What is Currency Correlation?
Have you ever noticed that when a certain currency pair rises, another currency pair falls? Or how about when that same currency pair falls, another currency pair seems to copy it and falls also?
If the answer is “yes,” you’ve just witnessed currency correlation in action!
If you answered “no,” you need to stop doing less important things like sleeping, eating, playing FarmVille or Angry Birds, and instead spend more time watching charts.
But no worries because we’re going to start with the basics and break it down yo…
Currency. Correlation.
The first half… easy. Currency. No explanation needed.
The second half. Still easy. Correlation: a relationship between two things.
In the financial world, correlation is a statistical measure of how two securities move in relation to each other.
Currency correlation, then, tells us whether two currency pairs move in the same, opposite, or totally random direction, over some period of time.
When trading currencies, it’s important to remember that since currencies are traded in pairs, that no single currency pair is ever totally isolated. (Did we just confuse you with our “currencies” tongue-twister sentence there?)
Unless you plan on trading just one pair at a time, it’s crucial that you understand how different currency pairs move in relation to each other, especially if you’re not familiar with how currency correlations can affect the amount of risk you’re exposing your trading account to.
If you don’t know what the heck you’re doing when trading multiple pairs simultaneously in your trading account, you can get KILLED! Murdefied! Destroyed! We can’t stress this enough.
History of Retail FX
Now that you’ve graduated from the prestigious BabyPips.com School of Pipsology College, you’re probably itching to start your pippin’ adventures. But before you set off on your journey, you need one more thing… An actual account with a broker!
Of course we want you to work with the best so we decided to come up with this section that’ll help you choose the best forex broker there is! We’ll begin by revisiting the pages of history to find out how brokers came to life.
Name the best thing that the mighty powers of the Internet have brought us. YouTube, Facebook, Twitter, BabyPips.com… Yes, those are all awesome. But what we want talk about is the greatest gift to forex junkies like you and me:
Retail forex trading!
In fact, forex junkies probably wouldn’t exist if not for the birth of online forex brokers. You see, back in the 90s, it was much more difficult to participate in the forex market because of higher transactions costs. At that time, governments were like strict parents keeping a watchful eye on exchanges, restricting their activities.
After time, the CFTC decided that enough is enough. They passed a couple of bills, namely the Commodity Exchange Act and the Commodity Futures Modernization Act, and opened the doors for online forex brokers. Since almost everyone had access to the worldwide web, opening an account with a forex broker was simple and convenient.
Various forex brokers started popping up here and there, eager to take advantage of the booming forex industry. But now that there are many choices out there, it’s a little tougher to distinguish between the good brokers and the evil ones. We’re not kidding about the evil ones, which are also known as bucket shops, and we’ll delve into that a little later.
Forex Account Managers
on’t have time to learn how to trade forex? Want to be part of the Billionaire’s Club?
If you answered “yes” to these two questions, the Account Manager scam is the fraud for you!
You can call our hotline at 1-800-4XFRAUDS!
This scam operates by having an investor “invest” with a “professional” trader, who trades the investor’s capital for a percentage of the profits.
This can sound appealing, especially to beginners who have no idea what they are doing or don’t have the time to learn.
They figure, “Well, he’s a ‘professional’ – he must know what he’s doing! It’s 100 times better than if I traded by myself!”
The problem with this is that the user is placing complete trust of his/her money into the hands of a complete stranger.
In a way, it’s like taking candy from a baby.
In many cases of managed accounts, the manager actually appropriates funds towards unrelated luxury items such as cars, islands, and castles.
When finally caught, the manager is not able to pay back the whole amount of stolen capital resulting in unhappy clients and multi-million dollar lawsuits.
Yes, we know it seems extreme but, more often than not, it happens and people can lose their entire investment.
Not ALL account managers are bad though. Some do have many years of trading experience and are well-qualified in trading real money, but that’s more the exception than the norm.
Some trading platforms even offer an option to let traders act as managers using the account structure of the broker.
This prevents an individual from taking funds to spend on New York Knicks tickets, trips to the Bahamas, or a Porsche Cayenne.
Sir Scam-a-lot
While this is a safer option compared to letting an independent manager trade your money, you still lose out on the priceless knowledge and experience gained through studying forex trading.
If there is one thing we want to stress to traders, it is education. There is simply no replacement for experience gained through personal studying and trading. In the end, the only surefire way to be profitable in the forex market is to be knowledgeable, practice, and stay disciplined.
