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Of all the financial markets, the forex market is perhaps the least well understood, and yet it impacts us all every single day of our lives, in a myriad of different ways. Whatever we buy or sell, no matter how small or incidental, will in some way have been influenced by what we call the forex market, or more accurately foreign exchange.

Perhaps the simplest and most visual example is when we travel abroad. The first thing we do, either at the airport or before, is to change some of our own currency to that of the country where we are traveling. If we are in Europe and traveling to another European country, then this is less of a problem since the introduction of the so called ‘single currency’, the euro. A German traveling to Italy has no such worries, since both countries use the same currency. But once he or she travels to the UK or the USA for example, then euros need to be exchanged for US dollars.

This is the principle of the foreign exchange markets, and the small electronic boards you see at international airports, are simply visual reminders currency exchange rates affect us all. Whether we are traveling, buying products from overseas, using base commodities such as oil and petrol, or consuming imported foodstuffs, all are subject to, and influenced by, foreign exchange rates between countries around the world.

Every country in the world has its own currency. It is the quoted exchange rate of one country’s currency against another, which is the simple principle on which the forex market is built.

I make no apology by starting with the basics, as these are the building blocks of your knowledge, so let me begin by answering the five most asked questions in forex trading which are as follows:

Forex trading is short for foreign exchange trading and, represents the market in which one country’s currency is quoted against that of another. It therefore provides the basis for anyone in the world, from governments, companies and private individuals to agree a rate of exchange between one currency and another. Without these market rates being quoted, parties wanting to exchange their currency, would be forced to agree a rate for each transaction on an individual basis. In other words, there would be no agreed standard by which to set these rates.

An interesting feature of the forex market is that it has no centralized exchange, such as in stocks or futures. As a result all trading is conducted over the counter (OTC), which simply means it is not conducted in a regulated environment, and indeed is often referred to as ‘off exchange’ trading. The forex market allows businesses, investors and traders to take advantage of the change in currency rates by taking a view as to the likely future direction of one currency, relative to another. As a result, all currency rates are quoted in pairs, with one country quoted against another.

To answer the question, what is forex trading? It is a financial market, like a stock market for example, where you as a trader take a view on the future direction of the price. In the forex market, you are simply taking a view on exchange rate movements between two currencies, rather than stocks.

Just like any other market, if you are right you make money, and if you are wrong you lose money.

The primary purpose of the forex market is to provide an easy and straightforward way for companies to conduct international trade, allowing businesses, banks, governments and countries, to convert from one currency to another easily and quickly. It is one of the largest financial markets in the world, and every day turns over in excess of 6 trillion US dollars, dwarfed only by bond markets.

If, for example, a US based company is importing goods from the UK, they can pay for those goods in the currency of the exporter, in this case the British Pound, and the forex market would provide the relevant exchange rate on the day of the transaction. Alternatively, the company may decide to fix the future rate in advance by buying the exchange rate on a forward contract, in order to avoid any currency fluctuations. In effect this ‘fixes’ the exchange rate.

This, of course, can help to fix the price for the goods, but equally, the company may also lose out on potential savings should the currency rate move in their favor. This is a judgement each company makes when dealing in the forex market, whether to fix a rate in the future, or to exchange at the current prevailing rates, with advantages and disadvantages for both approaches. The modern exchange rate system of today was created in the 1970’s when countries gradually moved to free floating exchange rates, from the previous fixed rate system. Under the fixed rates system, exchange rates were pegged using an artificial system known as Bretton Woods.

Over the last century there have been many attempts to ‘anchor’ currency exchange rates for many reasons, not least to try to help countries have a rate which is ‘fixed’ against some other tangible asset. The Bretton Woods agreement, and the Marshall plan of the 1950’s before it, were attempts to ‘fix’ exchange rates globally, using gold as the standard. In simple terms a price would be agreed for gold, against which any currency exchange rates would then be quoted accordingly.

