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Chart Patterns Forex Trading Guides

Chart Patterns: Start Here

Chart Patterns: Start Here

Chart Patterns: Start Here

Chart Patterns: Start Here

Something that I stress repeatedly throughout our series on chart patterns is the difference between traditional markets like the stock market and the forex market. I’m sure a good number of readers have spent time reading books on technical analysis and have recorded and have seen various statistics regarding the performance of the various chart patterns that exist. There’s a big problem that exists in the realm of technical analysis and its use in forex markets, and that is related to nearly 100% of all technical analysis trading material focused on the stock market. Why is this a problem? Several reasons.

  1. Statistical performance values for chart patterns based on the pattern’s performance in the stock market is overwhelmingly long-biased: the stock market has been in a bull market for over a decade.
  2. Forex markets do not ‘trend’ in the traditional sense of financial analysis, they range.

In a nutshell, just because a particular pattern in the stock market may not perform that well in the forex market, it does not mean that its performance isn’t positive in forex. I’ve learned that most underperforming chart patterns in the stock market perform very well in forex markets. As always, make sure you do your own due diligence and research – investigate each pattern for yourself and see how they play out in your own trading.

To begin learning about Chart Patterns, follow this series of education articles.

Chart Patterns: Pullbacks and Throwbacks

Chart Patterns: Symmetrical Triangles

Chart Patterns: Ascending Triangles

Chart Patterns: Descending Triangles

Chart Patterns: Head-And-Shoulder Patterns

Chart Patterns: Broadening Patterns

 

Sources:

Kirkpatrick, C. D., & Dahlquist, J. R. (2016). Technical analysis: the complete resource for financial market technicians. Upper Saddle River: Financial Times/Prentice Hall.

Bulkowski, T. N. (2013). Visual guide to chart patterns. New York, NY: Bloomberg Press.

Bulkowski, T. N. (2008). Encyclopedia of candlestick charts. Hoboken, NJ: J. Wiley & Sons.

Bulkowski, T. N. (2002). Trading classic chart patterns. New York: Wiley.

 

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Chart Patterns

Chart Patterns: Flags and Pennants

Flags and Pennants If you’ve ever traded a chart and you’ve seen what looks like a reversal in the trend, but as soon as you enter the trend seems to continue, odds are you were trading against a continuation pattern. Flags and pennants are titles given to patterns that show up as small countertrend moves […]

Flags and Pennants
Flags and Pennants

Flags and Pennants If you’ve ever traded a chart and you’ve seen what looks like a reversal in the trend, but as soon as you enter the trend seems to continue, odds are you were trading against a continuation pattern. Flags and pennants are titles given to patterns that show up as small countertrend moves […]

Flags and Pennants

If you’ve ever traded a chart and you’ve seen what looks like a reversal in the trend, but as soon as you enter the trend seems to continue, odds are you were trading against a continuation pattern. Flags and pennants are titles given to patterns that show up as small countertrend moves that ultimately trap participants and then use their momentum to keep the price moving in the direction of the trend. Flags are represented as rectangular channels, and pennants are represented as triangles.

Before a flag or pennant can be identified, we first need a flag pole. A flag pole is any clear trending price action that, well, looks like a pole. See below:

Flags and Pennants
Flags and Pennants

 

The images above show examples of bearish flags and bearish pennants, as well as bullish flags and bullish pennants. If you are unfamiliar with how to trade triangles or rectangles, refer to the articles that discuss the various triangle patterns. But we can review the basics of entering these great continuation patterns.

Bearish Pennant
Bearish Pennant
Bear Flag
Bear Flag
Bullish Pennant
Bullish Pennant
Bull Flag
Bull Flag

 

Learning how to trade flags and pennants is one of the most useful and enjoyable things that you can learn – especially as a new trader. Flags and pennants help train your brain to get used to buying dips during bull runs and shorting rallies during bear moves. If you get to a point where you can profitably trade flags and pennants, then you have transitioned into a trader who is very near outperforming the vast majority of your peers. It may seem like an easy thing to do – but it is an entirely different thing to execute. Analyzing and identifying a flag or pennant is easy; trading it is difficult.

