Lesson #1 - Forex Basics
What is Forex?
Forex is short for "foreign exchange", and is also known as "currency exchange", "currency trading", "forex trading" and, for short, "fx".
Generally speaking, forex trading is a speculative form of trading where traders look to get "long" or "buy" a currency pair (if they expect the exchange rate to go up), or to get "short" or "sell" a currency pair (if they expect the exchange rate to go down). These are the basics.
Is Trading Forex Risky?
Yes, and you need to understand what those risks are before you even get started. Like any form of trading, forex is as risky as you make it. For example, you can trade a free demo account to “get your feet wet” which carries no risk except time. Too often, though, new traders start off trading with a very high amount of leverage, trade with real money right away, and very quickly wipe out their equity before they have any clue what they are doing.
What is “leverage”?
Leverage is the amount of borrowed capitol that your broker lends you for each trade. In Forex trading the exchange rate changes are so small, for example the EURUSD might move from 1.3010 to 1.3015. That is a change of 0.005 or 5 pips. Without leverage then that difference is less than half a cent – hardly a big win or loss. With leverage that 0.005 exchange rate change can be turned into 5 cents, 50 cents, 5 dollars, 50 dollars, depending on the amount of leverage you use.
How much leverage should I use?
If you are asking this question then the answer is “none” – you should be trading on a demo account where you can’t hurt yourself or your equity. In general, the more leverage you use the riskier your trades are as you stand to lose more.
New traders who want to “get rich quick” often start with way too much leverage and get poor even quicker.
Ok, I understand trading forex is risky. How do I get started?
You should get started with a demo account first. On a demo account you can get the feel for buying and selling currencies without actually risking any of your hard-earned money. To find a demo account you need to find a broker.
What is a broker?
A broker is the middle-man between you and the banks that you are buying and selling the currencies from. The broker is also who provides your leverage, so choosing a reputable broker who you can trust is important.
We don't have any connections with brokers, but in general a broker that is heavily regulated (US or UK based-brokers are generally heavily regulated) is your best bet as they are required to adhere to certain transparency rules and to have certain levels of cash reserves. Also a broker with a “no trading desk” policy is favored by us so that we have a reasonable amount of confidence that our broker isn't actively trading against us.
How do I find a broker?
Head to Google and start doing your research. Make sure to read the actual broker’s site and to check their regulatory status – don’t just trust some random third party site (even us) to do your broker research for you. There are too many websites out there that just recommend brokers based on how much that particular broker is paying them to recommend them, if that makes sense.
Also make sure to use the demo accounts for several brokers to see which trading platform you like the best.
What is a “trading platform”?
A trading platform is the software that you use to do the actual buying and selling of the currencies. If you think about buying a new car, then the trading platform would be the actual car you are buying, the dealership where you bought the car is the broker and the manufacturer of the car would be the banks.
To find out which trading platform you like the best just get a demo account for each one. A broker that doesn’t offer you a demo account is probably not that great of a broker, as a blanket rule. Common trading platforms are Trading Station, MetaTrader, and Ninja Trader but there are a lot more than just those three. Again, do your homework and decide for yourself.
Also, just like buying a new car, in every step of that process there is a markup along the way for each middle man. In forex, the markup is called the “spread” or the “commission”. Spreads can range from a few pips for the major pairs (where beginners should be starting) to a lot larger spreads for “exotic” pairs (relatively low volume pairs that as a beginner you should ignore for now).
Ok, I have a broker. What now?
Demo, demo, demo! Now you need to keep trading a demo account until you are consistently profitable on that demo account. There is no rush here, no need to start risking all of your hard-earned equity trading live money right away. Hope is not a strategy.
How do I get a consistently profitable strategy?
Whoa, you are jumping the gun here. Can you tell me what the best timeframe to trade is? When the best time of day to trade is, for each pair? How to identify trends? The correlation between different currencies and commodities?
Remember: you are now swimming with sharks. The markets want your money, and they know a lot more than you. You wouldn’t show up to a pool hall with a wad of cash and just start wagering you could beat everyone there would you? Of course not – you’d be out of money before your drinks arrived. Don’t be fooled just because you can’t see your competition, they are out there and waiting for you, and they don’t care if you are rich oil tycoon or a single mother of three.
