In this episode of The Trader’s Handbook, Shaun Murison from IG Markets South Africa joined me once more to explore the fascinating and often misunderstood world of forex trading.
We broke down the complexities of currency pairs, leverage, and volatility while dispelling common misconceptions about the risks involved.
Whether you’re a seasoned trader or just starting out, this episode offers valuable insights into technical analysis, hedging strategies, and how to effectively trade forex using IG’s platform.
Listeners will also learn about the importance of building a solid trading system and why starting with a demo account is key to success.
Listen to the episode below and enjoy the full transcript for reference purposes:
Transcript:
The Finance Ghost: Welcome to episode nine of the Traders Handbook, my podcast collaboration with IG Market South Africa. As you’ve guessed, considering this is episode nine, there are eight other episodes that you should totally go and sink your teeth into. There really is a lot of great content we’ve talked about a lot, Shaun. We’ve done all kinds of things, from all the risk stuff – because obviously we try quite hard to remind people that trading is not easy. Of course, we’ve covered the opportunities as well. We’ve covered how this stuff works with CFDs etc.
Our last show was actually on index trading and why indices are quite popular choices for traders looking to take a view on the market and make some money along the way – hopefully! And this week we’re going to do another asset class, actually a different asset class because indices are really just a collection of stocks and we’ve been focused on stocks for a few shows – an index is just a way to buy a basket of stocks in one shot – but now we’re doing something different. We’re doing a completely different asset class this week, and that is the wonderful world of forex, which is probably the asset class that gets the most abused on social media by, shall we say, unscrupulous individuals advertising all kinds of dicey forex courses and trading signals and all these little things ranging from outright scams through to just questionable things, but at least done maybe with good intentions.
I’m not sure why they do so well, I think it’s because maybe people are just familiar with what a rand is and what a dollar is, so it’s easier to get them to believe they can make money from that. I’ve never seen anyone driving around in a Mercedes that says on the side: “Index trading – follow me for tips” or Telegram signals on indices, on stocks. I’ve literally never seen it. So I don’t know what it is about forex, but it does drive me mildly insane to see people getting scammed out of money and promised these crazy returns.
If you’re listening to this podcast, you are hopefully already very aware that life is not that easy and that IG Markets South Africa is a proper, reputable shop where we focus on a lot of educational stuff on this podcast. And you can go and then sign up for a demo account on the IG Markets platform, get started in trading and learn what it’s all about.
So, Shaun, welcome to episode nine. Thanks for doing this again with me. Pretty excited to do forex today.
Shaun Murison: Great being here.
The Finance Ghost: I think forex is probably one of the harder asset classes to trade, or at least that’s my perception coming in, which might just be a relative lack of understanding versus my understanding of how equities behave. I think at one point when I was studying, it could have been one of the CFA exams, I actually can’t remember, but I distinctly recall reading that forex goes on what they call a random walk statistically, which kind of tells you that it’s not so easy to guess where currencies are going. I would imagine that makes it quite a hard thing to trade, although maybe it just makes it hard to invest in and maybe it’s not so hard to trade.
I’m keen to start there. From your perspective, how hard is forex relative to some of the other asset classes that are on offer at IG?
Shaun Murison: Look, I don’t think it’s hard or easier. I think when you start looking at forex, a lot of people have the misconception that forex is a lot more volatile. But if you actually look at individual equities and shares, they’re going to move – remember we talked about volatility, that range of price movement – they move a lot more than a forex pair will move over the course of a day or an hour, most of the time.
So, it’s a misnomer that the forex market is more volatile. But where the risk comes from in the forex market is that it carries a higher degree of leverage. We’ve talked about leverage in the past, the amount that your profits or losses are magnified in the market. When you’re trading products like indices and forex, what happens is those profits and losses are magnified by a lot more than they are in the stock market when you’re trading them as derivatives, like CFDs, which we’re talking about today. If you don’t have a handle on understanding your exposure in the market, how big your position is, and that when you’re putting down a deposit, it’s just a fraction of that actual position size, then you can get yourself into trouble in the forex market.
But I think if you can get yourself a handle on understanding leverage and exposure in the market, then I think forex is quite an interesting one to trade because forex markets – we talked about random walk earlier on, but I think for me it’s really just about looking at the interest rate differentials and the outlook towards interest rates across the different regions, which is going to cause directions within those currency pairs.
