Any aspiring trader at the beginning of his career has difficulty understanding how forex trading operations work or if it really works. These issues are at the heart of the problem – the wrong approach.
The main reasons why many of those who are trying to start a career trader in the end are disappointed, empty and downright bitter hands are false motivations, unrealistic goals, greed, lack of haste, lack of effort and inadequate knowledge base.
Before you start, relax and realize how much it is to know how Forex works.
Forex only refers to a chapter of a book multivolume encyclopedia that explains the financial markets.
Ask yourself the following questions:
¿What I know about the fundamentals of pricing for every asset in the world?
¿What is the underlying structure of the trading industry?
¿What is the nature of international economic interactions?
¿What are the main principles in the analysis of market fundamentalists and technical schools?
¿What are the psychological complexities of being a trader?
¿What really happens when a dealer presses a button?
Let’s start at the beginning.
First there was supply and demand
In business, supply and demand is a model that explains how prices are determined in a competitive market. The price of the goods is determined when the demanded quantity is offset by the consumer by the quantity supplied by the manufacturer.
Let’s say you buy food. You need apples and it happens that it’s just a vendor with the right amount of apples. You negotiate, you can agree the price and makes the purchase: a fixed amount of money for a fixed amount of apples. Congratulations! Both you and the seller carried out an exchange request. The next day you want to buy the same amount of apples, but now there are two suppliers with the amount of apples you need. This means there is a larger supply of apples and therefore required for them. Competition among suppliers will lower the price of apples because they realize that they are likely to buy apples that are at a lower price, assuming all other things are the same. A new price that allows you to choose the deal with the seller and will be satisfied by the existence of a free market that allows these apples to be cheaper to buy. If on that day you had gone with a friend also interested in buying apples, but it was just a seller, there had been an increased demand for apples supply. The seller would have realized this and has raised the price for his apples, knowing that you and your friend will definitely want to buy all the apples, even if they are not enough.
This is the ABC of business and is absolutely important to you as an emerging entrepreneur, understanding the simple logic of how this small apple market works because it will help you understand how currency trading works.
From now on things will be exponentially complicated.
If the apple market scenario applies to the foreign exchange market, when a particular currency is bought, the excess demand is created in the market and imbalances, the price increases. Similarly, if a particular currency is sold, an oversupply that creates the price imbalances and depreciates. The effect is directly proportional to the volume of operations per transaction. For example, big players such as national banks, can cause a major imbalance by manipulating the supply of the local currency. Smaller companies like retailers can only slightly influence the market, but still do it through their numbers.
What Forex Charts brand is the constant change of supply and demand for foreign exchange.
The key to understanding how operations work with Forex online is the philosophy behind the equilibrium price, since all economic events in the world are relevant to the market for its large impact on the supply and demand of an asset, or even worth mentioning how much influence the planned supply and demand of an asset.
Coming back to the example of our apple market, if one of the sellers of apples goes bankrupt this season, sure you and your friend can anticipate an increase in the prices of apples before they even come to market.
Draw a mind map of the industry not to be missed
How the forex market works can be better presented as an ocean in constant change. There are enough fish in this ocean, big and small, depending on their purchasing power. There are multimillionaire leviathans such as national banks, transnational corporations, hedge funds, etc. The biggest waves are caused by their monetary policy and commercial decisions that bring prices out of balance. There are medium sized fish – private investors, companies that need hedging, private banks, etc. There are smaller participants – financial intermediaries, smaller banks and smaller investors. Most of the above participants have direct access to the market (forex) interbank market, where all the magic foreign exchange happens – simply because they are beyond the limit of funds available, which means that they can trade with each other without the need of intermediaries.
The smallest participant, plankton financial sea, swim trying to grow long enough to survive long, is the retail forex trader – you. The purchasing power of an occasional trader usually so tiny compared to the big fish, you need a forex broker or bank to provide a trading account with financial leverage and market access through trading servers.
Understanding how the forex market works, as well as your own position on the scale of things, will promote the necessary caution when conducting sales transactions.
¿What does all this have to do with the authorities?
As you may have already realized, Forex is the foreign exchange market and, unlike most other tradable assets, they are instruments and economic indicators. If countries were corporations, the currencies would have been generally their actions.
The competent authorities for policy central banks of the formulation are the largest manipulators of the money supply, so that their monetary decisions are an important factor to influence the price of forex transactions and how they work.
The most obvious and simplest example would be the interest rates set by the National Bank of each country in the world with an interest rate. As the US dollar, euro, pound sterling and the Japanese yen are the currencies most traded in the world, is the Federal Reserve Bank, the European Central Bank, the Bank of England and the Bank of Japan or the largest fish in the ocean.
¿Understanding how this can affect the economy will help you understand how the forex market works?
If the National Bank raises the interest rate, it becomes more expensive for all fish to borrow money from the bank. For a moment, there is a contraction in the foreign currency supply and the price of the currency is getting stronger. What is good, right? Who would not want a strong national currency? Well, not really. In the short term, this means less money for business development, less spending on family budgets and, ultimately, a lower growth rate. Not so good. However, this involves the inflationary process and slows down the inevitable accumulation of debt. Which is very good in the long run.
Alternatively, if the interest rate is lowered, all fish borrow more money. For a moment, an offer of excess money is created and the price of the currency falls. In the short term, this means more business development, an increase in the family budget, and a growing economy. Does that sound really good? Well, not really. The more money you borrow, the more money you owe. Long-term bank credit piled up every once in a while as a big storm and once again, we’ve known a financial crisis on our hands as a macroeconomic cycle.
