Buffett. This would require an in-depth understanding of the economic structure, detailed analysis and collective judgment of economic cycles and market maturity, as well as strong corporate evaluation, assessment and administration. Putting these demanding requirements into consideration, it would be much easier and practical to be just a trader.
As an independent trader, the most practical way to enhance yourself is to conduct trading based on real market situation. This is not as challenging as you might think. Everyone is born with this potential.
Lesson 9 – Types of Trading – Long-Term
If we say that a short-term trader is an artist, then a long-term trader would be an engineer. Artists always brim with excitement and passion when they create art pieces, whereas engineers often have to contend with hardships and challenges, as engineering projects require consistent hard work and no one can predict what will happen along the way. A long-term trader must act on logic and not on sentiments.
Theoretically, long-term trading is more suitable for common investors because it focuses on rational thinking. However, this rationality and objectivity also take away the excitement of daily trading. It is a lonely process that requires a lot of patience, much like a monk on a pilgrimage. This is the reason why so many are driven back to short-term trading. Long-term traders pursue market trends, as they believe the latter are their only true friends as well as source of income. They are not concerned about daily price fluctuations because they think these fluctuations are irrelevant. Such indifference make others think that they are fools. Long-term traders do not care about how the market will move the next day, their only concern is whether the trend has ended.
Their perseverance is not something a common investor can understand or accept.
There is a common misconception that long-term traders hold their positions for so long because they are very confident of their forecasts on market trends and know when these trends will end. This is a huge misconception! Long-term traders, just like you, have no idea how the market will swing. They merely track the trends in a disciplined manner.
Holding a position for such a long time and with such discipline is an agony others will not understand. You can even say that the prolonged period of suffering is an opportunity cost for the returns at the end! Huge market fluctuations can easily erode most of the profits held by the positions. What makes things worse is that most of the time you would have expected such retracements. In other words, you are staring at your profits while they are being nicked away. It is as though someone managed to rob you of your money even though you are well-prepared. Can you understand and endure such agony? Long-term traders have to forgo several sure win opportunities in order to hold out for long-term gains. Moreover, there are fewer opportunities for long-term trading due to high market volatility, during which the positions held by long-term traders suffer continuous depreciation. Very often, this is enough to turn initial profits into losses. Such torment is surely enough to crush anyone!
Sometimes, a market may experience drastic retracement which indicates the end of a trend, forcing you to close your positions even though you have lost a good chunk of your profits. After which, you realized that it was just an instantaneous phenomenon and the market continues to move according to its earlier trend. It will take a lot of courage and perseverance to enter the market once more. This may sound easy now, but it is a lot harder than you imagine.
The most important attributes of long-term trading are objectivity and discipline. Many a times, you will be forced to forgo your creative thinking and judgment. However, successful closure of a long-term position can reap huge rewards. This is what makes long-term trading attractive. The key characteristic of long-term trading is that you can keep your losses small while making huge profits. It is not about the number of gains or losses, but the amount. This is where it differs fundamentally from short-term trading.
Lesson 10 – Types of International Forex
The best time to trade Forex
Having a 24-hour market does not mean that you have to trade 24 hours a day.
For example, if you are trading in Japanese Yen, the currency’s volatility typically peaks during the first hour the Japanese market opens.
From 1pm to 5pm (GMT), the London and New York markets will be running concurrently. Therefore, this is the period of time when the volatility of the market and trading volume are the highest, making it the best time to trade.
Lesson 11 – Fundamental Analysis
Fundamental analysis is the methodical analysis of a collection of relevant market information within a specific time frame in order to determine the intrinsic value of the market which is used to compare against actual market prices so as to derive a conclusion on the market.
Fundamental analysis is a form of macroeconomics. Its biggest advantage is that it establishes cause and effect using scientific and rigorous analysis. However, in practical application, most investors think it lacks operability.
The main reasons are:
(a) Its practical application requires traders to have an extremely high level of professional knowledge. At the moment, even renowned economists do not dare to claim that they have completely grasped the theory of fundamental analysis, let alone common investors.
(b) It requires an extensive collection of real-time information and the establishment of a comprehensive database. Any information that may cause fluctuations in the market such as insider information and market sentiments must be collated and analyzed immediately to forecast the potential impact on the market. This is very difficult to achieve for common investors.
(c) The biggest setback of fundamental analysis is that it is not quantifiable. For example, after the Federal Reserve releases its GDP data, it is impossible to determine exactly how big an impact it will have on the forex market or how many pips it will move. There is no way to reflect all these in numbers. Fundamental analysis offers a comprehensive view of the market and a glimpse of the possible trends.
However, technical analysis is still needed for actual trading.
Lesson 12 – Application of Fundamental Analysis
Fundamental analysis is the comprehensive analysis of factors, such as the economic outlook, political situations and policies of central banks, which can cause fluctuations in the exchange rates of the different countries so as to determine the general trends of the market in the foreseeable future. Of the many factors, economic situation is the most important one that frequently creates fluctuations in exchange rates. Factors such as economic growth, international balance of payments and interest rate adjustments are some of the useful indicators you can look out for.
Political and central bank’s interventions do not occur frequently, but when they do, they often have a catastrophic impact on the market. You must be able to react quickly and seize these great investment opportunities. However, many investors, especially beginners to forex trading, may be confused and overwhelmed by the myriad of factors and economic indicators. They find that everything seems very complex and have difficulty understanding the underlying rules of exchange rate movements.
Actually, once you have understood the general principles, you just have to keep in mind one important fact: the factors mentioned above rarely occur at the same time. At any point in history, there will be different events and factors. Even if these events and factors happened at the same time, there will always be one or two dominant ones that dictate the market. As an investor, you must know the factors you should use for analysis and not be baffled by the sheer amount of information.