The Finance Ghost: Yeah, exactly, that’s an interesting point, right? It’s less volatile in terms of the range of moves. That makes sense. You’re not going to see a currency pair move 10% in a day. It’s just not going to happen, whereas stocks can easily do that, actually. But to your point, if there’s more leverage, then bearing in mind your deposit is effectively your exposure, the money you’ve actually put into the market, then a smaller move with higher leverage is effectively still quite a big range, right? I mean, that’s basically what you’re saying in terms of the risk.
So, there must be advantages, obviously, to trading forex, because otherwise it really wouldn’t be nearly as popular as it is. Obviously you can go long or short like equities. You’ve got to be very careful on these pairs because long the dollar would be short the rand, on a US dollar rand pair. Actually, I’m quite keen to understand that, are you trading the pair? How does that actually work on the platform? I haven’t done forex trading myself, so I’m curious to understand the long and short dynamics of a traded pair. And then of course, you’ve got 24 hours trading as well here, right? That’s another difference to equities, is you can technically do this whenever you want.
Shaun Murison: So like any other trading – equities, indices – you can take long or short positions, so you can take a view of whether the market is going to rise or fall, like you correctly said. Where it becomes a little bit trickier, is that you’re trading two things. So, I mean, if we look at something that’s familiar, I mean, the dollar versus the rand, in that pair you always look at the first currency as the base currency. So if we say USD ZAR, the base currency would be the dollar and the paired currency would be the rand. So if you’re taking a long position on that, essentially what you’re saying is you’re expecting the dollar to strengthen and the rand to weaken. I think the easy way of looking at it is that it’s really always about taking that base currency so the dollar and viewing that as one. And then it’s how many rands is it costing to buy $1? If you think it’s going to cost more rands to buy $1, then you’re taking a long position because the value of the dollar is going to go up in rand terms. If you think it’s going to cost less rands to buy $1 in the future, then you take a short position. So if that moved down, then your rand would be strengthening and your dollar would be weakening.
Sorry, you asked about the 24 hours market. So that is the interesting thing about the forex market is that, yes, it does trade very close to 24 hours, close to six days a week. You have your Asian session that starts in Australia on a Sunday and a Sunday afternoon or Sunday evening, and then all the way through to the end of the US session, which is about 10:00, 11:00 our time, depending on daylight saving.
The Finance Ghost: So just on those currency pairs, just to finish the point around long shorts. So is it the same trade if I’m long USD/ZAR as short ZAR/USD, if you mirror the pair and you’re long one and short the other, is it the same trade?
Shaun Murison: Effectively that would be the same trade, but most platforms, including IG, would only quote the major currency first. So it would be USD/ZAR. But yes, in theory what you’re saying is correct.
The Finance Ghost: Okay, so that makes sense because otherwise I thought you’ve got all these different options, but actually it’s the same trade. You’re going to quote the pair in one style, stronger, I think you said stronger currency first, so it would be USD/ZAR and then you either go long or short depending on what you want.
Shaun Murison: Yeah, the major currency.
The Finance Ghost: Yeah, okay, that makes sense. We can only dream of a world in which the ZAR is the major currency! It’s going to take more than the GNU to get us there, unfortunately. USD/ZAR is going to be the way it is forever, unfortunately.
So moving on from that, are you still actually trading CFDs in this case when you are doing forex trading, or do you end up owning the foreign currency itself, as opposed to like a CFD play on it? How does that actually work?
Shaun Murison: Okay, so everything IG offers is a type of CFD. You’re not actually taking delivery, essentially like you would of an asset if you’re trading the futures market or something like that. Or if you’re trading shares, you wouldn’t take ownership of the actual shares, but you’re benefitting from the price movement. When we talk about the DMA side of things, remember that the forex market doesn’t have a formalised exchange, like the stock market. When you have direct market access, it’s DMA to the orders on an exchange, like on the Johannesburg Stock Exchange, or on a US stock exchange. On the forex market, that exchange and that forex market is actually dictated by an interbank market, but it’s not a formalised exchange. So most brokers won’t offer a DMA-type offering where you can actually see the market depth for currencies. So it is slightly different and it’s mostly traded OTC.