We’ll leave you with just one question.
Congratulations! You Made It!
You made it!
You’ve read all six gazillion pages of the School of Pipsology and now you have everything you need to conquer the forex world, retire in a year or two, and then go travel the world in your Gulfstream jet, right?
Think again noob!
Sorry to burst your bubble, but you have just barely scratched the surface.
We’re not going to sugarcoat things. We told you early on that it was going to be difficult.
If you’re a noob and just finished the School, you’re most likely going to be horrendously bad at trading.
But that’s okay. Unlike noodles, there’s no such thing as an instant expert trader. Anything that’s worth learning well takes time. That’s why instant noodles taste disgusting.
Going straight into the markets and trading a live account would be like trying out for the NBA just right after reading “Basketball for Dummies”.
You’d probably get out-smarted, out-hustled, out-muscled, and out-maneuvered. You just haven’t developed the skills or mental/physical conditioning enough to hang with the pros yet.
It’s the same thing in the markets.
The currency world is dynamic and complex. It is ruled by braniacs with PhDs and MBAs from Ivy League Schools, who have huge amounts of capital, and all the technological toys money can buy.
When you enter the forex trading world, you have be ready to dive in and wrestle with the biggest sharks. And they love feasting on noobs.
Are you scared now?
Good!
We just did that to make sure you understand that even though you’ve got to have fun in everything you do, forex trading is serious business and you have to approach it that way.
With all that said, anyone with the passion and commitment to learn this business has the chance to get their piece of the pie and then some.
Yes, you can make it, but before beginning your Forex trading adventure, here are a few lessons we’ve learned that we’d like to share to help you get started on the right path.
If you’ve ever traveled to another country, you usually had to find a currency exchange booth at the airport, and then exchange the money you have in your wallet (if you’re a dude) or purse (if you’re a lady) or man purse (if you’re a metrosexual) into the currency of the country you are visiting.
You go up to the counter and notice a screen displaying different exchange rates for different currencies. You find “Japanese yen” and think to yourself, “WOW! My one dollar is worth 100 yen?! And I have ten dollars! I’m going to be rich!!!” (This excitement is quickly killed when you stop by a shop in the airport afterwards to buy a can of soda and, all of a sudden, half your money is gone.)
When you do this, you’ve essentially participated in the forex market! You’ve exchanged one currency for another. Or in forex trading terms, assuming you’re an American visiting Japan, you’ve sold dollars and bought yen.
Before you fly back home, you stop by the currency exchange booth to exchange the yen that you miraculously have left over (Tokyo is expensive!) and notice the exchange rates have changed. It’s these changes in the exchanges rates that allow you to make money in the foreign exchange market.
The foreign exchange market, which is usually known as “forex” or “FX,” is the largest financial market in the world. Compared to the measly $74 billion a day volume of the New York Stock Exchange, the foreign exchange market looks absolutely ginormous with its $4 TRILLION a day trade volume. Forex rocks our socks!
Let’s take a moment to put this into perspective using monsters…
The largest stock market in the world, the New York Stock Exchange (NYSE), trades a volume of about $74 billion each day. If we used a monster to represent NYSE, it would look like this…
You hear about the NYSE in the news every day… on CNBC… on Bloomberg…on BBC… heck, you even probably hear about it at your local gym. “The NYSE is up today, blah, blah”. When people talk about the “market”, they usually mean the stock market. So the NYSE sounds big, it’s loud and likes to make a lot of noise.
But if you actually compare it to the foreign exchange market, it would look like this..
Oooh, the NYSE looks so puny compared to forex! It doesn’t stand a chance!
Check out the graph of the average daily trading volume for the forex market, New York Stock Exchange, Tokyo Stock Exchange, and London Stock Exchange:
The currency market is over 53 times BIGGER! It is HUGE! But hold your horses, there’s a catch!
That huge $4 trillion number covers the entire global foreign exchange market, BUT retail traders (that’s us) trade the spot market and that’s about $1.49 trillion. So you see, the forex market is definitely huge, but not as huge as the media would like you to believe.
Do you feel like you already know what the forex market is all about? We’re just getting started! In the next section we’ll reveal WHAT exactly is traded in the forex market.
Advantages of Forex
There are many benefits and advantages of trading forex. Here are just a few reasons why so many people are choosing this market:
No commissions
No clearing fees, no exchange fees, no government fees, no brokerage fees. Most retail brokers are compensated for their services through something called the “bid-ask spread”.
