A Beginner’s Guide to Getting Started in Forex Trading:
Background
The Forex Market, with over $5 trillion changing hands in it every day, is the world’s largest and most liquid financial market. Even the New York Stock Exchange (NYSE), with its roughly $23 billion in daily trading volume, pales in comparison to it. Consequently, it potentially offers a lot of money-making opportunities.
However, before you can successfully cash in on those opportunities, you have to learn. You have to understand the market for what it is. It is when you do that you will be able to succeed in it. In this guide, we will be walking you through the basics and the tips that will equip you for that.
The Forex Market
The Foreign Exchange Market, Forex or FX for short, is the global financial marketplace where currencies are traded. In one way or the other, you have participated in this market before. Remember, for example, the last time you took a vacation to Europe. At the currency exchange booth at the airport, you changed your dollars for euros.
When you got to Europe, maybe, at a time, you accidentally offered to pay for some stuff with some of your dollars remaining, but you were politely declined. So, there, you spent euros. And with euros, you had an amazing vacation. On getting back home, you found out that you had some euros left, which you instantly exchanged for dollars at the airport. These two transactions of changing dollars for euros and vice versa were Forex!
However, as a speculator, the Retail Forex Market, which you will be investing in, is just a segment of the large Forex Market and it accounts for about $400 billion (representing approximately 6%) in daily trading volume of it. This segment is completely decentralized. That is, all transactions in it are electronic, being conducted over a network of computers.
As a result, unlike the stock market, it is open 24 hours a day, five days a week and does not have a physical exchange. Because of that and its other characteristic features, the retail Forex Market has become a huge attraction site for small and medium investors alike.
Currency Pairs
Forex is traded in pairs. That is, to buy one currency, you have to simultaneously sell another. There are numerous currency pairs to buy and sell, but because of the frequency of trading which affects liquidity, we recommend you trade only the major pairs, which constitute about 85% of the total market. They are combinations of the United States Dollar, the USD, and other currencies, such as:
- EUR/USD
- USD/JPY
- GBP/USD
- AUD/USD
- USD/CHF
- NZD/USD
- USD/CAD
Additionally, there are minors or crosses, which are currency pairs that do not contain the USD. They are also not as frequently traded as the majors. Generally, investors aim to profit from the rapid fluctuations in the exchange rates of those currency pairs. However, because the fluctuations, as rapid as they are, occur in small increments, investors have to use leverage to be able to make substantial gains on them.
Pip
A pip, initially, might sound complex to understand. However, it becomes less so once you remember that there has to be a unit in which the smallest price movement of a currency pair has to be measured. Pip is that. While stock traders will say that Apple shares increase by $1 in a trading day, Forex traders, instead, will say that a particular currency pair inches up by a pip more at a time.
A pip has a monetary value which depends on your account’s currency and the particular currency pair and lot size you trade. If your account is dollar-based, for example, one pip will be $10 on a standard lot, $1 on a mini lot, and 10 cents on a micro lot for trades taken on those currency pairs with USD as their counter currency.
Forex Quotes
Quotes are arguably the most difficult to read for Forex newbies. If you are one, you need to know first that the left and right currencies that make up the pairs are called the base currency and counter/quote currency respectively. For example, take the exchange rate of the EUR/USD pair as 1.12033.
What that means, considering the fact the base currency, is always equal to 1 unit, is that you need 1.12033 of the counter/quote currency, the currency on the right, the USD, to buy 1 unit of the base currency, the currency on the left, the EUR. This exchange rate will go up when the base currency strengthens and falls when it weakens.
Also, Forex quotes are accompanied by two prices which are called the bid price and the ask price. The bid price is the price at which you can sell the pair or the price at which the market will buy the pair from you. The ask price, on the other hand, is the price at which you can buy the pair or the price at which the market will sell it to you.
Expectedly, the bid price is always lower than the ask price and the difference between the two is called the bid-ask spread. For example, in the quote, EUR/USD 1.12033/1.12037, the bid and the ask are 1.12033 and 1.12037 respectively. The bid-ask spread, in this instance, is 4 and it is the gain that will accrue to the broker for its roles in the execution of the trade.
Leverage
Whenever you use leverage, you are trading on margin. This is when you are able to control positions larger than your account value using the money your broker borrows you. For example, with a $1000 account of 1:100 leverage, the generally recommended leverage for Forex traders, you can control as much as $100,000.
So, that means that you can initiate trades 100 times bigger than the money in your account. Hence, with leverage, you are able to buy more of a currency pair with less cash, while also giving yourself the potential of more returns. The downside of leverage, however, is that it also increases your losses if the currency does not go in your anticipated direction.
