ProSignal Forex Trading Manual Part I: Introduction to Forex Trading

Welcome to ProSignal's FREE Forex Trading Training course for Beginners and experienced forex traders alike. We are glad that you have chosen to study our course and learn fundamentals of Forex trading with us. In putting together this course, we had one major goal – to educate and develop successful self-traders in the Forex market, aiming to provide a single place for someone to find the tools they need to be competitive traders!

For years we have had a single purpose in mind - to be able to take the average person and provide them with powerful tools that are easy to learn and simple to use. Just like everything else in life, success revolves around the 80/20 rule (where 20% of the effort produces 80% of the results). We have applied that theorem to the information we have compiled over the years to create the ProSignal Express Forex Course for Beginners. We have narrowed our focus to that which is most important, weeded out the 80% which is least important to know (we figure you can pick that up on your own) to present you with as much, but also as little, as you need to know to experience the great rewards the Forex market has to offer.

The main goal of this course is to introduce you to the fundamentals of Forex. We will introduce you to technical and fundamental analysis and most commonly used indicators. Moreover we will give you some hints on how to open brokerage account and use trading platform and charting software. In addition, we will talk about some basic money management techniques and the role of human psychology in trading. Combined, this knowledge should enable you to start your Forex trading career and make your first steps in this exciting currency market.

Our courses will use a lot of real world examples and will give you an opportunity to practice what you have learned. During the course you will be given home work assignments and your performance could be evaluated by our instructors if you choose so. Moreover, at the end of each lesson you will be asked certain control questions to assure that you have learned all important concepts and understand the material covered.

If you will need any assistance throughout the course, you can always e-mail your questions to our instructors’ e-mail account and one of them will help you with your problem. Since the course offered is meant to be learned at your own pace and at your free time and will, we encourage you to cover at least one lesson a day and make sure you do all the homework and answer all control questions at the end of each lesson. If you do follow our instructions and dedicate enough time and will to this course, we can assure you that at the end of this course you will be able to conduct simple technical and fundamental analysis of the current market conditions, place educated trades and use most common indicators and price patterns in your trading.

Once you have finished the course, we encourage you to open a FREE Demo Trading Account and practice trading, or open a fully automated trading Demo account and let our AutoTrader platform do all the trading for you. This will help you to practice your trading skills and will give you an insight on how certain trading systems work. Once you have been profitable for at least one month trading your demo account, consider opening micro account and practice your trading with real money but at very low amounts. This will help you to practice and temper the psychological aspects of your trading. Keep in mind that demo trading totally different from real money trading and it is better to start with small amounts to practice your skill and train your psychology.

Foreign Exchange (FOREX) is a separate entity of the global financial market where one nation’s currency is exchanged for the currency of another. The history of the Forex market can be traced back to The Bretton Woods Agreement, which in 1944 has established fixed national currencies against the dollar, and set the dollar at a rate of USD 35 per ounce of gold. In 1967 a Chicago bank refused to extend a loan in British pounds to a college professor Milton Friedman because he wanted to use those funds to short the British currency. The bank's refusal to grant the loan was caused by the Bretton Woods Agreement.

The main goal of the Bretton Woods Agreement was to create international monetary stability by preventing the money of one country to be taken out from that country and used in other countries of the world. This would also repress speculations with the international currencies. Prior to Bretton Woods, the gold exchange standard -- paramount between 1876 and World War I -- ruled over the international economic system. Under the gold exchange, currencies experienced a new era of stability because they were supported by the price of gold.

However, the gold exchange standard had its own weakness of boom-bust patterns. As an economy strengthened, it would import more than export until it ran down its gold reserves required to support its currency. As a result, there was a substantial decrease in money supply, which triggered interest rates increases and economic activity would slow down to the point of recession. Ultimately, prices of commodities would dramatically decrease, appearing attractive to other nations, who would rush into a buying fury that injected the economy with gold until it increased its money supply, driving down interest rates and restoring wealth into the economy. Such boom-bust patterns abounded throughout the gold standard until World War I temporarily discontinued trade flows and the free movement of gold.

The Bretton Woods Agreement was established after World War II, in order to stabilize and regulate the international Forex market. Participating countries agreed to try to maintain the value of their currency within a narrow margin against the dollar and an equivalent rate of gold as needed. The dollar gained a premium position as a reference currency, reflecting the shift in global economic dominance from Europe to the USA. Countries were prohibited from devaluing their currencies benefit their foreign trade and were only allowed to devalue their currencies by less than 10%. The great volume of international Forex trade led to massive movements of capital, which were generated by post-war construction during the 1950s, and this movement destabilized the foreign exchange rates established in Bretton Woods.

During the year of 1971 the Bretton Woods Agreement was abandoned and the US dollar was no longer exchangeable into gold. By 1973, the forces of supply and demand controlled major industrialized nations' currencies, which now floated more freely across nations. Prices were floated daily, with volumes, speed and price volatility all increasing throughout the 1970s, and new financial instruments, market deregulation and trade liberalization emerged. The era of Forex market has begun.

