In this beginner’s guide to Forex trading we delve into the world of Forex, bringing you all the information you need to know about how to trade in a simple and easy to understand format.
Forex trading has become more and more popular for people who are looking for ways to invest and meet their financial goals.
While Forex is not the place to risk your pension fund or life savings, it is a way, albeit a risky one, to make profits from foreign currency moves and fluctuations. That is if you have the skill and patience required to trade in one of the most liquid markets in the world.
Navigating the Forex market can be challenging and complex; from understanding the terminology and strategies of trading, to choosing the right Forex broker and platform, there is so much you need to know.
We created this Beginners Guide to Forex Trading in plain English for you to easily understand the ins and outs of this financial market step by step.
Armed with the information in this guide you will be able to make an informed choice about whether to take the plunge into the Forex market or not.
And if you have already made the choice to start Forex trading, you will get the knowledge you need to begin the process in a considered way.
First let’s look at some essential definitions…
What is Forex?
Forex is a shortened word for foreign exchange. The Forex market is the place where currencies from all over the world are traded between buyers and sellers.
It may seem like currency is not really a big deal in the world, I mean, it’s just money, right? Yes, it’s just money but, on a global scale, there are very interesting relationships between currencies.
It’s very seldom that you would be able to take your local currency to another country and spend it there. You would have to take it to an exchange bureau, and they would give an equivalent amount of the local currency.
Hey! You’ve just joined the foreign exchange process!
The Forex market allows these kinds of transactions to take place without needing anyone to get on a plane, go to another country and make the physical over the counter exchange.
Instead, these over the counter exchanges can now take place in the digital space. You can have access to a number of markets around the world all from the comfort of your computer or mobile.
Currency exchange is all conducted electronically, and all transactions occur over global computer networks between various traders in different locations around the world.
Just like you need an internet provider to be able to use the internet and get the benefits that come with it, you need a Forex broker to access the foreign exchange market.
Why is Forex so important?
As an individual you need to know the value of your country’s currency against other currencies so when you are purchasing a product or service say in Dollars, you will know how much it will cost you in your home currency.
If you are travelling abroad, you will also need to exchange your home currency into the locally accepted currency of the country you are visiting, at the exchange rate governed.
Forex also facilitates international trade, for example an exporter or importer must be able to convert foreign currencies to be able to trade with each other.
Investors use the Forex market to buy or sell international assets.
A final reason Forex is so important is for investors and traders to buy and sell currencies to gain a financial advantage. This is the central goal of Forex trading.
Why the Forex market is so attractive
Making money is the goal when Forex trading whether you are at beginner, intermediate or advanced level.
While Forex trading carries a high risk, it is still very desirable, and this is why:
The forex market runs 24 hours a day, five days a week. You can trade whenever you want, from anywhere in the world. No matter where you are and in which timezone the Forex market is open for business.
A liquid market is where there are lots of buyers and sellers and the product being exchanged is in high demand. This means that you can execute a trade quickly and at a desirable price.
Even though the Forex market is a big one, it has basically eight currencies to trade in vs thousands of stocks to choose from in the stock market.
This means there is little confusion and it is easy to get a clear picture of what is happening.
The immense size of the market means no one, not even the banks, have the power to influence or control the market for an extended period.
In a single day, more money is traded in the Forex markets than the entire GDP of Japan: over 5.09 trillion USD is traded every single day.
For some of the most liquid pairs, you can trade Forex at a very low cost.
How does the exchange rate of a country get determined?
To be a successful in Forex trading you need to learn how economies work and how different economies around the world are inter-connected.
Exchanges rates are determined by factors like:
Each country has a central bank, for example the South African Reserve Bank, the Federal Reserve (US) and the Bank of England, to name a few.
The role of a central bank is to support the stability of the economy of their country.
They hold massive amounts of reserve currencies, and they control monetary policy to influence the amount of money circulating in an economy, the rate of inflation and the interest rates charged on loans.
A central bank will lower interest rates during an economic slowdown to encourage consumer spending. When they do this however, their currency is weakened which is reflected in the exchange rate.
As the economy improves the central bank will increase interest rates and this makes their market or country attractive to foreign investors.
Lower interest rates make a currency less attractive whereas higher interest rates cause a country’s currency to appreciate. Because higher interest rates provide higher rates to lenders, thereby attracting more foreign capital, this results in a rise in the exchange rate.
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Central banks will also intervene in the currency market to control inflation. Countries with lower inflation rates tend to see an appreciation in the value of their currency.
Inflation is the rate at which average prices of goods and services increase over time.
Inflation reduces the value of money. If there is high inflation it means that the purchasing power of a country’s currency has fallen, and the currency will depreciate in value.
Current account deficits
A current account deficit means that a country imports more goods and services than it exports.
An economy can run a current account surplus or deficit.
A current account surplus indicates that the value of a country’s net foreign assets (i.e. assets less liabilities) grew over the period in question, and a current account deficit indicates that it shrank.
If an economy is running a current account deficit, it means that it is absorbing more than it is is producing.
