What is Forex Trading? – A Beginner’s Guide Revealed (2020)

What is Forex Trading - A Beginner's Guide

What is Forex Trading - A Beginner's Guide

 

According to research in South Africa, Forex trading also known as FX, is a global marketplace for exchanging a multitude of national currencies with one another, for a variety of purposes such as commerce, tourism or trading.

Forex trading, also known as foreign exchange currency trading, is a decentralized global marketplace where all the world’s currencies trade with one another.

What makes Forex so appealing is that it is one of the most liquid markets in the world with average daily trading amounts exceeding $5 trillion.

What do we mean by liquid market you may ask? A liquid market is where a lot of buying and selling taking places, for very low transaction fees, making the market a very attractive one that has a low barrier to entry.

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Here’s a simple analogy. Think of it like a wholesale retail store where you buy low priced items because the brand buys in bulk! So, the store turns over a large quantity of items that people want, essentially a “liquid market” – the store makes a profit and you score a low price, making you want to return over and over again. Which of course you do.

Previously Forex was conducted by wealthier investors and larger firms, however after online trading platforms emerged, making money in the Forex market was made accessible to other retail investors.

Usually commercial and investment banks conduct the majority of trading in the Forex marketplaces on behalf of their clients, however there are many investors who trade individually or for professional reasons – they are known as retail investors.

If you are going to become a Forex trader individually you would be a retail Forex trader, smaller investment firms who trade on behalf of clients can also be considered retail Forex traders.

 

How are currencies traded?

 

Currencies usually trade against each other as pairs, which are know as exchange rate pairs, for example, USD and EUR.

As a Forex trader you buy and sell currencies with the main aim of making a profit, your profit (or loss) is the difference between the buy and sell rates of the currency pairs you traded. More on pairs later so keep reading…

These marketplaces exist as spot cash markets as well as other assists, known as derivative markets, that offer futures, options, forwards and of course currency swaps. This may seem confusing right now, but all will be explained later…

Usually traders who participate in the market use Forex to assist in hedging against international currency and changes in interest rate risks, as well as other factors such as geopolitical events.

 

A brief overview of the history of Forex

 

As a new-born marketplace the Forex market is not exactly the same as a stock market, which can be traced back centuries. The Forex market started in the 1970s to allow major currencies to float freely against one another.  Because the values of these individual currencies started to vary greatly, it gave rise to a need for essential foreign exchange services and trading.

This then became the Forex market we have today with a variety of trading platforms and services available on the market.

In the past, currency trading was extremely difficult for individual investors, most of the trading was conducted by large multinational corporations, hedge funds or high-earning and net worth individuals. Forex trading required a large amount of capital which individual investors did not have.

With the birth of the internet a retail market was founded with the aim of individual investors being able to become traders, which made it so much easier to gain access to the foreign exchange markets. You gain access through either brokers or banks.

Most brokers or dealers usually offer extremely high leverage to individuals who become traders to enable them to do a large trade with a minimal account balance.

 

Forex as the World’s Largest Financial Market

 

With over 5.09 trillion USD being traded every single day, more money is traded in the Forex markets than Japan’s entire GDP. Of some of these transactions, 254 billion USD is traded through CFDs and other instruments or assets.

While Forex is the largest, most active financial market in the world, it is also the world’s most liquid market, which means it’s relatively easy for traders to enter into and exit out of.

For some of the most liquid pairs, they can do this at a very low cost sometimes even less than a single pip. Forex is also extremely volatile, creating huge opportunities or huge losses for traders when trading on either positive or negative movements of currency pairs.

 

How does the Forex marketplace work?

 

One of the most unique and interesting aspects of this international marketplace is that there is no official central market for foreign exchange like with Stock Exchanges.

Instead, currency exchange is done electronically, which means that all the transactions occur over global computer networks between various traders in different locations around the world, instead of one centralized exchange.

The Forex marketplace is open 24/7, five and a half days a week, with hubs in some of the major financial centres in:

  • London
  • New York
  • Tokyo
  • Zurich
  • Frankfurt
  • Hong Kong
  • Singapore
  • Paris
  • Sydney

Across almost every time zone in these locations, trading is conducted. Which means that when the trading day in the U.S. for example ends, the Forex market begins again fresh in Tokyo and Hong Kong.

Due to this fact Forex marketplaces can remain extremely active at any point in the day, with prices changing regularly.

 

Understanding the risks

 

It may sound very appealing to trade in Forex because of the potential high gains, but before jumping in you need to understand the risks.

Almost any kind of trading has its own risks; it can also result in big profits which is one of the reasons so many people enjoy trading in Forex.

It is a risky, complex but also exhilarating task (when you are winning).

Forex is not something you should do without arming yourself with all the knowledge, tips and expert advice that you can get!

