Are you a beginning Forex trader, or are you just looking to relearn the basics of Forex trading? Well whatever group you belong to, you are at the right place, we are going to guide you bit by bit, on every single aspect of the Foreign Exchange market.
What you are about to read is a simplified, well-detailed, and easy-to-read article on the very basics of Forex trading. It entails important facts like what exactly forex trading is, how it works, why you may or may not want to trade the market, and the common terms in Forex.
What is Forex Trading?
Forex trading in simple terms is the act of selling or buying a currency in exchange for another, after speculating the depreciation or appreciation of those currencies, with the sole aim of making profits.
It’s simple. You will want to buy a currency that has the potential to increase in value and sell the one that tends to decrease in value, (or appears to be bearish). The two currencies involved in this transaction are what we call a currency pair. We are going to talk more about this as we go on.
Meanwhile, you should know that buying and selling of currencies are the basic actions that take place in the Foreign Exchange Market. There are still other complex activities though, but those two are the basics.
Forex Trading involves exchanging one currency for another with the aim of making profits
How Does Forex Trading Work?
The Foreign Exchange Market, just like every other market, works through the supply and demand factor. These factors are relative to a set currency pair and directly affect the exchange rate of that pair.
Let’s assume there is more demand for the US dollar by the Japanese, (i.e. more Japanese are giving up their yen in exchange for the US dollar). This of course would make the US dollar appear more valuable and the YEN less valuable, hence increasing the exchange rate of the US/YEN currency pair.
Also, the demand and supply of currencies are controlled by major economic and political events like the threat of war, the election of a new president, or even the outbreak of a national disaster.
For example, the Russian-Ukraine war. Do you recall how the conflict of this war started, and how the exchange went? Well, you probably didn’t know that business investors reacted to the news before the war even started.
Investors prefer a good and stable economy. Bad economic or political news reduces their activities and their demand for the country’s currency leading to fall in its value.
You see, like every good Forex trader, business investors are also speculators. And in recognizing that an event of war would be horrible for business, they acted accordingly. This negatively affected the Gross Domestic Product (GDP) of both countries, as well as the demand for both currencies.
The above is just an example of the details experienced traders look for before predicting the movement of any currency. Speaking of details, let’s talk about how and where traders go to exchange foreign currencies.
The Forex Broker
Who is a Forex broker? A Forex Broker is a financial institution that offers a platform for traders like retail traders, and investment banks, to buy or sell foreign currencies.
Forex Brokers are many, and this is part of the reason why the market is more decentralized, making platforms for trading more diverse.
Furthermore, thanks to the advancement in technology, they use their Apps and websites to provide services that allow traders to easily create accounts, and navigate and trade the Forex market.
Within the site or App of a Forex broker is what we call a Forex Demo Account. A Forex demo account as you may have gathered, is a practicing account that stimulates the experiences of a real Forex market.
A forex broker can act as a middleman in a forex trade. They profit from spreads.
You don’t have to deposit or risk losing your own money. This type of account is the perfect way for beginners to get familiar with the market, their chosen trading strategies, and themselves.
Since Forex Brokers offer these important services, one may want to know what they get in return
How do Forex Brokers make money?
The simple and plain explanation is that they make money from those who trade the Forex market through them. This means that Forex brokers profit from either spreads or commissions, for every trade that is made through them.
A spread is simply the difference between the Ask price (the price at which you can sell the base currency), and the Bid price (the price at which you can buy).
Now this is important. Some brokers may offer to collect fixed or varying spreads and some may claim to offer free commissions. Either way, it’s important to read the terms and policies of any broker you choose to trade with.
A forex broker can decide to trade directly with a client, this enables them to offer fixed spreads. They act as market makers, meaning they place the opposite of your trades. If you loose, they win, and vice versa.
Forex brokers make a fraction of every money you put into the market. Whether you buy or sell, gain or lose, these fractions, (mostly measured in pips,) are always collected.
A pip is simply a small unit of movement in a currency pair. It is characterized by the last decimal point on the price quote, (normally 0.0001 for most currency pairs, and 0.01 for the Japanese yen.)
Suppose you want to trade the EUR/USD currency pair, and you see two Bid and Ask quote prices of 1.0887 and 1.0891 respectively. The spread here is the difference between the bid and ask price, which is 0.0004(or 4 pips).
