As an American coming into the FX market was a weird thing. At the time, stocks weren’t stonks and didn’t always go up. The FX market was unregulated and there was crazy amounts of leverage available, meaning the industry brought out all kinds of unsavory characters with plots and schemes. But, if you could see through the bullshit there was quite a considerable opportunity there, particularly for a young trader willing to take on a lot of risk in the search for an even larger reward.
Regulation then happened, and the unsavory characters began to move over to an asset class that’s much more difficult to regulate: Crypto. And while that remains the hot button today, it’s certain to face a similar fate of regulation and, eventually, volatility suppression.
But it’s worth mention up-front in an article about Forex when so many are thinking that cryptocurrencies will overtake the global financial system. There’s a key reason that they won’t which also happens to be one of the reasons for their bull case: Governments can’t print them. And to anyone with knowledge of macro-economics, a government’s ability to print money is pretty much the only thing that keeps them in power. So fiat is here to stay and when it isn’t, I hope you have a good bunker lined out somewhere.
FX is Simply the Trading of Currencies
And as long as there are nationalities, there will be differing currencies. The concept of supra-national currencies hasn’t worked out so well in Europe. So, likely, we won’t be seeing any additional monetary unification anytime soon. But this will produce exchange rate dynamics given the differing currencies and for speculators therein lies the opportunity.
Because currencies are the base of the financial system, there’s no other way to value a currency than by using another currency
That’s some inception like shit. But, it’s true, and this also means that everything that you trade in FX is going to be a fraction. Unfortunately most people hate math, including and perhaps especially traders. So this can create an aversion to the market simply because of the mathematical juxtaposition of its pricing structure. But, in reality, it’s a significant advantage to those looking to wield strategy. This simply means that every market available becomes that much more flexible. If you want to buy Apple stock or an ounce of Gold, the price is the price and there’s not much that you can do about it. But, if you want to buy the Euro or the US dollar, you’re not done yet – you still have another choice to make. You have to decide whether you want to buy the Euro with the British Pound or the US dollar or the Australian Dollar or the Japanese Yen. The list is endless, for about another 30 or so currencies that you can trade the Euro against.
Realistically, there are about nine major currencies that are followed by markets. Each of those currencies can be meshed up against another to create a currency pair and that will dictate how the market is traded.
The Forex Quote
All FX markets are traded in pairs, and the above widget shows how those cross rates can be created. In reality, there’s a handful of pairs that most traders will follow and learn very well. Currencies represented by larger economies generally have greater liquidity and by far the most popular currency pair is EUR/USD, which is called Euro-Dollar. The Euro is the currency of the European Union and the US dollar is the currency of the world’s largest national economy, the United States. This pair remains liquid throughout the day but when looking at the quote below, you may have some questions.
The value of one euro, in terms of us dollar is (EUR/USD)
That’s the simplest way to think of it. A quote is basically saying ‘the value of one X (first currency in quote), in terms of (second currency in quote), is:’.
Below, you’ll see that the value of one Euro at that moment in time was about One US dollar and Eighteen cents. The next two digits are fractions of a penny, known as a ‘pip,’ and in this quote, there are 19 of them out of a total possible 100. You can dismiss the vestigial number 3 at the end of the quote, that’s a fractional pip and by most accounts isn’t necessary. But, the easy way to think of the quoted price below is:
The value of one Euro, in terms of US dollars at that moment in time, is One US dollar, Eighteen cents, and 19-100th’s of a cent.
its all about the pips
The key takeaway from the above is the ‘pips’ portion. Pips simply stands for ‘percentage in point’ and as looked at above, there’s 100 pips in each penny of the EUR/USD quote. One pip is one percent of one cent in the FX quote.
Why All the decimals?
Because of the leverage, which we’ll get to in a moment. But, again, we’re not talking about some small cap stock here, we’re looking at the base denominator of western capitalism, so trading currencies is going to be treated differently than trading common stock. But, greater detail in pricing can allow for speculation on even smaller moves. Conceivably, the Euro should never be worth more than 2 US dollars per Euro. If that were to happen, western civilization would have some very real problems at hand. But, if you’re a speculator and the currency isn’t going to move more than a few cents, what’s the point?
leverage as velocity
Leverage has been the tool of legend since the beginning of time. Human beings are relatively small creatures with the luxury of intelligence: Leverage is the manifestation of that intelligence as it allows a small person to wield a big hammer, and there’s considerable leverage available in FX. Because currencies generally don’t move as much as an individual stock, brokers can extend up to 50x leverage on some currency pairs in the United States. This means that if you have a $2,000 account, you can trade up to $100k worth of positions at maximum leverage.
This can be dangerous, however! In this very rudimentary example, a mere 2% swing on your $100k position would wipe out your $2,000 – and in FX, margin calls are automatic, so that position would be sold without you having so much as a say and you’d be left with nothing.
Realistically, most brokers hold a minimum amount of margin to secure the position and the customer needs to have even more capital to open and maintain the position.
Flexibility is your friend
FX is perhaps most appealing to advanced traders due to the flexibility that’s available. Like having greater control over the way that you can voice a trade on the Euro versus Apple stock or an ounce of Gold, there’s also considerable leverage available, although this can be a very bad thing, particularly for the uninitiated. To become initiated, by the way, you have to blow up at least one account. And maybe more, but your mileage may vary.
In FX, those blowups often happen because of leverage. realistically, traders should look to keep leverage inside of 10x. But in FX, leverage is available up to 50x, which is a fairly high probability of a margin call, which means death to the account, more or less. Using a margin call as a stop is a stupid idea because prices can easily gap through those levels, creating a larger loss than anticipated.
Perhaps one of the biggest drivers for people to learn FX is the ability to speculate on Marco-economics. As the world continues to change and adapt, the FX market continues to be a manifestation how the world is continuing to adapt. And this can create considerable opportunity for the trader. Take, for instance, the ‘Abe-comics’ of Japan from 2012-2020, most prominently in the first three years of the campaign. Incoming Prime Minister, Shinzo Abe, led an economic revitalization plan based on Yen-weakness. This crated a swell throughout currency markets that saw USD/JPY lift by more than 50% over a three-year-span. And this was an unleveraged currency pair, a mere 10x leverage could make that a 500% move.
Technical analysis – An added benefit
This would probably be a personal favorite but one of the main reasons why FX continues to get the majority of my attention is the manner in which technical levels will work. FX is, by and large, mean reverting over the long run. Sure, trends will take over a currency or a pair and that can drive things for months or even years: But, by and large, prices are oscillating and this crates considerable opportunity for the speculator.
The main reason why this is such an attractive premise to me is a concept I teach called probability based trading. This is simply the admission that the future is uncertain, analysis is a mere idea generator and the most important tenet for the trader is cogent risk and trade management. Probability based trading is really a holistic approach and in a market like stocks, where such a persistent bias on the bid means that looking for short positions is akin to swimming upriver.
Swing trading, adherence to support and resistance, and the general mean reverting nature of FX all make it an attractive market to focus on and work with for the professional trader.