Academy content

Topic 1: What is Forex & how do we make money from it?
 The Basics:

Forex (also abbreviated as FX) stands for foreign exchange and is by far the world’s largest market. A market that is open
24 hours a day only taking a break from Friday 21:00 UK time till Sunday 21:00 Sunday. Approximately 3-5 trillion dollars’
worth is exchanged A DAY! – an amount not easily comprehended by the general public. Let me try and show you visually…
One hundred x $100 bills is a little over 1cm in thickness and equates to $10,000
$1,000,000 (one million) is 100 lots of these – easily stored in a bag.

$100,000,000 (one hundred million) would therefore be an amount 100 times the above and could fit onto a pallet.

Want to see what one billion ($1,000,000,000) would look like – ten of the above

Okay ladies and gentlemen… this is how much one trillion (1,000,000,000,000) will look like (1000 of the above). That’s
right there are two lots of pallets stacked on top of each other and that little red spec is the man in the bottom left corner.

Now the kicker… 3-5 times the above is traded in foreign exchange globally EVERY, SINGLE, DAY! Hard to imagine right?

Foreign exchange put simply is exchanging one currency for another and is denominated as currency pairs (one currency
against another), simultaneously buying one currency and selling the other. How much of currency A will it take to
purchase a certain amount of currency B? Today, buying things from overseas online is common practice. Buying products
or paying for a hotel overseas, the monies from the purchase will be exchanged, allowing the seller to receive monies in
the currency useful for his/her domestic country. Without this conversion, if the seller wanted to sell globally, they would
have a heap of random currencies from all over the world.

Let’s use a real life scenario. Picture you are a hard worker who lives in Australia and have been saving for a trip to spend
next summer in Italy, Europe. While booking your favourite hotel on the Amalfi Coast, you see the total for the 5 days is
€750 EUR. At the payments page you select payment in Australian dollars and the amount changes to $1,170 AUD with a
notification indicating that today’s EUR/AUD exchange rate is 1.5600. This is showing you that every €1 EUR is worth $1.56
AUD. By making the booking, you have now completed a foreign exchange transaction!

In order to calculate this, all we needed to do was take the €750 and multiply is by the exchange rate of 1.56
EUR/AUD to give us the Australian dollar amount of $1,170.

You might ask yourself why I need to know what the exchange rate is and where it is going.

Let’s look at the exact same example, only now you have waited 4 months to finally book your hotel in Italy. In that time,
you didn’t notice that there has been a strong upward movement in the value of the EUR and some very good news has
come out from Europe about a strengthening economy (fundamentals you will learn about in later topics). As a result, the
strength of the EUR against the AUD has now jumped up to 1.79 EUR/AUD in that time.

In deciding to wait before you got the booking done, you now go online and although the booking still says €750,
when you select to pay in Australian dollars, the cost to you is $1,342.50 (€750 x 1.79). In that time, that same
booking is now costing you $172.50 more. It is movements like these that traders look for in order to make
money from the fluctuating currency prices.

 Profiting from FX movements:
1.2.1 The strength of one currency against another

A trader uses movements in the exchange rate, they predict which direction the market is going to go. It does not matter
whether the currency is going up or down, they can make money in either direction. Confused? We will explain later. The
basic mechanics is simply buying and selling money of different currencies. Technology and software have allowed the
retail trader to be able to access the markets through broker platforms which make it simple to speculate and profit using a
tool called derivatives WITHOUT having to buy, hold and sell any physical currency (underlying asset).

If we refer to the example before, the value of money can change over time. Sometimes these movements can be very
sudden and sometimes quite gradual. FX has a strong reputation for having the most volatile (rapidly changing)
movements and this is what makes it so attractive to traders. It can be a short time before a large movement occurs
allowing a trader to capture significant gains.

Like any market, the laws of economic supply and demand determine the value. If an economy is looking strong and
investing our money in that country will provide a larger return, foreign investors will be eager to put their money here.
This is known as foreign direct investment. First, they will need to buy that currency – and here lies the exchange. If more
people begin trying to buy the more desirable currency, this will push up the value as demand grows making it a stronger
exchange rate. Just like when investors buy shares in a company, the same concept is used with foreign currency.

While there are many methods and tools to use currency movements to your advantage, the most common and simplest
form is buying one currency, waiting until that currency is stronger, and then buy back the original. Let’s look at the
example below:

You are a trader with $100,000 USD in your hands and you notice that GBP/USD = 2.0000 (1 pound buys 2 dollars, or 1
dollar buys 0.5 pounds). Based on current market analysis, you believe the Great Britain Pound will be strong than that
against the USD in 5 days’ time, so you decide to swap your USD and buy £50,000 GBP ($100,000 / 2.0000).

- 5 days later you were right, an extraordinary move happened with the GBP strengthening and now the GBP/USD
is worth 2.1000 (a very large move).

- Happy with the movement, you decide to exchange your £50,000 back into USD, now at a rate of 2.1 instead of
2.0.

- £50,000 x 2.1 = $105,000 USD
- In 5 days’ time, the trader has made $5,000 simply by guessing the direction of the market.

1.2.2 Different tools to trade forex?
Traders most commonly use the following financial instruments to profit and speculate on the FX market. Each has
advantages and disadvantages such as differences in liquidity, transparency and costs.

 Spot market: currencies traded instantly and on the spot using the current market price. These topics will focus
on spot trading techniques as traded by the larger proportion of traders.

 Futures market: A contract exists to buy/sell an amount of the currency at a future date for a pre-determined
price.

 Options market: Contract in place to buy/sell an amount of currency at a specified price up to an expiry date. The
contract gives the buyer the right or the ‘option’ to use this contract if the market price moves in their favour. A
premium is therefore paid for this contract.

 Exchange-Traded Funds (ETF’s): A fund which can contain a number of products such as currencies, stocks and
the like allowing a trader to diversify.

Knowing when to buy or sell on a currency pair is one of the crucial steps to becoming a profitable trader. The other key
part of being a successful trader is self-discipline to enter and exit the market when needed – control the greed! The first
step is making sure you know the base currency (covered in later topics). If you expect the GBP (British pound) to remain
strong and feel the USD will weaken based on a falling U.S. economy, your move would be to BUY GBP/USD. The pound is
the ‘base’ currency and you are buying pounds on the basis they will rise against the dollar.