 

Risk #1 Unregulated brokers

 

The interbank market is highly regulated, however Forex instruments (the type of financial medium used such as swap, option, spot or forward) are not standardized and in some places around the world Forex trading is completely unregulated.

Let’s explain…the interbank market is made up of banks trading with one another around the world. These banks have established internal processes to help keep them as safe as possible and they have regulations to protect each bank that is involved in the process.

View all FSB regulated forex brokers 

Since the marketplace is created by each of the involved banks providing offers and bids for a specific currency, the market pricing is based off supply and demand. There are usually large trading flows happening at any given time in the system.

The upshot: it is difficult for rogue traders to influence the price of a currency and this system helps to create transparency in the market for investors who have access to interbank dealings.

However, in the Forex market small retail traders have a greater risk because they may deal with small and unregulated or semi-regulated brokers or dealers who do not have the same transparency as required by regulations.

 

Risk #2 Lack of Knowledge as a trader

 

One of the other risks is one that you are 100% responsible for: not sufficiently educating yourself.

Never jump blindly into Forex trading because a mate said he makes tons of money off it. You must know what is driving movement in currencies, the economic and political landscape in those economies as well as global events, to name a few.

A successful forex trader knows what drives currency values and has access to the best trading platforms and forecasting tools backed up with solid economic models.

It is vitally important to do your homework and choose the right forex broker (and trading platform).

Now we have got that out the way, lets move onto the intricacies of Forex trading.

 

Let’s discuss currency pairs

 

Essentially Forex is all about attempting to speculate on the fluctuating currencies between two different countries. These two currencies are usually referred to as ‘currency pairs’ and these pairs are made up of the base currency and the quote 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.

Some of the most popular currency pairs include EUR/USD, the USD/JPY (US Dollar and the Japanese Yen), GBP/USD (British Pound and the US Dollar) and the USD/CHF (The US Dollar and the Swiss Franc). Another great characteristic of major currency pairs are that there is almost always a smaller risk of them getting manipulated.

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 include EUR/USD, USD/JPY, GBP/USD and USD/CHF.

Source: Investing.com, 15 April 2020

A few other key points to take note of:

  • Cross currency pairs also known as Crosses, are pairs that do not include the US Dollar, which 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 family include the EUR/GBP, the GBP/JPY and the EUR/JPY.
  • Position trading is essentially a trade which is in progress currently. In trading the two positions are categorised as a long and short position.
  • Long position: is when the trader has already bought a currency while expecting that it will increase, once the currency is traded and sold back, the long position is closed.
  • Short position: is when the trader has already sold a currency while expecting that it will decrease. After the currency is bought back, the short position is closed.

 

How does Forex Quoting work?

 

In Forex, you will see that both ‘bid’ and ‘ask’ prices are quoted by the broker. The bid is the price at which you can purchase the said currency, the ask price is the price at which you can possibly sell it at.

If you are trading and purchase a currency, known as a long trade, the hope is that the currency pair will increase in value so you may be able to eventually sell it at a higher price and profit from the difference.

The same goes for the opposite if you are selling a currency; the risk is that the currency pair will fall in value, so that you can buy it back at a lower, cheaper price essentially meaning you will profit from the difference.

The number which is quoted from these prices is decided by the current exchange rate of the various currencies in the pair, or how much of the second currency pair you would essentially get from exchanging one unit for the first currency.

 

Forex Spread

 

In Forex, the spread is basically the difference between the bid and ask price of a currency pair. Let’s look at an example:

Let’s say that the bid price is 101.15 and the ask price is 101.20 the spread is 5.

A spread is measured in pips, so the above would be called a 5 pip spread. If this is a bit overwhelming check out our How to guide explaining all you need to know about Pips.

A pip is the acronym for “percentage in point” which is the smallest price move that an exchange rate can make based on what is currently happening in the market.

Currency pair traders will buy or sell a currency whose value is expressed in relation to the other currency. A pip is one of the most basic concepts of currency pair trading.

In Forex trading, the value of a currency pair will need to essentially cross the spread before it becomes profitable.

 

What are Forex Instruments?

 

A financial instrument is the financial medium used in a financial market and in the case of Forex the following are examples of instruments: Exchange-traded fund (ETF), Forward, Option, Future, Spot and Swap.

 

Let us look some of the ways to trade Forex using these instruments

Spot Forex

 

Sport Forex is the term that defines buying and selling the actual currency over a short period usually a 48-hour delivery transaction period.

For example, if you purchase a certain amount of one currency and then the value of that currency increases you exchange the first currency for another, essentially giving you more money back compared to what you originally spent on the first purchase.

