Forex trading is simply the buying and selling of currencies to profit from changes in exchange rates between currencies. Hundreds of currency pairs are available, but the goal is the same. The value of any currency listed on the interbank and online FX market will always change relative to another, so there is always an opportunity to profit from these changes.
Forex trading involves trading currencies in pairs and requires online brokers that provide trading platforms. They also act as custodians of the trading capital traders use to buy and sell contracts for difference on various forex pairs.
Forex trading differs from most other markets and does not occur on a single centralized exchange. Rather, forex trading is a complex market. It starts at the interbank level (production), where liquidity providers and major banks interface with central banks and rely on financial institutions to provide currencies for buying and selling. Next is the wholesale level, where prime brokers, hedge funds, high-net-worth entities, and market makers are the major players. The market ends at the retail level, where forex brokers offer simplified contracts for difference via a dealing desk to their clients to either buy a currency to profit if its value goes up relative to another currency, or sell in order to profit from a currency that is expected to lose value relative to another currency.
Specifics of Forex Trading
Forex trading always involves trading currencies in pairs, because what is being evaluated is the change in value of one currency relative to another. It is the change in relative value that traders aim to profit from. The relative value or exchange rate can go up or down, which makes the forex market a bi-directional market.
For instance, if a trader is expecting the Pound to become more expensive relative to the US Dollar, the trader’s forex trading position would be to buy the Pound against the US dollar. To do this, they initiate a long position on the GBP/USD pair. If indeed the exchange rate goes up, the trader makes a profit. In forex trading, this profit is a measure of the distance by which the Pound has gained vs the US Dollar (measured in pips), and the amount that the trader has committed into the trade (the lot size). However, if the Pound weakens against the US Dollar, this means that the exchange rate has fallen and the trader incurs a loss.
On the other hand, if the trader feels that the US Dollar will weaken against the Japanese Yen, the trader initiates a short position, selling the US Dollar and simultaenously buying Yen. If indeed the Yen appreciates against the US Dollar, the trader makes a profit.
The forex market operates 24 hours a day, five days a week, with activity occurring across several major financial centres. These financial centres have business hours, giving rise to the concept of forex time zones. The major financial centres are London, New York, Tokyo, Singapore and Sydney.
Why Do People Trade Forex?
Various participants in the forex market have different reasons for being there.
- Speculation: This is the realm of most traders, as they aim to profit from changes in exchange rates across different currency pairs.
- International business: Companies operating across countries typically need to make many currency exchange transactions to do business in those countries. They need to pay suppliers, receive payments, or participate in investment vehicles in countries other than their own, e.g., mergers and acquisitions or buying government bonds.
- Hedging: Investors and businesses also reduce their exposure to exchange rate fluctuations by hedging via forex instruments.
- Investment and Portfolio management: Financial institutions and hedge funds also trade the forex market as part of their investment portfolios, while banks trade forex as one component of their FICC (fixed income, currency and commodity) trading desks. Banks also receive forex allocations from central banks and take in foreign-currency deposits as part of domiciliary accounts.
- Central bank operations: Central banks print money and maintain the money supply. They may also intervene in currency markets to influence exchange rate conditions. Central banks also manage their nations’ foreign currency reserves.
How to Start Forex Trading
Trading requires the knowledge to navigate the markets, but it also requires market access. It also requires having a suitable payment method and access to the tools that are required to trade forex markets. With this in mind, here are the requirements to start forex trading.
1. Market Access
The first step in starting your forex trading journey is gaining access to the market where these currencies are traded. Due to the fact that the forex market does not have a centralized physical venue but rather is a virtual marketplace (which is an interconnection of computers and links in the foreign market), the way to get market access in forex trading is by choosing a stable broker.
Forex brokers offer trading platforms that give traders access to the forex market. Different platforms are available. Some are proprietary platforms, meaning they are specific to the brokers in question, while others are turnkey solutions, where a platform provider licenses and customizes a trading platform for use by several brokers. Under the latter category, you have platforms like MetaTrader (MT4, MT5), cTrader, NinjaTrader and ActFX.
2. Choosing a Forex Broker
Brokers typically provide access to the forex market through digital platforms, but this is not their only function. They also act as custodians of the trader’s account and set the trading conditions, such as commissions, spreads, customer support, and other services. Each broker has its own deposit and withdrawal procedures. Also, for broker review status, look at independent reviews, such as Trustpilot, which features reviews of entrepreneurs or businesses and the experiences they have had. This provides insight into how brokers treat their clients. You can also check to see if the broker is regulated or not.