I can not stress enough how profitable these patterns can be – and how easily you can miss them even in plain sight. The problem resides with your brain – that ‘lizard’ part that kicks in when you are are fearful of your account. When you begin to feel the fear of your account losing money, that triggers a powerful part of your brain known as the limbic system. The limbic system controls fear and pleasure. And when your fear sense is triggered, it hyper focuses the synapsis across your brain. Things that you would passively identify like flags and pennants are tertiary in their importance when the limbic system is acting in your defense. You need to find ways to ‘pause’ the process with things like alerts. On the images above, you saw horizontal lines above prior swing highs and below prior swing lows. Placing alerts at those points may be enough to interrupt your primary fear response and allow you to make money on your emotions.

Because if you are feeling it, so is everyone else.

 

Sources:

Kirkpatrick, C. D., & Dahlquist, J. R. (2016). Technical analysis: the complete resource for financial market technicians. Upper Saddle River: Financial Times/Prentice Hall.

Bulkowski, T. N. (2013). Visual guide to chart patterns. New York, NY: Bloomberg Press.

Bulkowski, T. N. (2008). Encyclopedia of candlestick charts. Hoboken, NJ: J. Wiley & Sons.

Bulkowski, T. N. (2002). Trading classic chart patterns. New York: Wiley.

Categories
Chart Patterns

Chart Patterns: Symmetrical Triangles

Symmetrical Triangles

Symmetrical Triangle
Symmetrical Triangle

Symmetrical Triangles

Symmetrical Triangles

Out of all the triangle patterns, symmetrical triangles are perhaps the most common and the most common and the most subjective. Symmetrical triangles have a standard neutral bias; however, symmetrical triangles most often form after a prior trend, because they most commonly form after a prior move. The preference of their trading direction is determined by the direction from the previous move. If the preceding move was bullish, then the symmetrical triangle is viewed as a bullish continuation pattern. Like all triangle patterns that form after a trending move, they are known as pennants.

The construction of a symmetrical triangle is like any other triangle: it requires to trendlines that intersect: one upward sloping angle and one downwards sloping angle. Price action should touch both the upper and lower trendlines at least twice – but ideally three times. A lack of open space within the triangle is ideal. Breakouts often occur in the final 1/3rd of the triangle. Volume typically falls before the breakout.

I believe that understanding the psychology of how this pattern forms is essential. The symmetrical triangle is the result of a condition that is very common in any traded market: consolidation. It’s not just common; it’s normal. Consolidation is representative of two things: equilibrium on the part of buyers and sellers and indecision by active speculators. The psychology of price action inside a symmetrical triangle is different than what occurs in an ascending or descending triangle, which both have a marked bias during the construction. Symmetrical triangles are the epitome of indecision, and traders can very quickly fall victim to whipsaws.

Symmetrical triangles, while the most common, are also the most confusing. Take the image below:

Symmetrical Triangle

The symmetrical triangle on the daily chart for the AUDJPY is a bearish pennant – a bearish continuation pattern. While any triangle that forms after an established trending move has a high probability of pushing the price in the direction of the trend, it doesn’t always happen that way. As I wrote above, symmetrical patterns are inherently neutral – so it is important to watch them. We can see that this symmetrical triangle did not cause a continuation move south – it reversed. Regardless of the direction of the breakout, some rules should be applied when entering a trade based on a breakout of a symmetrical triangle.

Symmetrical Triangle - Long Entry
Symmetrical Triangle – Long Entry

First, unlike the ascending and descending triangles, we don’t enter on the break. We want to enter when price breaks the prior high (or low). For the chart above, we would enter long above the previous swing high that touched the downtrend line.

Symmetrical Triangle - Short Entry
Symmetrical Triangle – Short Entry

The short entry from a breakout below a symmetrical triangle is the inverse of the bullish entry. On the chart above, the short entry is when price moves below the prior swing low that tagged the uptrend line – not on the initial breakout.