Alternatively, if you felt the USD would remain strong and the British pound would weaken, you would look to
SELL the GBP/USD.
We look at the ‘base’ currency on to be the ‘basis’ on which we buy or sell against the other currency. The next topic will
cover important terminology to ensure this makes more sense and how to read the currency pairs.

 Leverage & trading on margin – trade $100,000 using $500:

1.3.1 What is leverage?
The saying of you need to have money to make money is only partially true when dealing with Forex, you get some
assistance. Many new traders initially don’t understand how people can make so much return on forex trading. Does
everyone have a spare $100,000 sitting around to put on the market? Of course not!

Online trading accounts through brokers like the ones we give you access to offer a very useful facility called leverage. The
term is also referred to as trading on margin where you can multiply your position by up to 200 times (sometimes up to
500 times). This form of leverage allows traders to not tie up all of their capital in order to still make strong returns by
controlling a large amount of money and only using a small amount of your own.

By trading on a platform which gives you 200:1 leverage (0.5% margin), you are able to ‘control’ up to 200 times the money
you have available in your account. Let’s take the example earlier in this topic, in order to capitalise on his $5,000 profit,
the trader needed to have $100,000 to buy and sell currency with. This 5% return required a very large move in the market
of 1000 pips (discussed in later topics) and was traded at a 1:1 leverage (no leverage, full amount used).
If that same trader was using a trading platform offering 200:1 leverage, they would instead only need $500 ($100,000 /
200) to control the same amount. The platforms are essentially allowing you to control a much larger amount as long as
you have the available margin ($500). That same trade at 200:1 leverage of 1000 pips move would have profited him not
$5,000, but $1,000,000!!!!!
How this works is the platform will set aside (tie up) $500 as locked funds while you have that position open controlling
$100,000 worth of currency. Once the trade is closed, that $500 is freed up and once again available in the overall equity to
trade.

1.3.2 What is margin?
This $500 used and stored on the side from the example prior is called the margin. Think about this for a second, a trader is
now able to control $100,000 to trade with, and potentially make a $5,000 profit, by only having $500 available in margin!
It is because of these facilities that traders are able to make such large returns on their capital by effectively trading on
borrowed capital.

Example
Putting this into practice, we can see that when a trader opens one standard position (one lot = 100,000 units of the base
currency) on the EUR/USD, they are controlling €100,000 euros. For ease let us say the exchange rate for EUR/USD is
1.5000. This position holding €100,000 is equivalent to $150,000 U.S. dollars.
At our level of margin of 0.5% (200:1 leverage), a trader only needs USD$750 set aside as margin in their account to be able
to open this trade and control the equivalent of EUR€100,000 or USD$150,000.
Now, you are able to maximise your returns by trading on just one standard position/lot for USD$750 as if you had
USD$150,000.

As previously mentioned, when the trade is closed, the margin being used to keep the position open is again released and
returned to your cash balance. It is possible to see on most platforms the cash balance, margin used for open positions,
profit/loss and net overall equity available for more trades. Certain platforms will show the margin required to hold a
certain trade open while others will show the exact monetary value needed. When not enough equity is available, a broker
will likely request a margin call (top up your account in order to keep the existing trades open) otherwise some or all of
your positions will be closed out. Our topic ono risk management covers how to avoid margin calls and adequate account
sizes.

But be careful!!! Like the upside movement in your position of controlling $100,000 also comes the risk that the market
goes the other way and your losses can also chew away your capital fast. That is why it is very important to master the
psychology and risk management of trading (later topics). These exponential movements that happen on the upside can
just as rapidly deteriorate your account.

1.3.3 The cons of leveraged/margin trading
Not everything is rosy and peachy when it comes to trading on leverage and margin. While the upside when you’re in profit
can result in extraordinary returns, being on the losing side of trading on margin can be dangerous. This is why so much
time has been spent teaching and mastering the topics of psychology and risk management rules to help traders manage

the risk on the downside and enjoy the high returns on the upside. If it was easy, everyone would be cashing out by trading
forex, those that stick with it are usually the successful ones.

Now, let’s have a quick look at some of the downsides of trading on margin and having leveraged positions:
 Trading on margin increases both profits relative to the account capital as well as the losses. A trader with only
$10,000 in their account deciding to trade on standard contracts controlling $100,000 worth can wipe their
account out in hours.
o For the following basic example, the calculations and terminology used can be understood in the
following 2 topics. If a trader was silly enough to not use appropriate contract sizes and was seeking to
amplify the returns quickly, they could open two standard contracts at 200:1 leverage (0.5% margin) on
a EUR/USD and use allocate $1,000 in margin ($100,000 lot size x 2 contracts x 0.005 margin). This
position would experience moves of $20 per pip. If the trader decided to enter the market 1.3200 to go
up, and instead it went the other way and in two days was at 1.3000 (200 pips loss), this would mean
their position would be down $200 x $20 = $4,000 on a single trade. A 40% loss of your capital in one
trade over two days. This is why the topic of risk management is so important and will show you how to
avoid these scenarios.
 Traders can experience the dreaded margin calls if they are not using appropriate risk management. This
feeling of needing to deposit more money for a losing trade to not be closed out by the broker has but many
people in financial hardship and is not a pleasant experience.
 Higher leverage also affects the cost of the transaction taking place. If a trader was using more leverage this
means they are controlling a higher amount of money relative to their account. The way brokers make money is
through the bid/ask price spread. A trader on the EUR/USD offering a 2-pip spread using one mini contract is
looking at a transaction cost of $2 ($1 per pip value). If the trader decided to use a standard contract on the same
trade is multiplying his position by 10 and it would cost him $20 to enter the same trade.

Topic 2: Market structure & forex language/terminology

 FX Market Structure:
It is important to somewhat understand how this $3-$5 trillion a day industry operates behind the scenes. Many people
may believe that like the other tradable markets such as stocks/shares, there is an exchange somewhere which processes
all the orders for FX trade. Unlike the London Stock Exchange, the New York Stock Exchange or the Australian Stock
Exchange, there is no central exchange or physical floor for the FX market. In following topics we look at the difference and
comparisons between the stock market, commodity market and the forex market.