Spot Forex has these characteristics:

  • A direct exchange between two currencies
  • Cash, never contracts
  • No interest is included in the agreed upon transaction
  • Shortest of all transaction timeframes

CFD

 

The term CFD stands for ‘Contract For Difference’, which is a contract used to show the movement in prices of financial assets.

In Forex, this means that rather than buying and selling larger amounts of currency, you can profit on various price movements without owning the original asset itself.

With Forex trading, CFDs are also available on shares, indices, bonds, commodities and cryptocurrencies. In almost every instance, they essentially allow you to trade on the price movements of these instruments without having to actually purchase them.

Swap

 

Currency swaps are the most common type of forward transaction agreement.

A swap is a trade between two parties where they exchange the principal amount of a loan and the interest in one currency, for the same amount in another currency.

At the beginning of the swap, the principal amounts are exchanged at the spot rate. The transaction is then reversed at a pre-agreed upon future date.

Currency swaps can be negotiated to mature up to 30 years in the future.

 

Let’s talk about Hedging

 

Hedging should only be done once you are familiar with forex trading and understand market swings and timing.  However, it is worth mentioning here because at some stage once you are familiar with trading, you can use hedging to protect yourself against a major loss.

Hedging in forex is a way to reduce the loss you would incur should something unexpected happen in the forex market.

 

Simple hedging

 

A direct hedge is where you would make a trade to buy one currency pair, let’s say USD/GBP, and you would also place a trade to sell the same pair. This sounds wrong, because while the market is open your profit is zero! Think again, if you time it just right you make money when the trades close. But as we said, don’t try this if you are a junior trader!

Another forex hedge is where you trade the opposite of your initial trade, without closing the initial trade. Traders use this type of hedge to make money with the second trade. They do that by keeping the first trade open and when the market moves against it, the second trade makes a profit.

And to make it even less risky, you can put a stop-loss on the hedging trade or just close the trade if you see the market is going to reverse. This kind of strategy is something you will need to learn more about as you grow as a successful trader.

There is more complex hedging such as against multiple currency pairs and forex options, but we will keep that information for another time… let’s get back to learning to trade.

 

How do you begin trading Forex?

 

You want to become a successful Forex trader so the first – and most important step – is to choose the right broker.

Here are some of the questions you need answered when selecting a broker.

 

What regulatory bodies do they belong to?

 

The Forex market doesn’t have a central regulator. However, this doesn’t mean you should consider a broker without the question of regulation. Instead, look for the regulators most found in your location. In the UK this would be the FCA or Financial Conduct Authority; in Cyprus – CySEC or Cyprus Securities and Exchange Commission; ASIC in Australia – Australian Securities and Investments commission and in the US, the broker will usually use their experience as their selling point.

There are many benefits of choosing a regulated broker which can help ensure that you as the main trader are protected to the full extent of the law in your country of residence.

 

What quality of service does the broker provide?

 

It’s extremely important to consider the service of the broker you decide on, the platform they offer and certain choices you make to ensure that you can achieve the ultimate best trading results.

For example, if you enter your trade on a system that is slow or crashes regularly, you might find it difficult or might not entirely be able to enter or exit a trade at the price you would like.

As a beginner you would need to take advantage of resources, tools and a helpdesk to assist you when trading initially.

You ultimately want a broker that offers high levels of liquidity, low spreads and the ability to execute orders at the price you have decided on, or as close to these prices as possible.

 

What is the cost?

 

Forex trading can and has been a great income-generating activity; it is extremely important to treat this trading as a business activity.

It’s important to consider how to maximise your income, minimize your costs and risks, which are always a big part of trading.

You must always consider the costs of trading with Forex brokers, that is before you decide on the right broker for you.

You will need to have an account with a Forex broker to begin trading in Forex; because there are no set rules on how Forex dealers charge, you are going to need to investigate and compare the costs and services of brokers.

 

The most important costs you need to compare are

 

  • Commission per trades
  • Fee or mark-up on the spread between the bid and ask price quoted
  • Minimum deposits
  • Other fees such as rollover fees if your trade is held over to the next day, or other fees like inactivity or withdrawal charges.

 

Some key points to consider

 

The size of spreads

 

Spread does influence your potential profits in trading, as any currency pair needs to cross the spread threshold before a trade will become profitable. With this consideration in mind, look for a broker that offers low spreads.

 

Commissions

 

The ideal method here would be to choose a Forex broker that doesn’t charge commissions, as commissions can eat a sizable chunk of your potential profits. However, usually this means they need to make money somewhere, so investigate the spread costs and any other “hidden” fees.

 

The minimum deposit

 

Usually, Forex brokers will ask traders to make a minimum deposit when opening a live trading account, you want the lowest required amount.

While cost is an important criterion for selecting a broker, it is not the only factor; service is also absolutely critical.