Pullbacks and throwbacks occur 59% of the time. Symmetrical triangles are notorious for many false breakouts, so look for frequent wicks/shadows to pierce the trendlines. Dahlquist and Kirkpatrick wrote that volume that increases on the breakout increases the performance of the pattern, but it is otherwise below average in its performance.

 

Sources:

Kirkpatrick, C. D., & Dahlquist, J. R. (2016). Technical analysis: the complete resource for financial market technicians. Upper Saddle River: Financial Times/Prentice Hall.

Bulkowski, T. N. (2013). Visual guide to chart patterns. New York, NY: Bloomberg Press.

Bulkowski, T. N. (2008). Encyclopedia of candlestick charts. Hoboken, NJ: J. Wiley & Sons.

Bulkowski, T. N. (2002). Trading classic chart patterns. New York: Wiley.

Categories
Chart Patterns

Chart Patterns: Descending Triangle

[caption id="attachment_57098" align="aligncenter" width="3338"] Descending Triangle[/caption]
Descending Triangle
Descending Triangle
[caption id="attachment_57098" align="aligncenter" width="3338"] Descending Triangle[/caption]
Descending Triangle
Descending Triangle

The descending triangle is another version of the many triangle patterns in technical analysis. It is the opposite of the ascending triangle. This pattern is overwhelmingly bearish and is one of the more common bearish continuation patterns. If you’ve read Dahlquist and Kirkpatrick’s Technical Analysis, you will find that this pattern is treated with some considerable positivity. It was one of the best-performing patterns. But there is a caveat to why this is.

Descending Triangle
Descending Triangle

The two trendlines required for the formation of a descending triangle are a flat, horizontal trendline that acts as support with a downward sloping trendline that acts as resistance. Ideally, price should touch both the upper and lower trendlines twice. Volume typically decreases as price gets closer to the apex. Breakouts occur within the final 1/3rd of the pattern. Dahlquist and Kirkpatrick report that increasing volume is actually more favorable for this pattern. The most common breakout is lower at 64% of the time.

I’ve written in prior articles about the dangers of putting to much stock into technical analysis books where the initial testing of patterns and results have been in traditional equity markets (stock markets). I believe that one of the reasons that Dahlquist and Kirkpatrick have reported such powerful and swift moves with a downward breakout is due to the nature of bear moves in equity markets. Because markets like the stock market are exceedingly long-biased, any dramatic drop below crucial support will have an exceedingly more dramatic move when compared to the forex markets – which are primarily range bound. Another factor that may attribute to the overperformance of this pattern in stock markets vs. forex markets is the ease of shorting in forex vs. the stock market.

Sources:

Kirkpatrick, C. D., & Dahlquist, J. R. (2016). Technical analysis: the complete resource for financial market technicians. Upper Saddle River: Financial Times/Prentice Hall.

Bulkowski, T. N. (2013). Visual guide to chart patterns. New York, NY: Bloomberg Press.

Bulkowski, T. N. (2008). Encyclopedia of candlestick charts. Hoboken, NJ: J. Wiley & Sons.

Bulkowski, T. N. (2002). Trading classic chart patterns. New York: Wiley.

Categories
Forex Trading Guides Ichimoku

Ichimoku Kinko Hyo Guide – A walk through a trade.

Ichimoku Kinko Hyo Guide – A walk through a trade.
I want to preface this guide with a screenshot of my account.

[caption id="attachment_48804" align="aligncenter" width="1920"] Trade History[/caption]

The

Step Four - Reentry
Step Four - Reentry

Ichimoku Kinko Hyo Guide – A walk through a trade.
I want to preface this guide with a screenshot of my account.

[caption id="attachment_48804" align="aligncenter" width="1920"] Trade History[/caption]

The

Ichimoku Kinko Hyo Guide – A walk through a trade.

I want to preface this guide with a screenshot of my account.