This is an example of what Forex brokers collect.
How Do I Start Trading Forex?
Time Needed : 00 days 00 hours 30 minutes
This is the bold step every beginner should take, as the only way to get past the beginning stage is by actually trading. It is also the only way to gain the vital experience needed to make profits.To start trading, you should first do the necessary research needed to know the basics of the Foreign Exchange Market. Then, follow these five steps to implement this knowledge:
Research and Select a Forex Broker
Do your research by making a short list of Forex brokers, and select from your list. To optimize your decision-making, you need to carefully study and compare the terms and conditions of each of the brokers on your list.We recommend the metatrader4, as this Forex broker is one of the most popular forex brokers with efficient trading software.Download the Application of Your Selected Forex Broker
Although most forex trading Apps have an equivalent website which you can access through your browser, we still recommend that you use their Apps.This is because trading Applications make it easier to access the Forex market. Also, they can give you direct notifications and reminders about your set trading time in case you forget.Open a Demo Account
A Demo account is a dummy account that lets you familiarise yourself with the Foreign Exchange Market.You can open a Demo account by registering and verifying some of your personal information like your email account, your date of birth, passwords, and their likes.Bear this in mind though: it is never a good idea to immediately open a real Forex account, deposit real money, and start trading. Even if you feel you have read all there is to know about forex, you should start with a demo account.Do your research, and analysis and Start Trading
This is another crucial step to take before making any trade. You will first of all have to choose the currency pairs to focus on, then you will have to watch and study those pairs closely to discern when a particular currency will appreciate or depreciate.Here are two ways experienced traders can predict the movement of currency pairs:◉ Fundamental analysis◉ Technical analysisFundamental analysis is done by observing economic and political events and policies affecting currency pairs, as well as using this information to make trading decisions.Technical analysis, on the other hand, involves simply using “historical price action data and patterns to predict future movements.” (traders-trust.com).Advance to A Real Forex Trading Account
At this point, you must have chosen your preferred currency pairs, gotten familiar with your preferred trading system, and you must have mastered the complexities of Forex risk management.Important note. Using a Demo account will in no way make you an expert Forex trader, as it is just practicing. The emotional tensions of gaining or losing real money do not apply here.So, you need to trade in the real Forex world to grow as a trader.
Tools
- Metatrader 4
Materials
- forextechnics.com
How Long Does It Take to Learn Forex?
The time it takes to learn forex is dependent on the individual doing the learning. It depends on how dedicated you are. Supposing you want a number.
It takes an average of six months to one year to become a mildly good trader. Don’t get it twisted. You can master the basic technical analysis within weeks, but the real trading? No.
It takes years to master the psychology, as well as the risk management involved. You can’t master yourself and how you react to the market within a few weeks or a few months.
The time duration it takes to learn Forex depends on the person. Some people are more motivated than others, and some are more disciplined and more consistent. Setting all these factors right, it should take you three years or more to become a proficient Forex trader.
Where Can I Learn Forex Trading?
A common way to learn forex trading is through a forex mentor. Having a mentor can speed up the process of learning forex by up to five times! You get to learn from someone who has experienced the forex market.
The experience however must still be gotten from actually trading.
Thanks to technological advancements you do not necessarily need physical classes to learn to trade forex. You can learn through various written and visual content on YouTube and some other popular websites.
Also, if you prefer a more organized form of learning and have a few bucks to spare, you can decide to subscribe to online courses from highly reputable websites.
Here are some of those reputable websites:
- babypips.com: this website is known for explaining complex terms using words readable by a 5 grader.
- udemy.com: Udemy is popularly known for offering a range of excellent online courses, including paid and free versions of well-detailed guidelines for becoming a Forex trader.
- admiralmarkets.com: this particular website offers not only online Forex and CFD trading courses but also informative articles on the everyday life of a Forex trader.
Note that these websites are nothing but products of research, and there may be many other authoritative websites that offer better courses.
Is Forex Trading Profitable?
That’s a very good question, but a direct answer cannot be given.
Most forex traders who have been at it for a while must have come across the saying that only 90% of traders are successful.
