Fusion Markets

Embarking on your forex trading journey might seem daunting at first, but fret not! We’ve put together all the information you need to get started. 

This guide is your friendly companion, packed with real-world examples, easy-to-grasp basics, newbie-friendly strategies, handy tips, and a step-by-step roadmap to kickstart your forex adventures.

Contents 

Introduction to Forex Trading

How the Forex Market Works

Getting started in Forex Trading

Developing a Strategy 

Practical Tips for Beginners

Resources for Further Learning

Introduction to Forex Trading

Foreign exchange trading, or forex trading, is the process of buying and selling currencies in the global financial markets. It is one of the largest and most liquid markets in the world, with an average daily trading volume estimated to exceed USD$7 trillion. Unlike traditional stock markets, forex trading operates 24 hours a day, five days a week, allowing traders to participate in the market at any time.

Forex trading involves the exchange of one currency for another at an agreed-upon price. This is done with the aim of profiting from fluctuations in exchange rates. Currencies are traded in pairs, where one currency is bought while the other is sold. The most commonly traded currency pairs, or ‘the majors’ as they’re more commonly referred to, include EUR/USD (Euro/US Dollar), GBP/USD (British Pound/US Dollar), AUD/USD (Australian Dollar/US Dollar), NZD/USD (New Zealand Dollar/US Dollar), USD/JPY (US Dollar/Japanese Yen), USD/CAD (US Dollar/Canadian Dollar), and USD/CHF (US Dollar/Swiss Franc).

Examples of other currency pairs, most often referred to as “crosses”, are AUD/JPY (Australian Dollar/Japanese Yen), GBP/NZD (British Pound/New Zealand Dollar), EUR/CAD (Euro/Canadian Dollar) and so forth.

And finally, less-traded currency pairs are referred to as “exotics”. Examples of these include USD/TRY (US Dollar/Turkish Lira), USD/HUF (US Dollar/Hungarian Forint). It’s important to note that exotic pairs tend to have wider spreads and higher volatility compared to major and minor pairs.

Uses of the forex market

The forex market is used by many players, for many different reasons. Retail traders aim at buying or selling a currency to take advantage of short-term fluctuations in price, whereas corporates who conduct regular international trade often use the forex market to hedge against their local currency weakening.

Large-scale players such as hedge funds or investment firms, will use the foreign exchange market to take advantage of divergences in interest rates between two nations in the form of a carry trade.

For more information on the types of forex trading, head to Part Four.

Reading Currency Pair Quotes

Currency pair quotes consist of two prices: the bid price and the ask price. The bid price represents the price at which you can sell the base currency, while the ask price represents the price at which you can buy the base currency. The difference between the bid and ask prices is known as the spread, which represents the broker's profit margin.

In forex trading, currency pairs are quoted in pips, short for "price interest point," representing the smallest possible price movement. For most major currency pairs, prices are quoted with four decimal points, indicating a change of 1/100 of one percent or 1 basis point. However, the Japanese Yen is an exception, trading with only two decimal points.

For instance, if the bid price for the EUR/USD pair is quoted as 1.19040, this breakdown refers to the five decimal places displayed on the market watch.

How the Forex Market Works

In order to trade the foreign exchange market effectively, you need to understand the nuts and bolts of how it works.

The forex market is decentralised, meaning that there is no central exchange where all transactions take place. Instead, trading occurs over-the-counter (OTC) through a global network of banks, financial institutions, and individual traders. Some of the larger players in the forex market are Deutsche Bank, UBS, Citi Bank, RBS and more.

Prices are determined by supply and demand dynamics, with exchange rates fluctuating based on economic indicators, geopolitical events, and market sentiment.

How the system works

Market makers are key players in the forex world. They establish both the buying (bid) and selling (ask) prices, which are visible to everyone on their platforms. Their role extends to facilitating transactions with a diverse clientele, including banks and individual traders. By consistently quoting prices, they inject liquidity into the market. As counterparties, market makers engage in every trade, ensuring a seamless flow: when you sell, they buy, and vice versa.