2.1.1 Where is forex traded?
The FX market is traded on what is known as the interbank market or Over-the-Counter (OTC), meaning everything is run
24 hours electronically between networks of large financial institutions/banks. This is what makes the market spread
globally and contributes to the fact it is the world’s largest. There are no clearing houses to secure the trades. All
participants trade one another based on credit agreements that are set up. As traders do not need to go through a
centralised exchange, there is no single price for a given currency which is why you will see slightly varying price quotes on
different broker platforms. Each broker receives their prices/liquidity from usually more than one source and has differing
agreements, whether bank or other financial institution.

Liquidity is passed down from the original sources to the traders via a number of ways. The most common path starts from
the largest banks in the interbank market which use systems such as the Electronic Broker Services (EBS) to trade between
each other. The rates at this level are very tight and not like the ones eventually passed down through the broker platforms
to the retail traders. This is because the brokers and hedge funds in order to provide their services need to mark-up
spreads to make profit from the rates they receive from the commercial banks. Before the close of the century the growth
of electronic execution played a crucial role in reducing barriers to enter thus increasing the potential participants that
could utilise the market. Previously, only those who had millions to trade with were able to participate.

INVESTMENT/MAJOR BANKS  ELECTRONIC BROKER SERVICES (EBS)  SMALL/MEDIUM BANKS  BROKERS/MARKET
MAKERS/RETAIN ECNs/HEDGE FUNDS  RETAIL TRADERS

2.1.2 The USD and dollar index
The USD as we have covered in the previous topic is leading traded currency on the planet which comprises of more than
80% of all transactions. Key reasons for this can be attributed to the country’s largest economy, the USD being the reserve
currency of the world and having the largest and therefore a very liquid financial market. Since the euro was developed, its
popularity has risen to a strong second, however still only about half of the U.S. dollar. Almost all trading processed on
margin through brokers is known as ‘speculative’ trading, meaning traders are speculating on the movement of currencies
to gain profit. The buying and selling of these currencies intraday creates the largest portion of the volume made in the
forex world.

The USD with its status of being the common currency to be compared against has, as a result had an index created called
the U.S. Dollar Index and abbreviated as USDX. Several stock exchanges have an index (covered in later topics) which show
the movement of the equity markets based on weighted averages of several components, usually top shares. The USD has
a similar index which is derived from a basket of six other major foreign currencies against the dollar. Although only six
other currencies are used to derive the index, it is used globally to determine the USD strength.

The six other currencies and their weight contributed to make up the USDX are euro (57.6%), Japanese yen (13.6%), British
pound (11.9%), Canadian dollar (9.1%), Swedish krona (4.2%) and the Swiss franc (3.6%). Given the euro’s large
contribution given the number of countries which use it, many have argued that this index is too heavily influenced by the
strength of the euro. As a result, we often see the EUR/USD charts to be fairly inverse to what the U.S. Dollar Index is doing
(when one goes up, the other tends to be going down at a similar rate).

Image Source: Theice.com

Reading and trading the USDX is relatively easy to read as it is also represented as a chart like any other currency pair and
the value of the index is compared against 100, when the index was created. A value above 100 means the index is higher
than the original value and one lower than 100 means it has dropped in value. This value represents the relative strength
of the USD globally and can be used to show a clearer understanding of market outlooks for the U.S. and the general trend
for the USD as a whole.

 Understanding the forex language:
It is not surprising how large the foreign currency trading industry has grown to, and as such developed its own language
and lingo. It is common to hear traders use sentences such as ‘I shorted five lots of dollar swissy last night!’ and
completely understand what they are talking about [translated to: ‘I placed five standard contracts of 100,000 units for the
Swiss franc to strengthen against the U.S. dollar last night’].

2.2.1 Majors & minors – the nicknames
First, let’s take a look at the different names and nicknames some of the more commonly traded currencies (the majors)
use. For most currencies, the three letter currency symbol uses the first two letters to identify the country while the last is
to abbreviate the name of country’s currency. Traders have grown custom to using short and easy to use names for several
of the major currencies.

USD EUR JPY GBP CHF AUD NZD CAD
U.S. Euro Zone Japan Great Britain Switzerland Australia New Zealand Canada
Dollar Yen Dollar
Dollar/Buck Euro Yen Pound Franc Dollar Dollar Loonie
Euro/Fibre Cable Swissy Aussie Kiwi

The terms majors, minors, currency crosses and exotics are terms used for different types of forex currency pairs.

Majors: most traded currencies, often considered pairs against the USD
Minors/Currency Crosses: usually refer to any of the remaining, non USD pairs (covered in the next topic)
Exotics: a currency pair which is really rarely traded, for example the EUR/SEK (euro against the Swedish krona). Pairs such
as this are known to have significantly larger spreads due to the illiquid market available for trade.

Some common currency pair nicknames across the majors are derived from the individual nicknames seen from the
previous table have been shown below. The same can be done with currency crosses using EUR, JPY, GBP, etc.

EUR/USD GBP/USD USD/JPY USD/CHF USD/CAD AUD/USD NZD/USD
Euro dollar Pound dollar Dollar yen Dollar swissy Dollar loonie Aussie dollar Kiwi dollar

2.2.2 Long/short, bull/bear, base/quote… What do they all mean?
Any market with a price movement, whether FX, stocks commodities or other will go either up, down or sideways. There
are several terms traders and economists use to describe the movement of the market with the below being the most
common (all mention the term for a rising market first and a falling market second). This section will help clarify some of

the terminology and meanings around words used which ultimately mean a price moving up/down, buying/selling or if a
currency is on the left/right of a quote.

Base & Quote
Refers to which side a specific currency sits, right or left. The quote currency is the currency on the right and the base
currency is on the left. This means that 1 of the base currency on the left buys [exchange rate] of the quote currency on the
right. For example, if AUD/USD = 0.8412, this means that 1 Australian dollar will buy 0.8412 US dollars (approximately 84
cents US). This can also be read as 1 AUD / 0.8412 USD.

