As you look at your investment portfolio, are you looking to expand into a new investment vehicle? If so, forex trading is a great option to consider.
Trading foreign currency (forex) online is a way investors can increase wealth. But before you jump right in, you should take time to research the market and understand the ins and outs of forex trading.
Throughout this article we’ll explore what forex trading is, the advantages and disadvantages of adding it as an investment vehicle, and how you can get started forex trading.
Table of Contents
- What Is Forex?
- How Does Forex Trading Work?
- Benefits of Trading Forex
- Disadvantages of Trading Forex
- Best Ways to Learn How to Trade Forex
- Basic Forex Trading Terminology
- Steps to Start Forex Trading
- Forex Trading Strategies
What Is Forex?
First things first, we should explore what forex is before you make the decision to become a forex trader. The simplified way to understand forex trading is that you are buying one currency while selling another at the same time.
If you’ve ever traveled abroad and exchanged the U.S. dollar for another currency, you are likely already familiar with currency trading. The goal of forex trading, outside of traveling abroad, is to have the currency you buy exceed in cost compared to the one you sell.
Since you are already familiar with currency, after all you use the U.S. dollar on a regular basis, you just need to learn how forex trading works. What if you wanted to exchange the Dollar for Euros or Yen? That is where the forex (FX) market comes into play.
How Does Forex Trading Work?
Forex trading is done on the forex market — but the forex market is not a centralized exchange. Unlike the stock market, the forex market is run through a global network of banks and organizations across time zones in New York, London, Sydney, and Tokyo. It is open 24 hours a day, 5 days a week.
Trading currency is done in currency pairs. Each currency is signified by a three-letter code that represents the region and the currency itself.
U.S. Dollar = USD
Japanese Yen = JPY
When you look at forex expressed on the forex market you’ll notice the following format: XXX/XXX = #. This format is a comparison of the two currencies in relation to each other. For example, if you come across USD/JPY = 109.78 this tells you how many Japanese Yen are needed to buy one U.S. Dollar.
Benefits of Trading Forex
Adding forex to your portfolio can help increase your wealth. It appeals to many traders of all experience levels, from beginners to experts. Here are a few reasons why:
- High liquidity
- You can trade 24 hours a day
- It’s a vast global market
- You can use leverage to your benefit
Disadvantages of Trading Forex
Ready to jump into trading forex? While it comes with many advantages, you should explore all the downfalls of foreign exchange trading before you begin.
- Not required to be regulated
- Using leverage is high risk
- High volatility
- Market is full of scammers — be careful who you trust
Best Ways to Learn How to Trade Forex
As an investor you know to not just blindly hand your hard-earned money to whoever makes you the biggest promise. It’s clear you already do your research — which is what brought you here!
Learning the ins and outs of how to trade forex will serve you well before you dive head first into trading. There are numerous YouTube videos and podcasts that can give you an overview. But if you really want to learn how to trade forex, consider taking one of the best forex training courses to help you on your way.
Basic Forex Trading Terminology
When you begin forex trading, you’ll need to know the common terminology that you’ll come across. Many of the trading courses will give you an overview of these terms, but if you want to ensure you have an all-inclusive learning experience, check to make sure they discuss all of these terms and how they are relevant to forex traders.
- Currency Pair: The two currencies that are being exchanged. Using our example above, the currency pair for the U.S. Dollar and Japanese Yen is USD/JPY.
- Exchange Rate: This is the rate that one currency is exchanged for the other currency. In our above example, 109.78 Japanese Yen were traded for 1 U.S. Dollar.
- CFD: Contract for difference is an agreement between the broker and investor. This allows traders to leverage higher amounts of money to trade securities without owning the asset. For example, if you were to buy a CFD for $20 and sell it for $22, you would receive the $2 profit. However, if you predict wrong, you could owe the difference.
- Going Long / Going Short: Going long is when you purchase a currency pair with the expectation that the price will increase. Conversely, going short is when you sell the currency with the expectation that the price will decrease.
- Bid / Ask Price: Prices are quoted as bid/ask where the bid represents the price a trader can sell the currency (the left side of a currency pair). The ask is the price a trader can buy the base currency (still the currency on the left side of the currency pair). A bid/ask spread is the difference between the bid price and the ask price.
- Point in Percentage (PIP): This signifies the smallest movement an exchange rate can make on a currency pair. It signifies the price change to the fourth decimal on a currency pair.
- Margin: Margin is the amount of money that is required to open a trade.
- Leverage: Borrowing money within your trading account to increase your investment is using leverage.
- Lot Size: This is the measurement of a transaction amount. When you place orders they are quoted in lots. The standard lot size is 100,000 units. But there are also mini (10,000 units), micro (1,000 units) , and nano lot sizes (100 units).
- Bear / Bull Market: Describes the performance of the market overall. When in a “bear” market the price is going down. When in a “bull” market the price is going up.
7 Steps to Start Forex Trading
Once you have completed your research and are ready to begin forex trading, you’ll want to follow the following steps to get started.
