Currency Trading For Dummies. Kathleen Brooks

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 of fundamental information hitting the market at any given time. Currency traders regularly apply various forms of technical analysis to define and refine their trading strategies, with many people trading based on technical indicators alone.

      Or something else may be a driving force

      We’re not trying to be funny here. Honest. What we are trying to do is get across the idea of the many cross-currents that are at play in the forex market at any given time. Earlier in this chapter, we note that currency trading is just one form of market speculation, and that speculative trading involves an inherent market dynamic (see the section “What Is Currency Trading?” earlier in this chapter).

      

Call it what you like — trader’s instinct, market psychology, sentiment, position adjustment, or more buyers than sellers. The reality is that the forex market is made up of hundreds of thousands of different traders, each with a different view of the market and each expressing their view by buying or selling different currencies at various times and price levels.

      That means that in addition to understanding the currency-specific fundamentals and familiarizing yourself with technical analysis, you also need to have an appreciation of the market dynamic (see Chapter 8). And that’s where trading with a plan comes in (see the following section).

Developing a Trading Plan

      If your email inbox is anything like ours, you probably get inundated with random penny-stock tips or the next great Chinese stock initial public offering (IPO). (If you’re not, please send us your spam filter.)

      Those are about the only times you’re going to get a message telling you how to trade. The rest of the time you’re going to be on your own. But isn’t that what speculative trading is all about, anyway?

      Don’t get us wrong; we’re not trying to scare you off. We’re just trying to make it clear