The Basics Of Forex Trading
What is Forex Trading and the Forex Market?
If you’ve invested in stocks or other financial accounts and want to try something different, you should consider forex trading. But forex trading beginners may wonder what it is and how to get started. We’ll define forex trading, discuss how to get started with it, and define some of the standard terms you’ll hear.
Forex stands for foreign exchange. Foreign exchange trading means trading one country’s currency for another, usually, so you can buy things in that country.
The forex market is the largest and most liquid market in the world. Trillions of dollars in foreign currency change hands daily. It doesn’t have a central location. Instead, the foreign exchange is an electronic network of banks, brokers, institutions, and individual traders who mostly trade through brokers or banks that use trading systems. These people use algorithmic trading software to do algo trading for their customers.
An Overview of Forex Markets
There are two types of forex markets: spot markets and forwards and futures markets.
Spot Markets
The spot market is the largest market on the futures and forwards markets because it handles the largest underlying real asset. In the past, forward exchanges and futures markets were bigger. However, spot markets gained popularity when online trading and forex brokers became more popular.
When an agreement is finalized, it’s called a spot deal. In this type of deal, the delivery of a specific amount of one currency is made to the other, and the receiving of another currency at the agreed-upon rate is transferred. Settlement is made in cash after a position is closed. Although people perceive the spot market as one that deals with the present rather than future transactions, settling these trades takes two days.
Forwards and Futures Markets
In a forward contract, two parties agree to buy currency in the future at a predetermined price. As the name suggests, a futures contract is an agreement between two parties to deliver a specific currency at a future date at a previously determined price. Futures trading happens on exchanges rather than over the counter.
Unlike the spot market, the forward/futures market is an agreement for currency exchanging at a future date. Instead, they deal with contracts that specify claims to a particular currency type, a specific price, and a settlement date in the future.
People buy and sell contracts over the counter in the forwards market, negotiating the terms themselves. Based on standard size and settlement date, the futures market involves buying and selling futures contracts on public commodities markets, such as the Chicago Mercantile Exchange.
Spot Markets
The spot market is the largest market on the futures and forwards markets because it handles the largest underlying real asset. In the past, forward exchanges and futures markets were bigger. However, spot markets gained popularity when online trading and forex brokers became more popular.
When an agreement is finalized, it’s called a spot deal. In this type of deal, the delivery of a specific amount of one currency is made to the other, and the receiving of another currency at the agreed-upon rate is transferred. Settlement is made in cash after a position is closed. Although people perceive the spot market as one that deals with the present rather than future transactions, settling these trades takes two days.
Forwards and Futures Markets
In a forward contract, two parties agree to buy currency in the future at a predetermined price. As the name suggests, a futures contract is an agreement between two parties to deliver a specific currency at a future date at a previously determined price. Futures trading happens on exchanges rather than over the counter.
Unlike the spot market, the forward/futures market is an agreement for currency exchanging at a future date. Instead, they deal with contracts that specify claims to a particular currency type, a specific price, and a settlement date in the future.
People buy and sell contracts over the counter in the forwards market, negotiating the terms themselves. Based on standard size and settlement date, the futures market involves buying and selling futures contracts on public commodities markets, such as the Chicago Mercantile Exchange.
How to Use the Forex Markets
A couple of the ways people use forex markets is through hedging and speculation.
Hedging with Forex
When companies buy or sell goods and services outside their home country market, they take on risks because of currency fluctuations. Foreign exchange markets hedge currency risk by fixing the rate at which a transaction will be completed.
To achieve this, traders purchase or sell foreign currencies in forward or swap markets beforehand, thereby locking in a rate.
Speculation in Forex
Considerations like interest rates, government stability, tourism, economic strength, and political risk daily influence foreign exchange market volatility. There’s an opportunity to make money when changes affect the value of a currency. Because currencies are traded in pairs, predicting one currency's weakness is the same as predicting the other's strength.
Hedging with Forex
When companies buy or sell goods and services outside their home country market, they take on risks because of currency fluctuations. Foreign exchange markets hedge currency risk by fixing the rate at which a transaction will be completed.
To achieve this, traders purchase or sell foreign currencies in forward or swap markets beforehand, thereby locking in a rate.
Speculation in Forex
Considerations like interest rates, government stability, tourism, economic strength, and political risk daily influence foreign exchange market volatility. There’s an opportunity to make money when changes affect the value of a currency. Because currencies are traded in pairs, predicting one currency's weakness is the same as predicting the other's strength.
Find Out More About Forex
It’s not complicated, but forex trading is a specialized field that requires unique expertise. Currency price movements are driven by different factors than equity market movements, such as leverage on forex trades being higher than equity trades. To learn the ins and outs of forex trading, you can take several online courses.
Establish an Account with a Brokerage Firm
You’ll need a brokerage account to start forex trading. There are no commissions involved. Their profits come from spreads, also known as pips, between the buying and selling prices.