No middlemen
Spot currency trading eliminates the middlemen and allows you to trade directly with the market responsible for the pricing on a particular currency pair.
No fixed lot size
In the futures markets, lot or contract sizes are determined by the exchanges. A standard-size contract for silver futures is 5,000 ounces. In spot forex, you determine your own lot, or position size. This allows traders to participate with accounts as small as $25 (although we’ll explain later why a $25 account is a bad idea).
Low transaction costs
The retail transaction cost (the bid/ask spread) is typically less than 0.1% under normal market conditions. At larger dealers, the spread could be as low as 0.07%. Of course this depends on your leverage and all will be explained later.
A 24-hour market
There is no waiting for the opening bell. From the Monday morning opening in Australia to the afternoon close in New York, the forex market never sleeps. This is awesome for those who want to trade on a part-time basis, because you can choose when you want to trade: morning, noon, night, during breakfast, or in your sleep.
No one can corner the market
The foreign exchange market is so huge and has so many participants that no single entity (not even a central bank or the mighty Chuck Norris himself) can control the market price for an extended period of time.
Leverage
In forex trading, a small deposit can control a much larger total contract value. Leverage gives the trader the ability to make nice profits, and at the same time keep risk capital to a minimum.
For example, a forex broker may offer 50-to-1 leverage, which means that a $50 dollar margin deposit would enable a trader to buy or sell $2,500 worth of currencies. Similarly, with $500 dollars, one could trade with $25,000 dollars and so on. While this is all gravy, let’s remember that leverage is a double-edged sword. Without proper risk management, this high degree of leverage can lead to large losses as well as gains.
High Liquidity.
Because the forex market is so enormous, it is also extremely liquid. This means that under normal market conditions, with a click of a mouse you can instantaneously buy and sell at will as there will usually be someone in the market willing to take the other side of your trade. You are never “stuck” in a trade. You can even set your online trading platform to automatically close your position once your desired profit level (a limit order) has been reached, and/or close a trade if a trade is going against you (a stop loss order).
Low Barriers to Entry
You would think that getting started as a currency trader would cost a ton of money. The fact is, when compared to trading stocks, options or futures, it doesn’t. Online forex brokers offer “mini” and “micro” trading accounts, some with a minimum account deposit of $25.
We’re not saying you should open an account with the bare minimum, but it does make forex trading much more accessible to the average individual who doesn’t have a lot of start-up trading capital.
Free Stuff Everywhere!
Most online forex brokers offer “demo” accounts to practice trading and build your skills, along with real-time forex news and charting services.
And guess what?! They’re all free!
Demo accounts are very valuable resources for those who are “financially hampered” and would like to hone their trading skills with “play money” before opening a live trading account and risking real money.
Now that you know the advantages of the forex market, see how it compares with the stock market!
Forex Market Structure
For the sake of comparison, let us first examine a market that you are probably very familiar with: the stock market. This is how the structure of the stock market looks like:
By its very nature, the stock market tends to be very monopolistic. There is only one entity, one specialist that controls prices. All trades must go through this specialist. Because of this, prices can easily be altered to benefit the specialist, and not traders.
How does this happen?
In the stock market, the specialist is forced to fulfill the order of its clients. Now, let’s say the number of sellers suddenly exceed the number of buyers. The specialist, which is forced to fulfill the order of its clients, the sellers in this case, is left with a bunch of stock that he cannot sell-off to the buyer side.
In order to prevent this from happening, the specialist will simply widen the spread or increase the transaction cost to prevent sellers from entering the market. In other words, the specialists can manipulate the quotes it is offering to accommodate its needs.
Trading Spot FX is Decentralized
Unlike in trading stocks or futures, you don’t need to go through a centralized exchange like the New York Stock Exchange with just one price. In the forex market, there is no single price that for a given currency at any time, which means quotes from different currency dealers vary.
This might be overwhelming at first, but this is what makes the forex market so freakin’ awesome! The market is so huge and the competition between dealers is so fierce that you get the best deal almost every single time. And tell me, who does not want that?
Also, one cool thing about forex trading is that you can do it anywhere. It’s just like trading baseball cards. You want that mint condition Mickey Mantle rookie card, so it is up to you to find the best deal out there. Your colleague might give up his Mickey Mantle card for just a Babe Ruth card, but your best friend will only part with his Mickey Mantle rookie card for your soul.