IG does actually have a product where you can see that interbank market, something called forex direct. But the default way that most people trade is OTC.
We’re just looking at the primary bid and offer, you see the quoted price movement. You’d look at the base currency, that first currency, and you generate a profit and loss in the second currency. If you’re trading the USD/ZAR, you are generating profit or loss in ZAR, that second currency. If you’re trading something like the EUR/USD, the euro is the base currency, the dollar is your paired currency. You’d be generating a profit or loss in that paired currency.
The Finance Ghost: Okay, that makes sense. Thank you for the additional details there. It makes a lot more sense then in terms of how all these pairs work and what you’re actually buying, etc. Now, obviously, when you’re trading equities and maybe even indices, you’ve got a whole lot of things to choose from. Tons, actually. I would guess in the forex world, you’ve got very, very liquid pairs, and there will be pairs that are particularly popular, but people are probably not going and trading really unusual forex pairs on the platform, I would imagine. This is not like foreign currency when you’re traveling and you need to go and buy some of whatever the local currency is in whatever interesting little frontier market you’re traveling to. In the world of trading, I would imagine that it’s a set number of pairs with very deep liquidity, very tight spreads. And that’s the appeal, right?
Shaun Murison: Yes. So very, very liquid market. The size of the forex market actually dwarfs that of stock markets. I think I had a stat here – when you look at something like the forex market in particular, I know it’s over 6 trillion. You look talking about trillions and when you’re looking about stock exchanges, you talk about billions. So substantial difference in size, and obviously that equates to a substantial difference in liquidity. Most popular traded currencies are generally the majors, the currencies that represent major economies around the world, those majors include things like the US dollar, the British pound, euro, Japanese yen, Australian dollar, and the Swiss franc. Now, other currency pairs that are also quite popular is when you take those majors and you cross them against other exchange rates.
Minor currency pairs are also quite popularly traded. And the minors are generally taking one of those major currencies, like the dollar or the yen or the British pound and crossing it with decent sized currencies like the rand. So, USD/ZAR would be considered a minor currency. EUR/ZAR would be considered a minor currency pair.
The Finance Ghost: Interesting. Okay, cool. So the rand itself just makes it a minor pair immediately, even though we’re such a liquid emerging market currency?
Shaun Murison: Yeah. And obviously, we are the most developed economy in the African continent.
The Finance Ghost: Yeah, absolutely. Moving on to just the reason why you might want to be doing forex trading. Obviously, there’s the speculative side, which is you’re looking to make a profit. You are looking to take a view on a currency pair moving in a particular direction. And if you get your long or your short right, you make some money. That’s the sort of 101 of trading.
I would imagine that there’s a hedging element as well. If you’re sitting with, I don’t know, big offshore exposure in equities, for example, that’s going to move for two reasons. It’s going to move because of the underlying equity price in that market, and then it’s going to move again because of what happens to the currency on translation into where you are sitting, which in this case is likely South Africa. So that’s where the forex trading can also be a hedging mechanism. And there you’re not trying to make a quick buck here or there. You’re actually taking a longer-term view of trying to protect a position or lock in some kind of profit and stop it changing based on forex moves, right?
Shaun Murison: Yeah, I think you’ve explained that quite well. But you know, it doesn’t have to just be stock markets. Most traders are speculative traders when it comes to forex, the retail traders. But that hedging aspect is a definite use and a common use for the currency. So, you know, if you wanted to buy something in US dollars at a future date, let’s say you wanted to – whatever the product is – and you’re worried about the rand weakening up until the time that you might have to pay for that product, then you might actually just take a currency position, a long USD/ZAR position of equal size. It’s not there to benefit from the change in the currency price, but it’s really just to protect that future spend. So yeah, hedging out possible weakness within the currency.
The Finance Ghost: When we spoke about index trading last week, we talked about the efficiencies across leverage and costs. I think you’ve already mentioned on the show that forex has more leverage built into it in terms of the way trading it actually works. I think let’s go into the detail there just on number one, what are the costs of trading forex? Is it cheaper than trading equities and then how does it compare to trading indices?