Beginners may want to open up a micro forex trading account to start. Brokers who have these accounts can trade up to 1,000 units of a given currency at a time and have variable trading limits. In context, 100,000 currency units is one standard account lot. You can become more comfortable trading forex until you learn your style with a micro forex account.
Create a Trading Strategy
Trading strategies help set broad guidelines and a roadmap for your trading, even when it's difficult to predict and time market movements. They depend on your financial situation and circumstances. It considers how much you want to invest and how much risk you can tolerate without getting burned out. The key with building trading strategies is to build the strategies correctly. Consider a masterclass from a recognized expert, for example.
Keep Track of Your Numbers at All Times
Check your position daily after you start trading. Many trading software programs already provide a daily account of trades. Make sure that your account has enough cash for you to make future trades and do not have any pending positions.
Balance Your Emotions
Many emotional roller coasters and unanswered questions are associated with beginner forex trading. It is possible to become confused by obsessing over unanswered questions. Because of this, you need to cultivate an emotional equilibrium between your profits and losses when trading.
Important Forex Terms
Learn the language first before you start your forex journey. Let's go over a few key terms.
Forex Account
A forex account is used to make currency trades. Depending on the lot size, you could open a micro forex account, which lets you trade up to $1000 worth of currencies per lot, a mini forex account, which let you trade up to $10,000 with of currencies per lot, or standard forex accounts, which let you trade as much as $100,000 worth of currencies per lot.
Ask
This is the lowest price you are willing to pay for a currency. For example, if your ask price is $1.3891 for Great Britain pounds, that is the lowest you’re ready to pay for a pound in US dollars. This price is usually more significant than the bid price.
Bid
The bid price is the price you’re prepared to sell a currency for. As buyers inquire about prices in a particular currency, a market maker continuously puts out bids. While they’re usually lower than ask prices, they can be higher in times of high demand.
Bear Market
Currency prices decline during a bear market. Bear markets occur when economic fundamentals are weak or a catastrophic event, such as a financial crisis.
Bull Market
The price of all currencies increases during a bull market. Optimistic news about the global economy is the reason behind bull markets.
Contract for Difference
A contract for difference allows traders to speculate on the direction of currency prices without holding the assets themselves. Trading on the assumption that the price of a currency pair will rise will result in buying CFDs relating to that pair, and selling CFDs relating to that pair will result in selling them. A CFD trade gone bad can result in heavy losses when leverage is used in Forex trading. CFDs are not permitted in the United States.
Lot Size
A standard size of a currency trade is called a lot. There are four common lot sizes: standard, mini, micro, and nano. Standard lot sizes include 100,000 units of currency. Mini sizes include 10,000 units of currency. Micro sizes have 1,000 units of currency, and nano sizes have 100 units of currency. The choice of a lot size affects the overall profit or loss of the trade. Gains or losses are higher when the lot size is larger and vice versa.
Margin
Margin refers to the money set aside for a currency transaction. Even if a trade doesn't go their way, margin money ensures the broker that the trader will remain solvent. Margin amounts vary depending on the balance of the trader and the customer over time. Margin and leverage are used together for forex trading.
Pip
Pip stands for percentage in point or price interest point. It is the minimum price change in currency markets, equal to four decimal points. A broker's standard lot size can influence pip value. In a standard lot size of $100,000, each pip has a value of $10. Small price changes, expressed in pips, can have an outsized effect on trades because currency markets use significant leverage.
Spread
The difference between the bid and ask price of a currency is called the spread. Rather than charging commissions, forex traders make their money through spreads. Many factors influence the size of the spread, such as the trade size, currency demand, and volatility.
Sniping and Hunting
Sniping and hunting is purchasing and selling currencies at predetermined points to maximize profits. Brokers engage in this activity, and traders must monitor patterns of this activity and network with other traders.
Forex Account
A forex account is used to make currency trades. Depending on the lot size, you could open a micro forex account, which lets you trade up to $1000 worth of currencies per lot, a mini forex account, which let you trade up to $10,000 with of currencies per lot, or standard forex accounts, which let you trade as much as $100,000 worth of currencies per lot.
Ask
This is the lowest price you are willing to pay for a currency. For example, if your ask price is $1.3891 for Great Britain pounds, that is the lowest you’re ready to pay for a pound in US dollars. This price is usually more significant than the bid price.
Bid
The bid price is the price you’re prepared to sell a currency for. As buyers inquire about prices in a particular currency, a market maker continuously puts out bids. While they’re usually lower than ask prices, they can be higher in times of high demand.
Bear Market
Currency prices decline during a bear market. Bear markets occur when economic fundamentals are weak or a catastrophic event, such as a financial crisis.
Bull Market
The price of all currencies increases during a bull market. Optimistic news about the global economy is the reason behind bull markets.
