All About Currency Markets

Forex markets or currency markets are big bosses of all financial markets and this story talks about commonly used terminology, trading types, types of orders, developing a disciplined trading plan, etc.

Image source: internationbanker.com

Currency markets, also called Forex markets, are the big boss of all financial markets and they are open round the clock, unlike stock markets that close in the evening every day. Each cross border transaction passes through Forex markets at some stage or the other. The average trading volume of Forex markets is around 2 trillion dollars, which is equivalent to 10 to 15 times of all the trading in all other markets(stocks, bonds, etc) combined.

Trading in currency markets

Trading in currency market always involves the purchase of one currency and sale of other currencies.
Currencies always come in pairs and common pairs have names associated with them. Some of the common currency pairs that are traded and their names are:
USD, GBP — Cable
AUD, USD — Aussie
NZ, USD — Kiwi
If the currency pair does not include the US dollar then they are called crosses. Most actively traded crosses focus on 3 major currencies i.e Euro, Yen, GBP.

Terminology

Some of the commonly used terms used in currency markets are:

Liquidity — It is the level of market interest or the buying and selling volume available at any given moment for a particular asset or security. This determines how quickly prices move between trades and over time.

Going Long/Long position — Market position in which you buy security and expect the prices to go up.

Going short — Market position in which you sell a security that you never owned.

Squaring/Flat — Having no position in the market. If you have an open position and you want to close it, it’s called squaring up.

PIP — The smallest increment of price fluctuation in currency prices, also referred to as points. PIP is one of the easiest ways to measure profit and loss.
Size of the position * PIPS = Profit & Loss.

Position — Amount of currency owned.

Bid Price — Price at which you sell the base currency.

Ask Price — Price at which you can buy the base currency.

Spread — Difference between the bid price and ask price.

Big figure — First three digits of overall currency price.

Dealing price — Last two digits of the overall currency price.

Trading Types

1. Short term high-frequency trading
2. Medium-term directional trading
3. Long term

Short term high-frequency trading

Short term trading times in some markets are less than an hour, typically in minutes, whereas in other markets, say stocks, usually last a day or several days. Extremely short term in & out trading is referred to as jobbing the marker or scalping. Rapid reaction and instantaneous decision making are essential to successfully job the market. It also requires an intuitive feel for the market.

Guidelines

1. Trade only mostly liquid currency pairs like EUR/USD, USD/JPY, EURO/YEN, etc. Most liquid currency pairs have tightest trading spreads and a fewer sudden jump in prices.
2. Only trade during the peak liquidity and market interest. Marker liquidity is deepest when European session, Asian session, and North American sessions overlap.
3. Focus only on one pair at a time. Doing this also improves the feel for the pair.
4. Look for brokerages that offer fast trading as trading times matter when you are operating at such a fast pace.
5. Adjust your risk and reward expectations.
6. Avoid trading during data release as trading is impacted based on data.

Medium-term directional trading

Trading times are usually between a few minutes to a few hours and not longer than a day. The key distinction between medium-term and short term is not the length of the time but the amount of PIP’s you are seeking or perhaps risking based on what you are buying or selling. Most traders fall into this category. It requires a broader perspective and greater analytical effort. Traders in this category seek to get the overall direction right and profit from more significant currency rate moves. This type of trading is also referred to as momentum/swing trading.

People in this category take many different approaches.

Approaches

1. Trading a view — Have a directional based opinion on which way the currency pair is likely to move. It is usually based on prevailing economic growth trends or inter-trade expectations.
2. Trade technicals — Base their outlook on chart patterns, trend lines, momentum studies.
3. Trade events, data — Base their positions on outcome of events like central bank rate decision, G7 meetings, or individual data reports.
4. Trade with the flow — Base their position on the overall market direction/trend or information about major buying or selling.

Long term

Traders trade based on macroeconomic data. People with deep pockets like hedge funds or institutions are mostly in this category. They hold positions for months or years.

Types of orders

It’s good to know the types of orders in currency markets before jumping into trading the currency markets.

1. Take profit order — This type of order is used to lock gains when you have open positions. These orders sell the position when a certain level of profit is reached.
2. Limit orders— This type of orders is used to buy positions at lower than the current market rate. These are triggered at a more favorable set level than the current market price.
3. Stop-loss order — This type of order is used to limit the losses. If the price of the position falls below the stop loss order, then the order is triggered and the position is sold to limit the losses.
4. Contingent order — Combining several types of orders.

Developing a disciplined trading plan

An organized approach to executing a trading strategy that you have developed based on market analysis or outlook that you have is called a trading plan. Discipline is a must-have in trading and without discipline, you are prone to suffer huge losses. The following are a few things to note when developing a disciplined trading plan.

1. Deciding on the position size.
2. Deciding when to enter the position.
3. Setting stop losses and taking profit levels. These define exactly where you will exit both in case of winning and losing.

Focus on PIP’s and not actual money.

Source

Introduction to Financial Markets by Indian School of Business on Coursera.
Instructor — Vaidya Nathan.