Electronic Communications Networks (ECNs) play a crucial role in forex trading by aggregating prices from various market participants like banks, market makers, and fellow traders. They showcase the most competitive bid and ask quotes on their platforms, drawing from this pool of prices. While ECN brokers also act as counterparts in trades, they differ from market makers in their settlement approach rather than fixed pricing. Unlike fixed spreads, ECN spreads fluctuate based on market activity, sometimes even hitting zero during peak trading times, especially with highly liquid currency pairs like the majors.

Direct Market Access (DMA) empowers buy-side firms to directly access liquidity for securities they aim to buy or sell through electronic platforms offered by third-party providers. These firms, clients of sell-side entities like brokerages and banks, maintain control over trade execution while leveraging the infrastructure of sell-side firms, which may also function as market makers.

Straight Through Processing (STP) represents a significant leap in trading efficiency, transitioning from the traditional T+3 settlement to same-day settlement. One of its notable advantages is the reduction of settlement risk. By expediting transaction processing, STP enhances the likelihood of timely contract settlement. Its core objective is to streamline transaction processing by electronically transmitting information, eliminating redundant data entry and enabling simultaneous dissemination to multiple parties when necessary.

Getting Started in Forex Trading

Choosing a Broker

When selecting a forex broker, it's essential to not only consider the fees, but also regulatory compliance, trading platform, and customer support. Look for brokers regulated by reputable authorities such as the Financial Conduct Authority (FCA) in the UK or the Commodity Futures Trading Commission (CFTC) in the US.

Here at Fusion Markets we’re dedicated to offering a quality service with an affordable fee structure. You can learn more about trading forex or view our licences. 

Setting Up Your Trading Account

Once you've chosen a broker, the next step is to open a trading account. This typically involves completing an online application, submitting identification documents, and funding your account. Forex brokers offer various account types to suit different trading preferences, including standard accounts, mini accounts, and demo accounts for practice trading.

Developing a Strategy

Identify Your Trading Style

Before developing a trading strategy, it's essential to identify your trading style, whether it's day trading, swing trading, or position trading. Your trading style will dictate the timeframe you trade on and the types of setups you look for in the market.

Below are the types of pros and cons of each trading style:

Types of Analysis

Fundamental Analysis

Unlike technical analysis, which primarily relies on historical price data, fundamental analysis examines economic indicators, monetary policies, geopolitical events, and other macroeconomic factors to gauge the strength and direction of a currency's movement.

Central to fundamental analysis is the understanding that currency prices are ultimately driven by supply and demand dynamics, which in turn are influenced by broader economic conditions. For example, factors such as interest rates, inflation rates, GDP growth, unemployment levels, and trade balances can all impact a currency's value.

One of the key concepts in fundamental analysis is interest rate differentials. Central banks use interest rates as a tool to control inflation and stimulate economic growth. Currencies with higher interest rates tend to attract more investors seeking higher returns on their investments, leading to an appreciation in their value relative to currencies with lower interest rates. Traders closely monitor central bank announcements and economic reports to anticipate changes in interest rates and adjust their trading strategies accordingly.

Another important aspect of fundamental analysis is the assessment of economic indicators. These indicators provide insights into the health of an economy and can influence currency prices. For example, strong GDP growth and low unemployment rates are typically associated with a robust economy and may lead to appreciation in the currency. Conversely, high inflation or rising unemployment may weaken a currency.

Geopolitical events can also have a significant impact on currency prices. Political instability, conflicts, trade tensions, and other geopolitical factors can create uncertainty in the market and cause fluctuations in currency prices. Traders must stay informed about geopolitical developments and assess their potential impact on currency markets.

While fundamental analysis provides valuable insights into the long-term trends and direction of currency markets, it is important to note that currency prices can also be influenced by short-term factors and market sentiment. Therefore, traders often use a combination of fundamental and technical analysis to make informed trading decisions.

Technical Analysis

Technical analysis involves studying historical price data and using various charting tools and indicators to identify patterns and trends. Common technical analysis tools include moving averages, trendlines, and oscillators like the Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD). Traders use technical analysis to make short-term trading decisions based on price action and market momentum.

Technical analysis is a cornerstone of forex trading, offering traders a systematic approach to interpreting market dynamics and making informed trading decisions based on historical price movements and market statistics. Unlike fundamental analysis, which focuses on economic indicators and macroeconomic factors, technical analysis relies solely on price data and trading volume to forecast future price movements.