Bullish & bearish
A very common term used often in the stock market but applied to all financial markets. Bullish means the market is
heading upwards (price is appreciating), while bearish means it is heading down (price is depreciating). The best way to
remember which is which between a bull market (up) and a bear market (down) is to think of the animal and how they
attack. When a bull attacks, it strikes with its horns in an upward direction trying to throw its prey up in the air. On the
other hand when a bear attacks with its paws, it starts high and tries to lash downwards at its prey. Bull, upwards, bear,
downwards.

Long & short
Unlike the animals, long and short are terms which have been derived over time and often used in options trading
positions. When you are long in a market, you believe it is going up and when you are short, you believe it is going down.
Shorting the market or going short is a term often used when you have a position to make money when the market drops.

Buyers & sellers
Just like in basic economics of supply and demand given to us by the great Adam Smith (visit his statue in Edinburgh), when
there are more buyers in the market, the price tends to rise. Similarly, when there are more sellers in the market trying to
get rid of their stock/positions the market price will drop as they try and get rid of everything. A buyers’ market therefore
shows a rising price and sellers’ market shows a falling price.

2.2.3 The spread – Bid & ask prices
In short, the spread is the difference between the bid and the ask prices. The bid price and ask price are the two different
levels which differentiate the price offered to buyers and the price offered to sellers of the currency. If you have ever
travelled to another country and gone at the airport to exchange your money, you may recall there being two prices. Have
you ever got excited about a price you saw, calculated it in your head and then when you got to the counter were offered
significantly less? Chances are you may have used the wrong price to calculate.

The ‘bid price’ is what the person at the counter (i.e. the market) is willing to ‘buy’ the quote currency (on the right) for.
The ‘ask price’ (sometimes referred to as the ‘offer price’) is what the market would ‘sell’ the quote currency for against
the other. A currency pair showing both the bid and ask prices will always show the bid price on the left and it will always
be smaller than the ask price, on the right. This is known as the spread, which is how the platform providers take a slice of
the action. Most platform providers and brokers compete against each other by claiming to offer lower spreads which is
more beneficial for us as the trader. We benefit from lower spreads in price as our trades have to move fewer pips in the
direction we choose to turn profitable.
For instance, an 8 pip spread would mean the trade place would have to move 8 pips before it broke even. If the trade was
2 pips this would allow the trader to break even in 2 rather than the 8.
There are so many platform providers out there it creates a very competitive market, so don’t worry if you’re worried
about not getting the best deal (choosing a platform provider will be discussed later on in topic).

Some platforms will show you the spread on the prices – in this case, it is 0.6 (Ask 0.75044 – Bid 0.75038). Notice how the 0
is dropped off entirely and the focus is on the 03 and 04. This is because currencies move predominantly by pips which are
0.0001 (1 pip) of the price. This will be covered in more detail in the following topics. Recently platforms have added
pipettes (the 5th digit on the price for accuracy). Without these, the spread would actually just be 1 pip (0.7503 – 0.7504).

For example, someone who has just arrived to the US from Europe might go up and see the following:
EUR/USD: 1.3248 / 1.3848

They can then take their €200 they brought with them in their pocket and exchange them at the ‘bid’ price of 1.3248
receiving USD$264.96 (200*1.3248). When that traveller is leaving the US and goes back to the same counter (assuming
the prices haven’t changed at all) with excess USD needing to be changed back to euros, they would sell the quote (USD)
currency at the ask price. If they came back with exactly USD$264.96 they would then get back €191.33 ($264.96/1.3848).
This is a difference/spread of €8.66.

WAIT, I’ve learned pip values from earlier topics and I can see that 1.3848 – 1.3248 = 0.0600 (A 600 PIP SPREAD!?). This is
far too high and yes we agree. However unfortunately at the local banks and at airports most people are exchanging a few
hundred dollars and not trading lots worth 100,000 units. Assume the wholesale market price for EUR/USD at this time is
1.3548 (the approximate price the company at the airport can get the currencies. This means they charged the customers
an extra 300 pips on each side.

A traveller exchanging €200 at the airport for USD will therefore buy them at the 1.3248 price and will get $264.96. Assume
the airport company bought those EUR at the wholesale price 1.3548 and therefore received $270.96 for that €200. The
company made a profit of $6 from your transaction. As you can see, at the airport they need to have big spreads as the
transaction sizes are much smaller.

On a trading platform this spread would be astronomically too high for trading due to the leverage and as the spread is
much less, a two-pip spread on EUR/USD showing 1.3548 / 1.3550 can also be written as 1.3548/50.

2.2.4 Order definitions (placing trades on a platform)
Placing an order on the market means you wish to enter the market, either long or short, at a certain price level. This price
level to enter the trade can either be above the current market price or below it. There are several terms used which can
be a little confusing. Most platforms make it quite easy to determine where your trades are being ordered to go, however
there are some platforms which will use these terms and it is important to know which one means what when looking at
placing trades on order.

Buy: Place order for market to go up ↑
Sell: Place order for market to go down ↓
Limit: Level indicated to try maximise profits and an order to take profit at a predefined level or better
Stop: Placed at a predefined level on the trade to limit loss – order to close the position if market hits this level

Buy Limit Order: Going long ↑ – Buy when price drops to a level below market price (cheaper entry level)
Buy Stop Order: Going long ↑ – Buy when price exceeds to a level above market price (confirms market direction)
Sell Stop Order: Going short ↓ – Sell when price drops to a level below market price
Sell Limit Order: Going short ↓ – Sell when price exceeds to a level above market price

2.2.5 Shorting the market – profiting from a falling price
Trading short/down is the most effective use of today’s platforms with the ability to place a trade going down. Meaning if
you feel the market is about to drop, we can place a trade and make money as the price as falling. Short selling in several

markets, particularly in buying stocks, can be a difficult concept for initial traders to grasp. With currency works in a
different way as you simply buy/sell the opposite currency in the pair.