Contract for Difference
A contract for difference allows traders to speculate on the direction of currency prices without holding the assets themselves. Trading on the assumption that the price of a currency pair will rise will result in buying CFDs relating to that pair, and selling CFDs relating to that pair will result in selling them. A CFD trade gone bad can result in heavy losses when leverage is used in Forex trading. CFDs are not permitted in the United States.
Lot Size
A standard size of a currency trade is called a lot. There are four common lot sizes: standard, mini, micro, and nano. Standard lot sizes include 100,000 units of currency. Mini sizes include 10,000 units of currency. Micro sizes have 1,000 units of currency, and nano sizes have 100 units of currency. The choice of a lot size affects the overall profit or loss of the trade. Gains or losses are higher when the lot size is larger and vice versa.
Margin
Margin refers to the money set aside for a currency transaction. Even if a trade doesn't go their way, margin money ensures the broker that the trader will remain solvent. Margin amounts vary depending on the balance of the trader and the customer over time. Margin and leverage are used together for forex trading.
Pip
Pip stands for percentage in point or price interest point. It is the minimum price change in currency markets, equal to four decimal points. A broker's standard lot size can influence pip value. In a standard lot size of $100,000, each pip has a value of $10. Small price changes, expressed in pips, can have an outsized effect on trades because currency markets use significant leverage.
Spread
The difference between the bid and ask price of a currency is called the spread. Rather than charging commissions, forex traders make their money through spreads. Many factors influence the size of the spread, such as the trade size, currency demand, and volatility.
Sniping and Hunting
Sniping and hunting is purchasing and selling currencies at predetermined points to maximize profits. Brokers engage in this activity, and traders must monitor patterns of this activity and network with other traders.
Common Forex Trading Charts
Line Charts
Traders use line charts to identify a currency's overall trend. Forex traders most frequently use line charts. The user specifies the time period for which they want to see the closing trading price for the currency. A trading strategy can be devised using the trend lines in a line charge.
Bar Charts
These charts depict specific trading periods. Bar charts represent price information better than line charts. In a bar chart, a bar represents a single day's trading and shows the open, high, low and closing price for the day. Each dashed line represents the day's opening and closing prices.
Prices can sometimes be represented visually using colors, with green or white used for periods of rising prices and red or black used for periods of declining prices.
Candlestick Charts
This type of chart is easier to read and more appealing visually. Candles are used for determining both the opening price and the highest price point for a currency, and their lower portions are used to determine the closing price and the lowest price point.
In down candles, price declines are shown with red or black shading, while in up candles, rising prices are shown with green or white shading. Candlestick charts show market direction and movement by the formations and shapes. Shooting stars or hanging men are two common formations.
Conclusion
That’s how you get started in forex trading. Before you get started, consider how much money you’re willing to invest in forex trading and find a forex broker you can trust. If you do those things, your chances of making money doing forex trading will improve significantly.
Traders use line charts to identify a currency's overall trend. Forex traders most frequently use line charts. The user specifies the time period for which they want to see the closing trading price for the currency. A trading strategy can be devised using the trend lines in a line charge.
Bar Charts
These charts depict specific trading periods. Bar charts represent price information better than line charts. In a bar chart, a bar represents a single day's trading and shows the open, high, low and closing price for the day. Each dashed line represents the day's opening and closing prices.
Prices can sometimes be represented visually using colors, with green or white used for periods of rising prices and red or black used for periods of declining prices.
Candlestick Charts
This type of chart is easier to read and more appealing visually. Candles are used for determining both the opening price and the highest price point for a currency, and their lower portions are used to determine the closing price and the lowest price point.
In down candles, price declines are shown with red or black shading, while in up candles, rising prices are shown with green or white shading. Candlestick charts show market direction and movement by the formations and shapes. Shooting stars or hanging men are two common formations.
Conclusion
That’s how you get started in forex trading. Before you get started, consider how much money you’re willing to invest in forex trading and find a forex broker you can trust. If you do those things, your chances of making money doing forex trading will improve significantly.
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About The Author: Kevin Davey is an award winning private futures, forex and commodities trader. He has been trading for over 25 years.Three consecutive years, Kevin achieved over 100% annual returns in a real time, real money, year long trading contest, finishing in first or second place each of those years.
Kevin is the author of 5 highly acclaimed books, including "Building Algorithmic Trading Systems: A Trader's Journey From Data Mining to Monte Carlo Simulation to Live Trading" (Wiley 2014). Kevin provides a wealth of trading information at his website: https://www.kjtradingsystems.com
Copyright, Kevin Davey and KJ Trading Systems. All Rights Reserved. Reprint of above article is permitted, as long as the About The Author information is included.
Kevin is the author of 5 highly acclaimed books, including "Building Algorithmic Trading Systems: A Trader's Journey From Data Mining to Monte Carlo Simulation to Live Trading" (Wiley 2014). Kevin provides a wealth of trading information at his website: https://www.kjtradingsystems.com
Copyright, Kevin Davey and KJ Trading Systems. All Rights Reserved. Reprint of above article is permitted, as long as the About The Author information is included.