Trade History
Trade History

The screenshot is a series of some of the trades I’ve made in early April 2019. I do this because this guide on trading with Ichimoku will target the trade that is highlighted. Additionally, I think it is important that if I am showing you an example of a trade for a guide, I should show that I had skin in the game. There are a great many guides and strategies that authors, analysts, and traders suggest, but few will share if they took the trade. The highlighted trade for the EURGBP is the trade I will be using for this guide. It is a great example of the trading methodology I use with the Ichimoku System.

 

Multiple Timeframe Analysis – Daily, 4-Hour, and 1-Hour

The Ichimoku Kinko Hyo system is most effective when utilizing multiple timeframes. It is the only way that I use the Ichimoku system. In my trading, I use the Daily, 4-hour, and 1-hour time frames. Multiple timeframes are extremely useful in filtering your trade entries and ensuring higher probability trade setups. The process below will go through the process I used to take the trade.

Step One – Daily Chart Check: Price greater than Kijun-Sen, NOT inside the Cloud.

Step One - Check Daily Cloud
Step One – Check Daily Cloud

The very first thing I check is the daily chart. If the price is inside the Cloud on the daily chart, I skip the chart. It’s dead to me. If the price is not inside the Cloud, I then look for where the price is in relation to the Kijun-Sen. The daily chart determines my trading direction. If the price is above the Kijun-Sen, I only take long trades. If the price is below the Kijun-Sen, I only take short trades.

Step Two – 4-Hour Chart Check: Price above the Cloud, Chikou Span above candlesticks.

Step Two - Check 4-hour chart.
Step Two – Check the 4-hour chart.

If the daily chart determines the direction of my trading, the 4-hour provides the filter for the entry chart (the 1-hour chart). The only things I am concerned about with the 4-hour chart is that the Chikou Span is above the candlesticks, and that price is above the Cloud. Preferably, the Chikou Span would also be in ‘open space’ – but I don’t use it as a hard rule. I have not found the open space to be as important during the change of a trend or corrective move.

(a note about ‘Open Space’ – Open Space is a condition where the Chikou Span won’t intercept any candlesticks over the next five to ten trading periods. When the Chikou Span is in open space, this represents ease of movement in the direction of the trend with little in the form of resistance (or support) ahead.)

The EURGBP trade we are analyzing is a good example of why, at the current position, I don’t consider the open space as strict as I would on the hourly. I want to refer you back to the daily chart. If, on the daily chart, both price and the Kijun-Sen are below the daily cloud, but price moves above the Kijun-Sen – I don’t consider the open space variable as important on the 4-hour chart.

Step Three – 1-Hour Chart Check

Step Three - 1-hour Entry
Step Three – 1-hour Entry

The 1-Hour chart is my entry chart. As long as Step One and Step Two are true, the 1-hour chart is where the bread and butter of the trading occurs. My entry rules are this:

  1. Future Span A is greater than Future Span B.
  2. Chikou Span above the candlesticks and in ‘open space’ – for five periods.
  3. Tenkan-Sen is greater than Kijun-Sen
  4. Price is greater than the Tenkan-Sen and Kijun-Sen.

I generally look for a profit target of 20-40 pips, depending on the FX pair. For example, on the NZDUSD, I would look for 20 pips, and on the GBPNZD, I would look for 40 pips. But there are some hard technical reasons to leave a trade before that profit target is hit. The list below represents my exit rules on the 1-hour Chart – I exit the trade if any of these conditions occur.

  1. Exit if Chikou Span below candlesticks for more than three consecutive candlesticks.
  2. Exit if price enters the 1-hour Cloud.
  3. Exit if Tenkan-Sen below the Kijun-Sen for more than five candlesticks.

Step Four – Reentry Rules

Step Four - Reentry
Step Four – Reentry

Entry rules are fine, but the problem isn’t always finding the entry. One of the hardest problems is creating rules for re-entering a trade. Mine are as follows:

  1. Tenkan-Sen and Kijun-Sen must be above the Cloud.
  2. Chikou Span above the candlesticks.
  3. Price greater than Kijun-Sen and Tenkan-Sen.

