What is Forex trading? This article covers everything novice traders need to know about the industry, how to get started, how to grow as a trader, and most importantly how to reduce risks.
So you’re thinking about Forex trading. You’ve heard about it, maybe a friend or family member is trading, and you’re interested to know more about trading the foreign exchange markets and whether it’s right for you. This article will cover everything new traders need to know about the industry, how to get started, how to grow, and how to reduce risks.
What is Forex trading?
The concept of forex trading is very easy. Assume that you are an American citizen, who is travelling to Japan for leisure. You have $1,000 and the exchange rate for the Japanese Yen is $1 for ¥100. At the airport, you exchange your dollars into yens, and you get ¥100,000. After completing your stay, you go back to the US and find that the exchange rate has fallen to $1 for ¥90. You convert ¥100,000 into dollars and find that your $1,000 has grown into $1,111. By completing this transaction, you have engaged in the foreign exchange, or forex trading industry.
Globalisation has led to an increased global engagement. Today, multinational companies move currencies all the time to fund new investments. The same is true for individuals who have started to travel between countries more than ever. Consumers too are increasingly shopping internationally. In total, more than $5.3 trillion are exchanged every day making forex trading the largest industry in the world.
Currency pairs
In the Forex market, currencies are quoted in pairs. This is because traders exchange one currency to get another currency. There are hundreds of currencies in the world but in electronic trading, it is not logical to trade all of these pairs. Most traders focus on the highly liquid forex majors which include pairs like EUR/USD, GBP/USD, USD/JPY, and USD/CAD. Other currency crosses of the developed countries like EUR/GBP, EUR/JPY, and AUD/NZD are also popular pairs.
In a currency pair, the first currency is known as the base currency while the other one is called the quote or counter currency. When you buy a currency pair, you are simply buying the base currency while simultaneously selling the counter currency.
Forex brokers quote two prices. The price on the left is known as the bid price and is the price at which the dealer is willing to buy the base currency. The other price is known as the ask price and is usually the price which the broker will sell the base currency in exchange for the quote currency. The bid price is always smaller than the ask price and the difference between the two is known as the spread.
A pip is another important part of a currency pair. A pip is the last decimal of a forex quote and is how traders measure their losses or profits. Therefore, if a pair moves from 1.2500 to 1.2501, it has moved by one pip.
Why trade forex
Forex trading has some advantages over other types of trading for a number of reasons.
- Most forex brokers don’t charge commissions, which are common in stock trading. Instead, most brokers make money using the spread between the bid and ask prices.
- The forex market is open every weekday for 24 hours. This happens because there is always a major exchange open at any specific time around the world.
- Most brokers offer leverage to traders. This leverage ranges from 1:1 to 1:500. Therefore, a small trader with a $1000 account, using a 1:100, can trade assets worth $100,000.
- In the forex market, traders can make money regardless of the direction of the assets. A trader buys a pair they believe will grow in price and sells a pair they believe will fall in price.
- There are no middlemen. For example, in the stock market, sell-side analysts have been known to manipulate the markets by releasing reports that impacted these markets. In the forex market, this manipulation is almost impossible.
Who can trade the currencies market?
Anyone with an interest in the financial market, a fast internet connection, a computer, and some money can become a trader. The starting capital you choose depends on your risk appetite and the requirements from your broker. Some brokers accept as little as $50. However, starting a very small account is not recommended because of the risk of losing it all within a short period.
Order types in forex
In forex trading, traders can either buy or sell currency pairs. Buying a pair means being bullish on the base currency while selling a pair means being bearish on a pair. There are three main order types which traders can make. The market order means that the trader is initiating a trade at the current price. A limit order is an order to buy or sell a pair at a certain price. For example, if a pair is trading at 1.2000 and you want to buy it when it reaches 1.2010, you can place a buy limit at 1.2010. By doing this, the system will automatically open a buy trade even when you are not there. A stop loss order is an order to buy or sell a pair once the price moves past a certain price.
How to identify entry and exit positions
The challenge for all traders is where to initiate a trade and where to exit it. It is an area that requires intensive reading and practice. In summary, a trader needs to use technical and fundamental analysis.
Fundamental analysis is the process of using economic data to make decisions on currencies. For example, traders are likely to prefer owning currencies of countries that are stable and whose economies are growing. To know this, they use economic data like employment numbers, interest rates, GDP numbers, inflation numbers, industrial production, and retail sales to make decisions.
Technical analysis, on the other hand, is based on the movements of the charts. Its foundation is that, by looking at the charts, you can find patterns which will help you make decisions. A good way to find positions is to use trend indicators to find whether a trend is forming. Examples of these indicators are provided by Market Makers FX. After finding a trend, you can confirm it using the oscillator indicators. These include the Relative Vigor Index, Relative Strength Index, and the Stochastic. After using these indicators, you can use the charting tools such as the Fibonacci Retracement tool to find potential entry and exit levels.
How to reduce risk
Forex trading is a risky business and it is possible to lose more money than you invested. It is impossible to eliminate risks in trading but using several strategies, you can reduce your exposure to risk. Here are a few strategies traders use to manage risks when trading.
- Hedging: A trader opens two trades of correlated currency pairs simultaneously. For pairs that are inversely correlated, when one pair moves up, the other one will move in the opposite direction. In this case, the profit will be the difference between profit and loss.
- Stop loss orders: A free tool that automatically closes a trade when it reaches the maximum acceptable loss. This tool is important in risk management because it allows a trade to be automatically closed even when a trader is not physically present. A trailing stop loss, which is not fixed at a certain level, is a good way to lock up profits and reduce risks.
- Leverage: using smaller leverage is also a good way to reduce risk. To new traders, the idea of having a higher leverage ratio is always tempting. However, the reality is that a very high leverage ratio exposes a trader to a higher risk of losing money.
- Timing:- to reduce risks, traders should open trades when there is no major economic data expected. The volatility tends to increase before and after important data is released and so, for new, inexperienced traders, it is recommended to stay out during this time.
- Size of trade: opening small trades can help traders reduce the risk of higher losses.
Forex trading is an interesting industry. It is one of the few industries that allows you to make money 24 hours a day regardless of where you are. It’s starting costs are minimal and anyone with a computer and connection to the net can get involved. It is a dynamic industry that lets you learn new things every day. And, regardless of where you live and how much money you have, you can succeed in the industry if you are patient and willing to learn.
