Welcome to FX trading in Kenya! Before you start trading currencies, here are some basics you should know.
The Basics of Foreign Exchange
This article explains the basics of foreign exchange (also known as “Forex”). After reading this article, you’ll know how the Forex market works and how to make money by trading currencies.
The Foreign Exchange Market
The foreign exchange market is one of the most dynamic financial markets in the world. It is better than the stock market in terms of size and volatility. At the time of writing, this market handles roughly $5 trillion worth of transactions on a daily basis.
If you’ve traveled overseas before, you’ll think of “foreign exchange” as the money of the country you are visiting. You acquire their currency so you’ll be able to pay for your expenses while in that country. If you are going to Japan, for example, you’ll need to sell dollars and purchase yen. Here, you’ll get the yen so you can buy stuff in Japan.
But the Forex market works differently. As a Forex trader, you won’t receive the actual currency. Instead, the results of your trades will show up numbers in your trading account. The said account will also display your “open positions” (i.e. the currency pairs that you still own).
Because this market is 0ver-the-counter, people can make trades without the help of an exchange. Thus, you may sell and purchase currencies regardless of your location. All you need is internet connection.
The Market’s Different Characteristics
Here are the main characteristics of the foreign exchange market:
You can access your trading account online. Many brokers offer multi platform support – they let you use computers, laptops, cellphones, and tablets when trading. In addition, you can begin trading currencies without depositing a large amount of money.
- Funding Sources
Forex brokers allow their clients to transfer money from checking accounts, credit cards, and debit cards. Some brokers even accept online payment processors such as PayPal for deposits and withdrawals.
This market has high liquidity because currencies are traded worldwide. And the main benefit of liquidity is that it allows you to find sellers and/or buyers easily. In less liquid markets, it is usually difficult to acquire or liquidate assets.
Leverage means borrowing funds to facilitate transactions that require a large capital. You can use leverage to fund trades you think are going to be profitable. In the stock market, the leverage is usually 1:2. In the Forex market, on the other hand, you can get 1:100 or higher. Basically, the profits you can gain from Forex is much larger than that from stocks. Note, however, that leverage utilization can backfire. If you lose money on the trade, you’ll have to pay the funds you borrowed from your broker.
- Profit Opportunities
The Forex market usually makes real-time responses to world events. If there are news about war or political conflicts, for example, expect noticeable changes in the market. Although it is true that such changes usually come with serious risks, you should keep your eyes open for opportunities.
- Risk Management
You can determine the level of risk you want to face by setting stop losses. A stop loss is a type of order that gets executed once the value of an asset (e.g. a currency pair) reaches the predetermined point. Many forex brokers guarantee accurate execution of stop loss orders in their system.
This characteristic mostly applies to market makers. Market makers are broker-dealer firms that sell or purchase assets predetermined prices. These firms earn profits from “spreads” (i.e. the differences between the purchasing and selling prices of a currency pair). They also benefit from overnight trades through rolling fees. Thus, a market maker usually doesn’t charge commission fees for the orders they process.
The Trading Units
Forex trading involves currencies. And these characters always come in pairs. Currently, there are major currency pairs traded against the US currency. These pairs, known as the “majors”, are EUR/USD (i.e. euro/dollar), JPY/USD (i.e. yen/dollar), CHF/USD (i.e. franc/dollar), and GBP/USD (i.e. pound/dollar). Most trades in the Forex market involve these currency pairs. At the time of writing, the EUR/USD pair is the most traded pair in the market.
You are not required to trade majors. There are many currency pairs out there that you can use. Non-major pairs are known as “cross currencies” because their rates are computed based on the US currency. However, you should note that the major pairs have the most liquidity. That means you can trade them almost every time.
Some brokers even allow their clients to trade commodities, asset indices, and precious metals. If you want to create a diversified trading portfolio, you may combine these securities with your currency pairs.
- Currency Pairs
A currency pair consists of two currencies: base and counter. The base currency comes first and the counter goes second. In the JPY/USD pair, JPY is the base currency where the US dollar is the counter currency. If you will purchase this pair, you will buy JPY and sell USD. If you are selling, on the other hand, you will sell JPY and purchase USD.
Let’s assume that the pair’s current exchange rate is 112.708. In this example, you’ll get 112.708 yen for each US dollar you invest. Conversely, you need 112.708 yen to purchase one unit of dollar.
Each transaction involves two parties: trader and market maker. Traders are people who purchase and sell currencies in the hope of earning profits. Market makers, however, facilitate trades by offering bid prices and ask prices on every currency. The bid prices are the prices at which buyers are willing to buy. The ask prices are the prices at which buyers are willing to sell. Basically, a market maker literally creates a market where traders can perform their trades.
Important Note: Individual traders form a huge portion of the entire foreign exchange market. Some of the other participants in the market are hedge funds, small banks, securities dealers, large commercial banks, and multi-national companies.
