Our tutorial on forex trading contains general rules, tips and guidelines for a new trader. The first steps in the world of Forex.

Introduction

If you are not acquainted with the terms and don’t have the least idea of how this system works, this Forex tutorial is exactly what you need. From the very beginning, you will appreciate the accessibility of the provided information. After reading the first section of our forex trading tutorial, you will understand the way the Forex trading system works and you will be able to communicate with your trading peers as an equal.

Traditionally, like any other Forex trader tutorial, this tutorial contains basic information on fundamental and technical analyses. The main mechanisms of price formation, the market impact of political and economic events, and other factors that affect stock prices are set forth in a simple and understandable way. Particular attention is paid to the popular methods of technical analysis. The author examines in detail the indicators and graphical patterns used by traders.

As you may have already noticed, a great deal of Internet blogs is devoted to trading psychology. It’s not for nothing! The Trading Psychology section of our Forex tutorial deals with the question of what the psychological pitfalls of trading are and why it’s so important to work on yourself.

The money management section of this Forex tutorial is worth a special mention. It reflects the authors’ personal experience since this subject is part and parcel of practical application and therefore cannot be examined separately. You will learn to control risks and place Stop Loss and Take Profit orders wisely, the way Forex market professionals do.

The last section of our Forex tutorial will help you build your own trading strategy. Starting with the basic idea and concluding with testing and adjustment, you will develop your first trading system together with the professional trader. This section is a logical conclusion of the whole tutorial as from now on you can start your safe journey in the world of Forex trading. Feel free to download our Forex tutorial right from Litefxinvestments official site.

Why Forex? Main advantages of Forex trading

As it was already mentioned, due to high liquidity Forex allows to change without any difficulties practically all volumes of one currency to another. Moreover, high liquidity means that a transaction might be closed practically immediately. It is achieved due to two reasons. Firstly, the trading is carried out via electronic means, secondly, every moment the market is full with big number of buyers and sellers that in accordance create the highest demand and equitable supply. However liquidity and volumes are not the only advantages of Forex.

Working with Forex you have a possibility to choose when and how long you are going to work and when and how long you are going to have a rest, fun, to study or communicate with friends and relatives etc. Your profit depends only on you. It does not depend on your boss or your stuff, your business partners, supplies, terms, goods or services. There is seasonality at Forex but it does not influence your profit. You can choose the appropriate profitable tactics for every time period. You do not spend money on advertisement of your goods or services, you do not look for buyers, you are not obliged to certificate or license your production, and all this brings your overhead and commercial expenses to naught.

You will need a PC or a mobile device (laptop, tablet PC) with the net access for your work. This is all. LiteForex will supply you with special software for free. You can work in your apartment, dealing-room, Internet-cafe, to put it simply, in any place with Internet access. With the help of Internet data card you can choose a comfortable place for your work in any place of the world.

Apart from these there is one more advantage of Forex. Having fix profit on a percentage base (for example, 30% per month) your profit in absolute term will grow with the increase of your capital. Mathematicians proved that having a positive (no matter how small it is) mathematical expectancy of trade strategy, with the help of means of money management it is possible to provide anexponential growth of deposit. 

Currency pairs.

For a better understanding of what a position is, the concept of a currency pair was introduced on the Forex market. Instead of saying, “I bought euro for dollars” or “I sold euro for dollars”, traders use shorter expressions: “To buy euro-dollar” or “To sell euro-dollar” (respectively). Let’s learn more about a currency pair.

Currency pair record is abbreviations (in accordance with ISO 4217 standards) of the respective currencies in a succession (without spaces but sometimes written with the right slash “/”). For example, the euro (EUR) and the US dollar (USD) together make up a currency pair EURUSD (euro-dollar). Purchase of this currency pair means buying euros for dollars. And always, in any case, whatever the currency is included in the pair, the first currency in the pair is bought for the second. Therefore, purchase of AUDCAD means buying Australian dollars for Canadian dollars. Similarly, selling of EURUSD means selling euros for dollars.

It is more professional to say that the first currency in the pair is base and the second one is quote. Therefore, in a pair NZDUSD the base currency is the New Zealand Dollar (NZD), and the quote currency is the US dollar (USD).

When viewing the list of currency pairs (for example, in the window “Market Watch” in the client terminal MetaTrader 4 of the LiteForex Company), we can notice that there are financial instruments in which the base currency is the US dollar (for example, USDJPY, USDCHF, USDCAD). This is the case of a direct quote (it shows the quantity of quote currency units in one US dollar). At the same time, the US dollar is included in other currency pairs as the quote currency (for example, EURUSD, GBPUSD, AUDUSD, NZDUSD). This is called a reverse quote. The value of the price in this case should be interpreted as the quantity of dollars per one base currency.