The FX Ladder
Even though the forex market is decentralized, it isn’t pure and utter chaos! The participants in the FX market can be organized into a ladder. To better understand what we mean, here is a neat illustration:
At the very top of the forex market ladder is the interbank market. Composed of the largest banks of the world and some smaller banks, the participants of this market trade directly with each other or electronically through the Electronic Brokering Services (EBS) or the Reuters Dealing 3000-Spot Matching.
The competition between the two companies – the EBS and the Reuters Dealing 3000-Spot Matching – is similar to Coke and Pepsi. They are in constant battle for clients and continually try to one-up each other for market share. While both companies offer most currency pairs, some currency pairs are more liquid on one than the other.
For the EBS plaform, EUR/USD, USD/JPY, EUR/JPY, EUR/CHF, and USD/CHF are more liquid. Meanwhile, for the Reuters platform, GBP/USD, EUR/GBP, USD/CAD, AUD/USD, and NZD/USD are more liquid.
All the banks that are part of the interbank market can see the rates that each other is offering, but this doesn’t necessarily mean that anyone can make deals at those prices.
Like in real life, the rates will largely dependent on the established CREDIT relationship between the trading parties. Just to name a few, there’s the “B.F.F. rate,” the “customer rate,” and the “ex-wife-you-took-everything rate.” It’s like asking for a loan at your local bank. The better your credit standing and reputation with them, the better the interest rates and the larger loan you can avail.
Next on the ladder are the hedge funds, corporations, retail market makers, and retail ECNs. Since these institutions do not have tight credit relationships with the participants of the interbank market, they have to do their transactions via commercial banks. This means that their rates are slightly higher and more expensive than those who are part of the interbank market.
At the very bottom of the ladder are the retail traders. It used to be very hard for us little people to engage in the forex market but, thanks to the advent of the internet, electronic trading, and retail brokers, the difficult barriers to entry in forex trading have all been taken down. This gave us the chance to play with those high up the ladder and poke them with a very long and cheap stick.
Now that you know the forex market structure, let’s get to know them forex market playaz!
Trading Sessions
Now that you know what forex is, why you should trade it, and who makes up the forex market, it’s about time you learned when you can trade.
Yes, it is true that the forex market is open 24 hours a day, but that doesn’t mean it’s always active the whole day.
You can make money trading when the market moves up, and you can even make money when the market moves down.
BUT you will have a very difficult time trying to make money when the market doesn’t move at all.
And believe us, there will be times when the market is as still as the victims of Medusa. This lesson will help determine when the best times of the day are to trade.
Before looking at the best times to trade, we must look at what a 24-hour day in the forex world looks like.
The forex market can be broken up into four major trading sessions: the Sydney session, the Tokyo session, the London session, and Pipcrawler’s favorite time to trade, the New York session. Below are tables of the open and close times for each session:
You can see that in between each session, there is a period of time where two sessions are open at the same time. From 3:00-4:00 am EDT, the Tokyo session and London session overlap, and from 8:00 am-12:00 pm EDT, the London session and the New York session overlap.
Naturally, these are the busiest times during the trading day because there is more volume when two markets are open at the same time. This makes sense because during those times, all the market participants are wheelin’ and dealin’, which means that more money is transferring hands.
Now, you’re probably looking at the Sydney open and thinking why it shifts two hours. You’d think that Sydney’s open would only move one hour when the U.S. adjusts for standard time, but remember that when the U.S. shifts one hour back, Sydney actually moves forward by one hour (seasons are opposite in Australia). You should always remember this if you ever plan to trade during that time period.
Let’s take a look at the average pip movement of the major currency pairs during each trading session.
From the table, you will see that the European session normally provides the most movement.
Let’s take a more in depth look at each of the session, as well as those periods when the sessions overlap.
In the forex market, you buy or sell currencies.
Placing a trade in the foreign exchange market is simple: the mechanics of a trade are very similar to those found in other markets (like the stock market), so if you have any experience in trading, you should be able to pick it up pretty quickly.
The object of forex trading is to exchange one currency for another in the expectation that the price will change, so that the currency you bought will increase in value compared to the one you sold.
An exchange rate is simply the ratio of one currency valued against another currency. For example, the USD/CHF exchange rate indicates how many U.S. dollars can purchase one Swiss franc, or how many Swiss francs you need to buy one U.S. dollar.
