Forex Trading for Beginners
You hear the word Forex trading almost every single day and it must have already sparked you to understand what actually is Forex trading. Remember, Forex is a volatile market and unscrupulous decisions can cost you a fortune before you know it. The key to continuing trading in Forex requires consistent profitability, as not many people will fancy losing money – and valuable time during the process. Hence, it is vital to understand the nuts and bolts of forex trading to begin your journey smoothly – and sustain it.
So, if you are planning to dip your toe in it and make investments, then read this guide thoroughly to start as a pro.
The Forex (FX) or foreign exchange market is a decentralised global market place for trading different currencies. Instead of a traditional or centralised exchange, this buying and selling of currencies occur ‘over the counter.’ Forex market is the most liquidated market where over $5.5 trillion exchange takes place daily. It works 24-hour a day during the week (not on Saturday and Sunday) and opens on Sunday evening, North American time zone, and closes at 5-pm on Friday during the same time zone.
Like any financial market, FX works on the principle of ‘supply and demand.’ If there is a high demand for a currency or entity among investors, it’s price or share value increases and investors buy it. It’s called ‘going long.’ Conversely, investors tend to sell the currency if it’s depreciating, and it is called ‘going short.’
For instance, if there is a high demand for American dollars among British investors holding Pounds, and they start buying dollars and selling Pounds, the value of the dollar will increase relative to the Pound. However, this doesn’t affect the value of other currency pairs like the Dollar/Euro.
Investors in FX focus on two major types of analysis, namely: fundamental analysis and technical analysis. Fundamental analysis is assessing macro indicators that can trigger price movements of currency pairs while the latter is concerned with looking at price actions, trends, and patterns.
These two types of analysis focus on the factors that move or drive FX and cause currency movements.
This type of analysis focuses on the overall strength of a currency and evaluates various macroeconomic factors such as interest rate, GDP to tax ratio, unemployment, manufacturing, inflation, international trade, to name a few. The rationale is that the price value of a currency may vary from its real value. That’s why, many investors or markets misjudge or misprice the value of a currency in a shorter-term – and end up losing money. The fundamental analysis helps you evaluate the real price of a currency over a longer period.
The investors read financial reports and analyse significant events happening in the country that may affect financial markets. If an economy is speculated to hold strong, investors start buying it, causing its price value to appreciate. Interest rates are considered as the best indicator of a currency’s strength and a major fundamental analysis indicator. In FX, the investors are concerned with the nominal interest rate determined by the currency’s central bank.
For instance, if you want to trade in USD/Pound, then you should assess the relative strengths of both currencies – in terms of the above mentioned factors particularly interest rates. You will analyse how the interest rates of both currencies are likely to be in the coming weeks. Generally, the stronger the currency, the higher the interest rate and vice versa.
However, the process is currency manipulation is the primary concern of the investors. Many countries manipulate interest rates to level the economy. From the Forex market point of view, the best time to start trading is during changing interest rates. It increases your chances of earning more profits – and losses too.
Technical analysis entails the study of historical prices of a currency using Investors evaluate various indicators, financial reports, and other technical tools such as drawing tools, price charts,
It helps investors evaluate and determine the future patterns and possibilities of a currency and its price movements - and spot future opportunities and risks. The underlying premise of technical analysis is that the markets are volatile and no one can predict what will happen in the future.
So, successful trading depends not on being right or wrong, but determining the probabilities of when the odds are in your favor – and technical analysis helps you do that. Additionally, an investor assesses when to enter a market – and more importantly, when to get out of a market.
Most traders rely on technical analysis to trade efficiently
Reading an FX quote is the most crucial factor the all traders should understand. To become a pro trader, you should be fluent in reading Forex quotes. A Forex quote is a price value of a currency relative to others at a given time.
Forex quotes always involve currency pairs, as you buy one currency by selling others. It is expressed as GBP/USD - if we are been dealing in GBP and USD. It represents we are expressing GBP in USD – or quoting GBP against the dollar. Here, the first currency, GBP, is called the base currency, while the second, USD, is known as the quote currency. At present, almost all the currencies are quoted against USD, for America is the dominating power in the world, with few exceptions: USD/JPY and USD/CHF, where USD is the base currency.
Generally, Forex quotes are up to five decimal points and the number to the left of decimal point reflects a unit of the quote currency. The next two digits are cents and the third and the fourth ones reflect a fraction of a cent and are called pips.