All of these attempts ultimately failed, and following the collapse of the Bretton Woods agreement in the early 1970’s, the US dollar was established as the ‘de facto’ global reserve currency, and is now referred to as the currency of ‘first reserve’. It is the most widely held currency (after the home currency), by banks around the world. As you would expect, it is considered to be an extremely ‘safe currency’, as it is the currency of the largest economy in the world, and backed by the US Federal Reserve.

The gold standard was an attempt to peg currencies to gold, using an artificial model based on the price of gold, set at a fixed price per ounce within the agreement. All of these agreements, and many others, have all failed, and the demise of the Bretton Woods agreement, really ushered in the free floating currency model, which has been more or less adopted across the globe.

In the forex markets today, most exchange rates are left to ‘float free’, with market forces then pushing these rates higher and lower. Some countries do still peg their currencies, most notably to the US dollar, but for the purposes of this book, and the countries and currencies we are going to concentrate on here, these exchange rates are all considered to be free floating.

In simple terms there are five broad groups of players in the forex market, each of whom has very different trading objectives and strategies. It is important to understand their role in order to gain a deeper understanding of what drives prices, and why the forex markets react to the stream of daily news and analysis. The major groups are as follows, and we will look at each of these in turn in detail:

If we start with the market makers, in contrast to all the other participants in the forex market, these are the only ‘non customers’ and are there in order to provide a service to their paying clients. In general, these are the major retail banks, with the big three of Deutsche Bank (20%), UBS (12%), and Citigroup (11%) continuing to dominate the market. Between them they account for almost 45% of turnover on a daily basis.

These international banks are the only organizations large enough to manage the multi billion dollar transactions involved in the corporate world, and in effect create the market prices which are quoted on a daily basis. Whilst it is true to say the above statement is generally correct, in the last few years we have seen the market makers move way from their traditional role, and diversify into proprietary trading themselves, as well as trading on behalf of their clients, along with offering retail brokerage accounts to the small trader and speculator.

This blurring of once traditional roles in the market is likely to continue, as the profits to be made from trading in forex continues to increase exponentially, an opportunity these large banks can no longer ignore. Of the three banks above, Deutsche Bank is the only one (to date) who has entered the retail market. However, they subsequently withdrew in 2011, having failed to attract enough customers in an increasingly competitive market. But, do not be surprised to see one of the other market markers come in at the retail level in future. They simply will not be able to resist.

Until relatively recently, the forex market was almost a backwater for many banks, who simply offered this as a ‘minor service’ to some of their larger clients. In the last ten years, this has changed dramatically, as the forex market moved into the mainstream of the trading arena, with mass market appeal and consequently large profits to be made by the banks themselves.

Next we have large corporate companies who are the bread and butter of the forex world. In many ways this group are seen as the most logical players, requiring currency exchange for ‘real’ business purposes, such as paying for imports and receiving payments for exports, hedging future prices for large consumable items, and finally for major mergers and acquisitions. A well run finance department can save a large blue chip company millions of pounds or dollars a year, simply by ensuring purchases and payments are either fixed, or made at optimum times to maximize potential savings or additional profits, through the simple mechanism of an exchange rate. These are magnified as a result of the volume involved.

As a general rule, corporates are relatively conservative in their buying and selling decisions. They rarely speculate in exchange rates, preferring to fix rates and hence fix their costs or profits, rather than speculate on future exchange rates and run the risk of increased costs, foregoing (generally) the chance of increased profits.

The third major group of forex participants are the speculators, and in many ways these are the most interesting, and come in many shapes and sizes. Their primary aim is to make a profit from their analysis of the market, and they have no interest in acquiring real holdings of the currency, but simply ‘bet’ on which way the market is likely to move in the future. The biggest players in this group include proprietary traders (banks trading their own money), hedge funds, commodity trading advisers (CTA’s) and currency overlay managers.

