What is Forex

What is Forex

February 1, 2019 0 By waxmurderer

The Quest Starts Here

 Hello, this is Wax Murderer. Before I start my first post, let me give you a bit of introduction of me, the name of the blog, and also the purpose of the blog. I know the name Wax Murderer sounds a bit scary, but it originally came from an RPG game called Dragon Quest. I used to be a big fan of JRPG, and Dragon Quest V is one of the first RPG I played on SNES. If you wonder how this monster looks like, it looks like below.

 

image courtesy of dragonquest.fandom.com

Not particularly a strong monster in the DQ series (HP 24, the weakest monster in the series Slime is with HP 8), but I thought it would be a perfect name to use with my forex journey. Since the usual chart type for forex is something called candlesticks. 🙂

I am currently working as a data analyst in a startup. But not in a financial company. Data I’m dealing with most of the time is transaction data, user data, website traffic data, and so on. So it’s fair to say I’m not very familiar with all the difficult concepts in finance. But I can also say that I’m quite familiar with the concept of hypothesis building, testing the hypothesis, slice and dice the data to find some meaningful information from it and a bit of statistics. Even though I’m not sure if these skills will help me in the forex trading.

 

About This Blog

There are many good websites and blogs that can teach you the basic concepts of forex, technical analysis, fundamental analysis, advice on trading strategies. The purpose of this blog is quite different from those sources. As a newbie in forex trading, I want to study forex step by step, and this blog is to reinforce my own learning. I will study and research concepts, terms in forex in my own way, and also share my trials and errors, but it is far from professional advice on trading.

One more thing I will also include in the scope of this blog is data analysis using a coding language called Python. Python is the language I’m most comfortable with, since I studied my data skills in Python, and also been using it at my work. I might start with something basic such as “retrieving price data of a currency pair”, and “visualising the price data with candlesticks”, but we’ll see how it evolves.

What is Forex anyway?

Forex is an abbreviated form of “foreign exchange”. But so far, foreign exchange to me was only about buying foreign currency before travel. By looking into what Forex trading is, I realised that there is a market where foreign currencies are traded like they are stocks. When I first saw the candlestick chart I was mesmerised. Because currency rate that I was used to was just a flat daily rate you can see when you go to a bank or a post office to buy foreign currency. However, the candlesticks in Forex trading is moving up and down each second or even shorter than second like it’s alive. That alone just blew my mind.

In forex trading, every instrument is shown as pairs. Above chart is for USD/JPY. The first currency appears in the pair name is called base currency, and the second one is called quote currency. For example, USD/JPY at the moment (31/01/2019 18:38GMT) is around 108.844, which means you need 108.890 Japanese Yen to buy 1 US Dollar.

What does “trading” mean in forex?

In forex trading, you can either “buy” or “sell” a currency pair. Let’s think of a currency pair as a commodity with a fluctuating price. This will definitely help to understand the concept of “buy” and “sell”.

Let’s say you entered with a buy order (also called long position) on USD/JPY at 108.844. In this case, you want the price to go up so that you can sell at a higher price than the price you bought. This difference becomes your profit. If you have entered with a sell order (also called short position) on the same pair at 108.844. Now you want the price to go down so that you can buy back at a lower price than you sold. If you are not familiar with the concept of short selling like me, it might sound a bit confusing. When I first read this. I thought “How can I sell something that I don’t even have?” What it means is you borrow the commodity that you not yet own, and sell it in the hope of its price going down. Let’s say the price that you sold it was 100 and has dropped after a while as you hoped to 90. Now you buy it at 90 from the market with the money that you got from the previous selling, and what do you do? You return the commodity that you have borrowed in the first place. Even after you returned what you have borrowed, you have a profit of 10, which is the price difference between the selling price and the buy-back price.

If you want to know more in detail about short selling, I found an informative page from Investopedia explaining the concept. The explanation is regarding stocks, but the same principle applies to any other asset or instrument.

Leverage? Margin?