These factors are important:

  • Response times to any queries
  • Speed of platform response times when making a trade
  • Ease of communication with the broker
  • Resources to assist with trades

 

Deciding on products and markets

 

When deciding on the right broker for you, you will want to make sure that the broker has access to a wider range of various currency pairs, including major, minors and exotics. However, there are some other financial instruments involved too.

If you are considering trading with a Forex and CFD broker, it would be a good idea to consider the other instruments they offer also.

This essentially ensures that if you decided you would like to trade stocks, indices, ETFs, commodities, cryptocurrencies and other financial instruments heading into the future, you won’t exactly need to find a new broker to do so.

 

Available trading tools

 

Another factor to take into consideration is the quality of trading tools a Forex broker will offer. It can make a huge difference to your initial trading experience. Usually, the tools and features available to you depend on which trading platform or platforms are being used.

Initially you want a simple, intuitive trading platform, later on you can level up to take advantage of more advanced, professional features and tools.

 

Does the broker suit your needs?

 

Another important consideration is deciding whether a Forex broker and their platform will suit your trading style. Initially you may not find this an important consideration. However, as you advance you will soon develop strategies that work for you.

You might for instance be interested in following a Forex scalping strategy – scalping is a method of trading based on real-time technical analysis, in Forex scalping refers to making a large number of trades that each produce its own small profits.

With this in mind, you would need to ensure that any potential broker has minimum distance between the market price and your stop-loss and take-profit.

A stop-loss is an order that you place with your FX and CFD broker in order to sell a security when it reaches a particular price, ultimately with the aim of reducing your losses.

 

A few key points for deciding on a Forex platform

 

  • Is the trading platform reliable?
  • Will your funds and personal information be safe and protected?
  • You should be allowed to manage your trades and account independently.
  • Does the platform offer and provide built-in analysis?
  • Does the platform provide automated trading functionality?
  • Do your research.
  • Consider trading psychology and money management.

 

Pros and cons of trading Forex

 

Pros Cons
Accessibility Volatility
Leverage Small traders may face some disadvantages
Potential for fast returns Lighter regulatory protection
Easy short selling Fewer residual returns
Liquidity Large losses when unsure about capital exposure
Technical strategy A lot of competition as an individual trader
Less potential for insider price manipulation Just because it is open 24 hours a day doesn’t mean you should trade all day
Fewer fees and commissions No centralized exchange
Simple tax rules High Risk factors
Automation
24 hours a day five days a week trading

 

 

Forex trading is an accessible, flexible and highly lucrative activity involved in a large, liquid and semi-transparent environment, paving the way for making a good profit. While it is important to consider the risks with Forex trading, many of these are present in other trading activities.

The potential for success and ample opportunities depend on trader grit: that is being willing to learn and unafraid to lose a little in the beginner until you are familiar with the characteristics of foreign currency trading.

 

Popular Forex Strategies

 

Forex scalping

Trading strategy that involves buying and selling currency in pairs in a shorter time frame – usually between a few seconds and a few hours

Intraday trading

A more conservative approach to scalping with trades being focused on daily price trends. Trades may be open anyway between one to four days, but focus on the major sessions for each market

 

Swing trading

A medium-term trading approach that focuses on larger price movements than scalping or industry trading. Which means traders can set up a trad and check in on it every few hours or days rather than having to constantly watch their platform

 

Forex hedging

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

 

Tips for beginners

 

  • Do your research, educational videos for beginners, educational articles and tutorials, Forex trading seminars for beginners, Forex trading webinars.
  • Try out a demo account, or practice with simulation software.
  • Try not to over complicate situations, risks and other things.
  • Be careful of volatile markets.
  • Follow trends as they boom.
  • The trade is open until it’s closed.
  • Write down EVERYTHING in a log: points for further research, reasons to open or close a specific trade, your achievements and mistakes.

 

Final points to consider about Forex trading

 

  • Consider money management
  • Decide on how you will finance your trading in advance
  • Define your investment levels
  • Calculate your own risks
  • Determine the profits required to cover any potential losses
  • Start with smaller trades
  • Diversify your portfolio
  • Consider using leverage wisely
  • Focus on the long term
  • Do as much research as possible and continue your Forex education

 

We know Forex trading is a high-risk strategy, however, it can also be highly profitable with the right knowledge and research.

For those with limited funds, day trading or swing trading in smaller amounts is an easier strategy in Forex compared to other markets.

For those with longer-term plans, larger funds or a carry trade can possibly be profitable.

It is important to consider an understanding of macroeconomic fundamentals in which currency values are driven. In addition, experience with technical analysis could potentially help newer Forex traders become more profitable and continue with their trading over time, without having to deal with too many losses, according to research in South Africa.



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