Six dangerous forex myths and traps

While the equity markets obsess about the whys and wherefores of tapering in the US, those traders looking for some more reliable “action” for intra-day trading will have their eyes on the currency markets.

That’s why I thought that in this week’s newsletter I’d like to take a look at what every trader needs to know before dipping a toe in the forex markets.

1. FOREX MYTHS: Forex trading is high risk

Some forex traders would like you to believe that entering the currency markets is the trading equivalent to sky diving. Let’s face it – all trading is inherently risky. If it didn’t involve risk, it wouldn’t offer us the potential to make some spectacular returns.

However, provided you trade with a sensible percentage of your funds, use stop losses, and avoid major economic announcements (see below), there is no reason why forex trading should be any riskier than other forms of spreadbetting.

In fact, the immense size of the currency markets, and the diversity and liquidity that goes hand in hand with that, means that forex is often the most well-behaved and predictable market of them all.

2. FOREX TRAP: The lingo

Like most exclusive “clubs” forex traders like to impress each other with their grasp of jargon.

You probably already know that I’m not a fan of jargon. In fact, I loathe it.

But, you do need to understand what they’re going on about. So, here’s the bare minimum that you need to know …

Pip: This stands for “percentage in point” (don’t worry, you don’t need to understand the logic of that) – you simply need to grasp that a pip (like a “point” in other markets) is the smallest increment in currency trading. In most currencies, a pip is 0.0001 (the main exception to this is the Japanese Yen, where it’s 0.01).
USD: United States Dollar
GBP: Great Britain Pound
EUR: European members Euro
JPY: Japanese Yen
CHF: Swiss Franc (or “Swissy”)
CAD: Canadian Dollar (or “Loonie”)
AUD: Australian Dollar (or “Aussie)
NZD: New Zealand Dollar (or “Kiwi”)
Cable: GBP/USD
Base Currency: Currencies are always listed in pairs, such as EUR/USD. The base currency is the first one in the pair. So, if you see EUR/USD 1.2981, the Euro is the base currency, which means that 1 euro is equal to 1.2981 US dollars.
Quote Currency: In a currency pairing, the quote currency is the second currency in the pair. In the example EUR/USD, the US dollar is the quote currency.
Cross Currency: This is any currency pairing that does not include USD.

3. FOREX MYTHS: Forex trading is 24-hour

Like most myths, there is some truth in this. Yes, the markets are open 24 hours a day around the world, and you’ll always be able to find some currency action, somewhere around the planet. However, some trading times offer considerably better opportunities than others …

There are three main forex sessions, that overlap and follow one after the other: the Asian session, followed by the London session, and finally the US session.

Of these three sessions, one stands head and shoulders above the others.

London is home to most of the largest banks, used by businesses, government and individuals to exchange money. It is where you can find the maximum trading liquidity and volume in the forex market.

The other reason that London is so popular with forex traders becomes apparent when you look at the trading timetable:

Tokyo open: 0.00
Hong Kong open: 02.00am
Singapore open: 02.00am
Sydney close: 7.00am
Frankfurt open: 7.00am
London open: 8.00am
Tokyo close: 9.00am
Hong Kong close: 11.00am
Singapore close: 11.00am
New York open: 13.00pm
Chicago open: 14.00pm
Frankfurt close: 16.00pm
London close: 17.00pm
New York close: 22.00pm
Sydney open: 22.00pm
Chicago close: 23.00pm

Importantly, the London session also overlaps with forex markets in other countries. In the opening hours of the London forex session, we have the Frankfurt session, plus the closing of Tokyo, Hong Kong and Singapore. Then, at lunchtime, the US market wakes up.

And where markets overlap, you will find your optimal trading opportunities.

(But bear in mind that activity starts up before the markets officially open.)

4. FOREX MYTHS: You need to understand economics to succeed at forex trading

Equity markets in most major markets, like the FTSE or the S&P, have a level of international diversity built into them (over 80% of the FTSE’s sales exposure comes from overseas). This gives them a buffering from domestic and political issues.

The forex markets, however, are more are the mercy of political and economic news. So, forex traders need to be aware of this.

However, if you think that a grasp of global economics would help you to know which way news stories will send the forex markets – you’d be mistaken. The effects of economic and political wranglings by governments are very unpredictable.

Fortunately, the solution is refreshingly simple …

Most traders simply steer clear of times when economic data is released. It’s easy to find out when these times are by checking an economic calendar such as www.forexfactory.com

5. FOREX TRAP: don’t give robots access to your money

Chances are, you’ve received an email (or two!) telling you about how fantastic fully automated forex trading can be … how you can make easy money from the currency markets without lifting so much as a finger … your computer does all the hard work for you …

I’m all for minimum effort when it comes to making money – but leaving all the decision-making in the hands of a robot … well, that’s a step too far for me.

The truth of the matter is that more often than not, left to its own devices, a forex robot will rapidly relieve your trading account of all its cash!

Forex robots tend to trade a lot. This makes your broker rich – not you!

And forex robots trading records are often based on some rather dubious hypothetical backtesting. I’d need some stronger reassurances than that before I hand my wallet to a robot!

6. FOREX MYTHS: You need deep pockets in the forex markets

There are plenty of spreadbetting companies who will let traders get started with as little as 50p / pip. And provided you’re prepared to start small, risking a very small percentage of your initial fund on each trade, there’s absolutely no reason why you can’t trade forex with a very modest trading fund.

If you’re completely new to forex, I’d recommend that you start out with a demo account – many spread-betting companies offer these too, while you find your forex feet.

So, if you’re interested in trying out the forex markets, or in expanding your currency trading, we’ve some exciting trading ideas coming up in Trader’s Bulletin over the next two months.

Related posts:

What is the best time to trade forex My top tip for anyone starting out in forex