A quick summary of steps taken

  1. Checked the daily chart, the price was above the daily Kijun-Sen. The trade direction is long/buy.
  2. Check the 4-hour chart, the price was above the Cloud, and the Chikou Span was above the candlesticks.
  3. All 1-hour rules confirmed an entry; profit taken at 40 pips.
  4. Re-entered trade on 1-hour chart, exited when price entered the 1-hour Cloud.

 

Sources: Péloille, Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku Technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

 

Categories
Forex Ichimoku strategies Ichimoku

Ichimoku Strategy #1 – The Ideal Ichimoku Strategy

The Ideal Ichimoku Strategy is the first strategy in my series over Ichimoku Kinko Hyo. There are two sides to a trade, and so there will be two different setups

Bearish Ideal Ichimoku Strategy Entry
Bearish Ideal Ichimoku Strategy Entry

The Ideal Ichimoku Strategy is the first strategy in my series over Ichimoku Kinko Hyo. There are two sides to a trade, and so there will be two different setups

The Ideal Ichimoku Strategy is the first strategy in my series over Ichimoku Kinko Hyo. There are two sides to a trade, and so there will be two different setups for long and short setups. This strategy comes from the phenomenal work of Manesh Patel in his book, Trading with Ichimoku Clouds: The essential guide to Ichimoku Kinko Hyo technical analysis. Buy it, don’t pirate.

Patel identified this strategy as the foundational strategy. Because it uses all of the components of the Ichimoku system, I believe that this is the strategy that people should be able to know so well, that they can glance at a chart and understand what is happening. You should see this strategy and be ready to trade it profitably before you transition into trying other Ichimoku strategy. If you don’t, you can run the risk of being disenfranchised with the system and believe that it is another trading system that doesn’t work.

Moving on to the other strategies without mastering this strategy first is very dangerous to your trading development and your understanding of the Ichimoku Kinko Hyo system.

Ideal Ichimoku Bullish Rules

  1. Price above the Cloud.
  2. Tenkan-Sen above Kijun-Sen.
  3. Chikou Span above the candlesticks.
  4. The Future Cloud is ‘green’ – Future Senkou Span A is above Future Senkou Span B.
  5. Price is not far from the Tenkan-Sen or Kijun-Sen
  6. Tenkan-Sen, Kijun-Sen, and Chikou Span should not be in a thick Cloud.
Bullish Ideal Ichimoku Strategy Entry
Bullish Ideal Ichimoku Strategy Entry

Ideal Ichimoku Bearish Rules

  1. Price below the Cloud.
  2. Tenkan-Sen below Kijun-Sen.
  3. Chikou Span below the candlesticks.
  4. The Future Cloud is ‘red’ – Future Senkou Span A is below Future Senkou Span B.
  5. Price is not far from the Tenkan-Sen or Kijun-Sen.
  6. Tenkan-Sen, Kijun-Sen, and Chikou Span should not be in a thick Cloud.
Bearish Ideal Ichimoku Strategy Entry
Bearish Ideal Ichimoku Strategy Entry

 

Sources: Péloille, Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.

Patel, M. (2010). Trading with Ichimoku clouds: the essential guide to Ichimoku Kinko Hyo technical analysis. Hoboken, NJ: John Wiley & Sons.

Linton, D. (2010). Cloud charts: trading success with the Ichimoku Technique. London: Updata.

Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.

 

Categories
Forex Harmonic

The Cypher Pattern

The Cypher Pattern
The Cypher Pattern is another type of Harmonic Pattern – except it isn’t – but it is. This is one of the few patterns not identified by

The Cypher Pattern
The Cypher Pattern is another type of Harmonic Pattern – except it isn’t – but it is. This is one of the few patterns not identified by

The Cypher Pattern

The Cypher Pattern is another type of Harmonic Pattern – except it isn’t – but it is. This is one of the few patterns not identified by Scott Carney. Darren Oglesbee discovered this particular pattern.

