Forex is a shortened term derived from the words “foreign exchange.” The Forex market is where various currencies are traded at an agreed-upon price on the exchange. Forex trading is literally making trades of one currency for another at a specific price.
Forex trading is one of the most popular forms of trading available today and accounts for roughly USD $4 trillion in economic activity on a daily basis. Pairs of currencies are listed at specific values; allowing traders to exchange one currency for another based on whether they believe the currency price will rise or fall. Common list pairs include USD/EUR and many others.
Learning to trade in a new market is like learning to speak a new language. It’s easier when you have a good vocabulary and understand some basic ideas and concepts. So let’s start with the basics of forex trading.
WHAT AM I DOING WHEN I TRADE FOREX?
Forex is a commonly used abbreviation for “foreign exchange”, and it is typically used to describe trading in the foreign exchange market by investors and speculators.
Imagine a situation where the U.S. dollar is expected to weaken in value relative to the euro. A forex trader in this situation will sell dollars and buy euros. If the euro strengthens, the purchasing power to buy dollars has now increased. The trader can now buy back more dollars than they had to begin with, making a profit.
This is similar to stock trading. Stock traders will buy a stock if they think its price will rise in the future and sell a stock if they think its price will fall in the future. Similarly, forex traders will buy a currency pair if they expect its exchange rate will rise in the future and sell a currency pair if they expect its exchange rate will fall in the future.
FOREX TRANSACTION: IT’S ALL IN THE EXCHANGE
If you’ve ever traveled overseas, you’ve made a forex transaction. Take a trip to France and you convert your dollars into euros. When you do this, the exchange rate between the two currencies—based on supply and demand-determines how many euros you get for your dollars. And the exchange rate fluctuates continuously. A single dollar on Monday could get you .70 euros. On Tuesday, .69 euros. This tiny change may not seem like a big deal. But think of it on a bigger scale. A large international company may need to pay overseas employees. Imagine what that could do to the bottom line if, like in the example above, simply exchanging one currency for another costs you more depending on when you do it? These few pennies add up quickly. In both cases, you—as a traveler or a business owner—may want to hold your money until the exchange rate is more favorable.
WHAT IS AN EXCHANGE RATE?
The foreign exchange market is a global decentralized marketplace that determines the relative values of different currencies. Unlike other markets, there is no centralized depository or exchange where transactions are conducted. Instead, these transactions are conducted by several market participants in several locations. It is rare that any two currencies will be identical to one another in value, and it’s also rare that any two currencies will maintain the same relative value for more than a short period of time. In forex, the exchange rate between two currencies constantly changes.
For example, on January 3, 2011, one euro was worth about $1.33. By May 3, 2011, one euro was worth about $1.48. The euro increased in value by about 10% relative to the U.S. dollar during this time.
WHY DO EXCHANGE RATES CHANGE?
Currencies trade on an open market, just like stocks, bonds, computers, cars and many other goods and services. A currency’s value fluctuates as its supply and demand fluctuates, just like anything else.
- An increase in supply or a decrease in demand for a currency can cause the value of that currency to fall.
- A decrease in the supply or an increase in demand for a currency can cause the value of that currency to rise.
A big benefit to forex trading is that you can buy or sell any currency pair, at any time subject to available liquidity. So if you think the Eurozone is going to break apart, you can sell the euro and buy the dollar (sell EUR/USD). If you think the price of gold is going to go up, and based on historical correlation patterns, you think the value of gold affects the value of the Australian dollar, you might decide to buy the Australian dollar and sell the U.S. dollar (buy AUD/USD).
This also means that there really is no such thing as a “bear market,” in the traditional sense. You can make (or lose) money when the market is trending up or down.
ELEMENTS OF A FOREX TRADE
How Do You Read A Quote?
Because you are always comparing one currency to another, forex is quoted in pairs. This may seem confusing at first, but it is actually pretty straightforward. For example, EUR/USD at 1.4022 shows how much one euro (EUR) is worth in U.S. dollars (USD).