Ok then, how can I educate myself to become a better trader?
Now you are asking the right questions. The goal of this tutorial was to get you up and going and then to scare you into only trading with fake money for now. Your goal for the learning process is simple: survive.
What is a successful trading system?
Every trader’s goals and situation is different, and this means you must define “success” based on upon your situation. Some traders are able to sit in front of their computer and trade all day. Some might only have a few hours a day. Some might have even less. Some traders need lots of sleep. Other traders don’t mind waking up every hour to check their trades. Some traders have a lot of starting money. Some have very little.
All of these factors will play into what kind of system works for you, and will define the range and scope of your goals. Too many new traders go into trading with the goal of getting rich quick. As we often say, getting rich quick is not a realistic strategy. The only thing you will achieve with that mindset is getting poor quick.
Your goals must be realistic, and a realistic goal for you before you start live trading is to be able to consistently make and retain profit. Only when you are able to successfully make and retain profit on a demo account should you move to a live account with small leverage. And then only when you make and retain profit on a small live account should you even consider increasing your leverage.
Here are some important tips to remember when you are developing a trading strategy that works for you:
Approach Strategy Creation like a Scientist
Scientists come up with a hypothesis and then they test, test, test. After they are done testing they review the results. They try their best to identify the flaws in their own experiments. And then they test some more.
You need to do the same thing. You start with a hypothesis. Lets keep this first one simple, and say that you believe the EURUSD will go down if the RSI is above 70 on the 4h charts. That is your hypothesis. Now you need to test that. You have two options: backtesting and forward testing. Backtesting involves looking backward over the past times that the RSI was over 70 and see what happened. It is not enough to simply look back and say “oh yeah, I could have entered here.” Imagine if scientists just looked at some old data and said “oh yeah, this hypothesis probably would have worked.”
No, you must set specific guidelines for your trades: for example, when RSI goes above 70 I will enter short with a TP of 100 and a SL of 50. Now test every single time this trade would have been triggered, stick to your rules and tabulate your results without bias.
Start with Backtesting
The fastest way to do this is programmatically, in a trading platform like MetaTrader or Ninja Trader. You will have to learn some programming (C language, mostly), which does involve a learning curve, but once you are able to quickly code and backtest your own strategies that programming knowledge will pay for itself in spades. There are sites out there, such as eLance, where you can hire a trading programmer. The upside to doing that is that you don’t have to learn a programming language. The BIG downside is you have to pay a programmer upfront and then for every little change you make.
My recommendation: take the time, do it right, and learn a programming language such as MetaQuotes (which is what MetaTrader uses).
After you have found a strategy that performs well in backtesting, it is time to forward test the strategy in your demo account.
Then Test Some More
Just because a strategy performs well in backtesting does not mean that it will perform well in forward testing. In fact, past results are never indicative of future results, but that is a discussion for another time.
Begin testing your strategy in real time, in your demo account, and follow the exact same rules you followed in your backtesting. If the strategy performed well in backtesting and performed well in forward testing then that is about as good as it is going to get.
- ATR (Average True Range)
- Breakout Trade
- Consolidation Pattern
- Crosses (Cross Pairs)
- Interest Rate
- ECB (European Central Bank)
- Entry Order
- Event Risk
- Fed (Federal Reserve)
- Fundamental Analysis
- Lagging Indicators
- Long Squeeze
- Leading Indicators
- Rally (or rallies)
- RSI or Relative Strength Index
- Short Squeeze
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1. Question1 points
Forex is a speculative, risky form of investment!Incorrect
Forex is a speculative, risky form of investment!
2. Question1 points
“Forex” is short for what?Correct
3. Question1 points
Complete this sentence: “Never trade with money ______.”Correct
Forex is a leveraged, speculative form of investment, meaning you can make lots of money OR lose lots of money. Most new traders unknowingly start off with the riskiest strategies they can find because they show the biggest rewards, but those ultra-risky strategies are just as likely to lose as win. So if you need your money for something (your health, your family, etc.) then you should be using it for any investment like forex. Talk to a financial advisor and determine what the best course of investment is for you.Incorrect
Forex is a leveraged, speculative form of investment, meaning you can make lots of money OR lose lots of money. Most new traders unknowingly start off with the riskiest strategies they can find because they show the biggest rewards, but those ultra-risky strategies are just as likely to lose as win. So if you need your money for something (your health, your family, etc.) then you should be using it for any investment like forex. Talk to a financial advisor and determine what the best course of investment is for you.