The Trading Hours
The foreign exchange market is global in scope. That means you can submit orders 24 hours each day, almost six days per week. When the market of a region closes for the day, another one opens up. You may trade currency pairs on whatever region happens to be available. And the financial news you obtain for a region can also help you in other regions.
- Time Zones
In the Forex market, a trading week begins every Monday, 7 am Australian Eastern Time Zone and ends every Friday, 5 pm Eastern Standard Time. The global Forex market is open between those time periods. A trading day consists of three sessions: Asian, European, and American. People refer to the Asian session as “Tokyo”; the European session as “London”; and the US session as “New York”.
The Tokyo session opens at 21:00 GMT and closes at 8:00 GMT. This session overlaps with the London one, which starts at 06:00 GMT then closes at 16:00 GMT. The New York session overlaps with the London session. The former starts at 13:30 GMT then closes at 21:00 GMT. And when the New York session gets closed, the Tokyo session will run again and refresh the cycle.
Theoretically speaking, you can trade currencies continuously from 9 pm Sunday GMT to 9 pm Friday GMT.
Important Note: The market becomes highly active whenever two sessions overlap. During these times, currencies become volatile and are traded at large volumes. This is the reason why many traders actually wait for the overlapping of sessions before making a trade. The London session possesses the largest volume of trades because it is the midpoint of every trading day. Roughly 50% of all foreign exchange transactions occur in the London session.
Accessing the Market
You can access the foreign exchange market using the internet. In fact, you can view your trading account anytime, anywhere, on your preferred device as long as you can go online. Forex brokers allow clients to track the progress of transactions, modify their positions, close their positions, and withdraw earnings. This 24/7 connectivity is one of the major advantages of foreign exchange trading.
Important Note: You can check your trading account even if the market is still closed (e.g. during weekends). That means you may take advantage of “market downtime” to do what needs to be done on your account. With this approach, you will be able to focus on your trades once the market becomes active again.
When you make a Forex trade, you are assuming that a currency will strengthen while another will weaken. If you purchased JPY/USD, for example, you believe that the Japanese yen will increase in value while the US dollar will decrease in value. If your assumption is correct, you will earn money. If you are wrong, however, you will lose your funds.
You can reap profits even if the market is falling. That’s because you trade currencies in pairs. All you need to do is buy a currency while it is “weak” and sell it once it becomes strong again.
Important Note: You’ll know how to make a trade later in this chapter. A Forex trader usually bases his strategy on fundamental and technical analysis. Fundamental analysis focuses on the effects of news, announcements, reports, and data releases related to the economy. Technical analysis, on the other hand, aims to forecast price movements using graphs, charts, statistics, and historical performance.
Almost all Forex brokers simplify the transaction-related aspects of trades. You just have to put money into your account, choose currency pairs to trade, monitor their performance, and withdraw your profits. You won’t have to worry about calculating exchange rates or other complicated tasks.
You can set a base currency for your account. This is the currency you’ll use for trades regardless of which currency pair you are dealing with. Note that most traders set their local currency as the base currency of their account.
Demand and supply play a huge part in the value of currencies. When many people want to purchase a currency (i.e. when demand goes up), its price will go up. When there are too many sellers, meanwhile, the price will go down. But this well-known economic relation is not the sole reason why currency prices change. Some of the other factors are related to politics, geography, and economics. These are the factors you have to consider when performing a fundamental analysis.
- Additional Information
The economy can greatly influence currency prices. Economic indicators such as Gross National Product and unemployment are known to sway the value of currencies. Many people consider interest rates as the most powerful economic indicator. When the interest rates of a country change, other currencies might also get affected. When there is news about changes in the interest rates in the US, for instance, the value of the American dollar will certainly change. And since this currency takes part in most Forex trades, you can expect a domino effect to occur.
Economics and politics have a close relationship. Changes in the government or national policies are known to affect the price fluctuations in the forex market.
Riskiness of the Market
Just like other investment instruments, foreign exchange involves great risks. The volatility and dynamism of the market can deplete a trader’s capital. Since the value of currencies changes based on many factors, it’s impossible to predict price fluctuations with 100% accuracy. Fortunately, you can specify the level of risk you are willing to face by placing stop loss orders on your open positions. Setting a stop loss order on a position means your currency pair will get liquidated as soon as it hits your chosen price. Stop loss orders let you cut your losses without affecting potential profits.
Never invest funds you cannot lose. Instead of gambling your rent money or your kids’ college fund, it would be best if you’ll save up for your trading plans. You can further reduce the risks by learning more about the market and managing your capital carefully.
Important Note: The previous sections of the article taught you the basics of the Forex market. It discussed the what, when, who, and where of foreign exchange. Now that you know how the market works, let’s focus on making Forex trades. The remaining sections of the article will focus on that topic.
