The forex market is one of the largest and most liquid financial markets, with over $7 trillion in trades happening every day. Thanks to technological advancements, anyone can trade on the forex market. However, this does not mean success is guaranteed.
If you are a beginner and you want to get started in forex trading, here are some of the basics you need to know before you begin trading.
What is Forex Trading?
Forex traders speculate on the movements of currency exchange rates. They buy and sell currencies through a forex broker, trying to make a profit from rising and falling currency values.
The currency pairs you are most likely to start with are:
- EUR/USD (euro and US dollar)
- AUD/USD (Australian dollar and US dollar)
- GBP/USD (British pound and US dollar)
- USD/CAD (US dollar and Canadian dollar)
- USD/JPY (US dollar and Japanese yen)
The currencies in each pair are denoted by their three-letter ISO code. The first currency listed (EUR in EUR/USD) is known as the base currency, while the second (USD) is the quote or counter currency.
While major currency pairs like EUR/USD and USD/JPY see the highest trading volume, there are many other less actively traded pairs to consider. These include:
- USD/MXN (US dollar/Mexican peso)
- USD/ZAR (US dollar/South African rand)
- USD/HKD (US dollar/Hong Kong dollar)
- USD/SGD (US dollar/Singapore dollar)
- USD/SEK (US dollar/Swedish krona)
- USD/NOK (US dollar/Norwegian krone)
- USD/TRY (US dollar/Turkish lira)
- USD/CNH (US dollar/Chinese yuan)
The less commonly traded pairs are more volatile and widen spreads. However, economic and political events can lead to more trading opportunities. Beginners are best sticking to major pairs at the beginning of their trading journey but keep an eye on news that could impact the exotic pairs.
The relative value of currencies fluctuates based on economic and political conditions, interest and inflation rates, and investors' appetite for risk. Forex traders try to profit from these fluctuations in exchange rates.
How Forex Trading Works
Forex is an over-the-counter (OTC) market, meaning there is no centralized exchange like the stock market. Instead, trades take place directly between buyers and sellers. Because of this, the forex market is open 24 hours a day, five days a week. The advantage of this is that you can trade anytime, and if trading is not your full-time job, you can easily fit in trading activities around your other commitments.
Trades are executed through a forex broker. The broker will charge a small fee, known as the spread, for facilitating the trade. The spread is the difference between the bid (sell) price and the ask (buy) price for a currency pair.
For example, with fixed spreads, this difference stays the same and does not fluctuate based on market conditions. For example, a EUR/USD spread may be fixed at 3 pips. This means fixed spread brokers will buy the currency from you at 1.1500 and sell it at 1.1503, taking 3 pips regardless of volatility.
Fixed spreads provide certainty for traders and make costs predictable. However, they are usually wider than variable spreads from market makers. Traders sacrifice potentially tighter spreads for consistency. Overall, fixed spreads benefit beginner traders looking for simplicity and ease of calculating trading costs.
Leverage allows forex traders to control larger positions with a limited amount of capital. Leverage can be up to 50:1 in the US and higher in other parts of the world. While leverage magnifies gains, it also increases risks.
Minimizing Risks with Stops and Limits
Given the leverage available and the fast pace of the forex market, losses can add up quickly. That's why it's critical to use stop loss and limit orders.
A stop loss closes out your position automatically if the trade goes against you by a certain amount. It's important to place stop losses on every trade to limit downside.
Limit orders allow you to specify the maximum price you will pay or the minimum price you are willing to receive on a trade. This can lock in profits on winning trades.
Using stops and limits helps manage the inherent volatility in the forex market.
Developing a Trading Plan
Successful forex trading requires a plan. This includes defining your risk tolerance, capital to risk, strategies, entry and exit criteria, and goals. Develop a trading plan tailored to your style, whether day trading or long-term position trading.
Many beginners benefit from practicing with a demo account before trading with real money. Ongoing education, reviewing your trades, and staying up to date on economic events will improve your trading plan over time.
The massive forex market presents opportunities as well as risks for new traders. By focusing on major currency pairs, utilizing leverage responsibly, managing risk with stops and limits, and developing a trading plan, you can lay the foundations to become a successful forex trader. With patience and discipline, beginners can thrive in this exciting market.