At its core, technical analysis is based on the efficient market hypothesis, which posits that all relevant information is already reflected in an asset's price. Therefore, by analysing past price movements, traders believe they can identify recurring patterns and trends that may indicate potential future price directions.

One of the fundamental concepts in technical analysis is that of support and resistance levels. Support represents a price level where buying interest is sufficiently strong to prevent the price from falling further, while resistance is a level where selling pressure is sufficient to halt an upward price movement. Traders use these levels to identify potential entry and exit points for their trades.

Example of support and resistance areas on EURUSD Daily chart

Another key tool in technical analysis is chart patterns, which are formed by the recurring movements of prices over time. Common chart patterns include triangles, flags, and head and shoulders formations. By recognising these patterns, traders attempt to predict future price movements and adjust their trading strategies accordingly.

In addition to chart patterns, technical analysts also utilise technical indicators to aid in their analysis. These indicators are mathematical calculations based on price and volume data and are used to identify trends, momentum, volatility, and other aspects of market behavior. Popular technical indicators include moving averages, oscillators like the Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD), and trend-following indicators such as the Average Directional Index (ADX).

While technical analysis is a powerful tool for forex traders, it is not without its limitations. Critics argue that technical analysis is subjective and prone to interpretation bias, as different analysts may draw different conclusions from the same set of data. Moreover, technical analysis does not account for fundamental factors such as economic news and geopolitical events, which can have a significant impact on currency prices.

Despite these limitations, technical analysis remains an indispensable tool for forex traders worldwide. By understanding and applying technical analysis principles, traders can gain valuable insights into market trends and dynamics, allowing them to make more informed trading decisions and improve their overall trading performance.

Risk Management

Setting Stop-Loss and Take-Profit Orders

Stop-loss orders are used to limit losses by automatically closing a trade at a predetermined price level. Take-profit orders, on the other hand, are used to lock in profits by closing a trade when the price reaches a specified target. By using stop-loss and take-profit orders, traders can manage risk and control their downside exposure.

Position Sizing

Position sizing involves determining the appropriate amount of capital to risk on each trade based on factors such as account size, risk tolerance, and the probability of success. A common rule of thumb is to risk no more than 1-2% of your trading capital on any single trade to preserve capital and avoid significant drawdowns.

Your Strategy

Once you’ve determine what style of trading would suit you best, you now need to develop a strategy. There are thousands of different strategies out there so you have the choice of learning one from someone else, or developing your own.

Regardless, some common strategies include:

Trend Following Strategies

Trend following strategies in forex trading involve identifying and capitalising on established market trends. Traders employing this approach aim to enter positions in the direction of the prevailing trend, whether it's upward (bullish) or downward (bearish), and ride the momentum for as long as possible. These strategies typically utilise technical indicators, such as moving averages and trendlines, to confirm the direction of the trend and determine optimal entry and exit points. The goal of trend following strategies is to capture significant portions of a trend's movement while minimising losses during market reversals.

NZDUSD Daily Chart showing optimal entry points to go short during a bearish trend.

Range-bound strategies

Range-bound strategies in forex trading focus on exploiting price movements within defined ranges or boundaries. Traders employing this approach identify periods when a currency pair is trading within a relatively narrow price range, bounded by support and resistance levels. Instead of following a trend, range-bound traders seek to buy near support and sell near resistance, aiming to profit from the price being restricted to the range highs and lows.

USDJPY 15min chart with optimal buy and sell signals for a range-bound strategy

Breakout Strategies

Breakout trading strategies in forex involve capitalising on significant price movements that occur when an asset's price breaks through predefined support or resistance levels. Traders employing this approach wait for a clear breakout from the established range and then enter positions in the direction of the breakout, anticipating continued momentum in that direction. Breakout traders typically use technical indicators, such as trendlines, moving averages, and volatility measures, to identify potential breakout opportunities and confirm the strength of the breakout. The goal of breakout trading strategies is to capture rapid price movements and profit from the subsequent price trend.