For example, during the US presidential election in November 2000, apart from the US economy, the critical factor that will affect the forex market was the result of the election. This was the key factor during that time. Why? The presidential candidate George W Bush advocated that the US should not interfere with the European economies excessively,
including the forex market. During that time, the Euro was extremely weak; several European economists and financial experts proclaimed their support for the Euro and even warn investors against dumping the currency, but to no avail. The market felt that without the support from the US, the Euro is doomed. Under such a situation, George W Bush’s statement undoubtedly dealt a crushing blow to the Euro. It will be bad news for the Euro if he was to be elected as the president. From this analysis, it is important for investors to pay close attention to the result of the US presidential election.
During the vote count, the exchange rate for EUR/USD plunged when Bush was in the pole position and rebounded when Al Gore regained the lead.
After the media announced that Bush has won the election, the Euro sank by nearly 100 pips. Due to a series of vote counting disputes in Florida, the Florida High Court ruled on 8 December to allow manual recounts in some counties. This put Al Gore in a good position to overturn the result. At first, the exchange rate for EUR/USD declined from 0.89 to about 0.88 as more people bought the US Dollar after the release of the Non-Farm Payroll figure of 94,000 people which reflected its growing economy. However, following the Florida High Court’s decision, the Euro rebounded quickly from about 0.88 to about 0.89. This is a classic example of how a single dominant factor, the Presidential Election in this case, can affect the exchange rates. If you cannot grasp these key factors, it will be very difficult to forecast market trend and profit from it.
Lesson 13 – What is Technical Analysis?
Technical analysis is the forecasting of future market trends and price movements through the research of market data and figures that are presented in charts. It is a perfect fusion of professional knowledge and the different methods of research. Technical analysis has the following advantages over fundamental analysis:
Any factors affecting the market will eventually be reflected in the price movements which can be plotted on a chart. By following the trends depicted by the graphs, we will be able to grasp the momentum of the market. This is something that fundamental analysis greatly lacks.
(2) High flexibility:
Technical analysis can be applied to all kinds of speculative markets.
Once you have mastered its application, you will be able to simultaneously track as many markets as you like. In comparison, the complexity in data acquisition for fundamental analysis often overwhelms analysts so much that they are forced to concentrate on a single product or market.
(3) Applicable for any time frame:
Technical analysis can be flexibly applied to any time frame. You can apply technical analysis easily whether you are tracking price movement within the same day, or doing mid to long-term market analysis. This is different from fundamental analysis which is only applicable to macroeconomic studies.
(4) Clear buy/sell indicators:
The biggest advantage of technical analysis is that it is able to determine entry points in the trading process. No matter how well you can perform fundamental analysis, technical analysis is still more useful in actual trading.
Lesson 14 – Application of Technical Analysis
Technical Analysis Step 1: Learn to read the charts
The first step to technical analysis is to learn how to read charts. There are many types of charts but they are generally similar. The most basic and commonly used one is the candlestick chart.
As shown below, each candlestick represents a specific time frame. If you have chosen a 30-minute time frame, then each candlestick will depict the trading activities within a 30-minute period. If you have chosen a day as the base time frame, then each candlestick will represent the transactions within the day.
A black candle refers to a drop in price, meaning that the closing price is lower than the opening price. A white or unfilled candle refers to a rise in price, meaning that the closing price is higher than the opening price.
The horizontal lines at the top and bottom of the candlestick represent the opening or closing price, while the vertical lines that extend from above and below the real body are the highest and lowest traded prices within the set time frame respectively.
The candlestick patterns can be used to indicate when a market trend starts to reverse. If we can predict in advance when an upward trend will reverse, we can profit by going short in the market as early as possible. Similarly, if we can forecast that a downward trend is about to stabilize and rebound, we can grab this great opportunity to go long in the market. Candlestick patterns can also be used to determine whether the current trends will continue. Once you are able to master these patterns, you will be able to trade according to the trends. This will give you a lot of confidence to hold your positions or even add positions to earn bigger profits.
Technical Analysis Step 2: Learn to spot trends
The second step in technical analysis is to learn how to draw trend lines, as well as resistance and support positions. Support position is the price position which is supported by buyers. When price falls and approaches the support position, it will tend to rebound. Resistance position is the price position where there will be tremendous selling pressure. When price rises and approaches the resistance position, it will tend to retrace. The support and resistance positions are usually determined using trend lines. Alternatively, you can also use other technical indicators such as Fibonacci lines, moving averages and Bollinger bands.
Drawing Trend Lines
In an upward trend, choose two ascending low points and join them to make an upward trend line. In a downward trend, choose two descending high points and join them to create a downward trend line. In order to improve the accuracy of the trend lines in predicting future market movements, we will filter away those trend lines that are not good enough, leaving behind those that will be useful for our analysis.
A trend line must undergo a series of tests before it can be considered useful and effective. Those that fail to meet these stringent criteria should be discarded.
First, the existence of a trend must be verified. An upward trend must have two consecutive ascending lows while a downward trend must have two consecutive descending highs. Only then a trend can be considered real and the straight line that joins the two points can be called a trend line.
Next, after the trend line is drawn, a third point must be identified to verify that the line is an effective one. In general, the more points a trend line touches, the more effective it is and the more accurate it will be in predicting future movement.
In addition, we must continue to adjust a trend line based on subsequent market situations. For example, when an exchange rate breaks below an upward trend line but then quickly rebounds to move above it, the analyst must redraw the trend line from the first low point to the new low point or try to produce a more effective line using the second low point and the new low point.