The easiest way to explain the idea behind short selling with stocks however is to use this basic, theoretical example;
Say a trader is confident that the price of Stock A was going to drop and you wanted to make money off this drop
in price. The current price of Stock A is $100 per share. It would not do me any good to go and buy the stock as
the trader feels it will be worth less in a few days. So instead, he can borrow Stock A from someone who owns it
and promise (contracted) to give it back to them in a couple of days. Once he borrows Stock A, the trader
immediately sells it at the market price of $100 and now has $100 in his pocket. Three days later when he needs
to return Stock A to the owner, the trader goes back to the market and buys it back. Sure enough, they were
correct and the price dropped down to $75 per share. The trader can now buy it back at $75 and give the share
back, keeping the difference of $25 profit in his pocket.
If however the trader was wrong and he shorted Stock A and instead the price increased to $120, he would have
to buy it back at a higher price and lose money on his position.

This concept is used in many ways and allows traders to trade on any direction. All you need to know is that trading short
can be a very powerful method as the markets can fall very quickly allowing traders to make a lot of profit in a short
amount of time! Psychology forces us to think only trades going up are the best ones because throughout history and
today, things are better if they are valued higher. A great saying once told was never underestimate the power of trading
short, the market often takes the stairs on the way up and the elevator on the way down! The reason behind this is the
typical panic/herd mentality. When a price starts to drop, people panic and want to get rid of it quickly making the price
plummet much faster in case they are holding onto something worth much less. Remember this when finding
opportunities to trade on a falling market.

Topic 3: Understanding FX prices, profit/loss & interest rates

 Pip value, contract & lot sizes (direct & indirect):
This topic will give you the understanding of how several terms are used in Forex such as pips, lots, direct, indirect, etc. so
you will know the forex geek jargon.
‘Pips’ is a term you will hear most in forex trading and is used to determine how much a currency pair has moved in price.
They measure the smallest amount of change in the exchange rate and stand for “price interest point.” For currency pairs
which have four decimal places, one pip is equal to 0.0001. A movement in a rate from 1.2684 to 1.2685 is a 1 pip
movement. Some currency pairs which are quite high in value only use two decimal places (most notably the Japanese Yen)
0.01. Several brokers now offer fractional pips which just mean they also show a fifth decimal place (or three in the case of
the Yen). These fractional pips are called pipettes and are used for increased accuracy.

Determining a pip value comes down to three factors: the currency pair being traded, the size of the trade and the
exchange rate. As the movement of the rate changes even by a single pip, this can have a strong impact on the trade
position open. To determine the value, we look at what currency is on the right of the currency pair.

3.1.1 Contract & lot sizes

In forex terms, one ‘lot’ is a similar way to saying one contract or number of units. This was the language used in the past

and remains today. Understanding what size contracts to trade allows traders to manage the position sizing used for

appropriate leveraging and therefore risk management. On a standard contract 1 lot trade size is equal to $100,000… two

contracts would be worth $200,000 and so on. Trading platforms to accommodate for the larger range of traders have

created mini, micro and nano lots. This allows traders to use much less and enter into much smaller positions. Each

position is decreased by a multiple of 10.

Standard lot: 100,000 units

Mini lot: 10,000 units

Micro lot: 1,000 units

Nano lot: 100 units

E.g. A trader has 1 standard contract open and is controlling a $100,000 trade open on the AUD/USD. The trader opened
the trade for the AUD to strengthen against the USD at 0.9330 and closed the trade at 0.9350, making 20 pips (0.9350 –
0.9330 = 0.0020). In order to calculate how much this trade made us we multiply $100,000 * 0.0020 = USD $200 (same as
20 pips x $10 per pip). This is a USD $10 move for every pip. If the trader entered into 1 mini contract/lot, the profit would
be $20 instead of $200. Note that this works for when you are using a USD denominated quote currency (direct rate).
Remembering from previous topics, the quote currency is the currency on the right and the base currency is on the left.

This will be important when we begin learning about risk management and stop losses. With risk management we can
determine how much money is at risk when we place a stop loss a certain amount of pips away. On the above example, if
the trader had an account of $10,000 and only wished to risk 2%, they would calculate a stop loss which would risk only
$200 (2% x $10,000). At the direct rate of $10 per pip moves, the trader then will look to place his stop loss 20 pips from
entry ($200 risk / $10 per pip). This is one way of risk management; later topics will cover other ways to determine where
to place a stop loss and what a stop loss is.

For the following examples we will show how to calculate the value per pip in USD on a standard contract account.

Direct rates: Where USD is quote currency (USD on the right – e.g. EUR/USD)
Value per pip = Lot size x pips (100,000 x 0.0001 pips = $10 USD per pip)

Indirect rates: Most currencies are traded indirectly against the U.S. Dollar (USD on the left – e.g. USD/CAD). USD is the
‘base currency’ and CAD is the ‘quote currency.’ If USD/CAD = 1.2000
Value per pip = Lot size x pips / current rate (100,000 x 0.0001 / 1.2000 = $8.33 USD)

Cross rates: Currency pairs which do not involve the USD are considered as cross rates. An example of this is the EUR/GBP.
If EUR/GBP = 0.8123 and EUR/USD = 1.3258
Value per pip = Lot size x pips / current rate x base quote (100,000 x 0.0001 / 0.8123 x 1.3258 = $16.32 USD)

As you can see, the currency pair being traded, the size of the trade and the exchange rate are all very important in
determining the value of the pip.

 Currency cross pairs:
3.2.1 What are currency cross pairs

Currency crosses enable traders and people to exchange currencies without needing to first exchange it into USD, as was
done initially. Once upon a time, if someone wanted to use their Canadian dollar to buy the British pound, they would first
need to change their Canadian currency at the USD/CAD rate, and then use the USD amount to change into GBP. These
days, accessing the direct currency cross pair of GBP/CAD is simple!

3.2.2 Why trade cross pairs
As the USD still has great strength in several important areas of global trade including gold and oil and many agricultural
and industrial commodities which are priced in USD, there is a lot more influence on the USD pairs (which are the majors
“more liquid popular currency pairs”). This is why trading currency crosses provides a vast range of opportunities that are
not entirely influenced by the global reserve currency. The points below are great examples of when cross pairs have been
a great choice when choosing what to trade.