Example of an opportune entry for a bullish breakout trade on EURUSD 4-hour chart

The key to developing a strategy that works for you is by studying the charts and thinking about what makes sense to you. If you think patterns make sense as they identify areas of consolidation which can lead to a breakout, then pattern trading could be a good fit for you.

It’s important for any trader to stick with their chosen strategy and not switch strategies every time they encounter a losing streak.

Practical Tips for Beginners

Maintain a Trading Journal

Keeping a trading journal allows traders to track their performance, analyse their trades, and identify areas for improvement. A trading journal should include details such as entry and exit points, trade rationale, risk-reward ratio, and emotional state. By reviewing past trades, traders can learn from their mistakes and refine their trading strategies over time.

Avoid Overleveraging

While leverage can amplify profits, it also increases the risk of significant losses. Avoid overleveraging by using leverage cautiously and only trading with capital you can afford to lose. A general rule is to keep leverage levels below 10:1 to mitigate risk effectively. The best position is cash. You should ensure you’re only taking the most high-probability set-ups that are in-line with your strategy.

Stay Disciplined

Maintain discipline in your trading approach by sticking to your trading plan and avoiding emotional decision-making. Avoid chasing losses or deviating from your strategy based on fear or greed. Consistency and discipline are key to long-term success in forex trading. Sometimes it’s best to walk away from the charts and come back the next day with a clearer head.

Manage Emotions Effectively

Trading can be emotionally challenging, with the potential for both euphoria and despair. Learn to manage your emotions effectively by practicing mindfulness techniques, maintaining a positive mindset, and taking regular breaks from the market. Remember that losses are a natural part of trading, and it's essential to stay resilient and focused on your long-term goals.

Be realistic with your expectations

Trading can be very lucrative, but it can also be very costly. Traders should be realistic in their expectations – what % will you aim for each month? How much are you going to risk? Risking 20% of your equity per trade will be great on winning trades, but it won’t take long for you to eradicate your entire balance on a handful of losses. Whereas risking 1% equity per trade will allow you to conserve as much capital as possible, whilst still gaining 1%+ per winning trade.

Resources for Further Learning

To continue your forex trading education, consider exploring the following resources:

• Books: "Currency Trading for Dummies" by Brian Dolan, "Japanese Candlestick Charting Techniques" by Steve Nison, and "Market Wizards" by Jack D. Schwager.
• Online Courses: Investopedia Academy, Udemy, and Coursera offer a variety of forex trading courses for beginners and advanced traders.
• Forums and Communities: Join online forums and communities such as Forex Factory, BabyPips and TradingView to connect with other traders, share ideas, and learn from experienced professionals.

Ready to get started?

The forex symbol GBP/USD indicates how much the British Pound (abbreviated as GBP) is worth in relation to the US Dollar (abbreviated as USD). This article provides traders information on how much USD is needed to buy one GBP. Forex traders call an exchange of this pair as “trading the cable,” a nod to how New York and London used to transmit trading information.

The GBP/USD pair is among the oldest currency pairs traded in the world. It is also among the most popular pairs to trade and is considered a major forex pair.

If you’re considering trading this pair, read on for a quick dive into the history of these currencies, their dynamics, and how you can trade this pair.

If you want to read more articles about our pairs, check out our posts on: USD/JPY and EUR/CHF.

Currency background

The British Pound (GBP)

GBP is the official currency of the United Kingdom and its territories. Its history can be traced back to continental Europe. With over 1,000 years of history, it is one of the oldest, if not the oldest, currency still in use. In 1694, the Bank of England was established, and banknotes entered circulation shortly after.

The GBP’s importance goes beyond the UK and its territories. It used to be the dominant international currency before USD took over in the 20th century. However, it is still among the most widely used currencies for financial transactions worldwide, along with the USD and the Euro (EUR). Further, as of 2021, the GBP comprised 5% of official foreign reserves (i.e., share of currency reserves held by central banks).

The US Dollar (USD)

USD is the official currency of the United States, dating back to the 18th century. In 1785, the US adopted the dollar sign, which is now, perhaps, the most recognizable currency symbol in the world.

The USD plays a major role in the global economy, dominating international finance. It is the most active currency for international payments. It has also been the top international reserve currency since World War II, with an over 50% share of global reserves. In forex markets, almost 90% of all transactions involve USD.