What Is A Lot?
A lot is the smallest trade size available.Porter Finance accounts have a standard lot size of 1,000 units of currency. Account holders can, however, place trades of different sizes, as long as they are in increments of 1,000 units like 2,000; 3,000; 15,000; 112,000.
What Is A Pip?
A pip is the unit you count profit or loss in. Most currency pairs, except Japanese yen pairs, are quoted to four decimal places. This fourth spot after the decimal point (at one 100th of a cent) is typically what one watches to count “pips.” Every point that place in the quote moves is 1 pip of movement. For example, if EUR/USD rises from 1.4022 to 1.4027, EUR/USD has risen 5 pips.
What Is Leverage/Margin?
As mentioned before, all trades are executed using borrowed money. This allows you to take advantage of leverage. Leverage of 50:1 allows you to trade with $1,000 in the market by setting aside approximately $20 as a security deposit. This means that you can take advantage of even the smallest movements in currencies by controlling more money in the market than you have in your account. On the other hand, leverage can significantly increase your losses. Trading foreign exchange with any level of leverage may not be suitable for all investors.
The specific amount that you are required to put aside to hold a position is referred to as your margin requirement. Margin can be thought of as a good faith deposit required to maintain open positions. This is not a fee or a transaction cost, it is simply a portion of your account equity set aside and allocated as a margin deposit. Learn more about 24Option Margin Requirements.
Why Trade Forex?
Online forex trading has become very popular in the past decade.
FOREX NEVER SLEEPS
Trading goes on all around the world during different countries’ business hours. You can, therefore, trade major currencies at any time, 24 hours per day, five days per week. Since there are no set exchange hours, it means that there is also something happening at almost any time of the day or night.
GO LONG OR SHORT
Unlike many other financial markets, where it can be difficult to sell short, there are no limitations on shorting currencies subject to available liquidity. If you think a currency will go up, buy it. If you think it will fall, sell it. This means there is no such thing as a “bear market” in forex—you can make (or lose) money any time.
Because of the deep liquidity available in the forex market, you can trade forex with considerable leverage (up to 50:1). This can allow you to trade even the smallest moves in the market. Leverage is a double-edged sword, of course, as it can significantly increase your losses as well as your gains.
Because forex is a $5.3 trillion-a-day market, with most trading concentrated in only a few currencies, there are always a lot of people trading. This makes it typically very easy to get into and out of trades at any time, even in large sizes subject to available liquidity.
LOW TRADING COST
Porter Finance Standard accounts are made up of low, competitive commissions and super-tight spreads. You trade the direct quotes from our liquidity providers with no hidden markups. For beginners,Porter Finance also offers a Mini account with all-inclusive spreads.
As the world becomes more and more global, investors hunt for opportunities anywhere they can. If you want to take a broad opinion and invest in another country (or sell it short!), forex is a way to gain exposure while avoiding vagaries such as foreign securities laws and financial statements in other languages.
How to Trade Forex
OPPORTUNITIES IN FOREX: WHAT’S YOUR OPINION?
Just like stocks, you can trade currency based on what you think its value is (or where it’s headed). But the big difference with forex is that you can trade up or down just as easily. If you think a currency will increase in value, you can buy it. If you think it will decrease, you can sell it. With a market this large, finding a buyer when you’re selling and a seller when you’re buying is much easier than in other markets, subject to available liquidity.
Maybe you hear on the news that China is devaluing its currency to draw more foreign business into its country. If you think that trend will continue, you could make a forex trade by selling the Chinese currency against another currency, say, the US dollar. The more the Chinese currency devalues against the US dollar, the higher your profits. If the Chinese currency increases in value while you have your sell position open, then your losses increase and you’d want to get out of the trade.
MAKING A TRADE: HOW TO BUY AND SELL CURRENCY
You have an opinion. Now what? Open your free forex demo platform and trade your opinion.
