A Beginner’s Guide to Forex Trading

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 A Beginner’s Guide to Forex Trading

Summary

  • Forex is considered to be one of the largest financial markets, with global daily turnover of approximately US$5 trillion
  • Forex trading is done over the counter via the interbank market instead of a centralised exchange
  • Forex trading incurs low cost because forex brokers make their money on the spread provided the trade is opened and closed before any overnight funding charges are applied.
  • Forex has gained popularity with the rise of the internet, it is considered a leveraged product and is risky

What does Forex Market Mean?

The foreign exchange market, commonly termed as forex (FX), is a decentralised marketplace facilitating the traders, investors, institutions and banks for the buying and selling of different currencies.

The trading is conducted over the counter (OTC) via the interbank market (instead of on a centralised exchange), an online channel through which currencies are traded 24 hours a day, five days a week. Forex is one of the largest financial markets, with an estimated global daily turnover of more than US$5 tr.

How Does the Forex Market Work?

In a nutshell, the foreign exchange market works like most other markets, the subject to demand and supply. For instance, if there is a strong demand for the US Dollar from the British citizens holding Pounds, they will exchange their Pounds into Dollars. There will be an increase in the value of the US Dollar, and it will rise, while the value of the Pound will fall. As a result, this transaction will affect the GBP/USD currency pair.

What are the Factors Influencing the Forex Market?

Demand and supply, as mentioned above, is only one of the many factors that can move the FX market. Other factors include broad macro-economic events like the general election, or country-specific factors such as the prevailing interest rate, GDP, unemployment, inflation and the debt to GDP ratio, to name a few. Top traders make use of an economic calendar to stay up to date with these and other important economic releases that can move the market.

Key Terminology to Know for Forex Trading

Base currency: The first currency that appears when quoting a currency pair. For instance, in GBP/USD, the Pound is the base currency.

Variable/Quote currency: The second currency in the quoted currency pair, i.e., the US Dollar in the GBP/USD example.

Bid: The highest price that a buyer is ready to pay is the bid price.

Ask: The lowest price that a seller is willing to accept is known as the ask price.

Spread: The difference between the bid and the ask price, which represents the actual spread in the underlying forex market, plus the additional spread added by the broker.

Pips/Points: A pip or a point refers to a one-digit move in the 4th decimal place.

Leverage: Leverage allows the traders to trade positions, while only putting up a fraction of the full value of the trade. Leverage boosts gains and losses.

Margin: The amount of money needed to open a leveraged position is known as margin.

Long position: It is a position when the trader who buys, expects the currency brought by him/her to increase in value.

Short position: It is a position when the trader who sells a currency expects its value to decrease.

Why is Forex Trade So Popular?

Trading on forex has many advantages over other markets which are as follows:

Low transaction costs: Forex trading is cost-effective because forex brokers make their money on the spread provided the trade is opened and closed before any overnight funding charges are applied.

Low spreads: Spreads (Bid/Ask) are extremely low for major FX pairs due to their liquidity.

More opportunities to profit: Forex trading helps the traders in taking speculative positions on currencies appreciating and depreciating. Also, there are many different forex pairs for traders to spot profitable trades.

Leverage trading: Forex trading involves the use of leverage, which means that a trader need not pay the full cost of the trade but instead only put down a fraction of the cost. This helps to magnify the profits, but also the losses.

Which Are the Most Traded Currency Pairs on The Forex Market?

There is a total of seven Major currency pairs on the forex market. They are EUR/USD (Euro/Dollar), USD/JPY (US Dollar/Japanese Yen), GBP/USD (British Pound/Dollar), USD/CHF (Dollar/Swiss Franc), AUD/USD (Australian Dollar/US Dollar), USD/CAD (US Dollar/Canadian Dollar), and NZD/USD (New Zealand Dollar/US Dollar)

A currency pair which does not include the US Dollar is known as a ‘minor currency pair’ or a ‘cross-currency pair’. Hence the most popularly traded minor currency pairs include EUR/GBP (Euro/British Pound), EUR/AUD (Euro/Australian Dollar), GBP/JPY (British Pound/Japanese Yen), and CHF/JPY (Swiss Franc/Japanese Yen)

There are some exotic currencies (not widely used and have low trading volume) also which can be traded, such as the Thai Baht (THB), South African Rand (ZAR) and Norwegian Krone (NOK).

Tips for Beginners in Forex Trading

Before starting with something new, one should always begin with the fundamentals. Let’s have a look at trading tips every trader should consider before trading currency pairs.

  1. Know the Markets- It is very important to educate yourself on the forex market. Study the currency pairs, and factors affecting them carefully before risking your own capital.
  2. Make a Plan and Stick to It- A critical component of successful trading is creating a trading plan, which includes your profit goals, risk tolerance level, methodology and evaluation criteria. Once the plan is in place, make sure each trade you consider falls within your plan’s parameters.
  3. Practice- You should always put your trading plan to the test in real market conditions.
  4. Forecast the Market Conditions- Fundamental trading based on news and other financial and political data, and technical trading based on technical analysis tools are indictors to forecast market movements, which are the important tools one should use to find potential trading opportunities in moving markets.
  5. Know Your Limits- One should know how much he/she is willing to risk on each trade, setting the leverage ratio in accordance with his/her needs, and never risking more than can be afforded to lose. It sounds simple but is critical to the trader’s future success.

Other tips which are also equally important:

  • Know Where to Stop during the trade
  • Check Your Emotions at the Door
  • Keep It Slow and Steady
  • Don’t Be Afraid to Explore
  • Select the Right Trading Partner

Thus, forex trading has become popular with the rise of the internet. It has enabled the brokers to provide retail traders entry to this asset class, something that earlier was limited to big institutional traders like the banks and hedge funds. The internet provides retail traders with easy access to the markets and online trading platforms to facilitate trading. Forex has been considered as a leveraged product, and trading in forex is risky and may not be suitable for everyone, before trading in forex, one should fully understand the risk associated.

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