The Plaza Accord

No background of these two currencies would be complete without mentioning the historic Plaza Accord.

In 1985, the US, UK, France, Germany, and Japan—then known as the G-5—agreed to jointly intervene in the currency markets to correct trade imbalances. The devaluation of USD was meant to reduce the increasing US trade deficits.

In a couple of years that followed the agreement, the USD declined in value by about 50%, while GBP and the other currencies appreciated by about 50%.

Factors you need to consider in trading GBP/USD

The GBP/USD pair is among the most liquid in the forex market, with smooth price movements as there’s enough volume of trade in the market.

Various factors move the prices of currency pairs in the forex market. For most currency pairs, prices are affected by economic trends and geopolitical circumstances, both locally and globally.

Here are some factors that drive the GBP/USD dynamics:

Economy

Both the US and the UK are among the largest economies in the world.

Due to its size and role in the global economy, the economic situation and policies in the US affect many economies and markets worldwide. In general, the GBP/USD rises when the UK economy grows more than US economy.

If you’re trading US-based pairs, you can keep up to date with US economy updates through government data releases and economic reports or Fusion's economic calendar, which includes data such as GDP growth, interest rate decisions and balance of trade.

Trade balance

The US is one of the three largest players in global trade, along with the European Union and China. The US is among UK’s major trading partners, accounting for about 10% of UK imports and receiving over 15% of UK goods exports.

The trade balance situation generates some volatility for GBP/USD. GBP/USD rises when current account balance (i.e., the balance of trade between the two countries) increases for the UK.

Central Bank policies

The Federal Reserve (Fed) sets the monetary policy in the US, a key determinant of currency strength, with the aim of stabilizing US prices and maximizing employment. In the UK, the Bank of England (BoE) sets the interest rate to maintain low and stable inflation. It reviews rates every 6 weeks.

A rule of thumb here is that the pair rises when the BoE interest rates rise more than the Fed rates.

As the USD plays an important role in international markets, movements in interest rates set by the Fed have a critical impact on the movement of many currencies worldwide, including GBP. In 2022, steep rate increases have strengthened the US dollar, causing other currencies to dive as investors rush to USD.

Geopolitical conditions and global risks

Like other currency pairs, the GBP/USD is also driven by political uncertainties and global risks.

The GBP took a hit following the global recession in the late 2000s. In 2016, after the announcement of Brexit, the GBP dived to its lowest against the USD, as UK’s decision created uncertainties to how its trade prospects would pan out.

GBP/USD and GBP/EUR - 2014-2021

As USD is a global reserve currency, it serves as a haven at times of global uncertainties. During the height of the COVID-19 pandemic in 2020, the GBP/USD rate dropped by 12% as investors sold the GBP and rushed to the safer USD.

GBP/USD and GBP/EUR - 2007-2010

Conclusion

Is the GBP/USD pair worth going into?

The US and the UK are among the largest economies in the world, with both USD and GBP playing important roles in international finance. The two countries share strong economic relations.

In forex markets, almost 90% of all transactions involve the USD. Post-1980, the pair has been less volatile, with extreme movements stemming from major global and regional events such as the Brexit and the COVID-19 global situation. The pair is one of the most liquid in the market.

If you’re new to the forex market, trading with highly liquid currencies such as GBP/USD could benefit you. This is because many strategists recommend trading in these currency pairs while you’re still improving your grasp of forex trading. You're also in luck, in that, Fusion Markets is the lowest cost regulated broker on the market. Start trading today!  

The forex symbol EUR/CHF indicates how much the Euro (abbreviated as EUR) is worth in relation to the Swiss Franc (abbreviated as CHF), and how many Swiss Francs you need to buy one Euro. The pair is nicknamed “Euro-swissie” in the FX market.

As a cross-currency pair, EUR and CHF are traded directly, without the need to convert to a base currency first. This is also commonly known as currency pairs that do not involve the US Dollar (USD). The EUR/CHF currency pair is among the most popular cross-currencies in the forex market.

In this article we breakdown the history of these currencies, their dynamics, and how you can trade this pair. 