This pattern is very similar to the Butterfly in both it’s construction and where it typically will occur (near the end of trends). However, the Cypher Pattern is a rare pattern and not one that shows up with a high amount of frequency. Don’t confuse rarity with being more powerful or profitable. I do not know enough about this pattern, nor have I had the opportunity to trade it enough to gauge it’s ‘power’ versus its peers. All I do know is that in the times I have traded it, its positive expectancy rate is high, no different than a Bat or Alternative Bat in my experience. The same goes for the Crab and Deep Crab, for that matter. Just like all of the other Harmonic Patterns that you will have learned about, the Cypher has specific rules and conditions that must be met for it to be a specified Cypher pattern.

Cypher Confirmation Conditions

  1. B must retrace to an expansive range between 38.2% and 61.8% of XA. At least 38.2% but not exceeding 61.8%
  2. C is an extension leg and moves beyond A – but must move to at least 127.2%, but it is normal for it to go as far as the 113% – 141.4%. It is considered invalid if it moves beyond the 141.4%
  3. CD leg should break the 78.6% level of XC.
  4. The PRZ (Potential Reversal Zone) of D is a wide range where the price must get to. Price can move anywhere between 38.2% to 61.8%.

I’ve created a simplified approach to how to ‘see’ this pattern.

Simplified Approach (Bullish Cypher)

  1. C must be higher than A.
  2. D must be less than B but greater than X.
  3. We should see a higher high (C > A) and a higher low (D > X).

Simplified Approach (Bearish Cypher)

  1. C must be less than A.
  2. D must be more than B but less than X.
  3. The same approach as above, reverse: lower high (D < X) and a lower low (C < A).

This pattern can be confusing (all harmonic patterns can be complicated), but in a nutshell, what we see happening with the Cypher pattern is the first pullback/throwback of a trend (B). After B, the small pullback/throwback of B occurs with the C leg. From a bullish perspective, when we see prices making lower highs and lower lows, but there is no follow-through shorting pressure, we should be on the lookout for some powerful and influential moves to occur in a very short period of time. It is not uncommon to see a bullish candle engulf several days of consolidation with this pattern.

 

Sources: Carney, S. M. (2010). Harmonic trading. Upper Saddle River, NJ: Financial Times/Prentice Hall.  Gilmore, B. T. (2000). Geometry of markets. Greenville, SC: Traders Press.  Pesavento, L., & Jouflas, L. (2008). Trade what you see: how to profit from pattern recognition. Hoboken: Wiley.

Categories
Forex Harmonic

The Alternate Bat Pattern

Harmonic Pattern Example: Alternate Bat Bullish
The Alternate Bat Pattern
The Alternate Bat Pattern is another pattern by Scott M. Carney. This pattern comes from his second Volume Two in

Harmonic Pattern Example: Alternate Bat Bullish
The Alternate Bat Pattern
The Alternate Bat Pattern is another pattern by Scott M. Carney. This pattern comes from his second Volume Two in

Harmonic Pattern Example: Alternate Bat Bullish

The Alternate Bat Pattern

The Alternate Bat Pattern is another pattern by Scott M. Carney. This pattern comes from his second Volume Two in his Harmonic Trading series of books. He discovered this pattern roughly two years after (2003) his discovery of the Bat Pattern (2001). Carney wrote that ‘the origin of the alternate Bat pattern resulted from many frustrated and failed trades of the standard framework. The standard Bat pattern is defined by the B point that is less than a 0.618 retracement of the XA Leg.’ Essentially, with the Alternate Bat Pattern we observe an extension beyond the 88.6% level at D, where D moves slightly below X (in a bullish Bat) or above X (in a bearish Bat). I view Alternate Bats as classic and powerful bear traps and bull traps. And they are just plain nasty if you find yourself thinking that a new low means further downside movement and a continuation lower – but instead to you get whipsawed by a massive reversal.