It is estimated that FOREX is the largest financial market in the world with nearly $3 trillion in daily trading volume. This is five times greater than the combined amount of the U.S. Treasury and Equity markets together. Of the $3 trillion day trading in Foreign Currency Exchange, 83% of spot foreign exchange activity and 95% of swap activity involves US Dollars. The Euro is the second most active currency at 37%. The Japanese Yen (24%) and the British Pound Sterling (10%) are ranked third and fourth. The Swiss Franc is 7%, and the Canadian and Australian Dollars account for 3%.

What is very distinctive and interesting about the foreign exchange the fact that it has no physical trading floor or location and no centralized exchange. In addition to being the world's largest market, we believe the Foreign Currency Exchange Market – Forex - is the world's most powerful and persistent trading markets regardless of negative economic indicators. This is because currencies 'trend' better than every other market due to their macro-economic nature. Unlike many commodities whose supply and demand fundamentals can literally change overnight (as we found in the sudden dot com 'market adjustment' and even more abruptly on September 11, 2001), currency fundamentals are much less random, and far more predictable. This is well illustrated in the way interest rates are changed gradually and only in small increments.

The market operates through a global network of big banks, corporations and even individuals that trade currency. Unlike foreign exchanges, trading at the Forex market is going on for 24 hours a day and never stops. In all time zones in any of the world's major trading centers (London, New York, Tokyo, Hong Kong, Sydney, etc.) there are special firms - dealers - ready to give you the ability to start trading in both directions. Due to its huge daily turnover and permanent purchasing power, the Forex market has no match in the entire world regarding its dynamic and tension.

The main principle of forex is converting one currency into another. This market is the most liquid and unpredictable of all, not only because of its geographical spread and the variety of persons and organizations working here, but also because of a huge amount of factors affecting it. Among the main factors influencing currency exchange rates there are balance of mutual payments, economic condition, forecasts based on technical analysis graphs, as well as political and psychological factors.

The movement of capital between countries can be considered as the main factor determining the current state of the market. Besides, such factors as inflation and discount rates can also considerably influence currency exchange rates. At the same time, there is no doubt that another important fact is that there is always a certain state behind each currency. There are two ways states can control the market. The first one is just control and the second one is the so-called intervention. Currency control prevents citizens from doing anything that can have a negative influence on the exchange rate (for example, transferring money abroad). In the first place, intervention means changing the discount rate, which makes the currency more or less attractive for foreigners. And second, it means selling or buying the currency in order to increase or reduce its cost on the market.

All the factors mentioned above may cause sudden and often dramatic changes on the market if some unexpected and considerable changes occur in them. This is the main reason accounting for the fact that sometimes the anticipation of some economic changes alone exerts much more influence on the exchange rate than actual events. The activities of large financial funds also influence the market greatly. Though all of them can make moves on their own, they are at least well aware about all the peculiarities in the changes of exchange rates for each main currency. When the graph describing how some exchange rate floats reaches some node point, the market behavior becomes technically predictable and, therefore, managers of major financial funds react in a predictable way, which often means the same or similar way. As a result, there is a sudden and powerful upsurge in prices and large financial volumes get invested into the same positions.

The most popular possibility of getting an income by trading on Forex market is called a marginal trade, based on speculation on the fluctuations of liquid currency rates. This kind of activity becomes available for a private person in collaboration with a commercial bank, a broker or a dealing center providing such services. In the Foreign Exchange market there are no restrictions on short selling, which means that a trader can take advantage of an upward or downward market. Traders can buy or sell a currency with equal ease.

Major foreign exchange participants include commercial and investment banks and central banks. Other participants include corporations, hedge funds and millions of traders worldwide. Here the top 10 banks that trade the most volume according to the Euromoney FX Survey for May 2006.

Rank	Name	% of volume
1	Deutsche Bank	19.26
2	UBS AG	11.86
3	Citigroup	10.39
4	Barclays Capital	6.61
5	Royal Bank of Scotland	6.43
6	Goldman Sachs	5.25
7	HSBC	5.04
8	Bank of America	3.97
9	JPMorgan Chase	3.89
10	Merrill Lynch	3.68

Participation in the Forex market is differs drastically from the participation in stock markets. In Forex there are different levels of access. First level (highest) is so called inter-bank level of access. At this level largest investment banks exchange currency for their own needs and the needs of their clients. The spreads at this level are very different from what regular traders are used to and are very small and usually not known to general public. As we move from the highest level of access to lower ones, the spreads tend to widen (become larger). This is due to the traded volume at these levels, the greater the traded volume the smaller the spreads are. From the table above we can estimate that top 10 investment banks account for over 70% of all transactions.

Large investment banks are followed by smaller investment banks and large transnational corporations, big hedge funds and some large retails forex market markers (brokerage firms). According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown markedly over the 2001-2004 period in terms of both number and overall size” Central banks also participate in the forex market to align currencies to their economic needs.

Now let us look at some of the participants a bit closer because it is very important to understand what these big players are doing in the market and why they need to do it. This will help us get a deeper insight into the market moves and understand certain price movements, especially at the times when technical analysis keeps silence and is not giving us any clues but the market action is still there.