These trading groups are high risk traders, trading large volumes, and are happy to take on excessive leverage in order to make huge profits. Equally however, they are also subject to large losses, and it is this group that is responsible for the majority of intraday moves in the forex markets.

The fourth group are the central banks of the world who are responsible for managing the economy, with each National Bank responsible for its own currency. In general, central banks do not like to see their currency being used for speculative purposes, and as a result are not averse to stepping into the market in order to manipulate their own currency to reduce harmful volatility, which in turn could damage the reputation or economic stability of the country as a result.

The Bank of Japan, for example, frequently intervenes in this way, particularly where any strength in the Japanese Yen is likely to damage Japanese exports, which in turn makes them more expensive to overseas buyers. The Swiss National Bank is another. The role of the central bank is to manage monetary policy to ensure economic stability and to remove volatile currency fluctuations wherever possible, which is easier said than done for some countries.

Finally we come to the last group of traders in the forex market, which is us - you and me , and we could equally be classified as small speculators, as we have no interest in holding the currency we are buying or selling. We are simply looking to make a profit from our analysis of the market. Unfortunately, we come at the bottom of this list and are also the smallest, and generally provide a constant new supply of funds to the bigger market players.

If this sounds a little depressing, please don’t worry. This book will level the playing field for you, and by the time you have finished reading, will have nothing to fear from these 200 lb. gorillas (I like gorillas but not these ones)

The prices we see quoted on our screens every day come from one principle source, but arrive in front of us in very different ways. In simple terms, it's the major retail banks outlined above who effectively set the central exchange rates, by virtue of their interbank trading, and this is often referred to as the interbank liquidity pool. This group of banks, therefore, act as the central exchange for the forex market, and whilst they are regulated as a bank, they are unregulated as far as the provision of currency rates is concerned, and are able to influence market prices to suit their own investment and trading needs.

Indeed, the nirvana for any bank is to earn income from what is called ‘off balance sheet’, and this is where the forex market delivers in abundance, with millions in profit every day. All that's required is for the bank to set up a forex dealing desk, along with a proprietary trading group, and fairly soon the money starts rolling into its coffers.

The interbank liquidity pool is the starting point for the market, and from here the rates are then delivered via a number of live feeds through a variety of channels. The most expensive live feeds come from three major providers, namely www.currenex.com , EBS and www.fxall.com , and represent the professional end of the market. These feeds are generally way beyond the budget and pocket of the small retail trader, costing thousands of dollars a month. I have never subscribed, nor indeed have I ever felt the need to subscribe. I have managed perfectly well using simple feeds (both free and paid) and happily made money, and so will you.

However, if you do trade using one of these, you will effectively be trading at the ‘central exchange’ along with the major banks. Here you will be receiving the latest quotes, the tightest spreads and access to the deepest pool of liquidity, as well as the ability to see the depth of the market at any time - the equivalent of level 2 and level 3 data feeds in equity markets.

Whilst it is possible for individual traders to subscribe to these feeds directly, it is much more likely you will become a client of a broker who is using one of these feeds to provide live prices to their own platform, and this is the price you are likely to see quoted on your trading screen. However, it is important to note that as the broker is now ‘making a market’, the price quoted by one broker may be very different from that quoted by another, as each is able to present the price they wish at any time.

In addition, the price they quote may be very different from that being quoted in the interbank market. Many of these brokers are in fact trading against you, and along with market manipulation, lagging prices, and outright malpractice, represents one of the many challenges we face as forex traders every day. Some smaller brokers may not even be able to afford to subscribe to these feeds directly, or have sufficient funds to establish their own platform and to meet the minimum capital requirements under the various regulatory rules.

These brokers are known as ‘white label’ for the larger brokerage companies, in effect adding a further layer to the prices quoted, with all that this entails, removing you as the trader still further from the real price action in the interbank pool. And there are far more of these than you might think.