All forex trades involve two currencies because you’re betting on the value of a currency against another. Think of EUR/USD, the most-traded currency pair in the world. EUR, the first currency in the pair, is the base, and USD, the second, is the counter. When you see a price quoted on your platform, that price is how much one euro is worth in US dollars. You always see two prices because one is the buy price and one is the sell. The difference between the two is the spread. When you click buy or sell, you are buying or selling the first currency in the pair.
Let’s say you think the euro will increase in value against the US dollar. Your pair is EUR/USD. Since the euro is first, if you think it will go up, you buy EUR/USD. If you think the euro will drop in value against the US dollar, you sell EUR/USD.
If the EUR/USD buy price is 0.70644 and the sell price is 0.70640, then the spread is 0.4 pips. If the trade moves in your favor (or against you), then, once you cover the spread, you could make a profit (or loss) on your trade.
FRACTIONS OF A PENNY: TRADING ON MARGIN
If prices are quoted to the hundredths of cents, how can you see any significant return on your investment when you trade forex? The answer is leverage.
When you trade forex, you’re effectively borrowing the first currency in the pair to buy or sell the second currency. With a $5-trillion-a-day market, the liquidity is so deep that liquidity providers—the big banks, basically—allow you to trade with leverage. To trade with leverage, you simply set aside the required margin for your trade size. If you’re trading 50:1 leverage, for example, you can trade $1,000 in the market while only setting aside $20 in margin in your trading account. This gives you much more exposure, while keeping your capital investment down.
But leverage doesn’t just increase your profit potential. It can also increase your losses, which can exceed deposited funds. When you’re new to forex, you should always start trading small with lower leverage ratios, until you feel comfortable in the market.
Why Trade with 24Option?
Because we’re a leading forex provider around the world, when you trade with 24Option, you open access to benefits only a top broker can provide. You enjoy:
- Award-Winning Customer Service: Get 24/7 service when you need it, wherever you are
- Acclaimed Execution: Our innovative No Dealing Desk model offers competitive spreads and anonymous execution
- Free Premier Education: With on-demand lessons, webinars and real-time instruction, you get the trading edge you need
Plus, you can trade on our proprietary Trading Station, one of the most innovative trading platforms in the market. Open a free forex demo account to start practicing forex trading today.
How Can I Start Trading?
Before you begin trading, you need to find the right broker. After you’ve chosen your broker, it’s time to open a trading account; if your broker offers a demo account, try one of those first. The process of opening an account is typically very simple, and depending on the broker, may or may not require software installation.
If you’ve opened a demo account, practice making a few risk-free simulated trades and then open your real account when you’re comfortable with trading. After you’ve opened your trading account, you need to fund it from an approved funding source and then make your first trade.
Choosing the Right Forex Broker
There are some key considerations you need to take into account when choosing the right Forex broker for you. Remember that you are giving over real money into the care of your broker, and you should know what kind of recourse you have should they prove to be untrustworthy. It is also important to work with well-recognized and reputable market maker and ensure that their servers exhibit high stability and are subject to regulation in at least one, and preferably two, countries.
A reputable broker will ensure the security of your investment and a jurisdiction for handling appeals, should the broker become bankrupt. Keep in mind that brokers with a large number of employees will be better able to meet your needs when you place a phone order. The most important consideration for choosing a broker is their legitimacy; don’t jump on board with fly-by-night operations. After you’ve identified which brokers meet these initial requirements, then consider any perks or other offerings which would give you more value for your investment. Choose a broker with an easy-to-understand platform and the features in which you’re most interested.
Automated Forex Trading
This type of trading allows you to trade currencies using analysis-based software which are designed to help you make decisions about buying and selling various currency pairs. You have to teach your automated trading software how to decide when to trade based on signals that come from technical tools and analysis.
This gives the software “signals” to look at, just like a binary option robot does, and when the signals point the same way, the software makes a decision about buying or selling that specific currency pair. Keep in mind that when using automated trading software, you’re removing your instincts and intuition from the trade. Even the most accurate automated trading system still makes mistakes and can misread data that you might take as significant because of other knowledge available to you.
Check out the best free signal service called Privatesignalsgroup.
Forex Demo Accounts
Demo accounts are an excellent way to learn the basics of Forex trading without risking your investment. A demo account is very much to your advantage; it is a useful way to acquaint yourself with the trading platform and its features. You’ll also be able to test out some different trading strategies to find which style suits you best. Nearly all demo accounts offer full functionality and real-time market prices, without any risk to your investment while you’re practicing trades. Demo accounts give you an opportunity to familiarize yourself well with the Forex market in a safe and risk-free manner.
Video – Forex Trading for Beginners
Forex trading is based on buying and selling pairs of currencies. If you were buying the currency pairEUR/USD, you would be buying the first (EUR) and selling the second (USD). If you were selling the same pair, you’d be selling the first (EUR) and buying the second (USD). As demand grows for buying the pair, the euro gains strength, while the dollar loses strength. Conversely, if the demand to sell the pair grows, theeuro gets weaker while the dollar gets stronger. These movements cause the exchange rate to increase or decrease accordingly.
Currency Names & Symbols
Currencies are designated using a three letter abbreviation. The letters denote which country the currency originates in, as well as the name of the currency. For example, USD stands for “United States Dollar”. AUDwould denote Australia Dollar, while CAD is indicative of the Canadian Dollar. In the Forex market, there are some currencies which are the subject of more intense trader focus.
These currencies are called “majors” and are the most widely traded of all currencies. Relative to the Forex market, the “major pairs” are not to be confused with the “majors”; the major pairs are those pairs which include USD and a secondary currency. Pairs without USD are not considered major pairs. The first currency in a pair is typically called the base currency.
Longs and Shorts
In the most basic terms, if you make a trade based on the assumption that the currency pair’s price will rise, you’re trading on the long position; conversely, if you’re trading based on the assumption the price of the pair will fall, you are trading on the short position. The two ways of profiting in the Forex markets are therefore known as the “longs” and the “shorts”.
This position is established when you initiate the trade. If you’re buying, you’re taking the long position; if you’re selling, you’re taking the short position. An easy way to keep this straight is to remember that “sell” and “short” begin with the same letter. Buying and selling can be confusing in the Forex market, because it’s easy to mistake one for the other. In order to keep it straight, remember that the “buy” and “sell” positions are based on the first currency in the pair; for EUR/USD, you are either buying or selling the euro (while simultaneously doing the opposite with the dollar (i.e., either selling or buying, respectively).
What is Leverage?
Using leverage in the Forex market involves borrowing the initial capital for an investment. Instead of raising capital, borrowers get it from others instead of using more conventional means to raise the initial investment amount. When used on the Forex market, it is typically capital borrowed from the broker.
Forex trading is especially good for offering higher leverage from the viewpoint of preliminary margin requirements; traders have the ability to build and maintain control of large sums of money. If you’re looking to calculate leverage based on the margin, simply divide the transaction value by the margin amount required from you. Leverage may be used by individual investors or corporate investors and can greatly increase the available returns for an investment.
An interest rate is an amount that is being charged for the use of money. In the Forex market, interest rates can impact trading pairs because when the rate of return is higher, so is the interest that is accrued on invested currency. This, in turn, raises the profit realized from the investment.
This makes this type of Forex trading essentially an exercise in buying currencies with a low interest rate in order to buy the currencies with higher rates; doing this is known as “carry trading”. When you use the carry trade strategy, there are risks associated with the fluctuation of currencies that could offset the rewards gained on the interest. This happens when the currency that has a higher rate suddenly falls below the rate of the other.
Stock Market and Forex Correlations
Financially, correlation is typically considered to be a statistical measure indicating how two different securities are moving with relation to one another. In the Forex market, correlation is used to help figure the correlation coefficient, which has a value ranging from -1 to +1; a +1 coefficient is incredibly rare and is the result of perfect positive correlation, meaning that as one security increases or decreases in value, the other will follow suit every time. Conversely, a perfect negative correlation, denoted as -1, will ensure that the price of one security increases or decreases in perfect opposition to the other.
