The daily volume of money traded on the forex market is more than $5 trillion. This dwarfs the $780 billion that flows through the New York Stock Exchange every day. What’s even more surprising is that about 90% of all forex trading is speculative. In other words, there’s quite a bit of money to be made on the forex market (FX), and there are a lot of ways to do so.
Still, how to start forex trading? How do you choose a broker? What do some of the basic forex market terms mean?
To start trading, you need the answers to these vital questions. Let’s see if we can provide some of them!
What Is Forex?
The term forex is an abbreviation of foreign exchange. It’s a process of converting one currency into another. In its most basic sense, the concept spawned out of necessity centuries ago. But forex, as we understand it today, is a relatively modern invention.
In the past, the only participants in the forex market were central banks, commercial banks, large investment funds, and international financial institutions. Nowadays, through the use of the internet and online payment options like PayPal, forex trading is more available to retail traders than ever before.
What is a forex market?
A forex trading market is a global marketplace for exchanging national currencies in an effort to turn a profit.
An investor can profit from the difference between two interest rates in two different economies by buying the currency with the higher interest rate and shorting the currency with the lower interest rate.
You see, currencies sometimes gain or lose value independently of one another. Their relationships and price comparisons are known as exchange rates. This means that you can spend X amount of USD to buy a Y amount of EUR at the current price. In about a week’s time, the value of USD may drop, and the value of EUR may rise, which means that if you were to sell this EUR amount back, you would achieve a profit in USD.
This concept, also known as forex trading, is a way to make money on the foreign exchange.
How does the foreign exchange market work?
The basic terminology is the first thing you need to understand to successfully trade on the foreign exchange market.
As mentioned above, the exchange rate is the value of one currency for the purpose of conversion to another. These rates can be:
- Fixed exchange rate: This is a situation in which the monetary authority fixes one currency’s value against the value of another currency. It can also be measured against another asset (most commonly gold or other precious metals).
- Floating exchange rate: This is a monetary system in which the currency’s value and exchange rate are allowed to fluctuate relative to market events and the law of supply and demand.
Bear in mind that being familiar with the basic economic principle which allows people to make money on the forex market doesn’t mean you can reliably predict future market movements. There’s always a factor of risk involved.
Types of forex market
Understanding forex trading also includes the ability to differentiate the types of forex market. There are:
- Spot forex market: This is the physical exchange of currency pairs.
- Forward forex market: A contract to agree or buy currency at a specified price.
- Futures forex market: This is a contract to buy a set amount of currency at a fixed price and a set date in the future.
For all those confused about the subtle differences between the forward and futures forex market, the difference is that the futures contract is legally binding.
How Does Forex Trading Work?
The concept of forex trading implies that you are simultaneously selling and buying currency. These transactions are usually handled via a forex broker. Today, with the advantages of online trade, derivatives like CFD (contract for differences) are just as popular.
Keep in mind that derivatives may maximize your profits (seeing as how they’re leveraged products), but they can also increase your losses. This particular concept of trading currency implies that you assume a position. This is your speculation on whether the market will rise or fall. You get to reap profits based on the accuracy of your prediction.
Many platforms like Forex.com, for example, offer both forex and CFD trading.
How to trade foreign currency?
The value of different currencies moves in different directions and at different paces. Today, due to the hyperconnectivity of the world through the internet, these changes are quite rapid, and they can be followed in real-time.
While it is possible for you to trade in foreign currency, this currency’s direction depends on local and global socio-economic and political occurrences. Every time you trade a pair, you’re betting on one against the other. For this reason, you must know their correlation and develop an in-depth understanding of the local fiscal climate.
From a purely technical standpoint, this process starts with picking a currency pair. Speaking of which…
How to trade currency pairs?
There are more than 150 currency pairs in the forex industry, but brokers typically offer up to 130, with around 70 of them enjoying a high popularity.
Still, it is impossible for a regular trader to follow them all. At best, you can keep track of your local currency (its historical performance), as well as some of the most prominent currency pairs, colloquially referred to as major pairs. These are:
Keep in mind, however, that some minor pairs (like EUR/GBP, EUR/CHF, or GBP/JPY) can be just as lucrative. One more thing that you could have noticed is that these minor pairs consist of the same currencies as some of the above-listed major pairs.