Shaun Murison: So if you’re for example taking a EUR/USD mini-contract, every point that it moves is four decimal places to the right, referred to as a pip. One pip is worth $1. The cost of that trade is 0.9 pips, so not even a full $1 for the trade. It’s 90 cents for the trade, entry and exit costs combined. On a mini-contract, the value of your position is 10,000 of your base currency, in this situation the EUR, so the cost of 10,000 EUR exposure would be just $1. That’s cheaper than indices and certainly cheaper than single stocks.
If you hold positions overnight, there are interest rate calculations, which is the differential between the two currencies, interest rates, which is one of the reasons why we don’t hold for extended periods of time, any of the short-term trading, any of the CFD-type trades, but it’s not a high cost unless you’re holding on for months to years on a position. Yeah, very, very appealing in terms of costs.
The Finance Ghost: And then secondly, just how extensive is that leverage so that people are aware of what they are buying?
Shaun Murison: In terms of the leverage restrictions, a lot of regulators in different jurisdictions, like European regulators, the ESMA and FCA and that, have clamped down on leverage because sometimes it got a little bit irresponsible. We had some providers at some stage offering 500:1 times leverage and even more than that. Now, the standard is generally 30:1. If you’re trading stocks and your deposit requirement for a trade is 10%, then on the currency position it’s just over 3%. Your profits and losses are magnified by 30 times, whereas in shares, while it does vary between shares, your profits or losses will be magnified by, let’s say, ten times.
The Finance Ghost: The costs are relatively low compared to equities, and the leverage is relatively high, so you need less money in order to make money. That’s basically why this is appealing. And maybe that takes us all the way back to what I mentioned at the start of the show, which is, why does forex appeal to people? And, you know, even in a context where it’s not done in a positive way and not explained in a positive way, I guess it’s that ability to do well. And it’s the one or two stories of people who have done well, whether by luck or design, it kind of encourages other people to have a go. But I think it is just so important to understand what you’re actually buying and the best way to do that.
We keep encouraging people to try out a demo account first. I think on the forex side, even more so, because you’ve got to try and figure out how these things move. I would imagine there’s lots of technical analysis that goes with it. Yes. Interest rate differentials and all of that, absolutely, they give you a good idea of long-term where a currency pair is heading, but trading is not long-term, it’s short-term stuff. It’s going to be news driven, it’s going to be risk-on, risk-off, it’s going to be all that kind of stuff, right? And lots of technicals I would think, Shaun.
Shaun Murison: Yeah, I agree. I think good technicals reflect the fundamentals. So I think if you do a top down approach where you compare the different trends of these currencies, you can see what’s the strongest and you can see what’s the weakest, and essentially it will reflect what’s happening with interest rates anyway. When we talk about things like the news, like you’ve had mentioned, obviously a lot of the news, like when you start looking at inflation, interest rate announcements and GDP, the major types of news events, they change sentiment around what to expect from interest rates going forward. So you’ll see those reflecting on this currency markets as well. And like I said, I’m a technical trader predominantly myself, and I think those good technicals will reflect what’s happening, will summarise that information for you if you’re using them correctly.
The Finance Ghost: Perfect. So let’s get into the technical section of the show. As we’ve done for the last few episodes, we kind of end off with doing some techs because it’s just too much to do in one show. It’s a bit overwhelming to listen to. And this week it sounds like we are sponsored by a shampoo brand because we are doing “head and shoulders” – but it means something completely different in the world of trading. It’s a pretty interesting chart pattern. And what’s particularly interesting with it is you can use it in the normal way or you can invert it actually and then use it to give you the opposite signal. It’s quite a lot harder to spot it on an inverse basis. We’ll obviously talk about that now. But if you just use it in the sort of traditional head and shoulders manner, then this is a way to identify potential trouble, right? This is something going from bullish to bearish, and this is a way to guess how that might play out, isn’t it?
Shaun Murison: All right, so head and shoulders. Very, very commonly recognised pattern in technical analysis terms. I think the important thing here is that I think we’ll give the listeners a link to the article when they can actually visualise what we’re talking about.
But if I can just cover the principles of what we’re actually looking at here – we talk about markets that move in trends, and when we talk about a head and shoulders, it’s a pattern that generally comes after a trend, and it’s a warning sign that that upward trend – it comes after an upward trend – is changing direction.