Correlation coefficients of 0 indicate that movements are completely random and have no correlation. Perfect correlations hardy ever occur in securities. Correlations should not be exclusively relied upon for buy and sell signals; instead, correlations should be considered in tandem with other market indicators.
The general direction in which an asset or market is moving is called a trend. Trends may be short-term or long-term; trends may also be mid-range, or intermediate, in length. If a trend can be identified, it can be very profitable because trader can then “trade with the trend” to maximize returns.
Generally, trading with the trends tends to be the easiest and most profitable strategy of Forex trading. If the market or asset is on a generally-upward trend, it’s not wise to invest in that trend being reversed. Trading with the trend may be one of the most effective strategies for Forex trading and is especially useful for novice traders.
Support and Resistance
When a stock or price repeatedly fails to rise above a certain point, this is known as the level of resistance. The level of resistance may also be referred to as the ceiling, because prices appear to be trapped underneath it. Prices that do not fall below a certain point are referred to as support. This may also be referred to as the floor, because it acts to prevent the price of an asset from being driven down past a certain point.
Both ceilings and floors are important indicators for the price of an asset, but should be taken into consideration with other indicators for the asset’s potential future price and market movement.
In technical analysis, the moving average is a useful indicator that helps to smooth out the action of a price by acting as a filter to remove the background noise of randomly fluctuating prices. Moving averages are lagging indicators that follow trends based on previous prices.
There are two different types of moving averages that are used most commonly; these are the simple moving average, or SMA, which makes simple averages of securities over a specifically defined amount of time periods, and the exponential moving average, or EMA, which uses a formula that gives additional weight to the most recent prices. Moving averages, or MAs, are commonly used to identify the directions of trends, as well as determining the level of resistance and support.
Relative Strength Index (RSI)
The relative strength index, or RSI, is a technical indicator of momentum which makes comparisons between the extent of recently-made gains versus recently-made losses in an effort to determine whether various assets are being overbought or oversold. Traders who make use of the RSI should keep in mind that large price surges and price drops for any asset can cause false buy and sell signals to be generated.
It is a good complementary tool to be used in conjunction with other tools to choose stocks. Some of the indicators which should be considered in tandem with the relative strength index are the support and resistance levels and market trends.
Basic Trend Trading Strategy
Trading with the trends is a strategy for trading that seeks to increase returns by analyzing the momentum of a particular asset to determine its direction. To trade with the trend, traders should enter the long position when the price is trending upward and the short position when the trend is downward. The strategy works on the principle of asset prices continuing their upward or downward motion over a short period, an intermediate period or over a longer term. You can try this with binary options brokers like Banc de Binary or 24option.
Once a trader assumes the long or short position, they will retain that position until the trend begins to reverse. When trends begin to reverse, traders should take precautions to ensure their investment is not lost.
Carry trading involves selling specific currencies due to their lower interest rates and buying other currencies due to their high interest rates. The trader profits by capturing the difference between these rates, which has the potential to be a substantial sum, especially given various types of leverage that may be used. The risks associated with carry trading typically center on the uncertainty presented by exchange rates.
If one of the pair of currencies falls below the value of the other, the trader stands to lose their investment. Carry trade transactions are usually carried out using quite a bit of leverage, meaning that even small moves in the rates of exchange may end up translating into huge losses unless the position has been properly hedged.
In the Forex market, managing risk includes identifying, analyzing, and accepting or mitigating the uncertainties of the decision-making concerning the investment. This is an essential part of the transaction for serious investors and fund managers because it is an attempt to quantify potential loss and taking (or not taking) action according to their objectives for investing and tolerance for risk.
Insufficient risk management can lead to excessive losses and consequences which are very severe for both companies and individuals. The 2008 recession owes some of its roots to insufficient risk management associated with extending credit to borrowers who were not properly qualified. Managing risk consists of two distinct steps; first, determine which risks are inherent in the investment, and then implementing strategies which are suited to your specific objectives.