For more currency pair breakdowns, check out our USD/JPY Overview.

Currency background

The Euro (EUR)

As of 2022, 19 out of the 27 member countries of the European Union (EU) use EUR as their official currency.

Since its debut in 1999 and entry into circulation in 2002, EUR has become one of the most widely used currencies for financial transactions worldwide, often second only (or at times at par with) USD.

Owing to its credibility, EUR has also, until recently, been a relatively stable currency. This stability has allowed it to extend its importance well beyond the EU. Over 50 other countries and territories globally have adopted the EUR as currency or have pegged their currencies to EUR. Furthermore, it accounts for over 20% of global foreign exchange reserves, second only to USD.

The Swiss Franc (CHF)

CHF is the official currency of Switzerland, as well as of Liechtenstein. In contrast to EUR, CHF traces its origin over a century back to 1850.

CHF is among the top ten most traded currencies globally. It has long been considered a safe-haven currency, owing to the stability of the Swiss economy and its political neutrality. However, unlike EUR, no other country uses CHF as a peg for their own currency.

What to consider in trading EUR/CHF

Compared to most currency pairs in the market, EUR/CHF experiences fewer price movements. The trends are typically slower and more stable.

Several factors affect the prices of currency pairs in the forex market. For most currency pairs, price movements are mostly tied to economic and geopolitical circumstances, both locally and globally.

Here are some factors that drive EUR/CHF movements:

Economy

The EU, as a single market, is one of the largest economies in the world and one of the three most prominent players in global trade. It is Switzerland’s primary trading partner, with the EU accounting for over 60% of Swiss imports and receiving over 40% of Swiss exports. The economic situation in the Eurozone has a history of affecting the Swiss economy, such as in the 2010s.

If you’re trading EUR-based pairs, you can keep up to date with happenings in the EU economy through European Commission economic reports, including economic forecasts and reviews, as well as Fusion's Economic Calendar. The European Central Bank also publishes economic bulletins that provide insights on monetary policy, a key determinant of currency strength.

Swiss policies

The Swiss National Bank, which issues CHF, has traditionally been non-interventionist. Several of its moves, however, have impacted currency markets. In 2011, it pegged the CHF to EUR, in a move to help Swiss businesses to increase their profitability. A few years later, in 2015, it abandoned the peg, stunning investors, causing market turmoil, and leaving a profound impact on the EUR.

EUR/CHF 2011-2015 Weekly Time Frame

Global risks

Investors on the move to mitigate global economic risks are drawn to CHF due to its solid reputation for financial stability. In the aftermath of the global financial crisis in the late 2000s, widespread buying of CHF saw a 20% depreciation of EUR to CHF.

Geopolitical conditions

Investors also turn to CHF in times of political uncertainty in the EU, such as during the Greek sovereign debt crisis following the 2008 financial crisis. Demand for CHF had also soared during the Brexit negotiations, with investors using it as a hedge for protection against Brexit.

Movements in USD

A distinct advantage of EUR/CHF is its independence from USD. As they can be directly traded with each other, the pair isolates traders from USD-related volatilities. 

Conclusion 

The EU is one of the largest economies in the world, with EUR used in a majority of global transactions. The EU and Switzerland are not only geographically close, but also share strong economic ties, such as trade relations.

The EUR/CHF as a cross-currency pair experiences fewer price movements, with less volatile trends compared to other forex pairs. Both currencies are credible, with CHF long considered a safe-haven currency. Even during the COVID-19 global pandemic, investors have trusted CHF.

If you're looking to trade EUR/CHF, you'll be able to get ultra-tight spreads and $2.25 commissions per lot with Fusion Markets. Don't wait on the sidelines, be part of the action.

Or why we tend to rely heavily upon the first piece of information we receive.

Our minds can have an enormous impact on our trading and the returns that we generate from it. The way we think, act and behave when we trade or invest is at least as necessary if not more so than our trade selection, particularly in the kind of one-way markets that we have seen post the covid crash.  

A rising tide lifts all ships they say, and, in this case, the rising tide of the markets was provided by the printing presses of the major central banks along with the stimulus packages from national governments.