Of course, by simple mathematical transformation we can easily obtain USDEUR from EURUSD. Indeed, suppose that the price of EURUSD at some point is 1.39224, then:

 — This would be the price of UDSEUR.

But why quote lists of the largest brokerage companies do not have such a financial instrument? – It is just a historical tradition.

The listed above pairs: USDJPY, USDCHF, USDCAD, EURUSD, GBPUSD, AUDUSD, NZDUSD constitute a group of so-called “Majors” – they are united by the fact that one of the currencies in the pair is always the US dollar. This is the most highly liquid financial instruments that have a significant volatility and capacity to fluctuate substantially and, therefore, they carry a nearly inexhaustible potential for profit.

There are also other groups of instruments. If, for example, the base currency is the Australian dollar, and the quote currency is the Canadian dollar, this is AUDCAD cross-rate. The so-called cross-rates are divided into “major crosses” and “minor crosses” according to their liquidity in the financial markets.

Besides the fact that there are various groups of financial instruments, we can mention that some currencies can often play one or another typical role. In particular, the currencies of the most stable countries, as well as contracts for precious metals (USDCHF, USDJPY, XAUUSD, XAGUSD) can play the role of financial instruments, investments in which can help you safely ride out times of crisis on the markets. In trader’s jargon, such instruments are called “safe haven” (ref. “safe haven”). The currencies of those countries in whose export system raw materials prevail are often called commodity currencies (e.g.: USDCAD, AUDUSD).

Price reversal candlestick analysis

The following patterns are reversal patterns:

А. Hammeror Hanging Man

Reversal candlestick:

  • The body is at the top (bottom) of the price range. The color of the body is irrelevant.
  • The lowest shadow is twice as long as the body.
  • The reversal candlestick has no upper shadow, or it is very short.
  • Intensifying factors:
  • The longer the lower shadow, the shorter the upper one, and the bigger the body – the greater the potential.
  • Although the color of the body is irrelevant, the bullish color of thehammer indicates greater bullish potential, while the bearish color of the hanging man means greater bearish potential.

Peculiarities:

  • In the case of the hanging man,it is important that the bearish signal is confirmed. The more the downward price gapbetween the body of the hanging man and the opening price of the next day (period), the more likely it is that thehanging man willform a high.
  • The hammer is characterized by the previous price dynamics. If there is an explicitly bearish candlestick before the hammer (e.g. a long body with no shadows), this is evidence that the bear market is gaining momentum.In this case it is reasonable to wait for confirmation that the bulls are in control (for example, the next candlestick with the closing price higher than the closing price of the hammer). It is important to monitorwhether the hammer has not broken an important support level.

B. Double Top or Double Bottom

Reversal patterns Double Top (bullish trend changing to bearish) and Double Bottom (bearish trend changing to bullish) is formed in the event that the price forms two local extremums and thenbreaks through the line at the bottom (the support line in the bullish trend or the resistance line in the bearish trend).

The illustration shows abstract patterns Double Topand Double Bottom. The double bottom figure is a mirror image of the double top figure.

This figure allows the analyst to suggests that after the breakdown of the support level (in double top) or the resistance level (in double bottom), the price might move in the same direction for a distance at least greater than the height of the figure (from base to the high or low).

C. Head and Shoulders, or three-high figures

The figures of this groupare reminiscent of the previously discussed double top or double bottom. The general principles of their formation are the same as above described except that the pattern consists of three highs instead of two. Here we will discuss only one situation, namely, upward trendchanging to the downward, but it is implied that if mirrored, the same will be true for the downward trend changing to the upward trend.

The model is formed by three highs. If two (outer) of the three highs are lower, and the central high is higher, the pattern is called Head and Shoulders. The same modelwith all the three highs located at close price levels will be called Triple Top. In case of the breakdown of the pattern’s base, the price is likely to move in the direction of the breakdown by no less than the height of the figure (from the base to the high).

Continuation patterns

A. “Flag”

Flag as the model of continuation pattern is shown at the following illustration.

Flag is the movement of the price in certain range, that is shown by red dashed line on the illustration. The potential of the movement when the price leaves the channel has at least the same size as “flagpole”.

Picture 11. “Flag” continuation pattern

B. “Pennon”

Picture 12. “Pennon” continuation pattern

“Pennon” pattern is one of the individual cases of the flag pattern. It is formed in those cases when the support gradually increases, and the resistance gradually lowers. From the point of view of price dynamics the consolidation takes place. The break in the level of resistance, as a rule, leads to the formation of new current trend and the potential of this movement is no smaller than the size of the “flagpole”.

