Technical Analysis is probably the most common and successful means of making trading decisions and analyzing forex and commodities markets.
Technical analysis differs from fundamental analysis in that technical analysis is applied only to the price action of the market, ignoring fundamental factors. As fundamental data can often provide only a long-term or "delayed" forecast of exchange rate movements, technical analysis has become the primary tool with which to successfully trade shorter-term price movements, and to set stop loss and profit targets.
Technical analysis consists primarily of a variety of technical studies, each of which can be interpreted to generate buy and sell signals or to predict market direction. Please see our Technical Studies page for a detailed description of these studies and their uses.
One use of technical analysis, apart from technical studies, is in deriving "support" and "resistance" levels. The concept here is that the market will tend to trade above its support levels and trade below its resistance levels. If a support or resistance level is broken, the market is then expected to follow through in that direction. These levels are determined by analyzing the chart and assessing where the market has encountered unbroken support or resistance in the past.
For example, in chart below EURUSD has established a resistance level at approximately .9015. In other words, EURUSD has risen up to .9015 repeatedly, but has been unable to move above that point:
The trading strategy would then be to sell EURUSD the next time it gets close to .9015, with a stop placed just above .9015, say at .9025. This would have indeed been a good trade as EURUSD proceeded to fall sharply, without breaking the .9015 resistance. Hence a substantial upside can be achieved while only risking 10 or 15 pips (.0010 or .0015 in EURUSD).
On GCI's integrated charting system (GCI Multi-Currency Charts), the red support line shown above can be drawn by clicking on the "Trend" button at the top of the chart window, and then drawing a line by clicking the mouse once at the beginning of the line, and again at the end of the line.
There are certain features that make forex trading extremely appealing to individual traders as well as to other financial institutions and banks. These are:
- The market is open for 24 hours and for 5½ days in a week.
- It offers highest liquidity with ease of transaction with almost all major currencies of the world.
- Widespread volatile presenting huge profit opportunities.
- Can potentially cover risk exposures with various standalone instruments.
- You earn profit from rates going up as well as down.
- Good leverage with low margin requirements present high profit potential.
- Various options available for zero-commission trading.
How Price is Quoted
In forex trading , currency prices are always quoted in pairs. For example, on a particular date, the rate of EUR/USD is 1.0856 and if you buy 1000 Euros on that particular date, you will have to pay 1085.60 U.S. dollars. But, at a later date if this rate becomes 1.2082, which implies that the value of euro increased in relation to the USD, you can sell 1000 Euros and will receive 1208.20 dollars.
Therefore, you make a net profit of $122.60. So, as an investor, your aim should be to buy currencies at low price and sell those in future in higher prices. If you buy or sell a currency but do not sell or buy back the equivalent amount, it would be referred as open trade or open position.
Major Currencies Traded in Forex
In Forex trading, most of the currencies are traded against USD. The other prominent currencies are Euro or EUR, the Japanese yen or JPY, the British pound sterling or GBP, and Swiss franc or CHF. These five currencies are known as the Majors. The pairs are quoted like USD/EUR or CHF/JPY, where the first one is referred to as the base and the second as the counter or quote currency. The value of the base currency is always 1. All trading is done with currency pairs.
Prices in Forex are quoted to the fourth decimal point (leaving JPY, which is quoted till second decimal point) and in pips or percentage in point. It is the smallest price increment and one pip is equal to 0.0001. When the bid for EUR/USD is 1.0856 and offered rate is 1.0859, it has a spread of 3 pips. Spread, in simple terms, is the difference between the bid and the ask price. The forex market is mainly operated by the brokers who do not charge a commission for their services. And, it is the spread with which they make their profit. For investors, therefore, the lower the spreads the more saving is made.
Margin is the minimum security that ensures that the investor can pay back the amount in case of losses. It is a deposit that covers any future currency trading losses. With margin, you can hold larger positions than you have in your account.
The concept of leverage is also quite common in forex trading, which is the ratio of total available capital to actual capital. If, for example, the leverage is said to be 200:1, it means the Forex broker will lend you $200 for every $1 of your actual capital investment. Though leverage is very important for your trading, higher leverage exposes your investment to higher risks.
Common Methods of Forex Trading
There are three methods for common investors to trade in forex market. They are through the spot market, the forwards and futures market, and the options.
- Spot is the simple currency exchange processes. Here, the settlement date is the second business day after the day the deal or trade is struck.
- Forward transaction is the process where the deal is for more than two days. Future is a type of forward contract, which has fixed currency amounts as well as fixed maturity dates. These are traded in future exchanges and not through general foreign exchange market.
- Options is the process in which fixed currency transactions are carried out with mentioning some specific future date.
Risk Factors in Forex Trading
Although forex trading is extremely lucrative, it has several risk factors involved. Those are risks involving currency exchange rate, interest rate, and risks with credit and country. The average lifespan of a typical trade varies from 2 to 7 days. There are technical and fundamental indicators, which are to be consulted to decide the entry, exit, and other decisions, like order placement etc. You should have solid risk management features and disciplined trading strategies to earn profit in forex trading without risking your investment.