The interbank liquidity pool is dominated by the following major banks, who between them control around 80% of the forex market:

The easiest way to understand how prices are quoted between the various entities in the market is to think of these banks as wholesalers. In every other business we have wholesalers and then we have retailers. A wholesaler is generally a company that buys in volume and therefore gets the best price. The goods or services are then broken up into smaller order sizes, and bought at a higher price by the retailer, who sells the product in single quantities to the end user - you and me in other words. This is the way most markets operate, with the wholesaler making a profit in selling to the retailer at a higher price, and the retailer then selling to the consumer at a higher price still, once again making a profit on the sale. The forex market works in much the same way.

Prices from the Interbank pool follow the same principles. This group of ten major banks effectively sets the wholesale rates for the rest of the market, with every ‘retailer and distributor’ (large or small broker) in the chain quoting a rate, which then allows them to make a profit.

This, in basic terms, is how prices arrive on the screen, but I will cover this in much more detail when we look at the different types of brokers, and how they manipulate the prices quoted on your screen.

If the last sentence surprises you, it's a fact of life. Indeed the forex market is the most manipulated of all the financial markets and it’s not hard to see why. There is simply too much money to be made. Whilst there are many types of manipulation, the one that is perhaps the worst is that by the Interbank market makers themselves, and before we all cry ‘not fair’, if we were in their position we would do the same.

Here is a group of ten banks who effectively control a market of several trillion dollars a day, and which has no central exchange. It would be unreasonable to think otherwise. And this is what they do, day in and day out, generally using the stream of economic news and comment from around the world to push the market back and forth, triggering stop losses and forcing traders into weak positions. That’s the bad news. The good news is that with the MT4/MT5 platform, and indeed others, we have the perfect weapon to fight back, and it’s called volume.

Volume reveals activity, and provided you understand the volume price relationship and how to interpret what this is telling you, you can literally see the market makers at work. Now you might ask, how does this help?

Well first, if we see a price move where the market makers are not joining in, we stay out. If we see a move where they are joining in, so do we. It really is that simple, and it’s all revealed for you in the volume price relationship. What I call Volume Price Analysis, or VPA for short. After all, the market makers can manipulate the prices as much as they like, but the one activity they cannot hide is volume, which is why this technique is so powerful. In addition, both volume and price are what we call leading indicators.

In other words they are at the leading edge of the market, so a double whammy if you like. If all this sounds a little overwhelming, please don’t worry. I will show you how in a later chapter, and if you are keen to learn more, I have written a complete book (along with several others) on the subject, not surprisingly called ‘A Complete Guide To Volume Price Analysis ’ - not very original I know. It is one of my passions, and I hope will become one of yours too.

As I said before, as small retail forex traders we are at the bottom of the heap, and are generally considered by the rest of the market as ‘fair game’ both by the institutional banks and market makers, as well as by our own brokers. The forex market is a voracious beast, which requires fresh money every day. With such huge sums being made, it is no surprise it often attracts the worst kind of business practice and outright profiteering, which can leave new traders disillusioned and substantially less well off than when they started. This was one reason I wrote this book. To help to level up the trading playing field.

The market makers have had it too easy for too long, and now, as retail traders we have the tools to fight back. The tools we have are free and part of the MT4/MT5 platform, which is also free. Learn how to use them and you will be amazed at what they reveal. No longer can the market makers hide their activities, and once you have read this book, you will be able to see them at work, just as I do on my screen.

Finally, just to wrap up this introductory chapter, let me round off by explaining some of the other basic concepts, before moving on in the next chapter to look at currency pairs and how they are quoted.

Although we are perhaps getting a little ahead of ourselves in asking and answering the above question at this stage, you might well be wondering, how and where do we trade. Is it simple, complex and who offers these prices for us to see? And the answer is the retail forex broker. Twenty years ago, trading in the foreign exchange markets would have been extremely difficult, if not impossible, but the internet has changed all that. Now you can find hundreds of brokers, all offering a very popular platform known as MT4 (MetaTrader 4) which is free (or increasingly MT5 which is becoming very popular), who will open an account for you and have you trading in minutes. I hope that answers this particular question, which then leads on logically, to who am I trading against?