3. Open a Trading Account
Once you have selected a broker, complete its account registration and verification requirements. Brokers typically offer different account types, including standard, raw-spread and commission-based accounts.
Compare their trading conditions before selecting an account. Pay particular attention to minimum deposits, contract sizes, leverage limits and applicable charges.
4. Payment Method
To trade forex, you must deposit funds to buy or sell currencies. If you are making profits, you also need to withdraw them. Therefore, participating in the forex market requires a suitable payment gateway for deposits and withdrawals. In this respect, the forex market has made major advances, moving beyond the days when bank wires and credit cards were the only means for traders to deposit and withdraw funds. Now you can choose from many channels, and many brokers offer more local coin options worldwide, covering the jurisdictions where their clients operate.
5. Knowing How to Trade
Learning to trade as a new forex market entrant commences with understanding the platform you will use to trade and studying its layout and functions. Pay attention to concepts such as the spread, bid/ask prices, leverage, margin, lot sizes, etc. You should also study the macroeconomic fundamentals that move the markets and form the basis for news trading. These events are then listed on the Forex news calendar. This calendar provides you with a schedule of events. The global hit may cause massive volatility immediately. Learn how to use this volatility to your advantage and reduce the risk it poses to your vault account. I do. Practice this on a demo account before you commit real money to the market. Once you have practiced on a demo account, the next step is to open a real-money account where you can use a very small amount to trade and see how real market conditions play out.
6. Start With Controlled Risk
One component of trading you have to master is risk management. Only use money that you can afford to lose. After depositing money into your brokerage account, ensure you master position sizing and know how to place orders. Buttery fingers can make you enter position sizes you did not intend to use and can lead to large losses. You have to know how to size your positions and how to use leverage. Get to feel the market and understand how the pair you have chosen to trade works. No two forex pairs behave alike. Understand the macro drivers behind each currency in a pair before you start to trade it.
Frequently Asked Questions About Forex Trading
How much money do I need to start forex trading?
The minimum amount you need to start trading forex depends on the broker you choose and the account type offered. Some brokers accept as little as $10. However, you must understand that using an amount as low as $1 or $5 doesn’t mean that money is inherently safe to trade without jeopardizing this margin principle. Sometimes it is best to use a low amount to learn the ropes of real-money trading, but if you want to make substantial inroads into trading and build a trading business, you need to commit a substantial amount of capital, such as $1,000 or more. Only deposit money you can afford to lose.
Can beginners make money trading forex?
Beginners can make money trading forex, but those gains are usually temporary and not sustainable because beginners need to learn a lot to make money in forex over a long period. Beginners should focus not on making money in forex, but on learning the principles of risk management, execution, and how to develop quality strategies that work.
What is the best currency pair for beginners?
There is no consensus on the best currency pair for beginners. However, beginners are best served by trading highly liquid currencies with low spreads. Currencies like EUR/USD and GBP/USD match these parameters. You should avoid trading currencies with high spreads and large intraday ranges.
Is forex trading available 24 hours a day?
The forex market runs around the clock, Monday to Friday. However, trading hours may occasionally change due to Daylight Saving Time, or holidays in countries whose currencies are traded in forex markets. Sometimes, brokers may also make some instruments unavailable due to excessive volatility. Generally speaking, the forex market is a 24-hour market that operates five days a week.
What is the pip?
A pip is the abbreviation for Percentage Interest Point. It is equivalent to 0.0001 points. The PIP measures the change in the exchange rate of a currency pair.
What is the spread?
The spread is the difference between the bid and ask prices. Spreads are also expressed in pips and represent the broker’s profit. Spreads also have monetary value. The trade’s lot size determines the spread’s monetary value.
Is forex trading suitable for everyone?
Forex is not suitable for everyone. Not everybody can navigate the world of leveraged trading. It’s also not stable for those who do not have one that they can afford to lose or who do not fully comprehend the products and the risks involved in forex trading
Risk disclaimer: Forex and leveraged CFD trading involve substantial risk and may not be suitable for every investor. You may lose some or all of your trading capital. This article is for educational purposes only and does not constitute investment advice.