4. Question1 points
What is leverage?Correct
5. Question1 points
Why is leverage both good and bad?Correct
6. Question1 points
Trading a demo account is _____.Correct
Demo trading does differ from live trading, but when it comes to learning and practicing your strategies a demo account is your best friend.Incorrect
Demo trading does differ from live trading, but when it comes to learning and practicing your strategies a demo account is your best friend.
7. Question1 points
What is a broker?Correct
For most beginning traders brokers will be the middle man between you and the market makers, and they will provide you with your trading platform.Incorrect
For most beginning traders brokers will be the middle man between you and the market makers, and they will provide you with your trading platform.
8. Question1 points
You want your broker to be strictly regulated by a government because:Correct
Sufficient regulation can help ensure your broker has enough working capital to survive large market moves, as well as provide you some recourse against any potential broker abuse.Incorrect
Sufficient regulation can help ensure your broker has enough working capital to survive large market moves, as well as provide you some recourse against any potential broker abuse.
9. Question1 points
Which of these answers best describes a successful trading system?Correct
If you have a strategy and you are ahead of 50% of new traders. Have a strategy that profits and you are ahead of 75% of new traders. Have a strategy that makes and retains profits over the long-term and you are ahead of 95% of new traders.Incorrect
If you have a strategy and you are ahead of 50% of new traders. Have a strategy that profits and you are ahead of 75% of new traders. Have a strategy that makes and retains profits over the long-term and you are ahead of 95% of new traders.
10. Question1 points
Complete this sentence: If you try and get rich quick, ______________.Correct
You wouldn’t start playing basketball and bet all your money you’d be one of the elite basketball players in the world in a couple months, would you? Of course not. You can succeed at forex, but you have to smart about it, and be realistic about your goals.Incorrect
You wouldn’t start playing basketball and bet all your money you’d be one of the elite basketball players in the world in a couple months, would you? Of course not. You can succeed at forex, but you have to smart about it, and be realistic about your goals.
11. Question1 points
You should trade on a demo account until:Correct
Trading on a demo account allows you to hone your trading skills and strategy in a risk-free environment, as well as giving you some valuable practice on your trading platform.Incorrect
Trading on a demo account allows you to hone your trading skills and strategy in a risk-free environment, as well as giving you some valuable practice on your trading platform.
12. Question1 points
Approach trading strategy creation like a _________.Correct
Test, test, and then test some more.Incorrect
Test, test, and then test some more.
13. Question1 points
Complete this sentence: Backtesting __________.Correct
14. Question8 points
Drag the terms to the matching description below!
- Breakout Trade
- interest rate
Correct 8 / 8PointsIncorrect / 8 Points
Using this volatility gauge can help traders set stop-losses that won't get "whipped out" by market zig-zags.
The type of trading that SwingPRO relies on.
A chart-type that shows the high/low/open/close (HLOC) of any timeframe.
a trending price range
The part of the trading strategy used to filter out low-probability setups
When the exchange rate drops
When the exchange rate rises
Fundamental event that that can direct the exchange rate, months in advance.
15. Question7 points
Drag the terms to the matching description below!
- a "pip"
- short squeeze
- long squeeze
- event risk
- consolidation pattern
Correct 7 / 7PointsIncorrect / 7 Points
Price "bounces" up and down in this, between support and resistance
A very small measure of change in the forex markets
Technical indicators that some traders use to determine whether a pair is "overbought" or "oversold"
When price rallies faster and faster as short positions are stopped out before moving back down.
When price dips faster and faster as long positions are stopped out before moving back up.
Market-moving fundamental events. Some technical traders avoid these markets to avoid getting "whipped" out.
When price volatility tightens after a large move as the market searches for new direction.