Investment banks are the most active participants in the foreign exchange market. Some banks deal with other financial institutions and corporations who contact them, typically by telephone, to ask for their rates, and want to buy foreign currency from, or sell, to the bank at those rates. This is known as market making: the banks will at all times give quotes for buying or selling certain currency pairs - dollars to the euro, British sterling to the Canadian dollar and so on. The market makers gain profits on the difference between their buying and selling rates, but they have to be ready to change their prices very quickly in order to avoid holding a currency whose value is falling (depreciating), or being short of a currency which is rising (appreciating). Banks also deal on behalf of corporations and another, typically smaller, banks. We have to keep in mind that some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account.

An increasing part of the banks' trading with each other is taking place on electronic booking systems that have negatively affected the traditional foreign exchange brokers. There are also banks that have developed in house trading platforms for their corporate clients.

Central banks are other important participants of the Forex market. Central Banks always try to control the money supply, keep inflation low, and use interest rates to do just that and often have some official or sometimes unofficial target rates for their countries’ currencies. Central banks can use a number of tools to achieve these goals. For example, they can use their substantial foreign exchange reserves to intervene the currency market. Among the most important responsibilities of a central bank is the restoration of an orderly market in times of excessive exchange rate volatility and the control of the inflationary impact of a weakening currency.

The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives, however. The combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 1992-93 with the European Exchange Rate Mechanism (ERM) collapse and 1997 throughout South East Asia.

The most important influence upon world exchange markets is exerted by the US central bank – the Federal Reserve System (US Federal Reserve, or the FED). Next comes the European Union with its European Central Bank and Britain with the Bank of England (nicknamed the Old Lady of Threadneedle Street).

The commercial companies' international trade exposure is the backbone of the foreign exchange markets. Multinational companies exposure in accounts receivables and payables denominated in foreign currencies are protected against unfavorable moves with foreign exchange. That is why these markets are in existence. Commercial companies often trade in sizes that are insignificant to short term market moves, however, as the main currency markets can quite easily absorb hundreds of millions of dollars without any big impact. It is also clear that one of the decisive factors determining the long-term direction of a currency's exchange rate is the overall trade flow. Some multinational companies, whose exposures are not commonly known to the majority of market, can have an unpredictable impact when very large positions are covered.

Until recently, the foreign exchange brokers were doing large amounts of business, facilitating interbank trading and matching anonymous counterparts for comparatively small fees. The increased use of the Internet has forced a lot of this business to move onto more efficient electronic systems that are functioning as a closed circuit for banks only. The traditional broker box providing the opportunity to listen in on the ongoing interbank trading is still seen in most trading rooms, but turnover is noticeably smaller than just a few years ago.

The arrival of the Internet has brought us a host of customer brokers. There is a large number of these non-banks offering foreign exchange dealing services, technical analysis, and strategic advice to private customers. The fact is many banks do not undertake foreign exchange trading for private customers at all, and do not have the necessary resources or inclination to support private clients adequately. The services of such customer brokers are more similar in nature to stock and mutual fund brokers and typically provide a service-orientated approach to their clients.

Hedge funds have gained a reputation for aggressive currency speculation in recent years. There is no doubt that with the increasing amount of money some of these investment vehicles have under management, the size and liquidity of foreign exchange markets is very appealing. The leverage available in these markets also allows such a fund to speculate with tens of billions at a time. The herd instinct that is very apparent in hedge fund circles means that getting George Soros and friends on your back is less than pleasant for a weak currency and economy. It is unlikely, however, that such investments would be successful if the underlying investment strategy was not sound. It is also argued that hedge funds actually perform a beneficial service to foreign exchange markets. They are able to exploit economical weakness and to expose a countries unsustainable financial plight, thus forcing realignment to more realistic levels.

Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager with an international equity portfolio will need to buy and sell foreign currencies in the spot market in order to pay for purchases of foreign equities. Since the forex transactions are secondary to the actual investment decision, they are not seen as speculative or aimed at profit-maximization.

Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. Whilst the number of this type of specialist firms is quite small, many have a large value of assets under management (AUM), and hence can generate large trades.

Under current conditions practically all financial operations on the FOREX market are speculative by nature. One of the more expressive signs of the growth of this market, are the daily figures of the completed exchange operations. They have grown in the first ten major financial centers from USD 206 billion in 1986 to 967 billion in 1992. IMF statistics show that generally the turnover exceeds an amount of USD 2.5 trillion daily, while on some days the volume tops 3 trillion. To compare, the overall gold and currency reserves of the more developed countries of the world summarily reached 555.2 billion in 1992, which was less than a fifth half of the daily turnover on the FOREX market. There are indications, that the daily volume of foreign exchange operations is 40 times greater than the daily foreign trade turnover.

The analysis shows, that among the main speculators on the FOREX market it would seem right to single out official government institutions, followed by private financial and other bodies. The main trait of the eighties was the growth of international activities of private financial institutions – the pension funds, insurance companies, mutual funds, trusts and some others. But by far the largest segment, undoubtedly, is the general public sector.

For speculators, the best trading opportunities are with the most commonly traded (and therefore most liquid) currencies, called "the Majors." Today, more than 85% of all daily transactions involve trading of the Majors, which include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar.