Like some other forms of trading in financial markets, foreign exchange (forex) trading may seem complex, abstract and intimidating for beginning traders. However, the underlying activity involved—trading one national currency for another—is relatively simple. Whether one buys low and sells high, or sells high and buys low, the mechanism for profiting in the currency markets is relatively straightforward.
Forex trading used to be the exclusive territory of large market operators, but it's now accessible to the general public and there are many resources available to help beginning traders achieve success. That being said, those same traders will want to consider the following information about the market before they start trading forex.
Why Forex Trading?
There are several reasons forex can be an attractive market, even for beginners who have little experience. The forex market is accessible, requiring only a small deposit of funds for traders to get involved. Also, the market is open for 24 hours per day/5 days a week (it's closed for a short period on weekends). This means that traders can get into the market at any time of day, even when other more centralised markets are closed.
Forex traders also pay only a simple trading fee determined by the spread between currency bid and ask prices, and trading is often governed by simplified tax rules. Finally, traders can pre-determine their stop-loss and trade exit prices prior to entering each trade, meaning they have full control over how much risk they want to take on.
Further, the following upsides to currency trading also draw participants to forex trading:
The extended trading hours and abundance of products afford those that trade forex a vast array of unique opportunities. No matter if one is focussed on the majors, minors, or exotics, there's always a market to engage.
Forex currency pairs offer a plethora of leveraging options. This is ideal for retail traders as positions may be sized in accordance with available risk capital and evolving market conditions. Also, the ability to increase or decrease applied leverage opens the door to many previously off-the-table forex trading strategies.
Low Barriers To Entry
In many cases, the resources needed to start trading forex are minimal. As an industry-leading brokerage, FXCM furnishes traders with no account minimums and a collection of powerful platform choices. At FXCM, all one needs to do to get started currency trading is confirm their country of residence and fill out the online questionnaire.
Advancements in technology allow traders to engage the market in real-time via desktop or mobile application. Through a few screen taps or clicks of a mouse, one can execute forex trades from anywhere there is an internet connection. From order entry to account management, the process couldn't be easier.
Forex trading does involve some risk, and traders should be aware of this before jumping into the market. Below are three of the most prominent.
In forex, volatility is the fluctuation of exchange rates over time. Periods of sudden volatility lead to extreme price action, which can produce extraordinary profits or losses. Although volatility can be beneficial, it also enhances any trade's risk profile. Also, in some situations of price volatility, traders may also be exposed to "execution risk," which occurs when market orders are not able to be filled at exactly the same price that was requested.
Applied leverage is a primary driver of risk for currency traders. Forex leverage refers to the amount of currency being controlled in the live market. As a general rule, the greater the leverage, the greater the assumed risk.
According to the United States Office of the Comptroller of the Currency (OCC), counterparty risk is "the probability that the other party in an investment, credit, or trading transaction may default on contractual obligations." When trading forex, one relies on brokerages and market makers to honor transactions. One can greatly reduce counterparty risk by trading with the best forex brokers that are licenced, regulated and reputable.
In addition to the aforementioned risks, it's important to recognise that a bulk of the world's forex trading is still done among major banks and financial institutions. These entities generally have more information, leverage and technology resources than individual traders. As a result, traders in the retail forex market often find themselves under the influence of market movements they may have little or no power to control.
How To Get Started
While the forex market can be complex and may require some study for traders to become familiar with it and trade successfully, getting involved in forex trading is relatively simple. All one needs to start trading is a bit of capital, brokerage account, computing power and internet connectivity. Upon securing these assets, the rest is routine.
Aspiring traders who are new to the market will need to:
- set up a trading account at a forex broker,
- install a trading platform on their home computer or mobile device using the broker's trading software
- and deposit at least £50 in their trading account before beginning trading.
Once they have their account set up, traders will have access to live price movements, enter orders and set up trading strategies. Currencies are traded in pairs, so every time a trader buys one currency, they are selling another. Many currency pairs are available for trading, involving several major currencies and also a number of less-well-known, or minor, currencies.
Before diving headlong into the forex market, traders will do well to test the waters with a demo trading account. Many brokers offer this service so traders can get used to the trading and forex market environment.
Demo accounts are great for anyone that wishes to fine-tune their trading skills without putting their money in harm's way. They offer no-risk market access, which is ideal for those learning forex trading or transitioning to new strategies. One can trade the euro (EUR), U.S. dollar (USD), or British pound sterling (GBP) all without committing any capital to the live market. Without question, the demo account is a powerful tool for enhancing performance.
Demo accounts will allow traders to track actual market situations and simulate trading strategies and trades so they can practice trading without having to put any money on the line. Once they feel confident they are ready to begin, they can then go live on a real trading account.
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Although many experienced traders make use of technical analytics such as Japanese candlestick charts, most are familiar with the market fundamentals of the currencies they're trading. It's a good idea to get to know the countries and national policies governing the currency you are planning to trade. This may also include getting to know the calendar of key data releases, such as interest rate decisions, and national trade and balance of payments information.
Most brokerages will offer traders access to margin to leverage their trades under guarantee of a deposit in a margin account. Margin functions as loan collateral to help multiply the amount of funds that are effectively placed on a trade and potentially also multiply profits.
However, margin can also multiply losses if a trade is unsuccessful. Given this, it's typically wise for traders to begin trading with a small amount of leverage and increase it only once they have begun to gain confidence in the success of their trading strategies.
Margin is the driving factor behind applied leverage and position sizing. The best forex traders understand that margin is a "double-edged sword" and use it within the context of a comprehensive trading plan.
One helpful rule of thumb traders use to minimise their risk is to trade with a "risk-reward ratio" in mind. This means that when they enter a buy or sell order, they will set a stop-loss allowing a given amount of risk and a limit (or profit limit) at a given amount of profit that is a multiple of the amount of their risk.
Typically, the ratios might range from 1-to-1 to 1-to-5 (or more), depending on the trader's risk tolerance. For beginners, what may be counterintuitive is the old adage of "let your profits run." This means that they will want to assure that they can get enough profit out of any given trade to assure that their overall trading activity less any commission, fee or tax costs is profitable.
What often happens in forex trading, however, is traders get "stopped out," meaning their stop losses are triggered and their traders are cashed out at a loss before they have a chance to make a profit. These are some of the reasons why traders may want to carefully study the market environment they are trading in and come up with a promising strategy before they start trading.
Traders may use a variety of styles, depending on what is most comfortable for them. Generally, these may affect the amount of time and intensity of the activity they dedicate to trading during their week.
- "Day traders" will be looking at short time frames of minutes or hours to complete their trades.
- "Swing traders" may trade on market tendencies within a period of one day to a week.
- "Position traders" may trade over time frames of one week to a month or more.
Swing and position traders may need to dedicate less time to following short-term movements in the markets, allowing them more time to dedicate to other activities. However, they may also need to take on larger amounts of risk to account for price volatility over time and use lower leverage, meaning their profits could be relatively lower.
One of the key attributes of successful forex trading strategies is that they align the trader's available resources, aptitudes and goals. In doing so, internal conflicts are eliminated from the adopted strategy and harmony is promoted.
Ultimately, any day, swing or position trade must be complementary to its inputs. If not, one's chance of making money in the currency markets over the long-run is severely compromised.
The forex market lends itself particularly well to automated trading, which is another reason it has attracted a growing number of participants. Trading platforms at many brokerages allow for trades that will automatically be put into effect when certain price or market conditions occur.
Automated strategies are ideal for institutional and retail traders interested in taking a "hands-off" approach to the currency markets. With automation, there is no need to monitor the forex market in real-time or make split second decisions. All forex trades are executed automatically, independent of human intervention.
In this way, trades can be left unattended while the trading account holder is busy with other activities. Working with automated trading does require that traders invest some time learning about the platform trading features and strategies that they intend to use.
Forex is a fast-moving and accessible market with potential for rewards as well as losses beyond initial investments, even for beginning traders. Forex trading is not more difficult than trading in other markets, but the forex market does present its own particular conditions, behaviour and risks that beginners should be aware of before they start.
Leverage: Leverage is a double-edged sword and can dramatically amplify your profits. It can also just as dramatically amplify your losses. Trading foreign exchange/CFDs with any level of leverage may not be suitable for all investors.
This article was last updated on 18th October 2021.