Now while there is no official survey for this, it is most likely correct as almost every forex community consists of a large pool of forex traders finding it difficult to make profits in their trades.
Some claim to make profits and offer magic courses for a certain amount. And yes, they are mostly not profitable just like the rest.
A profitable forex trader can consistently make net profits after trading over some time such as a month. He or She is a trader who can make a profit of 10 to 20 pips every month.
So to answer the question. Yes, Forex trading is profitable for the few traders who are ready to put in the time, effort, and discipline to learn.
Pros and Cons of Forex Trading
Below are some of the advantages and disadvantages of trading in the Forex market.
Pros
Low Transaction Costs
The transaction cost (which is the bid/ask spread) for trading the Foreign Exchange Market could be as low as 0.1% for smaller retail trades, and 0.07% for larger trades.
All-Round Clock Trade
It is perfect for those who want to trade on a part-time basis as the market is technically on 24 hours, during weekdays. The Forex market opens on Monday morning by 5 am in Australian time and closes on Friday night by 5 pm, New York time.
You can choose from a Variety of Currency Pairs
This is a Forex trading advantage because you are not limited by a few sets of currency pairs. With currency pairs of about 50 in the Forex market, (depending on the Forex broker,) you can easily choose a pair or set of pairs that works best for you at any time. Learn how to choose your best set of currency pairs here.
Leverage
Leverage allows a forex trader to control larger contracts using minimum capital, which can make you bigger profits. We are going to speak more about this later.
Low Start-Up Capital
When compared to stocks, bonds, and other portfolio investments, very little capital can be used to trade in the market, even as low as $50.
Cons
High Volatility
Sudden changes in economic and political policies (like an announcement of new interest rate prices,) can make the market very volatile. This can be unfavorable to traders, especially those who enter the market with low stop losses.
Fewer Residual Returns on Investments
Although the Foreign Exchange Market can make huge amounts of profits, the returns on investment are normally low when compared to markets like the stock market.
Leverage
This as I have said before gives traders the chance to make more money with relatively low capital. But that’s just the good part. It’s a double-edged sword, and as you’ll see below, you can lose a lot of money trading with leverage.
Possibility of Being Defrauded
Lots of Forex brokers dominate the market, so beginning traders are already at the disadvantage of trading with professionals.
Also, there could be a problem of transparency as brokers are the ones that let your trades play out.
We have seen cases of traders complaining that their brokers did not trigger their take profit orders.
Difficult Price Determination Process
Most Forex traders’ analyses are solely technical. This should not be so because the market is affected by various economic and political factors, which should also be taken into consideration.
These complex factors make it difficult for traders to select prices as analysing wrongly could result in a loss.
Common Forex Trading Terminologies
Leverage
Trading with leverage simply means borrowing money from your Forex broker to be able to control larger contracts and make more profits.
For example, to control a million-dollar position, your broker could set aside $10,000. This expressed in ratio, is a 100:1 ( 1,000,000/10,000) leverage. So, you are now controlling a million-dollar position with just a $10,000 margin.
How is it a double-edged sword?
Let’s say you came up with the whole one million dollars yourself, (i.e. leverage of 1:1, ) and you make a crappy 1% profit( $10,000). This same $10,000 gain would be a whopping 100% profit if you used leverage.
However, it could also mean losing 100% of your staking capital, or 1% of your entire capital, assuming you used a 1% (or 100:1) margin
Currency pair
This is simply a price quote of two currencies stated side by side. For example, 1.415 GBP/USD. The first stated currency– the GPB– is the base currency. The second one (the USD) is the quote or counter currency.
The quote currency is used to measure the value of one unit of the base currency. Using the illustration above, the price quote reads that 1.415 US Dollars equals one Great Britain Pound.
There are three classifications of currency pairs. They are:
- The major currency pairs
- The crosses
- The exotics
The major currency pairs are 7 in number. They have the US Dollar attached to every one of them. These seven currency pairs are:
- The euro and US dollar: EUR/USD.
- The US dollar and Japanese yen: USD/JPY.
- The British pound sterling and US dollar: GBP/USD.
- The US dollar and Swiss franc: USD/CHF.
- The Australian dollar and US dollar: AUD/USD.
- The US dollar and Canadian dollar: USD/CAD.
- The New Zealand dollar and US dollar: NZD/USD.
