Currency Trading For Dummies. Kathleen Brooks

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on a daily basis. In Chapter 3, we look at who the major forex players are.)

      Few trading restrictions exist — no daily trading limits up or down, no restrictions on position sizes, and no requirements on selling a currency pair short. (We cover all the mechanics and conventions of currency trading in Chapter 4.)

      

Selling a currency pair short means you’re expecting the price to decline. Because of the way currencies are quoted and because currency rates move up and down all the time, going short is as common as going long.

      Most of the action takes place in the major currency pairs, which pit the U.S. dollar (USD) against the currencies of the Eurozone (the European countries that have adopted the euro as their currency), Japan, Great Britain, and Switzerland. There are also plenty of trading opportunities in the minor pairs, which see the U.S. dollar traded against the Canadian, Australian, and New Zealand dollars. On top of that, there’s cross-currency trading, which directly pits two non-USD currencies against each other, such as the Swiss franc against the Japanese yen. Altogether, there are anywhere from 15 to 20 different major currency pairs, depending on which forex brokerage you deal with. (See Chapters 5 and 7 for a look at the fundamental and market factors that affect the most widely traded currency pairs.)

      Most individual traders trade currencies via the internet — on a desktop, tablet, or even smartphone — through a brokerage firm. Online currency trading is typically done on a margin basis, which allows individual traders to trade in larger amounts by leveraging the amount of margin on deposit.

      One of the key features of the forex market is trading with leverage. The leverage, or margin trading ratios, can be very high, sometimes as much as 200:1 or greater, meaning a margin deposit of $1,000 could control a position size of $200,000. (Note: Margin rules can vary by country.) Trading on margin is the backdrop against which all your trading will take place. It has benefits, but it carries its own rules and requirements as well. Leverage is a two-edged sword, amplifying gains and losses equally, which makes risk management the key to any successful trading strategy.

Before you ever start trading in any market, make sure you’re only risking money that you can afford to lose, what’s commonly called risk capital. Risk management is the key to any successful trading plan. Without a risk-aware strategy, margin trading can be an extremely short-lived endeavor. With a proper risk plan in place, you stand a much better chance of surviving losing trades and making winning ones. (We incorporate risk management throughout this book, but especially in Chapters 11 and 18.)

      

Downturns don’t affect the forex market as they do other financial markets. Selling a currency pair is normal in the forex market. This is different from other markets — for example, stock markets, where retail investors rarely sell physical stocks due to the financial risks involved. Because selling is so common in the forex market, the forex market is fairly immune to downturns. You trade one currency against another, so something is always going up, even in times of financial crisis. (We talk more about risk on and risk off and what this means for currencies in Chapter 2.)

What Affects Currency Rates?

      In a word, information is what affects currency rates. Information is what drives every financial market, but the forex market has its own unique roster of information inputs. Many different cross-currents are at play in the currency market at any given moment. After all, the forex market is setting the value of one currency relative to another, so at the minimum, you’re looking at the themes affecting two major international economies. Add in half a dozen or more other national economies, and you’ve got a serious amount of information flowing through the market.

      Fundamentals drive the currency market

      Fundamentals are the broad grouping of news and information that reflects the macroeconomic and political fortunes of the countries whose currencies are traded. (We look at those inputs in depth in Chapters 7, 8, and 9.) Most of the time, when you hear people talking about the fundamentals of a currency, they’re referring to the economic fundamentals. Economic fundamentals are based on

       Economic data reports

       Interest rate levels

       Monetary policy

       International trade flows

       International investment flows

      There are also political and geopolitical fundamentals (see Chapter 7). An essential element of any currency’s value is the faith or confidence that the market places in the value of the currency. If political events, such as an election, a war, or a scandal, are seen to be undermining the confidence in a nation’s leadership, the value of the country’s currency may be negatively affected.

      

Gathering and interpreting all this information is just part of a currency trader’s daily routine, which is one reason why we put dedication at the top of our list of successful trader attributes (see the earlier section “Speculating as an enterprise”).

      But sometimes it’s the technicals that are driving the currency market

      The term technicals refers to technical analysis, a form of market analysis most commonly involving chart analysis, trend-line analysis, and mathematical studies of price behavior, such as momentum or moving averages, to mention just a couple.

      We don’t know of too many currency traders who don’t follow some form of technical analysis in their trading. Even the stereotypical seat-of-the-pants, trade-your-gut traders are likely to at least be aware of technical price levels identified by others. If you’ve been an active trader in other financial markets, chances are that you’ve engaged in some technical analysis or at least heard of it.

      

If you’re not aware of technical analysis but you want to trade actively, we strongly recommend that you familiarize yourself with some of its basics (see Chapter 6). Don’t be scared off by the name. Technical analysis is just a tool, like an electric saw — you don’t need to know the circuitry of the saw to know how to use it. But you do need to know how to use it properly to avoid injury.

      Technical analysis is especially important in the forex market because of the amount

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