And indeed this is a question which even seasoned forex traders have difficulty answering, and is often one that new traders don’t like to ask. Let me answer it here for you, and the answer also introduces a further aspect. Trading in currencies can be done in many different ways, using different instruments. After all, when we travel, we are simply changing our currency from that of one country to another. It just so happens we do this at the airport and use physical cash. But the process is the same - we are still changing currency.

Let me take the second part first.

As you might expect there are several ways to trade in the forex market, but the two most popular are using what we call the spot market and the futures market. There are others, but these are the two principle ones, and the one we are going to focus on for the remainder of this book is the spot market.

You can think of the spot market as a cash market if you like, and it’s called the spot market as prices are settled ..... on the spot. In other words, there and then. Think of this in just the same way as you might buy a stock or share. Here you are buying and selling your stocks or shares with real cash and as soon as you buy or sell, the order is completed. It’s the same with the spot forex market, which you can think of in this way. There are some nuances to this simple statement, which I explain later in the book when we look at how transactions are ‘settled’ after the order is complete, but in terms of the price, it’s effectively fixed ‘on the spot’.

The futures market on the other hand is very different, and here you are buying and selling a ‘defined contract’, which has a settlement date in the future. The futures market is also very different in another respect. It has a central exchange, and all the buying and selling is executed through the exchange in the same way as when you buy or sell stocks and shares.

To answer our first question then. Who am I trading against? In the spot forex market, we are often trading against our broker (although not always as you will see later), and in the futures market we are trading against someone who has taken an opposite position in the market. In the futures market, if I have bought, then I am matched with someone who has sold, and vice versa. In other words, if I win, then he or she loses, and conversely if I lose then he or she wins. The futures exchange sits in the middle and manages all this trading on our behalf, and everything is transparent.

In the spot market this is very different, and here we are often trading against our broker, or they are trading against us. This leads to the next question which is whether this raises a conflict of interest? And the answer is - it depends on your broker. This is why it is so important to ask the right questions, and also to understand the different types of brokers in the market. Some will be trading against you directly, whilst others will pass your orders through electronically with no dealer intervention. A key difference and one I will explain in the section where we look at the various types of brokers and how they work.

But for now, and for the remainder of this book, we will be focusing solely on the spot forex market, and using charts and examples from the MT4 platform.

One of the many beauties of trading the forex market is it is one that is open twenty four hours a day, and almost six days a week. This means even if you have a full time job, or are in a different part of the world, the market is always open .

It rarely if ever closes, and unlike many of the physical stock exchanges, or futures exchanges, never closes on public holidays, with virtually the only days being Christmas Day and New Year’s Day. The remainder of the year the market is open.

For traders in the Northern Hemisphere, the forex market opens on a Sunday evening and finally closes late on Friday night, before reopening on Sunday evening once again, as a new trading week starts afresh.

This is all shown in Fig 1.10. Here you can see the cycle the forex market takes, as first one major trading centre opens, before moving on to the next, with the first then closing. If we move from right to left, the first market to open is New Zealand, followed shortly after by Sydney, which opens at 10.00 pm GMT. These are joined two hours later by the first major Asian centre Tokyo, along with Hong Kong. The markets then trade together until 7am GMT when the European forex market opens, with London following an hour later, and consequent deep liquidity as a result. The Asian markets close, leaving the UK and European markets to trade together until the open of the New York market at 1pm GMT.

At this stage we have three major markets trading once again for a two hour period, before Europe closes at 3pm GMT followed by the UK at 4pm GMT, leaving the US market to trade on until the NY close at 9pm GMT, with the West Coast closing between 9 and 11 GMT, before the cycle repeats itself once again with the Sydney open.