Getting Started: Forex Trading in Kenya
- Creating an Account
Find a reputable Forex broker and create an account with them. Then deposit your money from your preferred funding source. You may use your checking account, credit card, debit card, or online payment processing account for this. Perform some analysis to find the most profitable currency pairs and trade them. Next, use the broker’s charting tools to determine the performance of your chosen pairs. Most Forex brokers offer personalized support and training – you should take advantage of this as much as possible.
Inexperienced traders can learn the basics of the market using demo accounts. A demo trading account allows a person to trade currencies through virtual money. The price fluctuations follow those of the real world, so the users will have actual trading experience. Once they are confident with their trading skills, they may create a live account and trade in small amounts. They can increase their trading capital after acquiring more experience.
- Terms to Remember
Here are the terms you’ll encounter while trading currencies:
Pips: The term “pip” is actually the abbreviated form of “percentage in point”. This is the unit used in measuring price changes. Often, a single pip is equal to 0.0001. This is because the quotes for most pairs have four decimal places. However, there are certain currency pairs (e.g. USD/JPY) where a pip is equal to 0.01.
Spreads: Every trade involves two prices: the bid price and the ask price. When you are buying a currency pair, you purchase the first currency and sell the second one. When selling a pair, meanwhile, you will sell the first currency and buy the other one. Traders use the term “spread” when referring to the difference between these two prices. In other words, spreads are the differences between the money you’ll spend on currency pairs to acquire them and the amount you can earn from them upon selling.
Going Long: A trader is said to “go long” when he purchases a currency pair and hold it for some time. He does this because he believes that the currency will increase in value. The currency pairs you bought are known as “long positions”.
Going Short: Going short means selling a currency pair because you think its price will fall. This is a strategy you can use when there events that can affect a currency negatively.
Margins: Trading on margin means borrowing money from your broker to finance your trades. Before you trade on margin, you need to set up a margin account with your broker and put some money in it.
- Take Profit and Stop Loss Orders
There are two types of “automated” orders in the Forex market: take profit and stop loss. These orders let you sell assets automatically once a predetermined price level is reached. Traders place these orders to save time. If you have these orders in your account, you won’t have to monitor your positions continuously.
With take profit orders, your goal is to set a price that will protect the profits you have earned. Let’s say your trade went well. You may want to place a take profit order on it at about three pips higher than its current value. Once that price point is reached, your pair will be sold back to the market and your profits will be secured. Why sell an asset that is increasing in value? It’s because prices constantly change. You want to take advantage of favorable price shifts. The last thing you want to do is to watch the value of your currency pair plummet.
Stop loss orders, on the other hand, are designed to minimize your losses. For example, you may place a stop loss order at three pips lower than the pair’s value. The pair will be sold once its price fall by three pips. This way, you can prevent erroneous trades from depleting your capital. Use this type of order to minimize your losses.
Different Types of Orders
There are three major types of Forex orders available today. These orders are:
Day Trade Orders: Day trade orders (or simply “day orders”) are orders designed to be fulfilled at the current prevailing price. Here, you won’t care about what the current bid or ask prices are. You’ll just simply acquire or sell a currency pair based on its “market price”. Consequently, this type of order has the shortest average execution time.
Limit or Pending Orders: This type of order lets you specify a price point at which your trade will be executed. Your order will be pending until your chosen currencies reach the predetermined price. Once the value of the currency hits the price you specified, the order will be executed. Pending orders can either be “good for the day” or “good until cancelled”. The former option “kills” the order if it is still unfulfilled by the end of the trading day. The latter, meanwhile, keeps the order active until you cancel it manually.
Forward Orders: With a forward order, you’ll prepare the order in advance. Forward orders are set to get executed at the date you specify. These orders share many similarities with day trade orders.
Important Note: You can set take profit and stop loss points on all of these types of orders. Thus, you can manage risks even during the order submission phase.
- Holding a Position
The duration of your positions depends on your trading strategy. If you are a day trader, you want your positions to stay open for the whole trading day. But you have to close all your positions before the day ends. If you are using the “scalping” strategy, however, your positions might be open from several minutes to a few hours. This short time-frame allows scalpers to get the most out of their trading scheme.
Your positions might stay open for several days if you are a swing trader. Here, you will exploit the price swings (i.e. significant and continuous price changes) present in the market. Once the price slows down or goes backwards, you have to liquidate your currency pairs immediately.
The position trading strategy is different in that it is of the buy-and-hold type. That means you will sell or purchase an asset hoping that its price fluctuations will go according to your predictions. In this strategy, it is not unusual for a trader to keep his positions open for two to three weeks. Some traders even hold their currency pairs for a month.
Important Note: The ideas and strategies discussed above can help you become a successful Forex trader. Now that you are familiar with the trading sessions, order types, and how the Forex market works, you can go ahead and create your own trading account.
This article discussed the most basic aspects of foreign exchange trading. Because the foreign exchange market is complex, it would be best if you’ll read eBooks and other articles. This way, you can gather more information that will help you make great trading decisions. Trade using a demo account before using your own money. Lastly, don’t forget to set take profit and stop loss orders for each of your positions.