Forex Trading: Guide to Getting Started
Forex is a decentralized global market where worldwide currencies trade. The forex market is extremely large and liquid, where daily trading volume exceeds $5 trillion. Forex, also known as foreign exchange is the market where forex trading takes place.
Why Do People Trade Forex?
In simple terms, investing’s objective is to buy a currency at a price point and sell it at a higher price point than paid for it to earn a profit. Because of the volatility in the exchange, there is an opportunity to make a nice return on a trade when buying at the right times.
Another benefit to the foreign exchange is the trading hours never stop. The market is open 24 hours per day with a substantial amount of liquidity throughout the day. The US market opens and closes, following the opening of the European (London) and Asian (Tokyo) markets to fill the remaining time slots of the day.
The liquidity of the foreign exchange allows traders to use leverage to their advantage. The leverage in the currency market is what makes it such a volatile one to monitor. For example, a trader can use 100:1 leverage on a $1,000 investment. This gives the trader control of $100,000 in capital for that investment. Owning this leverage provides a much higher risk. If the currency owned decreases by 1%, the capital value drops to $99,000 representing a $1,000 loss. The $1,000 loss is the entire initial investment.
Isn’t Forex Gambling? This is a common misconception.
Understanding the Terminology
Base currency: The currency being held. The currency a trader is buying in. In the United States, you’ll probably be using the U.S dollar.
Quote Currency: The currency being purchased. For example, Buying the British Pound using USD conversions.
Base Rate: The lending rate of the central bank of a given country.
Bid Price: The price the market is willing to pay for a product. The bid price represents the price the trader can sell the base currency to the broker.
Ask Price: The price the market is prepared to sell a product for. The asking price is often referred to as the offer. The ask is the price the trader can purchase the base currency for.
Spread: The difference between the bid price and the asking price. The bid price is always higher than the asking price and simply put, the spread is the broker’s commission.
These are only a few of the many other terms traders may hear about during forex trading experiences, but they are the basics for getting started. After grasping these terms, a new trader should be able to read more about forex trading and understand some of the terminology referenced in much of the research that is put in. It may be best to find an online glossary or book for reference.
Understanding Currency Pairings
Forex trading is the exchange of currencies, where a base currency is used to buy another currency to buy another. This exchange is done in pairings. For example, the U.S dollar and the British pound are represented as USD/EUR.
Trading in the forex market is done in currency pairs.
The combination of pairs would require a separately written article but all ‘major’ currency pairings involve the USD.
An example of how to translate a currency pairing is done as follows:
This may look unfamiliar, but it’s actually pretty simple to understand. What GBP/USD is saying is that 1 British Pound is worth $1.6451 US Dollars.
The decimal places are called pip. Forex currencies increase or decrease in value in pips. A pip is a price interest point and it is the smallest incremental value of a currency pair.
All forex pairs are priced at the 4th decimal place as shown above except for the JPY. The Japanese Yen (JPY) is priced at the 2nd decimal place.
Something else that might be seen is the bid and ask pricing. This is where the broker earns their spread.
GBP/USD at 1.2512/1.2514.
This means that if a trader wants to purchase GBP/USD, the trader will pay 1.2514.
If the trader wants to sell GBP/USD, the trader will sell for 1.2512.
The 2 cents difference represents the spread. This is what the broker will earn from this transaction. Don’t worry it’ll all come together with time. I felt the same at the start too. Practice will help perfect your trading skills, thus earning more profits.
What is Fundamental Analysis?
Fundamental analysis in the traditional stock market is the process of measuring a company based on their true value. This can be done in a similar fashion on the forex market by taking into consideration economic and political factors to evaluate a currency’s true value.
An example of fundamental analysis can go as follows.
The US dollar is gaining strength due to an economic surge in the United States. As the US economy improves, raising interest rates may be necessary in order to control inflation.
As the rates go up, USD financial assets become more valuable.
Some other major economic indicators analyzed to gain an edge using fundamental analysis include:
- Gross Domestic Product (GDP)
- Retail Sales
- Industrial Production
- Consumer Price Index (CPI)
- Purchasing Managers Index (PMI)
- Producer Price Index (PPI)
The list goes on.
The important thing to do is not only look at the numbers of these reports but also to understand what each indicator means and how exactly this indicator will have an impact on the nation’s economy.
For example, just because I can define the Consumer Price Index doesn’t mean I’ll be able to use it to my advantage with forex trading. However, if I know what the economy does at its different levels I can gain an edge to make predictions where the currency will move based on the Consumer Price Index.
These reports and statistics can be invaluable when used properly.
What is Technical Analysis?
Technical analysis is a far different approach to investing and requires a different level of attention to principles and detail. Defined as the study of historical price action in order to identify patterns to determine the probability of future price movements in the market, technical analysis is useful for traders to make profits.
The two major factors to technical analysis are identifying trends and identifying support and/or resistance through price charts.
The pricing of a currency can either move up (increase), down (decrease) or sideways (stay the same). Looking at a chart will show the trader that pricing typically moves in zigzags. These zigzags provide an opportunity to spot trends in the price movements.
Due to the 24 hour timeframe the market works in, forex trading has much more data to analyze compared to the stock market and makes it more difficult to accurately analyze price movements.
The main reason traders will revert to technical analysis is the assumption that all economic and political factors that influence the price of currency are already factored into the current exchange rate being offered by the market. Spotting trends in price movement are viewed as a simpler task than identifying a mispriced asset on the market.