So, if a Forex quote is like 121.23/121.25, the spread - or the difference in the bid and ask prices - would be two pips.
There are seven major currency pairs in Forex trading, which are:
· EUR/USD
· USD/JPY
· GBP/USD
· USD/CHF
· AUD/USD
· USD/CAD
· NZD/USD
These seven pairs account for more than 80% of the total trade volume on the Forex market. All these seven currencies have high liquidity and low volatility – with the USD leading the pack.
Notwithstanding the volatility of the Forex market, many investors are attracted to the Forex market and invest from a few thousand dollars to millions of dollars. The reason is that Forex trading gives them significant advantages over traditional markets, such as:
Forex allows investors to forecast the appreciation and depreciation of various currencies and make more money by investing in the right currency. Additionally, you can pick many Forex pairs to spot profitable trades.
Forex trading involves the use of leverage. It means you can start trading in a currency without paying the full cost of the position up front, rather than just a fraction. It reduces the risk of losing all your investment in just one transaction. The profits or losses you make will reflect the whole value of the trade when it’s closed.
Simply put, you trade on margin and increase the chances of maximising your profits – but the same goes for losses. It can also increase your losses beyond the initial investment.
Even though the transaction costs vary from broker to broker, but overall, Forex trading is cost-effective. The investors make transactions before the overnight funding charges are applied and hence, save money. In comparison to traditional markets likes equities, Forex doesn’t involve commission charge and in case it is, the commission almost $1 per transaction.
The foreign exchange market is opened 44-hours a day, 5 days a week. It’s made possible due to over the counter (OTC) transaction - direct transactions between investors – instead of through a centralised bank. Also, Forex is a global market, so an investor can always take advantage of different time zones and make transactions any time of the day.
Being the most liquid market in the world, all the transactions in the Forex trading are done quickly and efficiently. It means transaction spread – or transaction costs – are decreased significantly since many investors are looking to buy or sell shares at any given time.
It offers a golden opportunity for traders to forecast price movements and any pips in your favour are pure profit.
The best thing about Forex trading is that you can buy and sell in various currencies. Speculating major global events and the relative strength of currencies, you make investments in the right currency and earn more profits.
Now, let us discuss various key terms of Forex trading (some already used in the article) that will improve your understanding of the market.
In a Forex quote, the first currency is called the base currency. While quoting GBP/USD, the GBP is the base currency.
The second currency against which the quote is made is variable or quote currency. In GBP/USD, the variable currency is USD.
The highest price an investor or buyer is willing to pay is the bid price. Whenever you wish to sell a Forex pair, you will see the bid price of your asset. Generally, it is to the left of the quote and coloured red.
Ask is the opposite of bid price and shows the minimum price a seller is willing to accept for an asset. When you’re buying an asset, you see the ask price present to the right of the quote in blue.
The difference between the bid price and ask price is called spread or actual spread. It also includes the additional spread added by the broker as his/her commission.
In a Forex quote, one digit move in the fourth digit represents one pip or point. This is how traders respond to currency movements and how media reports fluctuations in Forex trading, i.e., EUR/USD rallied 100 points today.
So, if the bid price for the GBP/ USD pair falls from 1.13335 to 1.13344, that represents a difference of 1 pip.
Margin is the amount of money an investor deposits to open a leveraged position. It is simply an investor’s account balance that he wants to invest in other trade. It indicates the strength of your trading account.
As the name implies, a margin call is a notification to the investors to apprise them that they need to deposit more money in a trading account – or risk losing position. When your total capital invested falls below a specified requirement, you get a margin call.
Putting it differently, it notifies you that you are approaching the Stop Out level.
Any currency or asset is considered liquid when it can be sold or bought easily. The availability of many potential buyers of an asset increases its liquidity.
In terms of FX, a currency pair has high liquidity, if more buyers are willing to trade in it.
Spot Forex, or spot transaction, is an agreement between the buyer and the seller to purchase and sell currencies at an agreed price on the fixed or specified date. It entails buying and selling real currencies.
And the price at which this transaction happens is called spot Forex price.
CFDs is short for "Contract for Difference". It is a contract between two parties, particularly between the investor and CFD broker, that lets the buyer (broker) pay the difference between the current value of a currency and its value at the time of contract. CFDs are very popular in FX and are now available in bonds, cryptocurrencies, stocks, etc.
It is meant to offset the losses incurred to the seller due to price fluctuation during the starting and settling of a transaction or contract. It doesn’t involve the delivery of physical assets.