How to Read a Forex Quote
Currencies are always quoted in pairs, such as GBP/USD or USD/JPY. The reason they are quoted in pairs is because in every foreign exchange transaction, you are simultaneously buying one currency and selling another. Here is an example of a foreign exchange rate for the British pound versus the U.S. dollar:
The first listed currency to the left of the slash (“/”) is known as the base currency (in this example, the British pound), while the second one on the right is called the counter or quote currency (in this example, the U.S. dollar).
When buying, the exchange rate tells you how much you have to pay in units of the quote currency to buy one unit of the base currency. In the example above, you have to pay 1.51258 U.S. dollars to buy 1 British pound.
When selling, the exchange rate tells you how many units of the quote currency you get for selling one unit of the base currency. In the example above, you will receive 1.51258 U.S. dollars when you sell 1 British pound.
The base currency is the “basis” for the buy or the sell. If you buy EUR/USD this simply means that you are buying the base currency and simultaneously selling the quote currency. In caveman talk, “buy EUR, sell USD.”
You would buy the pair if you believe the base currency will appreciate (gain value) relative to the quote currency. You would sell the pair if you think the base currency will depreciate (lose value) relative to the quote currency.
Long/Short
First, you should determine whether you want to buy or sell.
If you want to buy (which actually means buy the base currency and sell the quote currency), you want the base currency to rise in value and then you would sell it back at a higher price. In trader’s talk, this is called “going long” or taking a “long position.” Just remember: long = buy.
If you want to sell (which actually means sell the base currency and buy the quote currency), you want the base currency to fall in value and then you would buy it back at a lower price. This is called “going short” or taking a “short position”. Just remember: short = sell.
Bid/Ask
All forex quotes are quoted with two prices: the bid and ask. For the most part, the bid is lower than the ask price.
The bid is the price at which your broker is willing to buy the base currency in exchange for the quote currency. This means the bid is the best available price at which you (the trader) will sell to the market.
The ask is the price at which your broker will sell the base currency in exchange for the quote currency. This means the ask price is the best available price at which you will buy from the market. Another word for ask is the offer price.
The difference between the bid and the ask price is popularly known as the spread.
On the EUR/USD quote above, the bid price is 1.34568 and the ask price is 1.34588. Look at how this broker makes it so easy for you to trade away your money.
If you want to sell EUR, you click “Sell” and you will sell euros at 1.34568. If you want to buy EUR, you click “Buy” and you will buy euros at 1.34588.
Let us start with the definition of scalping and pipsing. These trading strategies are employed by forex traders for taking profit from intraday price oscillations occurring on the currency market. As a rule, deals remain opened during only several minutes. One position will not bring much profit but these strategies require a huge number of deals.
A scalper or a pipser can execute about two hundred deals per day. However, no all deals are profitable. The result for a trader is positive summary of deals by the end of a trading day. The stop-loss level set as close to the opening price as possible enables a trader to achieve the positive result. Stop-loss is necessary for minimizing the risks in case a price moves in the opposite direction.
It is well-known that Forex is the market with the highest liquidity. During the day a price is moving up or down in a certain period of time according to the cycle. If the price passes about 60 pips during the day the difference between high and low points will be much more. Chances of getting profit increase if to trade on the hourly price oscillations. It is the main reason why so many traders decided to employ such trading strategies as scalping or pipsing.
Newbies may think that scalping or pipsing allows earning huge amount of money and the opportunity of reinvesting may turn it to the enormous sums. However, it is not that simple. There are several disadvantages of such trading methods. They are:
• Setting the stop-loss level close to the opening price increases the risk of losses even during the insignificant price oscillations. Even if you succeeded to predict further direction of the price movement the possibility of losses are still very high if you incorrectly evaluate the back bullish or bearish force on the market. It is much easier to make a mistake determining the price movement direction for a short period of time (one-two hours) than for the whole day.
• The decision can be the absence of order but in this case a trader has a risk to lose even more money after the unfavorable price movement when it goes so far that the pullback is impossible in the nearest future.
• Emotional excitement and nervousness possessed by most traders who work with real money. As a rule all traders start on demo account because it allows testing the strategy with the virtual money. Consequently, trading on real account causes anxiety which is strengthening with every pip in case the market moves in the unfavorable direction.
In general, scalping and pipsing are for experienced traders. Short-term trading as scalping or pipsing implies interruptive work in front of the screen which increases the risk of stress and leads to the inconsiderate acts.
There is also one more evident disadvantage for traders – brokers do not like those who accomplish the great number of deals daily. Traders who open deals almost every second are asked to close their accounts or imposed the limits.