Cross-currency pairs do not include the USD. These pairs normally involve the Euro and the Japanese YEN.
Also, Exotic pairs are either a combination of one of the 8 major currencies and an emerging currency or a combination of two emerging currencies. Examples are:
- AUD/NOK (Australian Dollar/Norwegian Krone)
- CAD/SGD (Canadian Dollar/Singapore Dollar)
- CHF/SEK (Swiss Franc/Swedish Krona)
- EUR/PLN (Euro/Polish Zloty)
- MXN/JPY (Mexican Peso/Japanese Yen)
Ask Price
An Ask price is a price at which your Forex broker is willing to sell one unit of the base currency to you, in exchange for the quote currency. It is usually the second listed price with an ask tag below or under it.
Bid Price
The bid price, on the other hand, is the price your broker is ready to buy a unit of the base currency from you, in exchange for the counter currency. It is usually the first listed price with the bid tag below or under.
Spread
Spread as we have explained before, is the difference between the bid and ask prices. It is measured in pips and is one of the ways Forex brokers make their money.
Pip
Pip means Point In Percentage. It is a unit used to measure the changes in the price fluctuations of currency pairs. For example, let’s say the EUR/GBP changes from 1.5483 to 1.5484. The difference between these two numbers is 0.0001. This is the value of a single pip (1 pip).
Pips are usually the last significant decimals of a price quote. Assuming a rise of 0.005 or 0.0051, these would be equivalent to 50 and 51 pips respectively.
The math is simple. Whatever the increment is, all you have to do is divide by 0.0001 or 0.01 depending on the number of decimals of the price quote to get the value in pip.
More examples.
- A price quote increment of 0.0400 would be equal to (0.4÷0.0001) which is 400 pips
- A price quote increment of 0.0004 would be (0.0004÷0.0001) which is 4 pips
- An increment of 0.31 for the USD/YEN currency pair would be (0.31÷0.01) which is 31 pips.
N.B: All these calculations depend on the number of decimal places of the price quote. You can see from the third illustration above that the USD/YEN only has two decimal places, hence 1 pip equals 0.01.
Lot size
This is a way that Forex brokers use in measuring market orders. There are typically four types of Lot.
1. A Standard Lot
This type of lot represents 100,000 units of the trading currency.
2. Mini Sized Lot
This one represents 10,000 units of trading currency.
3. Micro-Sized Lot
Represented by 1,000 units of trading currency.
4. Nano-Sized Lot
This is equal to 100 units of the trading currency.
It is just like going to the market and ordering a dozen pencils. We all know that a dozen packs equal 12 pencils.
Frequently asked questions about forex trading
Is Trading Forex Gambling?
No. Forex trading is not gambling. There are risks involved but those risks can be diminished by proper backtesting, a good study of previous charts, and proper observation of traded currency pairs.
How Much Money Do I Need to Start Trading?
It depends on the Forex broker. Some brokers offer as low as $5 to start a real account. You should note that most of the top successful forex traders started with around $25000 accounts. While cases of traders making millions or thousands with a $5 or $100 account are extremely rare,
How Do I Learn Forex Trading?
It is best you have a guide or roadmap while learning. Above we listed some authoritative websites that offer forex trading courses.
Can I Join Forex Trading Without Money?
You can trade in the forex market without real money using a demo account. Otherwise, you have to use real money to trade a real Forex account.
Can I Trade Forex With $100?
Yes, you can. Some forex brokers even allow you to trade with as little as cents. You can also trade with larger capitals using Forex Prop Trading Firms.
Conclusion
Forex Trading has been digitized. With progress in technology, it is easier than ever to trade currencies. Traders should understand the basics of forex to be able to navigate easily and understand complex forex subjects.
References
Speculating – Forex speculation explained by babypips.com
Bearish – What it means to be bearish by ig.com
Currency pairs = Currency pairs explained with examples by investopedia.com
Exchange rate = What Exchange rate is according to forex.academy
Retail traders – Who a retail trader is by financemagnets.com
Investment banks – Explained by investopedia.com
Decentralized – How forex is decentralized by forex.academy
Forex Demo Account = The general definition of a trading demo account by investopedia.com
Trading strategies – Defined by wikipedia.org