A country which struggles to attract enough capital inflows to finance a current account deficit will see a depreciation in their currency.
If there is a collapse of confidence in an economy or financial sector, this will lead to an outflow of currency as investors seek to limit their risk. This outflow of capital causes a depreciation in the currency.
Collapse in confidence can be due to political or economic factors.
Public debt, also called sovereign debt, is how much a country owes to outside debtors. These can include individuals, businesses, and other governments.
Public debt is the result of years of government leaders spending more than they take in via tax revenues.
Political instability and economic performance
A country’s political situation and economic performance can affect the strength of its currency. A country that has less political turmoil is more attractive to foreign investors, resulting in increased foreign capital which leads to an appreciation of their currency.
A country prone to political instability may see a depreciation in exchange rates.
Poor economic performance also affects the value of a country’s currency. When a country experiences a recession, its interest rates are likely to fall, decreasing its chances to acquire foreign capital. As a result, its currency weakens in comparison to that of other countries, therefore lowering the exchange rate.
If a country’s currency value is expected to rise, investors will demand more of that currency in order to make a profit in the near future.
As a result, the value of the currency will rise due to the increase in demand.
With an increase in currency value comes a rise in the exchange rate.
How to trade Forex
Forex trading is all about attempting to speculate on the fluctuating currencies between two different countries. These two currencies are called ‘currency pairs’.
Every Forex trade you will do will involve the purchase of one currency and the selling of another. You can only trade with pairs. When you buy a currency pair, you buy the base currency and sell the quoted currency.
The most traded currency pairs of all is the Euro against the US Dollar, which is represented as EUR/USD. The first currency set that appears in the Forex pair is the base currency, this is the one that is bought or sold for the quote currency.
The most popular currency pairs are called major pairs and essentially make up 80% of the entire trading amount in the forex market.
Major pairs: EUR/USD, USD/JPY, GBP/USD and USD/CHF
The forex market is a market comprising probably a thousand or more currency pairs, for example US dollar and the Rand, the EURO and the Swiss Franc, the Japanese Yen and the British Pound.
In reality, however there are only eight major currencies that are actively traded on the Forex market.
Minor currency pairs or crosses
Minor currency pairs also known as crosses, and are pairs that do not include the US Dollar. This immediately makes them more volatile and less liquid than the other major currencies.
While the US Dollar features in every major pair, crosses are usually more concerned with more of the ‘minor’ currencies such as the EUR, the GBP etc.
Some popular pairs in the crosses are:
What do all these Forex words mean?
You would have already discovered that the jargon in Forex is quite extensive and whenever you’re trying to get up to speed you always have to pause to find the definition of the new word that you’ve just discovered.
Let’s take a look at a few of these to help get the ball rolling…
This involves buying and selling the actual currency, as opposed to instruments related to it.
You can buy a certain amount of one currency with another currency and later sell it once the value improves.
The acronym for Contract for Difference, are contracts that are used to represent movements in the prices of financial instruments. So, unlike spot forex, you can take advantage of price movements in currencies without actually owning the physical currency.
It’s important to note that all brokers and traders agree that CFDs are part of the higher risk instruments.
A Pip is the base unit of the currency pair. The units of measure are in intervals of 0.0001. Movements in prices of currency pairs are represented in pips. E.g. If the bid price in a currency pair moves from 1.16667 to 1.16677 then the movement is 1 pip (1.16677 – 1.16667 = 0.0001 (1 pip))
Spread refers to the difference between the purchase price and the selling price of any specific currency pair. You can expect to find low spreads amongst more popular currency pairs. If you’re looking to make a profit in Forex, then you will want to make sure that the currency pair value must exceed the spread.
Whenever you want to open a trade, you will be required to keep a minimum amount in trading account. This is referred to as margin.
If you’re starting off as a Forex trader, it is highly likely that you won’t have enough margin to make good profits. Enter: Leverage
As a beginner in forex trading, it’s important that you understand this concept.
Leverage is the amount of funding that a Forex broker can give to you in order to facilitate larger trade volumes. Leverage is like credit that you get from a bank.
It may sound very attractive for great gains, but you need to be wary that the losses will be just as severe if the deal is not profitable.
Therefore, make sure that you use leverage with caution. Make sure that you’re up to speed with your Forex broker policies on zero and negative account balances.
What exactly happens in Forex trading step by step?
Here a few steps involved in the Forex process and a few key indicators and tools that you’re going to need to be conscious of.
Open an account
Your first step will be to open an account with a trusted Forex broker. Most platforms allow you to setup an account very quickly and easily.
We advise you to upload all the right verification documents and follow the recommended process at the outset. This is very important when withdrawing funds as the best Forex brokers will have verification procedures in place.
Price and Quote
When you’re trading, you will see Bid and Ask prices:
You will notice that you can place trades that are referred to as “long” or “short”.
This happens when you buy a currency with the expectation that its value will increase thus making a profit on the selling price.
This happens when you sell a currency with the expectation that the value will drop, and you will be able to buy back at a later stage for a lower purchase price.
