How You Make Money in Forex

Money mountainIn 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.
Example:
Trader's Action EUR USD
You purchase 10,000 euros at the EUR/USD exchange rate of 1.1800 +10,000 -11,800
Two weeks later, you exchange your 10,000 euros back into U.S. dollar at the exchange rate of 1.2500 -10,000 +12,500**
You earn a profit of $700 0 +700
*EUR 10,000 x 1.18 = US $11,800
** EUR 10,000 x 1.25 = US $12,500


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:


GBP/USD quote

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.
Long dog, short dog


"I'm long AND short."

Bid/Ask



EUR/USD quote
"How come I keep getting quoted with two prices?"

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.
Now let's take a look at some samples.
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Best Days of the Week to Trade

So now we know that the London session is the busiest out of all the other sessions, but there are also certain days in the week where all the markets tend to show more movement.
Below is a chart of average pip range for the major pairs for each day of the week:
Pair Sunday Monday Tuesday Wednesday Thursday Friday
EUR/USD 69 109 142 136 145 144
GBP/USD 73 149 172 152 169 179
USD/JPY 41 65 82 91 124 98
AUD/USD 58 84 114 99 115 111
NZD/USD 28 81 98 87 100 96
USD/CAD 43 93 112 106 120 125
USD/CHF 55 84 119 107 104 116
EUR/JPY 19 133 178 159 223 192
GBP/JPY 100 169 213 179 270 232
EUR/GBP 35 74 81 79 75 91
EUR/CHF 35 55 55 64 87 76
As you can see from the chart above, it would probably be best to trade during the middle of the week, since this is when the most action happens.
Fridays are usually busy until 12:00 pm EST and then the market pretty much drops dead until it closes at 5:00 pm EST. This means we only work half-days on Fridays.
The weekend always starts early! Yippee!
So based on all these, we've learned when the busiest times of the market are. The busiest times are the best times to trade because they give you a higher chance of success.

Managing Yo Time Wisely

Unless you're Edward Cullen, who does not sleep, there is no way you can trade all sessions. Even if you could, why would you? While the forex market is open 24 hours daily, it doesn't mean that action happens all the time!
Besides, sleep is an integral part of a healthy lifestyle!
You need sleep to recharge and have energy so that you can do even the most mundane tasks like mowing the lawn, talking to your spouse, taking the dog for a walk, or organizing your stamp collection. You'll definitely need your rest if you plan on becoming a hotshot trader.
Each trader should learn when to trade.
Actually, scratch that.
Each trader should know when to trade and when NOT to trade.
Knowing the optimal times you should trade and the times when you should sit out and just play some Plants vs. Zombies can help save you a pound of moolah (pun intended).
Here's a quick cheat sheet of the best and worst times to trade:

Best Times to Trade:

  • When two sessions are overlapping of course! These are also the times where major news events come out to potentially spark some volatility and directional movements. Make sure you bookmark the Market Hours cheat sheet to take note of the Opening and Closing times.
  • The European session tends to be the busiest out of the three.
  • The middle of the week typically shows the most movement, as the pip range widens for most of the major currency pairs.

Worst Times to Trade:

  • Sundays - everyone is sleeping or enjoying their weekend!
  • Fridays - liquidity dies down during the latter part of the U.S. session.
  • Holidays - everybody is taking a break.
  • Major news events - you don't want to get whipsawed!
  • During American Idol, the NBA Finals, or the Superbowl.
Can't seem to trade during the optimal sessions? Don't fret. You can always be a swing or position trader. We'll get back to that later. Meanwhile, let's move on to how you actually make money in Forex. Excited? You should be!
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Session Overlaps

Forex Session Overlaps
Quick pop quiz! What time of the day are TV ratings highest? If you said during prime time, then you would be correct!
What does this have to do with trading sessions? Well, just like TV, "ratings" (a.k.a. liquidity) are at their highest when there are more people participating in the markets.
Logically, you would think that this happens during the overlap between two sessions. If you thought that way, you'd only be half right. Let's discuss some of the characteristics of the two overlap sessions to see why.

Tokyo - London Overlap

Liquidity during this session is pretty thin for a few reasons. Typically, there isn't as much movement during the Asian session so, once the afternoon hits, it's pretty much a snooze fest. With European traders just starting to get into their offices, trading can be boring as liquidity dries up.
This would be an ideal time to take a chill pill, play some putt-putt or look for potential trades to take for the London and New York sessions.

London - New York Overlap

This is when the real shebang begins! You can literally hear traders crack their knuckles during this time, because they know they have their work cut out for them. This is the busiest time of day, as traders from the two largest financial centers (London and New York) begin duking it out.
It is during this period where we can see some big moves, especially when news reports from the U.S. and Canada are released. The markets can also be hit by "late" news coming out of Europe.
If any trends were established during the European session, we could see the trend continue, as U.S. traders decide to jump in and establish their positions after reading up what happened earlier in the day. You should watch out though, at the end of this session, as some European traders may be closing their positions, which could lead to some choppy moves right before lunch time in the U.S.
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