It also allows the investors to make profits of price movements without having to own the underlying asset.
Every beginner should know the major risks of Forex trading. As a Forex trader, you should be aware of:
The interest rate is the primary indicator of a currency’s strength. If it goes higher, the market value of currency increases. Any boost in investments in a country can strengthen the currency – stimulating higher interest rates. But any sudden fluctuation in the interest rate of a currency offsets the profits earned by investors. Also, many currencies manipulate interest rates to stay competitive in the short term, and investors for that – and end up losing investments.
So, evaluate the interest rate trends of a currency conscientiously and continuously.
Leverage in Forex trading is like a double-edged sword that impacts both profits and losses by the same magnitude. The higher the amount you leverage, the greater your losses or benefits. Sometimes, investors end up losing more money than the initial investment.
It refers to the negative effect of exchange rate fluctuations during the entering and settling a contract. These risks increase when the beginning and end of a contract takes more time.
You can minimise this risk by analysing your business cycle, assessing where transaction risks occur, and hedge FX risks. Also, never let hedges squeeze your investment capital.
This risk comes in play while dealing with third-world or developing countries. Such countries fix the exchange rate corresponding to a stable economy – like the USD. But the central banks of these countries must ensure considerable foreign exchange to maintain a fixed exchange rate.
Any balance of payment issues and resultant devaluation of currency leads to an economic crisis. In forex trading, the currency crisis is equivalent to liquidity dangers and credit risks and the investors may find their assets insolvent as no one will willing to buy shares of a evaluating or unstable currency.
As a beginner, you should know the fundamentals of long and short trading. You can do both but having a better understanding of their basic will help you assess the risks and opportunities associated with them.
In long trade, an investor buys an asset with speculations that its value will increase in the future – in the hope of earning more profit. Investors buy orders and hold them for a long position. For instance, if someone invests in EUR/USD, he will not sell them for a considerable time expecting that the USD will appreciate. If a trader buys three lots of EUR/USD, he is said to have two long positions of EUR/USD.
Investors rely on buy-signals or ‘bullish trend’ to enter long positions, like if a currency is expected to appreciate in the coming months due to national or global political dynamics.
The short trade is the opposite of the long trade where the investors start selling the assets. Here, they expect that the price value of a given asset will depreciate in the near future. Then, when the price falls, they buy again the same assets for lower prices at a later date – earning profit from the difference of the higher and lower prices.
In the forex terms, if an investment shorts GBP/USD, they are selling GBP to buy USD – hoping that GBP will depreciate soon.
Here also, the investors look for sell signals or other such indicators like the bearish trend of a currency to enter a short trade. A common indicator is when the value of a currency reaches for the level of resistance. It is a price level that the underlying currency has struggled to break above.
Forex traders use three types of charts, namely: a candlestick chart, bar chart, and line chart, to analyze the past behavior of currency and predict its future trends.
Also known as a Japanese Candlestick Chart, a Candlestick Chart makes it convenient to analyze the forex price movements because of a wide array of information it displays. You can easily recognize and currency prices and patterns and price action on a candlestick chart.
It shows the high, low, opening, and closing prices of a currency pair. When the candlestick chart is filled, it reflects that the closing price of the underlying currency pair is lower than the opening. Contrarily, if the chart is hollow, it shows that the currency pair closed higher than it opened.
Compared to the candlestick chart, a bar chart is difficult to read and shows the high and low prices of a currency pair, as well as opening and closing. Its top shows the highest paid price while the lowest traded price is represented by its bottom – for a specific time.
Generally, this type of chart is used to assess the contraction and expansion of price ranges. The horizontal lines show the closing (right) and opening prices (left).
A line chart is the easiest to understand and analyse. For beginners, it’s the best option - and the first thing they should learn - to assess the price movement of a currency pair. It shows a curve indicating closing prices for a specific time.
This curve is drawn by connecting a line from one closing price to the next, and so on. On completing the chart, it represents the price movement of a currency pair through that period – and helps to determine currency patterns and trends.
The Forex market is a promising opportunity for people who wants to earn a huge fortune in a short span of time. But it is also risky and you may lose hard-earned money – if not done in the right way. In a way, it’s a double-edged sword, but you can earn big returns if you are mentally strong and have insights into the basics of Forex trading.
Investors who have a hawk-eye for predicting price fluctuations and trends of underlying currencies are bound to achieve success.