In forex trading, a standard minimum trading unit is 100,000 units. If it’s USD, it means you need at least $100,000 to trade. That sounds like a huge sum. But don’t be sad yet, there are also mini forex trading accounts available, which enables you to trade with just 10% of the standard lots, which is $10,000. But that still sounds quite a lot, at least for me. Here’s where the leverage comes in.

Let’s say you open a forex account with a broker which offers you 1:100 leverage. You put $1,000 into your account. With this $1,000 armed with 1:100 leverage, you can trade as if you have $100,000 in your account. The concept of using borrowed money to trade, especially when the borrowed amount is much bigger than your affordable amount, might sound a bit scary. Because it sounds like you can lose more than you deposited in the first place.

But with the concept of margin, a broker won’t let you lose more than you deposited. Margin requirements can be either as same as your leverage or depending on a broker, they might have different margin requirements for different currency pairs. In the case of simple “leverage”=”margin requirement”, if the leverage is 1:100 that means you need at least 1% of the trading size that you want to enter. Let’s say you want to enter a position in USD/JPY with 10,000 units on 1:100 leverage. This means you need at least $100 to enter a position. If the market moved the opposite direction to your hope, and now your position becomes an unrealised loss. Usually, when this unrealised loss goes over a certain threshold, a broker will notify you with “margin call”, which means you have to either deposit more money to keep your position or close the position. Then a broker will automatically close your position, and normally they will do this even before your unrealised loss will use up all the amount in your account.

And on top of that, in my view, as long as you manage your stop losses, then the concept of leverage shouldn’t be that scary. I will try to write another post on “stop loss”.

Spread?

I briefly mentioned “broker” above. In order to participate in the forex market, you will need to do it through a broker. When I hear “broker”, I always think of a fee that I will have to give to them. All types of brokers in this world mostly work with either some fixed amount of fee or % commission. In forex trading, many brokers don’t take any fee. To be more precise, they take their charges in a slightly different form called “spread”.
 

From the above picture, you can see two different prices. One for “sell”, the other for “buy”. And there’s 0.014 difference between these two prices. The price you see on a candlestick chart is the middle of these two prices. With the example above, the price you’ll see on the chart will be 108.845. The way brokers make a profit is by deviating your entering position slightly in favour for them. For example, in the above case, when you want to enter as a sell position, the price you enter will be 108.838. On the other hand, when you enter as a buy position, the price will be 108.852. So even if you enter a position and clear it within a fraction of second, your trading will end up in loss because of this spread.

Pip?

A pip is the smallest measure of a currency pair. If we take another look at the “sell” and “buy” price from the above “Spread?” section, for example in “sell” price 108.838, if “sell” price goes down one pip, it will be 108.828. At this point, some of you might think “Wait, wait. isn’t the last decimal digit 8 should be the pip? Why ignoring this?”. The answer is the last digit in this particular broker’s case is a pipette. A pipette is equal to a tenth of a pip, and depending on brokers, some quote currency pairs down until pipette. Normally, they will make it distinguishable so that you can see it’s a pipette. In the above case, the pipette part is displayed in red.

In forex trading, you are betting on this minute change of a currency pair. It might not be much if you are trading just one unit, but with the leverage provided by your broker, you are betting a large sum and try to make profits on these minute changes.

 

Lots?

Depending on brokers, some will offer flexible trade unit size, which means you can trade from 1 unit. Some will offer a fixed trade size called lots. In the above “Leverage? Margin?” section, I briefly mentioned that minimum standard trade size is 100,000 units. This is the case of fixed trade size. There are also smaller lot sizes, such as mini lot (10,000 units), micro lot (1,000 units). When a broker offers nano lot, this basically means that they offer flexible trading size since one nano lot is equal to just one unit.

 

Thank you for reading. In this post, I have explored through some basic concepts of forex. By writing as a blog post, it really helped me to digest what I have read and researched. But as I have already said, I’m a newbie who just about to start his forex journey. That being said, if you find any mistake, or if you think it needs any correction, please do let me know by a comment to this post. Any advice will be appreciated. Or if you are a newbie like me, as a fellow newbie I’m more than happy to hear from you.

 

In the next post, I will look at forex trading profitability as a retail forex trader and a mindset that I want to build to be a successful trader.