Basic Concept: The forex hedge’s change in value is opposite to the change in value of the foreign
currency exposure (hedged item). These two amounts offset each other to obtain cost certainty or revenue certainty by fixing the foreign exchange rate for your transaction.
There is typically a cost associated with forex hedging and generally, forex hedging will require a certain amount of margin cash (retail online forex broker) or available credit from your financial institution, while the forex hedge is outstanding.
There are a couple different methods to complete the forex hedges. For the assumed example, the company uses the United Stated Dollar (USD) as its reporting currency and it has a future Euro payable amount. With all forex hedges, your company is buying one currency and selling another currency.
1. Forward contract. Your company would purchase a forward contract from a banking institution which would give you the right to purchase a contracted amount of euros at a future date at a fixed price. Your future exchange rate would be based upon the current exchange rate, likely profit paid to the bank, and forward points. Forward points are calculated based on interest differential (interest carry costs) on the two currencies traded. You pay interest on the currency sold (USD) and you receive interest on the currency bought (euros). If you change the amount to be paid or the date of the expiry date of the contract, your financial institution will likely charge your company a fee.
· Your company will need adequate credit (borrowing capacity) with the financial institution, which supplies the forward contract.
2. Carry Spot Trade. With a retail online forex broker, you will enter into the carry spot trade whereby your company will buy the Euros and sell your local currency. Over the expected time frame between when you purchase the carry spot trade and complete the euro transaction in the future, your account will be charged the interest differential (interest carry costs). Once again, your company pays interest on the currency sold (USD) and you receive interest on the currency bought (euros). The carry spot trade may be partially or fully terminated at any time, which provides flexibility for when your euro transaction is completed.
· Your company will need adequate margin with the online retail forex broker, which enables the carry spot trade to be transacted.
3. Forex Options. A currency option gives the holder the right, but not the obligation, to sell or buy a face amount of currency at a set price, on or before a given date. A currency option has a strike price—the amount for which the currency can be bought or sold—and an expiration date. U.S. options can be exercised at any time up to and including the expiration date, whereas European options can only be exercised on the expiration date. Options are one-sided contracts that are priced based on a number of variables: exchange rates, interest differentials, duration of contract, historical exchange rate volatility, and a built-in commission for the provider. They offer a method of speculating on future currency movements, but you pay a price for that right to speculate.
4. 
Forex Exotics tend to be combinations of a variety of products (typically options and forward contracts) with many different names and flavors (including features such as floors, ceilings, collars, participating forwards). They are often sold with the promise of limited downside risk and the potential of unlimited or limited upside benefit. They’re similar to standard options, but should be left to very experienced forex traders because their complex structures often hide extra profits for their providers.
Remember, hedging is not about making money on the hedge transaction. Hedging is obtaining cost certainty or revenue certainty. You are locking in the future exchange rate for a certain future forex transactions.
As an example, let us assume you are a USD currency company. You plan to purchase $40,000 in European product in eight months. If you entered into a carry spot trade to buy 40,000 EUR/USD trade on an online retail forex platform , then you will receive cost certainty in an assumed eight months. With this example, the current EUR/USD price is 1.5600. The first currency listed is known as the quote currency and always equals 1. In this case, therefore, you would buy 1 EUR with selling 1.5600 USD. Your current USD expense is 62,400. (40,000 multiplied by 1.5600)
In the future, your euro payable is a (40,000), so your forex hedge will be to purchase the 40,000 euros on the carry spot trade by selling the USD.
If in the future, the EUR/USD price is 1.61, then you will have made $2,000 on your forex hedge trade [ 1.61 minus 1.56 = 0.05 multipled by 40,000 = $2,000], however, when you make the payment to the supplier, the 40,000 EUR would cost you 64,400 USD. Your net cost for the product would be $62,400 USD. (Actual cash payment to your supplier less the amount made on the forex hedge).
OR
If in the future, the EUR/USD price is 1.51, then you will have lost $(2,000) on your forex hedge trade[ 1.51 minus 1.56 = (0.05) multipled by 40,000 = $(2,000)], however, when you make the payment to the supplier, the 40,000 EUR would cost you $60,400 USD. Your net cost for the product would be $62,400. (Actual cash payment supplier plus the amount lost on the forex hedge.)
This is the hedge. The forex carry spot trade’s win or loss will be offset by the actual amount of money paid to the foreign supplier. In the end, you have obtained cost certainty for your company.
For all forex hedging, your company will pay (or receive) interest carry costs. When you open a carry spot trade as a forex hedge, you are simultaneously buying one currency and selling another. Until the trade is closed (settled), your account will be charged (or earn) the interest differential on the open position. You will be charged interest on the currency sold and you will earn interest on the currency purchased. In your example, you would be buying EUR and selling USD. At today’s interest rates (July 2008), the interest earned will exceed the interest paid, so while the forex hedge is outstanding, you will earn net interest. This will depend upon the two currencies traded.