The theory of technical analysis is that predicting exact price movements is impossible but determining probabilities and making trades that provide the trader the best odds can lead to long term profitability in the market. To determine probabilities, traders forecast market directions and decide when to enter the market. This is their way of factoring in a risk/reward ratio on each trade.
Continue to learn about the market and improve the trader’s probability determination is the best way to give yourself the best odds to be successful. Great traders rely on discipline and great risk management ability to avoid losing big on a downswing.
Types of Trades
There are 3 main buy order types in forex trading:
- Market Order
- Limit Order
- Stop Order
A market order is paying the current price for the trade.
This is for a trade the trader does not want to wait on and would like to enter the market immediately for. This is a long term strategy because the trader is paying a premium to enter the marker right away with certainty.
A limit order is a trade where the trader sets a price he or she is willing to pay, and the trade only occurs if the market reaches your predetermined price.
For example, the current price for an asset is $200. The trader decides there is no value in buying at a price above $195. He or she may place a limit order at $195. At this point, the trader will only enter the market at $195 if the price of this asset drops to $195. Otherwise, the trade will never happen.
The downside of limit orders is the possibility of missing the move on a trade. It could be 1 cent that you miss the trade by in some circumstances. The positive is the price you pay is your desired, cheaper price.
A stop order is the opposite of a limit order. You enter trades when the price moves in your desired direction.
For example, if the asset trades at $200. You can place a buy stop at $205. If the asset trades to $205, your trade will occur. If the asset never reaches $205, your trade will not occur.
Traders use this strategy as a way to ride momentum on a breakout. This strategy can be a risky one if you buy an asset at the peak of the momentum and end up owning at a higher price.
Forex Trading Tools
Using FX tools are a smart and efficient way traders can increase their productivity and performance on the market. Tools are always improving with technology and something new and better is readily available to gain a new edge on the market.
Some popular tools include:
Up to date with the major economic indicators, news, and alerts as they happen and when scheduled to happen. For example, the calendar includes things like holidays and economic report dates.
The excel trader allows for integration between MS Excel and the trader’s preferred trading platform. Information from the preferred trading platform and Excel moves on to the next step, analyzing. Transferring allows for seamless integration with excel algorithms and functions to analyze data in an efficient manner.
Forex Expert Advisor
An automated trading software developed to automate the trading process. Designed to alert the trader as specific price points for a buying or selling opportunity. Additional features include automated to send orders, manage or adjust all types of trades, and other trading strategies. An advanced tool designed for the highest level of traders to implement all types of strategies in the trader’s trading process.
We’ve all used a calculator before, a device for calculating mathematical solutions. These are a bit different and don’t require any leg work to get answers. Some of these calculators include margin calculator, pip calculator, profit calculator, and conversion calculator. All of these do exactly what their name indicates.
Forex News Timeline
The forex news timeline provides real-time updates on new events happening across the world in major forex markets.
There are a variety of tools that may or may not help the trader’s specific investing needs. Doing research according to what the trader is looking to gain from a new investment forex tool will give the trader a better understanding of what is available.
Finding a Broker
Like anything else, a broker with a good reputation will provide a new trader a sense of safety and security. Let’s face it, traders don’t need any more reasons for concern. Focus on trading itself.
There are a few things to look for in a good broker.
First, reputation. In 2019, it is almost impossible to run a shady business with an online presence due to all sorts of media that can expose these frauds. Properly research brokerage firms utilizing reviews to make an educated decision.
Second, regulation. Regulated brokers provide a form of insurance to traders. They have a policy in place to protect their clients in difficult situations. Avoid an unregulated broker who suddenly shuts down or decides to refuse withdrawal requests. It can happen.
Where do I find them?
Research always begins on Google. Start by researching for broker reviews on reputable forums and creating a shortlist of the positive reviews.
One major factor I like to use to make my decisions is by opening demo accounts with a number of brokers to get a feel for each and making my decision this way. This gives the trader a chance to use the platform in real market conditions but with no risk or commitment holding them down.
Brokers design demo accounts to be identical to the live environment of the forex trading market so not only is this a great way to choose a broker, but it also provides new traders a chance to see what forex trading is all about.
How Much Money Should I Start With?
A valid question that is extremely important and should be understood clearly. Don’t overextend. I often see people treating forex trading like a get rich quick scheme and they think the more money invested, the quicker they will come up big overnight. That’s not how it works, trust me on this.
I would start by deciding on an amount of money you could lose without it having any major impact on the way you live or your future lifestyle. Make this decision as if you are spending this money without any chance of getting it back.
Once you decide on a dollar figure, deposit 30% into your trading account, the nest egg. There’s nothing wrong with starting slow.
When you are turning your money into profits consistently, deposit the rest of your funds into your live account.
The idea here is to give your time to understand your own strategies, master the platform, and maintain a slow approach that will last for the long run. This is what’s most important investing – longevity and consistency.
In conclusion, before entering the forex trading market, spend time familiarizing yourself with all trading tools and platforms. Be an expert with the technology.
Read economic news, pay attention to forex news, and continue to learn about the types of risks forex traders will face.
Become a master of your craft and know your strategies better than anything else. The most important trait of a successful forex trading is discipline, remember this to be successful.
You can learn more about how to live a Forex Lifestyle here.
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