The foreign exchange market consists of buying and selling various currencies around the world. The needs to exchange currency is why the forex market is the most liquid financial market. With just under $5 trillion being traded everyday, this makes the forex the largest market in the world.

But what moves these markets? From the spreads on the account to the fundamentals that moves the markets, this is a market where opportunity is endless. Let us look at what the basics of Forex are and what drives this market.

Forex Basics

First and foremost, we must take into consideration of the spreads. Spread in trading is the difference between the bid and ask price. The main reason for a spread is how the broker would earn their money. In stocks, when you enter a trade, you normally pay a commission fee per trade. With forex, the broker makes money on the spread they offer. Suppose the bid and ask price was 1.82753 and 1.82798, respectively. The spread is the difference between the two, which is 0.00045. When you enter a trade going long, you will be placed on a trade with an average price that is 0.00045 higher than the current price and vice versa. In other words, your P&L will be negative at the start of every trade, making up for the spread fee.

When taking a trade, you must account for the spread difference. Once you have that in place, you can consider how to maximize your profits. But how do you calculate profits in forex? In Forex, there is something called a pip, stands for price interest point or percentage in point. Understanding the pip allows traders to enter a trade and exit a trade. A pip calculates the change in a currency pair, often calculating to the last decimal point, majority of the times being the 4th decimal point.

The Two Types of Analysis

Fundamental analysis involves the examination of any external factors that may affect the security’s price. Analysts take macroeconomic factors into consideration such as the country’s economy and industry conditions. For stocks, they also take a look at the financial factors and how the company is putting out its numbers in their financial statements. Company earning reports also have a huge impact on price. Particularly in the forex market, analysts look at the economic calendar and the big events such as the America’s Non-Farm Payrolls that may affect the dollar or the Great Britain Consumer Price Index (CPI) that might affect the pound sterling.

Look at how the Bank of England’s Monetary Policy Committee (MPC) votes effected the pound against the dollar on Nov 2, 2017 with the majority of the votes in favour of increasing the interest rates. The pound dropped 93 pips against the dollar in just 30 minutes. Trading using fundamentals can be a great idea once you have a clear understanding of a company or how a country’s economy is performing.

Technical analysis is a completely different type of analytical approach when looking to trade a security. It involves pure chart scanning and looking for the best probability approach in terms of chart patterns and pure price action trading. Past market data and volume along with identifying trends can predict future price levels for any security. With technical analysis, many use technical indicators such as the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD) and many more oscillators that provide trading opportunities.

Fundamental and Technical analysis are the two ways people look to make money in the markets. Combining the two can result in a profitable combination. They are the reason why markets react the way they do and can also predict future movements.

You may also be interested in: Why Should You Trade in the Forex Market?

Writer: Saket Patel

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