All currency pair trade values are based on the current exchange rates of the currencies in the pair. You will make profits by collecting the differences in the selling and buying prices (spreads).
You will find that the more liquid a currency pair is, the more movement is experienced. The more unpopular currency pairs normally have very little movement in a trading day.
Charts are always a great way to represent data in forex trading as it easy to identify trends. As a Forex trader, you will discover 3 main chart types: line charts, candlestick charts and bar charts.
Line charts are the most basic chart type used by traders. The chart connects the closing price of currencies for the time frame that you’re viewing. It’s mostly used to map out a bigger picture for the trend with not much detail
Candlestick charts have been in use since the 18th century. They can show the open, high, low and close values of a specific time period. They are most often identified by the ‘floating box’ between the opening and closing prices, also known as the ‘body’ of the candlestick.
Candlestick charts seem to be the most visually appealing choice of the Forex charts.
Bar charts (OHLC bar chart) are most useful to determine who is currently controlling the market – buyer or sellers. The bars in the chart form the basis of the candlestick chart.
Can I have a test run before using my own money? The answer to that question is, emphatically, Yes!
Not only are you able to, but it is recommended that you should. Some brokers offer new traders a feature called the ‘Demo Account’. This will allow you to get to grips with all the dashboards, graphs, indicators and jargon.
You will have the opportunity to spend ‘money’ on trades with data that is in sync with the live markets. This will make your transition into the Forex world less frightening and is a sure way to build some confidence.
What strategy should I adopt?
Ok, so now that you’re up to speed with all the technical jibber jabber, the next thing to look at is how to use the tools that you’ve amassed to achieve the goals that you’ve set for yourself.
It’s important to align your strategy with the goals that you wish to achieve as the markets can facilitate a variety of outcomes.
You may think that it would be practical to just adopt what other people do, and that is a valid point, just always remember to stick to a strategy that will achieve your goal.
Forex Trading Strategies
This is the strategy with the smallest profit returns. A ‘scalper’, as they’re endearingly termed, is a person who put through large volumes of small trades very close to each other (between a few seconds and a few hours). This strategy may prove to be quite practical to most traders.
This is considered the more conservative approach for traders who are still beginners. Price trends are monitored over one hour or four hours. These windows are tailored more for the main sessions for each Forex market.
This strategy adopts the longest trade windows ranging from a few days up to a few weeks. This strategy is best suited for traders who are trading on a part-time basis.
Risk management technique in which a trader can offset potential losses by taking opposite positions in the market.
Forex martingale strategy
For every losing trade, you double the investment made in future trades in order to attempt to recover your losses, as soon as you make a successful trade.
Forex grid strategy
Uses buy and stop orders and sell stop orders to profit on natural market movements.
What are trading platforms, and which one should I choose?
A trading platform is a utility offered by Forex brokers to assist you with your Forex endeavours. It is important, when you choose a Forex broker, to fairly assess the platforms offered as they will have a direct impact on your trading experience and, ultimately, your trading success.
Here are a few elements that you should consider when assessing trading platforms:
The platform that you choose needs to be trusted to deliver on its performance and reliability. Features need to work as advertised and downtime must not be a reality that you need to weather.
The trust and reliability of platform could be the main element that could prematurely shut or keep open any potential windows of opportunity
It’s no surprise that this indicator made the list. Cybercrimes are a reality in today’s tech savvy world.
Thankfully there are measures that have been developed to ensure that your information is protected.
Thoroughly inspect the security options offered by trading platforms and make sure that you are comfortable with the security that they are offering. Two-factor authentication is fast becoming the standard.
Independent account management
It may seem like a nice feature for your broker to sometimes get involved in managing your account, but you should always be the only authorised decision maker on any action on your account. These details are sometimes hard to find in the t’s and c’s so make sure to be thorough.
There are many platforms that do not have built-in analysis tools. This is not necessarily a deal breaker but be mindful that you would need to be switching between the platform and the analysis tool while trying to put through your trades.
It’s a great bonus if the analysis tools are included in the platform and have real-time data updates.
Are there risks involved in trading?
There are a few risks that you’d need to be cognisant of in Forex trading and you will get up to speed as you go along but here a few to get you off the mark…
Leverage may be an amazing concept with sizable profits but there is the glaring risk of equal and opposite losses.
Interest Rate Risk
A country’s currency value is heavily linked to their interest rate. An interest rate increase/decrease has a direct impact on foreign investment and, ultimately, demand and supply of that currency which will affect the exchange markets.
This type of risk is influenced by all differing time zones from country to country. It most often occurs sometime between the opening and closing of a contract. Exchange rates can change before contracts are settled. The transaction risk becomes greater as the difference in time zone increases.
Now that this beginner’s guide to Forex trading has provided you with some of the background and jargon of Forex trading, you should be a little more comfortable to start your journey into the world of currency trading.
If you are still confused don’t worry the more you get knowledge, and the more you practice on a demo account, you will become a more confident trader. Like anything in life, practice makes perfect.