So if you’re trading that type of pattern and you start to see that, you might see that pattern as a warning. If I’m long in the market, maybe that’s a signal that I could be looking at exiting my position. And if I was looking to short the market, maybe I’d wait below a break of a neckline or key support level, because it’s showing you when the market’s actually moving into a new downtrend to possibly short that market. But the key point is it’s a reversal pattern. And what is it reversing? It’s showing you that an uptrend is now reversing into a downtrend which can inform your sort of trading direction in the market.
The Finance Ghost: Okay, fantastic. And then if you use it on an inverse basis, it’s telling you the opposite thing, right? You’re basically flipping it on its x axis and then looking for that pattern in reverse.
Shaun Murison: Yeah. So again, it’s still acting as a reversal pattern. So that shape, that head and shoulders shape, is showing us that a market that’s moving in a downtrend, a series of lower highs and lower lows, has now started to change direction, started to make higher highs and higher lows. So, moving from a downtrend into a new uptrend. Again, if you’re short into the market and you saw this inverse head and shoulders, which is that pattern upside down, you might consider looking at exiting some positions. And, you know, when we break above that neckline or the key resistance point, we might consider taking new long positions within that market in line with the new trend which is developing.
The Finance Ghost: And then just a general question around these trading strategies. It’s something that I’ve learned from you and from this show, which I’ve started to apply even when I’m doing normal equities now, you know, non-CFD type stuff, because it’s really, really helpful, is to what extent do you wait for confirmation instead of trying to be a hero and trying to be a little bit early. To what extent do you wait for confirmation that something is playing out before you actually have a go? Because I think that’s something traders are quite good at. They’re not trying to always get 100% of a move. They’re just happy to get a piece of a move and to nail that more often than not. And then your win ratio is great.
Shaun Murison: Yeah. So I think you’ve got to have a defined set of rules and criteria for your trading, especially in the short term game. For me, it’s something as simple as you have a lot of intraday activity, let’s say you were waiting for a breakout, a market moving above a key level might go up and down and up and down through that level. I like to see it settle there, I wait for a close. It might be different for different people, but I think you need to be consistent in what you’re doing rather than pre-empting your signals, because sometimes your signal that you’re waiting for doesn’t actually confirm and so you’re actually just trading on a hunch, trading with your gut.
You need to set out some mechanical rules with your trading: when to get in, what are your confirmations? For me, it’s if I’m looking at key price levels, it’s a close above, I’d like to see the price settle above a particular level if I’m looking for a long, or settle below a certain level if I’m looking for a short. If I’m looking at stocks, I’d like to see strong volume accompanying a breakout, showing that there’s a lot of momentum to that directional move.
That subject is quite broad, but I think for the listeners, I’d say that just set out definite criteria and try stick to the rules of those criteria that you place for your trades rather than pre-empting what you think might happen.
For example, another one would be a lot of people like to trade moving average crossovers, and the moving averages look like they’re going to cross over, and that could be a buy signal, but then they don’t actually cross over. You’re actually trading not on a strategy, but on a whim.
Set out some rules for yourself would be the advice there.
The Finance Ghost: Yeah, absolutely. Trading is about building a system. I think that’s been the one consistent piece of feedback that’s really been a feature of these podcasts. Thank you for that.
Shaun, I think that brings us to a close on this one. We’ve done some good stuff here on forex, obviously highlighted the head and shoulders pattern, and in the show notes, I’ll ensure that the links are there. It’s really important to actually go see this with your own eyes. You can’t just listen to that and try and understand what that is. The idea of mentioning the technicals on these shows is really just to highlight that these things exist and to point you in the direction to go and actually engage with those examples and charts and the excellent content that gets put out on the IG Markets academy. Go and check it out.
And of course, as we keep saying, go and open your demo account. Go and give it a try. See if it’s for you. Rather go figure that out with monopoly money than real money, go make your mistakes with monopoly money rather than real money. It’s always better to do that. It really is.
Shaun, thank you for another great show and I look forward to welcoming you back for the next one where we will be dealing with commodities as another example of an asset class that can be traded on the platform, adding to the suite of equities and indices and forex that we’ve now done. Thank you and we’ll do this again soon.