 Traders enjoy trading cross pairs as they are less likely to be influenced by large spikes in the market due to
economic and news reports. An announcement on the USD can potentially cause dramatic spikes in for example
the EUR/USD whereas if you were looking for a gradual trend in a cross pair such as EUR/CAD it is more probable
to have continued on its path.

 Expecting to trade on economic fundamentals can be a wise decision not to trade on the majors and opting for a
currency cross pair. For example, say you saw an influential piece of information was due to be released in
Europe and you were expecting it to increase the EUR but you also note that the USD has been trending upwards.
The impact of the EUR result in your favour would not be as strong given both currencies are appreciating
causing a flatter move. Now, instead you have picked up that the Australian dollar has been on a downward
trend for the last 3 months… One would think this cross pair could result in a much larger move in your favour
given the information came out as you expected, potentially resulting in a smart trade which sees you capture
the larger move on the same information – thus gaining more profit.

 Saves traders from needing to trade on synthetic pairs. Synthetic pairs are opening two trades to get the same
result of a cross currency pair. For example, buying EUR/JPY by opening a buy position on EUR/USD and a buy
position on USD/JPY (the USD cancels each other out and you have the same result as a EUR/JPY trade). This is
done mainly by very large institutional level trading when they do not have enough liquidity to enter the trade
and need to use currencies which have the liquidity they need such as against the USD. Doing this yourself will
only cost you the spread twice as well as tie up more capital in margin. There is no reason.

 Even a trader more inclined to trade on the majors can use currency crosses to help make better decisions as
they can provide hints about the relative strength of the major pairs. By assessing the EUR/AUD, it is possible to
see which of the EUR/USD or AUD/USD is a better trade based on similar indicators. For example, if EUR/AUD
was trending upwards (strengthening EUR against AUD), then to buy the EUR/USD would be the right answer as
the AUD is likely to strengthen less against the USD and provide less pips for profit.

The second and third most traded currency after the USD are the EUR and JPY making them also very liquid and attractive
currencies to trade on. Arguably it has been noticeable that news which comes out from Europe or Japan will affect the
EUR and JPY crosses more than the EUR/USD and USD/JPY. However there will always be some influence on what happens
in the US. As dollar pairs move (those which include USD), there will be action of buying or selling of the other currency
against the dollar which will somewhat appreciate or depreciate the currency even against the other pairs.

A significant thing to remember about cross currencies however is that they are not as popular, and as a result will have
less people trading them. This means that liquidity will be lower and a risk may be run to see strange changes in volatility
levels. Trading on very abstruse pairs may increase exposure to more spikes than the USD and due to this we see more
traders when looking at cross pairs stick to yen or euro cross pairs. Lack in liquidity could potentially also mean a wider
spread and therefore costs more to trade.

Examples include: CAD/CHF, ZAR/JPY, NZD/CHF, etc.

3.2.3 Calculating currency cross pairs

Manually calculating the cross rate is simple, but unnecessary as broker platforms now provide the exchange rate of each
cross pair. Traders do however use mismatched rates between the example rates above to try and make risk free profits.
This is called arbitrage trading; we won’t spend much time on this in this section. Large institutions have software which
utilises speed and significantly large sums buy and sell using millions or billions of tiny mismatches in the rates to capture
risk free profit.

Let’s take a quick look at very simple example how cross pairs are calculated. In order to determine the GBP/CAD, we need
to use rates with a common denominator (most typically USD). By selecting two rates USD/CAD and GBP/USD given they
both have the USD associated with it, we can simply multiply them together to get the cross pair.

 Given USD/CAD = 1.3000
 Given GBP/USD = 1.5000
 Then GBP/CAD = 1.9500 (1.3000 x 1.5000)
Notice that in order for this to work, the currencies being multiplied need to have the USD (common currency) on opposite
sides. If you are trying to work out the cross pair for currencies with the USD on the same side, all you need to do is invert
one of them to switch the sides. Inverting the rate is simply dividing the rate by 1 (1 / rate). For example is you are trying to
find out what the AUD/EUR rate is by using the AUD/USD and EUR/USD, you cannot just multiply them as is.
 Given AUD/USD = 0.7500
 Given EUR/USD = 1.3000
 Then AUD/EUR = ((0.7500 x (1 / 1.3000)) = 0.5769… SIMPLE.

Remember that you don’t need to know how to calculate these as all platforms will already have the cross rates available
that you will want to trade.

 Interest Rates:
3.3.1 Interest rate rollover

Although there are many traders who have become successful without fully understanding the daily rollover interest rate
either paid or earned, there are advantages to knowing how it works.
Remembering that trading on margin is effectively trading on borrowed money, at the end of each day (broker platform
cut-off time) which is typically for US brokers 5pm EST, if a trade is still open. Technically, each trade is closed and re-
opened (rolled over) each day and if a trader does not wish to pay or earn interest then they must look to close the
position before the close of the day.

Interest is calculated on the position size and either added or subtracted from your account depending on which currency
pairs are traded and in which direction. Added to my account you might be thinking? Why would the broker be paying me
interest when I am trading on their margin? As we know from previous topics, trading currency is buying one currency
while selling another and therefore borrowing one currency to buy another. Interest is therefore paid to the broker on the
currency borrowed and earned on the currency bought.

Each country has their set interest rates on the currencies which are all relatively low globally since the Great Financial
Crisis. Given the broker used have not adjusted the rates or other factors, buying a currency with a higher interest rate
than the one you are borrowing will earn you interest (i.e. buying AUD/USD in 2016 as the cash rate in Australia was 1.75%
and in the United States 0.5%). A reliable website we have found to check what central bank interest rates and national
inflation rates are is global-rates.com.

3.3.2 The power of trading interest rate differentials & carry trade
After reading about interest rate rollovers, it may become obvious that we can make money while making money. If we are
on the buying end of a currency with a much higher interest rate differential than the currency we are selling, while being
on a winning trade, we have essentially earned a little bonus on our trade (given the trade is left open overnight). The
concept of trading on interest rate differences is known as carry trade.