At this point let me try to put this into some sort of context for you. Many forex traders mistakenly believe the currencies that are traded most heavily remain the same, whatever the time of day or night. In other words, a currency that is traded heavily in the London session, is also traded heavily in the Tokyo session. However, nothing could be further from the truth. This is a key point as we move deeper into the book, and in particular as you start to consider your own approach to the market, which will be heavily influenced both by the time you have available, but also where you are in the world. I am privileged to live in a timezone which makes it very easy for me trade in the markets when they are at their most active, and in those currencies which are heavily traded. You will often hear this referred to as ‘deep liquidity’ and in fact I used this term above. All this means is a market which is very active, and you can think of this in terms of - yes you've guessed it - volume. Volume is activity and activity is volume.

You may not be so fortunate, and you may also have work and family commitments which restrict your trading time further. The choice of which currencies to trade, and over what timeframes, then becomes an important consideration. This decision has to fit into your work/life balance, as well as allowing you access to those currencies and currency pairs when they are at their most heavily traded.

In Fig 1.11 and Fig 1.12 you will see two pie charts for various currency pairs, and for two distinct times during the 24 hour session. The first is for the Tokyo session, and the second is for the London session. Each pie chart shows the percentage of trading in a variety of currency pairs, and just to explain what each is, ahead of the next chapter, the JPY is the Japanese yen, the USD is the US dollar, the EUR is the euro and the GBP is the British pound.

Let’s take a look at each chart in turn.

We can see instantly from the pie chart one slice dominates this trading session, with the US dollar and the Japanese yen responsible for 78% of the volumes traded. If we add in the other two slices for the EUR/USD at 15% and the EUR/JPY at 5%, then between the yen (JPY), the US dollar (USD) and the euro (EUR), these three currencies account for 98% of the trading activity. This is a staggering percentage with the session dominated by trading in the Japanese yen. The message here is clear and simple. If you are trading in the overnight session in Asia and the Far East your focus will be primarily on the Japanese yen, either against the US dollar or the euro, since these are the most heavily traded currencies.

This is no great surprise, since over 40% of forex trading volumes in the retail sector (you and me in other words) are from Japanese speculative traders, whose primary focus is on one currency - their own. Now let’s take a look at what happens as we move around the globe to the London session.

What a difference. In the space of a few hours, with the focus of the market moving from Tokyo to London, interest in the Japanese yen (JPY) has fallen dramatically, with the USD/JPY part of the pie chart dropping to just 17%. The EUR/USD on the other hand has risen dramatically to almost 40% and has now been joined by the British pound with the GBP/USD at 23%.

This is one of the ironies and paradoxes of the foreign exchange market. It is both vast and global, and yet in some ways parochial as you can see from these charts. As each session moves on, the focus also moves from one local currency to another. In Tokyo, attention is on the Japanese yen, as we move to Europe and London this focus falls away and moves to the euro and the pound, and as the market shifts to the US the focus shifts also towards the US dollar.

The constant change in focus translates into the trading volumes and price action for each currency or currency pair, and herein lies the problem. Some traders, and you may be one of them, are not fortunate to live in a timezone which fits into this 24 hour world. After all, we have to sleep, eat and may also have work commitments, which make it difficult to trade in those currencies and markets when they are at their most active. This is one of the many issues I cover later when we start to think about building a trading plan, but this is a key point. The focus of the forex market is constantly changing, depending on where it is in the world.

Whilst it is certainly a 24 hour market, it is not one that remains constant. Trading volumes in the various currencies change dramatically as the market moves around the world, and therefore in your trading plan, you must consider this too. We explore this later, and there are many ways to overcome this issue - it’s simply a question of adapting your approach and strategy to suit your lifestyle, your commitments, and your timezone.

This then is the forex market. A global market available twenty four hours a day, wherever you are in the world. The opportunities are there, provided you have a guide and mentor to help you succeed. This is what the book is about. To help you avoid all the pitfalls, and to hold your hand as we go step by step, deeper into the forex market.