However, Central banks won't always be there to rescue us and we need to be aware of the kind of tricks that our brains can play on us if we are to avoid making the wrong trading decisions.

One of these tricks has a nautical moniker, anchoring, in which our brain subconsciously latches on to an idea, an assumption or a set of figures and uses that information in decision making, regardless of whether it's accurate or even relevant to the matter at hand.  

What's more, as humans, we tend to carry these impaired decision-making processes forward so that we end up using an inherently flawed system and often without realising it.

Behavioural psychologists have highlighted these tendencies in their experiments.  

In the case of anchoring American academic Professor Jay Edward Russo performed tests on 500 graduate students in which he asked them pairs of questions on history and general knowledge, but, unknown to the students, he had "salted "the questions with erroneous dates and figures.

The student's answers invariably reflected the incorrect numbers, which were varied across different groups of students within the experiment, highlighting a clear bias.

Professor Russo was effectively projecting those values into the student's subconscious, creating an anchor point.

When we become anchored to figures or a plan of action, we filter new information through that framework, which distorts our perception and decision making.  

This can even make us reluctant to change our plan or framework even if the situation calls for it.

There are few consequences if any when this happens in an experiment inside a university psychology department. Still, if it happens in the real world like in trading or investing, then there most certainly can be consequences.

Anchoring Bias has been described as one of the most robust effects in psychology, the fact that our decisions can be swayed by values not even relevant to the task (or trade) at hand.

Let's say we are negotiating the purchase of a house and I tell you it's worth $1,000,000, and I wouldn't sell it for less. You, as the willing buyer might have only had a price of $800,000 in your head. But all of a sudden, you now are anchored on my price. Not yours. The worst part is that the person who goes first in the negotiation tends to anchor the other party (remember this for the next salary negotiation you need to do with your boss!)

The studies even show that if you rolled a pair of two dice, gave the numbers (e.g. 10 and 19) to the study participant, that subconsciously, you would anchor them on these two numbers. Ask them what they would pay for a house, bottle of wine, or in one notorious study, the judges sentencing a criminal, these numbers are in and heavily influencing the participant's decisions whether they like it or not.

Anchoring always occurs in making our trading decisions, especially as it might help to explain our fixation with round numbers. E.g. EURUSD at 1.20. Gold at $2000/ounce. DJ30 - 30,000. Once we get hooked on the number, we always use it as a reference point in future, probably because it "feels right".  

Let's say in the past you might have successfully gone long EURUSD at 1.20 earlier in the year, and now whenever it comes back to that number, you will buy it again (the same thing happened to EURUSD at 1.10). You can't explain it, but you had past success with that number and you will gravitate towards it without understanding why.

Take a moment to consider some key support and resistance levels on your favourite instruments. Are they round numbers too? Why might that be? Could it be because people are anchored at Gold at $1900? And that every man and his dog has placed their buy orders at that level because it's "good value" or has spent time around that level in the past? Remember that the market is driven by sentiment and agreed upon narratives. Think what else could the crowd be anchored on that might be to your advantage knowing what you know now.

How do we avoid being anchored? 

Given that we don't completely understand the processes that cause anchoring to happen in the first place, we are unlikely to avoid it entirely.  

However, by being aware of its existence, we can revisit and retest our assumptions when making important decisions, to ensure that we are acting rationally and basing our decision on the situation at hand, not irrelevant inputs.

Perhaps the best way to avoid anchoring in trading is to treat every trade as an individual event and to judge a trading opportunity on its current merits. By doing this, you have a better chance to ignore any reference or prior interactions you have had with the instrument you are trading. It won't be easy to do at first, but it could prove to be a valuable discipline over time. As mentioned, this is crucial to comprehend for putting your stops and limits around key support and resistance levels.

Think about a time you have been fixated on a number. Was it buying a house? A pair of shoes? Trading? Now think whether that number could have been influenced by someone else, e.g. the seller, the shoe store etc.

Anchoring can certainly also play a part in other hidden biases and behaviours such as loss aversion (e.g. not wanting to close your open losing trade).

The next time that you are about to trade, take time to think about why you are fixated with that number for entering and exiting the trade, and how you reached the decision to pull the trigger. A few moments of reflection might make all the difference.