This summit is common to all capitalist economies. National banks are trying to balance the equilibrium continuously through periodic interest rate hikes or declines, which is called a microeconomic cycle. These business cycles are very similar to the cycles of climate change – slow, unstoppable and very dangerous for fish that did not anticipate.
¿How do trading transactions with Forex work? Analysis is the key
The analysis is not only key to success in the exchange of currencies, to a certain extent, the analysis is synonymous with transactions of sale, the only thing that makes Forex trading transactions really work.
The two main schools of market analysis are the Fundamental School and the Technical School.
Fundamentalist analysis is an evolved form of financial audit conducted at the country or, sometimes, the planet scale. This is the oldest way to forecast prices within an economy by reviewing: its current stage in the cycle, relevant events, prognosis and weighing the possible impact on the market.
The fundamentalist analysis takes charge of the Gross Domestic Product (GDP) of the country and the unemployment rate, interest rates and export volume, war, elections, natural disasters, economic advances and so on. The impact is weighted in terms of influence on supply and demand. For example, recent advances in bituminous shale oil drilling technologies promise a steady and increasing supply of oil, both now and in the near future, which caused oil prices after a decade to fall during the winter of 2014-15.
Fundamentalist analysis requires an understanding of the international economy, is responsible for factors still unknown by the market and works for investment and long-term trade.
The drawback in this type of analysis is the element of uncertainty that is generated.
The advantage of fundamentalist analysis is that when done correctly it predicts the fluctuation of the essential prices that can help generate profits over a prolonged period of time.
Technical analysis is a newer form of market analysis that only deals with two variables: time and price. Both are strictly quantifiable, explained by the market and are undeniable facts. This is why for many forex trading operations work better when instead of asking economic questions, the graphs are studied.
Whether you are looking for support and resistance, identifying key levels, applying technical indicators or comparing candlestick charts – you are thinking about how Forex online trading works without looking at the causes of supply and demand. The technical analysis can be used for long and short term transactions. It’s the only thing available to traders with a quick style like resellers, who make their profits from the infamous volatility of the daily currency instead of a trend tracking.
The strength of the technical approach is in analyzing quantifiable information with the same precision that the market has done, with a specific price at a specific time. The drawback is that it has already affected the market. To rely on the results of technical analysis, one must agree with the notion that price formation in the past may have had an effect on price formation in the future, which for many fundamentalists seems ridiculous.
Putting it simply, fundamentalist analysis is like an economic detective with elements of future prediction, while technical analysis is like a visual archeology of price-time combined with statistics.
Fortune favors the preparations
The main reason why many aspiring traders fail before they can understand how trading operations with Forex work, is the lack of preparation.
Numerous books have been written on the psychology of the trader, on how to avoid the obstacles that the mind puts on a trader. Again, again and again – the problem is how one embraces it without getting confused when everything is new.
Due to the nature of their business, often some Forex brokers, consider the forex market as an attraction of pseudoscientific bets that basically is like launching a currency that only has a better methodology, is more fun, has much more prestige and opportunity to make a lot of money quickly.
As a result of such advertising, beginners come with little or no training, hoping to make a fortune with $ 10 by making a few decisive clicks with the computer mouse. They enter the market full of hope and this one offended them and left them empty-handed. Most Forex traders lose money and their Broker business model fits that trend. This is neither good nor bad – this is the reason why the market exists. Every time someone closes with a profit, someone else has to close with a loss.
¿How do trading transactions with Forex work from a practical point of view?
The value of the currency is measured by how much you can buy from the other currency. This is called the quote of a currency. There are always two prices in a quote – buyer price (offer) and sale price (demand). The sale price is used in the purchase of a currency, while the buyer price is used when it is sold. Keep in mind that the sale price of any financial instrument is at all times higher than the buyer price. Therefore, a bank will always buy its currency a little cheaper and sell it a little more expensive. Banks can do that because they always have a space to negotiate greater than that of the trader. The difference between the buyer price and the sale price is called difference (between prices).
Participants in the market communicate at all times almost instantaneously both supply and demand prices, except when the market is closed. Through the internet, the trader receives quotes from the brokerage company that opened a purchase account for him. For its part, the brokerage company receives price quotes from its liquidity providers – the banks. In general terms, it is better for everyone when there is greater liquidity, because there is a greater narrowing in the difference between prices of supply and demand. In general, negotiation is ongoing, carried out smoothly and liquidity is abundant. However, there are times when there is a disparity in prices due to large price changes during short periods of time, such as when there are important press releases.
Everything else is simple technical details of Forex.
The transaction is carried out by just clicking on the computer mouse on the trading platform. For example, when a purchase order is placed in the currency pair EUR / USD, a part of the funds in the trader’s account is used to buy the base currency of the Euro pair and the secondary or quoted US dollar currency is sold. The broker does this and is called: placement of a purchase order, which is executed with the broker (market maker) or communicating directly to the interbank market (execution by electronic communications network), where large fish are found. It is important to understand that a trader can place in an order to sell a currency that he does not “own”.
Then, depending on the transaction strategy, the trader can wait until the value of the purchased currency grows with respect to the one that was sold. When the accumulated profit is satisfactory for the trader, he closes the order and the broker does the opposite operation of transactions: he sells euros and buys US dollars.
The reverse process occurs when the trader places a sales order.
At first, the concepts of buying and selling currencies can be confusing, since in each transaction one currency is exchanged for another, that is, a currency is always bought and sold. For a beginner trader it might be easier to think of a currency pair as an abstract financial instrument to which the market has assigned a price.
You have already been informed of the main driving forces of the market, its underlying structure in terms of its key participants, about the two main schools of market analysis and how online Forex trading transactions work from a point of view