Lot Size
Forex is traded in lot, which denotes the number of the base currency units. The larger the lot size, the larger the number of the base currency units you are either buying or selling at a time, and the higher the risks you are taking on. That is why a standard lot is 100,000 units of the base currency, the mini lot is 10,000 units, while the micro lot is just 1000.
Newbie Forex traders are encouraged to stick to either the mini or micro lot because of the high risks associated with trading the standard lot.
Forex Trading Tips
You have learned the rudimentary aspects of Forex trading. Now, you can take a plunge. Hence, the following are tips to help you get started in it.
Understand what Forex is
There are many strategies for trading Forex. However, what is important is that you first understand its basics such as currency pairs, pips, bid-ask spread, leverage, etc., as we have earlier discussed. You should also learn how to analyze the market and identify tradable opportunities yourself before you put your money on the line. Check out our next posts for this.
Plus, Forex is more than just taking trades, and you should know that before you set at it. It is as psychological as it is technical. So, prepare your mind!
Develop a Plan
If you fail to plan, you plan to fail. Perhaps, there is nowhere else where the maxim holds so true as much as in Forex. A trading plan will serve as your lens through which you will be seeing the market.As a Forex trader, not having a plan is a recipe for disaster. So, it is surprising to know that many are guilty of this.
In your trading plan, you should highlight your method of approaching the market, your profit goals and your risk tolerance. As a result, you should properly detail your ideal trading conditions such as entry and exit points, risk/reward ratios, stop-loss, and general money management rules. Such a plan will go a long way in making you a disciplined trader.
By the way, having a plan without following it is as bad as not having any at all. Hence, make sure you always stick to your trading plan!
Choose Your Broker Well
Before the 90s, the Forex Market was almost exclusively for institutional investors. Multinational corporations, hedge funds, and large investment banks, with their technical and large capital edge, dominated it. Fortunately, the advent of the internet allowed ordinary investors to start accessing the market.
That is possible via the online trading systems offered by retail Forex brokers, which serve as the intermediaries between retail investors and the Forex market. However, not every broker goes. You have to choose your broker well. For example, your broker has to be regulated by one of the leading regulatory authorities such as CFTC, NFA, and FSA.
With that, the safety of your money will be ensured. Also, your broker’s trading platform must be easy to use, with excellent trading conditions.
Manage Your Emotions
Emotions are the Forex trader’s enemy. It is not that they are bad in themselves. After all, humans are beings of emotions, and traders are human, too. And even, the market itself is mass psychology in action, with emotions such as greed, fear, and indecision beingresponsible for extreme market moves.
For instance, uptrends are initiated and sustained when traders are “greedy” about a currency pair. But whenever they are fearful, amidst panic selling, downtrends are initiated and sustained until whenever the negative sentiment wanes. Sometimes, overall market sentiments are indecisive and the market is said to be consolidating.
However, you should learn to manage those emotions. For example, you should not attempt to take revenge on the market for your lost trades and you should not cut your winners short because of fear. Again, this is why you should stick to your trading plan. When you do, you will be able to make objective trading decisions devoid of too much emotional interference.
Learn Risk Management
Risk Management is an integral part of Forex trading. In fact, if you do not learn how to manage Forex trading risks, sooner or later, you will be swallowed by them. Fortunately enough, as far as Forex risk management is concerned, traders who have got their fingers burned trading Forex have been able to discover what works and what does not.
To be able to succeed as a Forex trader and stay in the game for long, you have to learn risk management concepts such as stop-loss, position-sizing, and, as earlier discussed, emotions control. These effective concepts exist to protect you so you must use them with every trade you initiate.
Additionally, it is important to talk about leverage too. Leverage is a double-edged sword. As it can increase your gains so can it magnify your potential losses, too. So, you have to learn how to reasonably use it.
Practice
Finally, practice. Practice, anyway, they say, makes perfect. And in Forex, that is true, too. In fact, it is only those who practice that have the hope of succeeding as Forex traders. Why? Because Forex trading can be tricky. The learning curve is steep. And the amount of information you will need to learn can be overwhelming.
Hence, you should be practicing as you are learning. You can do so with a demo account. Apart from helping to reinforce what you learn, practicing also helps you understand the risks inherent in Forex. You get to see how price action develops and even develop new strategies or test out your existing trading plan in a risk-free environment.
At no cost at all, before you go live, a demo account will also intimate you with the trading environment that your broker provides.