 

Alternate Bat Elements

  • Whereas the 88.6% retracement is nearly singular to the Bat Pattern, the Alternate Bat Pattern utilizes the 113% retracement of XA to determine the endpoint.
  • B must be a 38.2% or less retracement of XA.
  • Minimum projection of 200%
  • The AB=CD pattern must be an extended AB=CD and often is a 161.8% level.
  • The pattern is potent when using a form of divergence detection, such as the Composite Index, to confirm the pattern.

 

Sources: Carney, S. M. (2010). Harmonic trading. Upper Saddle River, NJ: Financial Times/Prentice Hall.  Gilmore, B. T. (2000). Geometry of markets. Greenville, SC: Traders Press.  Pesavento, L., & Jouflas, L. (2008). Trade what you see: how to profit from pattern recognition. Hoboken: Wiley.

Categories
Forex Course

4 – Understanding The Mechanism In Buying And Selling Of Currency Pairs

Introduction
The mechanism of the forex market is quite different when compared with other markets like stocks and commodities. In the stock market, we essentially consider a company’s stock to

Introduction
The mechanism of the forex market is quite different when compared with other markets like stocks and commodities. In the stock market, we essentially consider a company’s stock to

Introduction

The mechanism of the forex market is quite different when compared with other markets like stocks and commodities. In the stock market, we essentially consider a company’s stock to trade. But in the foreign exchange market, we cannot trade a single currency. Instead, we must trade them in pairs.

In the previous lessons, we understood the meaning of base and quote currencies and also the right way to read the symbols. In this lesson, let’s explain how exactly this buying and selling happens in the Forex market.

The working principle

Before getting into the topic, let us understand a few common terms to grip the concept much better.

Long – It is a basic term in trading, which refers to the ‘buying‘ of security.

Short Selling – This term refers to the ‘borrowing’ of security from the broker and selling it at the current market price. You can assume this to be the right opposite of long. Note that Shorting security and selling security are two different terms.

For example, let’s say you went long on a security, and now you wish to close it. To close it, you will have to ‘sell’ it. Here, you are ‘selling’ and not ‘shorting’ the security.

Now, with this on our back, let us get into the working of buying and selling currency pairs.

Going Long on a Currency Pair

When you go long on a currency pair, you actually buy the base currency, and short sell the quote currency. For example, if you go long 100,000 units on EUR/USD, you are buying 100,000 Euros and short selling 100,000 US Dollars.

Short Selling a Currency Pair

Short selling in the forex market is quite different from that of the stock market. In the forex market, when you short sell a currency pair, you will be selling the base currency and buying the quote currency. Hence, shorting in forex is the same as placing a regular sell order.

However, the main motive remains that the prices must decline from the point you executed the short position to generate a profit. For example, if you short 10,000 units of USD/CAD, you are actually selling 10,000 US Dollars and buying the same number of Canadian Dollars. Hence, here, you’re not borrowing a certain amount of currency to go short.

What next?

With the concept of the long and short sell, let us understand how to make a profit from it.

To profit from a long trade, you need the currency pair prices to increase.

To profit from a short trade, you need the currency pair prices to decline.

This also implies that, in a long trade, an increase in the base currency prices will put you in profit, and in a short trade, a decrease in the base currency prices will give you profits.

Example

Consider the current market price of USD/CHF to be 0.9850. Let’s say you went long on this currency pair. The buy/sell mechanism here is simple – you bought the USD (the base currency) and simultaneously short sold the CHF (the quote currency). Hence, to make a profit from this, you need currency pair prices to increase, which in turn means that you need the value of the base currency (USD) to increase or the value of the CHF to decrease because you’ve bought the USD.

This is how the buying and selling of currency pairs work internally. However, since all of this is managed by the broker, all you need to know is if the prices should rise or fall according to the position you took.

In the next article, we will be discussing the sheer size and liquidity of the Forex market along with the perks involved. For now, check if you can get the below questions right.

[wp_quiz id=”42315″]