This concept can get exciting for some but we need to remember that we are trading on leverage of 200 times or more.
This means that if we were to open a position on a trade buying a currency with 6% p.a. interest and selling a currency with
2% p.a., the 4% per annum difference would actually equate to 800% return (4% x 200 times leverage). Now doesn’t that
sound inviting! If however a trader did successfully pick a trade to be profiting after a year, the bonus return from interest

rates could be significant. It is just as important to be mindful of longer term positions which may find you paying relatively
high interest rate differentials.

Beware however, that this would mean the market would need to finish at the same position you opened it after an entire
year and not fluctuate against you enough to close you out. Keeping a position open runs the risk of staying in a market
moving against you which could cause high losses. Using strategies such as stop-losses (talked about in later topics) can
help manage this risk.

Australia has comparably (2016) to the rest of the developed economies one of the highest interest rates while Japan has
for a long time had near zero and at times negative interest rates. This has made the long AUD/JPY a popular currency pair
when it comes to trading for interest carry trading over longer periods.

In summary, if you plan to trade a position for a longer period of time to capture a long-term trend, it is worth while
looking at whether you may be paying interest on the position and how much this could accumulate to. This will allow you
to stay in the position for as long as necessary to capture the full growth and profit.
A good trader will know when certain economy’s market sentiment feels like they will be growing or dropping, which often
results in an increase or decrease in the country interest rate respectfully. Two key things to look for when opting the carry
trade strategy are:

- Find an interest rate differential with high returns
- Look for a strong and stable trend which would result in earning the interest rate differential

Topic 4: Reading the charts – prices & timeframes
 The common price charts:

In time, FX charts will become your best friend! They are what you will refer to before any trade is placed unless you wish
to go in blind, this is not advisable! Would you cross the road without looking or hire a new executive to run your company
without finding out their experience? Success is in the preparation going into a trade with eyes wide open.
Charts show a historical picture and when it comes to trading, history repeats itself many times over but also has the
potential to do completely unexpected things. More often than not, they can be predicted by identifying the correct
indicators and with the correct risk management and psychology, you can protect yourself from the unexpected moves.
Trading is not an exact science but if you master the risk management and good strategy you can slant probability in your
court. This topic will show you how to read the charts and determine how the price has moved at any given time.
Many will agree the most influential item you will see on a forex chart is the price level. This can be represented by a line
chart, bar charts and most noticeably, the candlesticks. Both bar and candlestick charts are very popular because of the
information they represent and the ease of interpretation. Colours are also important. You may already know that red
commonly indicates a fall in price and green represents a rise in price. If a bar is green, this means that the price for that
time frame closed higher than the price when it opened for that period. The opposite if the bar is red. Some charts use
black and white colours to represent the rise and fall in the markets among many other colours (charting software lets you
set up any colours you want).

4.1.1 Bar charts & time frames
Bar charts contain an open level, a vertical line and a close level. The 4 key pieces of information they represent are the
open level, the high (highest point), the low (lowest point) and closing level of the timeframe the bar chart represents.
The great thing about most charting software is that you can select what time frame each bar represents.
For example, if you select a daily chart, each bar will show the open, high, low and close of that day. 5 bars in a row
represent 5 days in a row. The open level shows the price when the day began (the first price traded that day), the high
shows the highest price traded of the day, the low shows the lowest price traded of the day and the close shows the
closing price (last price the product was) that day. Similarly, if you open the charts for a one hour time frame, each bar will
show those levels in that hour and five in a row will represent five hours of historical information.
The direction of the bar, whether it went up or down, is not only represented by the colour, but where the open and close
is. The open (shown on the left side), is lower than the close (shown on the right side) if the market went up (close price is
higher than open price).

The image below shows what a bar chart looks like and the level it shows. The range of the price (in a day if we are looking
at the daily charts), is represented by the difference between the high and the low prices.

4.1.2 Candlesticks
Candlesticks are effectively the same as bar charts as they show the same information. The only difference is that they are
shaped in a way to have a body, a head and a tail. The two tails on top of the body show the high and the low levels while
the body shows the open and the close. The main difference is that looking at single candlestick will not show whether it
has moved up or down without either seeing the entire chart or seeing the colour of the body (e.g. green for up and red for
down).

4.1.3 Line charts
Line charts are much easier to interpret. They can be selected to show the market points at the mid, high and low of the
trading period and are used to indicate an easier view of the overall trend of the market. They are drawn as a single solid
line and use to make it easier to see the direction of the price levels. As you can see below, they don’t show nearly as much
information for each period as the candle or bar charts.

 Interpreting the candlestick & bar charts:
It will become very useful to find the ways to interpret the charts which will identify opportunities or changes or
continuations of the price movements. Below are a few if the important, stock standard identifiers in price movements
throughout a bar or candlestick which show you what happened throughout the hour, the day or the month. Being able to
identify these along with other strategies shown in later topics, traders can maximise their opportunity for returns.

4.2.1 Long vs short bodies
The size of the candlestick also tells a small story which traders use to their advantage. Generally speaking, the longer the
body of a bar/candlestick, the stronger the buying or selling pressure has been, driving the market price to either spike

heavily or plummet right down. Alternatively, a short body indicates very little price change in that timeframe and
represents consolidation of the market.
If we are looking at a chart using green and red for a rise and fall respectively, the longer the green body is, the further the
close is above the open for that period. This shows that price has moved upwards significantly and buyers are more
aggressive than sellers. A single bar/candlestick which is very large compared to the others in the upward direction does
not necessarily mean the overall market is bullish. Likewise for a long red/black bar or candlestick does not show the
overall market is bearish. This could be a one off movement. Look at the image below which shows a strong move upwards
but the market remains in a downward trend as well as the same for the opposite.

4.2.2 Long vs short tails
Long and short tails, like the bodies can give more insight in indecisive movements in the market. The upper and lower tails
(or shadows as they are sometimes called) above and below the open and close can provide great information about the
trading session. The upper tail shows the session high and lower tail shows the session low. If the tails are quite short, this
means that the price didn’t move too far away from the open and close levels and most of the trading was done within the
body. Alternatively, if the tails are quite long indicate the trading levels for that time frame extended well past the open
and close.
If a bar or candlestick shows a long upper tail, this means that at some point the buyers were very dominant and drove the
price upwards, however later in the session the sellers became more aggressive and drove the price down (vice versa for a
long lower tail and short upper tail.