Step 1: Research and Select an Online Forex Brokerage Account
Not all forex brokerage accounts are created equal. Some come with additional educational resources for traders, others have lower fees than others.
Determine what you’re looking for out of your brokerage account, then select one of the best forex brokers to help get you started.
Step 2: Open a Trading Account and Deposit Funds
Once you’ve selected the right forex brokerage account based on your personal goals, you are ready to begin the process of setting up your account. Follow all the prompts requested by your brokerage, then you’ll be ready to deposit funds.
Each account has a variety of differences, including a minimum amount to get started. Some require just $100 to get trading, others require a more substantial initial deposit. Begin your deposit with the amount you are comfortable with.
Step 3: Choose a Currency Pair
When you were doing your research, were there any currency pairs that were of interest to you? If so, fantastic, you can go ahead and move on to step 4.
If you are ambivalent, it’s time to dive a little deeper. Each brokerage has a different quantity of currency pairs that can be traded through their accounts. Discover which ones are available to you and then begin step 4, analyze and research.
Step 4: Analyze and Research the Market
Start working on a trading strategy based on your research of the market. While it is impossible to predict and perfectly time the market, understanding the market and your desired outcome will help you mitigate risk and make solid investing decisions.
Step 5: Read the Quote
Once you’ve selected your desired currency pairs, you will look at the quote. The quote consists of the currency pair followed by a bid and ask price. The spread is the number of PIPs between the bid/ask.
Here’s an example of a forex quote:
EUR/USD = 1.1704/1.1708.
The bid price = 1.1704
The ask price = 1.1708
The bid price signifies what you would be selling for, whereas the ask price is what the broker is asking traders to pay to buy.
Step 6: Determine Your Position
Once you’ve made a decision on the currency pairs, you’ll want to determine how much of your account to risk on the trade. It’s recommended that you do not risk more than 1%, but some traders will risk up to 3%.
Depending upon your account size, the percentage you want to risk can now be calculated at a dollar amount. Let’s assume you have $10,000 in your account and you are willing to risk 1% per trade. 1% of $10,000 is $100 that you are willing to risk.
After you’ve made that determination, you can then figure the PIP risk on your desired trade. This is the difference between the entry price and the stop loss order price. Some people always have a 10 PIP stop, while others adjust based on market conditions.
Once you’ve determined your risk amount and PIP risk, you can determine your position based on this formula: $ at Risk/(Pip Risk x Pip Value) = Position size in lots
- The “$ at Risk” is what we explored in paragraph 1 of this step.
- The “Pip Risk” is what we explored in paragraph 2 of this step.
- The “Pip Value” is an already known variable. They are fixed at $10 (standard lot), $1 (mini lot), and $0.10 (micro lot).
- Using information from our example we can calculate the following: $100/ (10 pips x $1) = 10 mini lots
Once you have your own information to plug in, you will be able to determine the proper position for your trade.
Buy: A buy-stop order is the instruction you give to your broker to buy a currency pair once it reaches your specified price or higher.
Sell: A sell-stop order is the instruction to sell your currency pair when it reaches a specified price.
Step 7: Make Your Move!
Last but not least, you’re ready to place an order. Make your selection and begin trading currency pairs.
Be sure to continue watching the market to keep on top of any decisions you should make with your forex trades. Depending upon your desired trading strategy, you might be moving quicker than you think.
Forex Trading Strategies
There are various forex trading strategies that you can utilize to improve your overall wealth. Some might appeal to you, others might not. There’s no right or wrong here. Each one allows traders to determine when they want to buy or sell a currency pair.
As its name implies, day trading is a strategy in which you buy and sell currency pairs within the same trading day. You can do this on a single trade or multiple trades over the course of the day.
Scalp trading is a trading strategy where you take small profits on a more frequent basis. This is done by opening and closing multiple positions over the course of the day. Traders can do this manually or with an algorithm that has set guidelines on when/where to enter/exit positions.
Position / Trend Trading
Compared to the other strategies listed above, trend trading / position trading is a longer-term strategy. It attempts to have positive returns by making moves based on the market’s momentum.
Swing trading follows short-term surges and dips that go against typical trend direction. It capitalizes on these surges, but it requires quick action and intense market oversight. It relies heavily on technical analysis.
How To Be a Successful Forex Trader
Understanding the intricacies of forex trading will be beneficial to your trading journey. Take the time to review courses online and any resources provided by the broker of your choosing.
There’s no one-size-fits-all forex trading strategy, but with time you can find what works best for your personal financial journey. You can also reach out to your financial advisor for guidance to ensure your strategies work long term and with your overall goals.
Frequently Asked Questions
Yes. There are numerous online resources that provide you with the tools needed to learn how to trade forex. The best forex training courses are a great place to start teaching yourself how to trade forex.
You can get started with as little as $100, but depending upon the brokerage you select, you might need to open an account with a higher balance.
When you travel internationally you will need to exchange your currency for the currency of the country you are traveling to. But because the exchange rate fluctuates between currencies, trading currency has become a viable investment opportunity even when investors are not traveling abroad. It allows traders to capitalize on the currency fluctuations against each other.