The fundamental analysis

Fundamental analysis means measurement of a financial asset value in connection with political and economic processes and events.

There is a connection between financial-economic, political, and economic events that take place in individual countries and blocks of countries as well as in the whole world and currency exchange rates and stock prices.This connection can be studied using the fundamental analysis.

Fundamental analysis is the most difficult part of economic analysis of the market. It is more difficult than any other one, because under different conditions the same factors can have different impact on the market and major factors can become quite insignificant. In addition to certain initial official rules, such analysis requires practical experience.

In practice, methods of fundamental analysis are used by market traders in combination with other types of market analysis and allow evaluation of general history and perspectives of trading instrument rates based on interdependence between fundamental, economic and other factors and standard response of trading markets to them.

Fundamental analysis takes into consideration the following factors:

  • Political crises;
  • Much publicized resignations and Cabinet of Ministers reshuffles;
  • Imprudent statements in press;
  • Release of economic indicators for countries and blocks of countries;
  • International conflicts;
  • Awaited elections;
  • Natural disasters (force-majeure).

All events considered in the fundamental analysis can be planned or unplanned. All planned events (release of economic indicators, planned speeches given by the Heads of the Cabinets or other influential officials, release of the election results etc.) are published in the economic calendar. Unplanned events include any force-majeure (fire, natural disasters, acts of terrorism etc.). Furthermore, in the course of fundamental analysis politics means redistribution of public good and resources based on economics-related reasons.

Market response to any unplanned event as assessed in the context of fundamental analysis is unpredictable and depends on a specific situation. The history has seen political events that changed dollar exchange rate against other currencies by 200 points within a very short period of time. (For example Caribbean Sea oil spill, the capture of Saddam Hussein by U.S. forces, Hurricane Katrina and so on).

Nevertheless, it is possible to predict further movements of the trading instrument rate upon the planned release of economic indicators. For example, changes in statistical data on the unemployment rate will have a clear impact on the national currency exchange rate. At the same time, market response to the release of economic indicators follows a certain mechanism.

In your work we recommend using the economic calendar of events that you can find at www.forexpeoples.com.

Release of economic indicators from leading countries influences currency exchange rates to a different extent. According to their importance, such indicators can be divided into the following groups:

1. Very important

  • Gross-National Product
  • Trade deficit
  • Payment deficit
  • Inflation indices (Consumer Price Index [CPI] and Wholesale Price Index [WPI])
  • Unemployment and employment data
  • Money supply data (М4-М0 monetary aggregates)
  • Official discount rates
  • Parliamentary, congressional, or senatorial elections. Presidential elections (currency is influenced by election promises made by the candidates and historical preferences of the parties).

2. Moderately important

The exchange rate can sometimes react to this group of news. Everything depends on the specific situation on the market.

  • Size of retail sales
  • Size of housing starts
  • Size of factory orders and durable goods orders
  • Industrial production index
  • Producer price index [PPI]
  • Consumer price index [CPI]
  • Productivity.

3. Non-significant

  • Futures exchange rates
  • Deposit rates
  • Stock indices (Nikkey, Dow Jones, DAX etc.). Growth of these indices shows that national economics is in good state, and increases the demand for national currency of this country.
  • Dynamics of prices for government securities (T-bills, T-bonds).

Influence of the indicator on the currency exchange rate is shown in the Table below.

IndicatorChange of indicatorChange in national currency
Trade deficitGrowthDrop
Payment deficitGrowthDrop
Inflation indices: Consumer Price Index [CPI] and Wholesale Price Index [WPI]GrowthDrop
Official discount rates (repo, Lombard etc.)GrowthGrowth
Gross-National Product (GNP)GrowthGrowth
UnemploymentGrowthDrop
Money supply data (М4, М3, М2, М1, М0)GrowthDrop
Presidential or parliamentary electionsGrowth
Size of retail salesGrowthGrowth
Housing startsGrowthGrowth
Size of ordersGrowthGrowth
Producer price indexGrowthDrop
Industrial production indexGrowthGrowth
ProductivityGrowthGrowth
Forward exchange rate
Futures exchange rate
Effective exchange rate
Deposit repos
Stock indices (DJI, NIKKEY, DAX, FTSE)GrowthGrowth
Prices of government securities (T-bills, T-bonds)GrowthGrowth

Release of fundamental data, as we have mentioned above, is a planned event, and according to existing international agreements, countries with leading economics are obliged to publish their projected and actual macroeconomic indicators. Bear in mind that the market takes projected indicators immediatelyinto consideration, and there is a possibility of a rapid market response if an economic indicator released is significantly different from that previously projected or when indicators from the previous periods are reconsidered. Predicting market response is challenging and requires practical experience.