4.2.3 Spinning tops & doji
Spinning tops & doji are often used for direction selection by traders. A candlestick with a long upper and a long lower tail
with a short body are called spinning tops. Spinning tops represent indecision as they show little movement from open or
close but both buyers and sellers were active during the session – without a clear winner as the price closed close to where
it opened. This is even more significant if the candlestick is used to show longer periods such as a daily period. It may not
be as significant if it was used to show the time in 5 minutes.

Doji are very interesting and are shown when the open and close price is the same or pretty much the same and the
resulting bar/candlestick looks like a cross or a plus sign. They convey a tug-of-war between buyers and sellers and the
result is a stand-off with neither buyers or sellers being able to gain control, often showing a turning point in the market.
The relevance depends on the preceding trend of the market. After a strong bullish candlestick, a doji above signals that
the buying pressure is starting to weaken. After a strong bearish candlestick, it can indicate the selling pressure is starting
to weaken (the longer the tails on a doji, the greater the indecision in the market). It is important to use other information
and pattern recognition along with the doji to decide whether to enter into the market.

 Using different time frames:
One of the most common questions asked of traders is, what is the best time frame to analyse and use as the entry points?
You will see that the chart can change significantly if you select the 5 minute view to the hourly to the weekly. There are
clearly quite a few different time frames to work with.
GBPUSD Weekly Time Frame (each stick represents a week)

GBPUSD Daily Time Frame (each stick represents a day)
GBPUSD Hourly Time Frame (each stick represents an hour)

4.3.1 Best time to trade
As we saw before, there are multiple options with the timeframes the price bars represent. Select the timeframe to suit
your trade style and your own personality. Unfortunately, there is no correct or easy answer. One of the best ways we have
found to select timeframes is to determine your own goals and length preferred in the market. In a very basic
approach/principle, if you seek to stay in the market for short term trading, then it is best to assess shorter timeframes.
Traders that look at bar charts representing the weekly moves aren’t going to use these for a quick decision on a reversal
expecting to occur in the next 5 minutes and give them a quick return. These trends could take weeks to come to fruition.
But it is always good to look at the overall picture and see the overall market trend with longer timeframes even when
trading off the shorter terms.

While the overall daily could be showing a downward movement, the hourly could be showing the market is actually
showing an up-ward trend throughout the day or the last two or three days. So which way do we trade it? Building your
strategy is important around this. Incorporating the longer time frame allows you to see the bigger picture of the general
trend or sentiment while the shorter timeframe can be used to find the ideal entry point of the trade. By using multiple
timeframes traders can take multiple vantage points they are looking to trade.

Types of traders Intraday Traders Short-Medium Term Long-Term
Pros Traders who trade several times Typically use between the hourly Traders which won’t usually ever
throughout the day will use very and daily charts at the most. The
short term timeframes such as 15, look at the minutes or hourly
common 4-hour chart is often charts. These traders focus on
5 or even 1 minute charts. used for these traders as it is a long term trends and keep the
These are entered for short term good midway view. Trades are trades open for possibly weeks to
periods and exited before the day often held anywhere from several get the full pips they are targeting.
Focus mostly on weekly charts
is done. hours to several days. with notice of what the daily and
monthly charts are doing. Trades
Trades aren’t left overnight and It can be assumed that the
exposed to changes in the market majority of traders fall in this can last months and should
definitely consider daily interest
for longer times. Psychology is category as it has trading rate rollover payments or find a
easier to manage when trades opportunities come up often
aren’t left in the market for long enough to maximise the return pair to receive interest.
Costs are much lower as fewer
trades are entered into. Traders

do not need to check their
positions as often. More time is

available to come up with

periods of time. Can use smaller without needing to stay in the strategy.

account sizes to maximise market for weeks. Can use smaller

leverage and margin used. stop-losses which means smaller

account sizes can be used.

Cons Traders need to be available all Trades are likely to be left Psychology is harder as trades are

day to watch the market and overnight which means potential open for longer. Influences can

decide on entry and exit points. As global market influence changes come about more often to impact

well as the time used all day, the overnight and possible interest the direction of the market.

costs of entering and exiting the charges. Interest rollover costs can

market several times to snap up potentially be very high to leave

usually smaller sized wins increase the trade open for that long.

significantly from the spread. Account sizes may need to larger

to accommodate for movements

on the downside/upside before

heading up/down.

4.3.2 Methods to try – using 3-4 time frames at once
At Bull and Bear, the strategy for the bigger picture is to use all of the monthly, weekly, daily and hourly timeframes on the
chart to at the least view the overall trend of the market and select an entry/exit point. It is best to zoom out as much as
you can so you can see the whole picture of where the price has been and the trend that it is going. Once this is clear, start
to delve into the daily, 4 hourly and hourly to depict a shorter timeframe from within the days where the market is
heading.

- Weekly/monthly: Identifies the main longer term trend of the market
- Hourly/daily: Medium term trend and areas to find the ideal entry points
- 5-min to 30min: Short term view to pinpoint exactly the best entry point and stop-loss for the trade to enter

Swing traders will often use the 4 hour charts to look for entry after grading the trend from the daily. By doing this you can
see very clear support and resistance opportunities (see strategies), trend lines as well as other useful patterns for entry. It
is common to see that on the longer time frames, support and resistance indicators are more effective and more
meaningful. Take a look at our strategies to learn more about how to determine good entry points.

As a trader, it is important to try all of the different time frames to see which suit your own personality and available time.
Several traders who like to operate quickly will work with the 5-minute charts as this will allow for many more
opportunities to enter and exit the market based on the signals they seek. Hourly traders have fewer signals however the
moves can be considered slightly more significant. This suits traders who like to take their time. Further still, those who
select entry points based on daily and weekly timeframes have to wait longer to confirm their trade opportunities. It is
important to try the methods out first by paper-trading or going on a demo account first to get a feel for it. Just remember,
demo accounts give you good practice when it comes to the analysis, placing the trade and getting use to the platform. It
will almost never prepare you for the psychology of trading with real money, in fact often it does the opposite. This is a
common mistake for new traders and they use the demo account for the wrong reasons.