Data from the fundamental analysis can and should be taken into consideration when developing trading strategies but only in combination with technical analysis data. Taking trading decisions based solely on fundamental data or shortly before the release of major fundamental data is unacceptable as the market response cannot be predicted. Besides, there is a practice where a planned release of an economic indicator leads to the re-evaluation of the previously published data on this indicator, which often reverses an overall response of the financial market. Let’s take a look at the example below.

The number of initial unemployment claims in the USA (data published every two weeks) at the moment of release was 418,000. The previous figure was 515,000 and the projected figure was 452,000. The number of initial unemployment claims filed is clearly less than expected, which indicates that economic situation has improved. The market would respond by rapid growth of the US dollar exchange rate against all other currencies by a certain amount (in practice, up to 50 points). Two minutes after the US dollar exchange rate has already started to move, a revision of the previous two-week-old indicator may be published, and the figure of 515,000 may be revised to 468,000. Then, the projected figure is little different from that released two weeks ago in terms of the absolute value, and the reverse reaction would follow returning the exchange rate to its initial level within a short period of time (approx. 10 minutes) or, alternatively, provoking a reverse movement. Commonly, a sharp increase in oppositely directed volatility of currency exchange rates may occur for a short period of time when a group of major macroeconomic indicators are released, followed by the price returning to the same level existing before the release of indicators.

Bear in mind that different macroeconomic indicators influence price movements of financial instruments based on different time intervals. For example, the ratio between discount ratesof State Central Banks is an indicator influencing global trends in the movement of currency rate ratio. The higher the discount rate of the State Central Bank is, the more profitable the investments in this currency are (however, consider inflation expectations). When the Central Bank changes the discount rate level, investors re-evaluate profitability of investments in this currency and refocus their interest towards another financial instrument. A similar situation exists with respect to the assessment of the market value of temporary CFDs for shares of the largest world holdings. The fundamental indicator is the profitability level of stocks (%) over the previous financial period. For assessment of investment profitability in the short term, investors use profitability reports over shorter (up to one month) time periods.

Methods of fundamental analysis are discussed in an easy-to-understand manner in the recommended literature.

Trading Psychology

Before starting this section on psychology it should be noted that the author of this course is a system analyst, i.e. shares the opinion that trading is the work of mechanic trading systems (refer to Section 6 of this course). However, the author strongly recommend that everyone, including future system analysts, should read this section because “human factor” is part of all or almost all processes that should not be excluded from consideration. What’s more, ignoring trading psychology would border on criminal negligence. The thing is that, eventually, it is a human who trades, even if operations are performed by a robot. But it is a human who has opened an account and installed this particular robot. He/she has allowed the robot to trade at exactly this time. He/she has installed these particular settings and can interfere with robot’s work etc. Finally, at a certain point in time a human can withdraw too much money from the account which blocks the robot’s work. Therefore, it is quite desirable to be at least aware of the main psychological aspects of trading, if not studying them in depth.

The second note we should make is related to psychotherapy. When a person experiences dissonance between what he/she would like to feel (in the most general sense of this word) and what he/she actually feels as well as between how he/she would like to behave (in any situation or sphere of life) and how he/she actually behaves, he/she arranges an appointment with a psychotherapist. There are lots of opinions, gossips, wild guesses and fantasies about the process of psychotherapy itself. There are also lots of schools and movements of psychotherapy. We are not going to discuss all of these. It is important to understand what the most general and the most important objective of psychotherapy is (regardless of movements or methods used by a specialist). This objective can be formulated as follows: to help a person realize what and why is happening to him/her in order to enable him/her to make an informed choice of what should be done.

We will establish a similar objective for this course. We believe a trader should know (or at least be aware of) psychological factors driving him in order to be able to make informed choices as to whether to resist or, conversely, make use of them.

There are dozens of fundamental and hundreds of popular scientific books about trading and trader’s psychology. However, we believe this subject has not been elaborated yet in depth. Then again, we cannot expect this subject to be “sufficiently” elaborated any time soon for a simple reason of it being related to human psyche which is far from being thoroughly studied. It is hardly possible to provide enough information in this article about at least main ideas developed by psychologists in cooperation with practicing traders, that’s why we can only refer you to those sources that are related to this topic.

In our course, we will be able to outline typical challenges facing traders and propose some solutions.