This may confuse those wondering how to start forex trading, but the answer is quite simple actually. The major vs. minor forex pairs have more to do with the total volume of the trades than the currencies involved. Still, to a retail investor, even the statistics regarding minor pair currency trading volumes will seem quite impressive.
How to day trade forex?
Generally speaking, the forex market operates between individuals (almost always represented by brokers), between brokers and banks, and between banks. However, retail investors can take part in this market, as well.
To start forex day trading, you need to pick the right brokerage. Fortunately, there are a lot of great day trading platforms out there for you to choose from. The key thing you need to do is compare them based on their features. These are the number of supported currencies, costs, commissions, and research materials. Seeing as how we’re talking about high-end online trade, technical support and digital tools available on the platform is also a high priority.
A forex trader who is constantly on the move should also look for mobile apps. The thing is that while some platforms have multiple apps, others merely have a browser version for mobile users. While this makes mobile trading technically possible, it’s not nearly as convenient or user-friendly as a fully-optimized application.
Also, broker-assisted trades are not available on every platform, at least not free of charge. On some, this service will be significantly more expensive than those offered by their competitors.
How to Start Forex Trading?
Before you can start trading on the forex market, it’s pivotal that you educate yourself. Foreign currency trading is not as simple as it may seem, and there’s more than just knowing the exchange rates. And once you know the forex trading basics, you should build up expertise.
We’ll go through the initial steps of this journey.
Choose a broker
The first thing you need to do is make a priority list for choosing a proper broker. The three most important factors here are:
- Regulatory compliance
- Currency pairs offered
- Account features
Other than this, you’re also looking at things like customer service, the technical aspect of the platform, etc. The reason why these aren’t as high of a priority when choosing a forex trading app is that you really can’t check them before you actually start using them. The above-listed three priorities, on the other hand, need to be disclosed in advance.
Some platforms allow you to open a practice (demo) forex account. This enables you to gain some experience while trading in a simulation of a live trade environment and check out all of the platform’s features without committing any funds.
As far as forex trading for beginners is concerned, this is definitely the feature you’re looking for. So, when picking a platform, always check if they offer a demo account.
Know your limits
Like with any other kind of investing, currency trading requires you to show some level of restraint. The simplest way to do so is to limit yourself from the very start. You see, you need to set a minimum capital that you will use for currency trading and only stick to these funds. Never invest more than you can afford to lose.
Understanding forex trading is about more than just knowing how the technical aspect of currency trading works. It is an investment like any other, and, as such, it comes with its own set of risks and rewards. Knowing them in advance will minimize the chance of having a negative currency trading experience.
Forex Trading Strategy Types
There are quite a few forex trading strategies that you can adopt once you develop a better understanding of forex exchange.
Price action trading
This is a strategy that involves an elaborate study of the recent and actual currency prices. Decisions are based on the value movements rather than technical indicators.
Range trading is an active investing strategy that identifies a range of overbought and oversold currency (also known as areas of support and resistance) at which the investor buys and sells at over a short period.
Every now and then, the market will get a directional momentum. Those who manage to exploit it are trend trading. Keep in mind, nonetheless, that these oscillations go both ways.
This is the most long-term of all trading strategies. Position trading implies looking at the broader picture instead of minor market fluctuations.
Once you learn forex trading, you will be tempted to try out a bit more intensive trading aspect, the so-called day trading. This is a scenario in which all your positions are closed before the market closes for the day. In other words, all your financial instruments are traded within the same day (hence the name).
To successfully engage in FX trade, you need the right broker, enough starting capital (although minimum capital is not specified), and an in-depth understanding of the currency exchange market and the pairs you trade. Once you have all three, your odds of success will increase drastically.
Another thing you can do is try to practice via a demo account and research some trading strategies. This will give you some initial experience in the field, as well as some consistency in your trading patterns.
In the end, most importantly, don’t forget to only invest as much as you can afford to lose.
Technically, it is possible to start trading forex with a budget of as little s $50. However, the majority of brokers require a $100 to $500 initial investment, and many also have a forex trading minimum account deposit. However, it’s always possible to find a no minimum deposit alternative for those who find this to be a huge obstacle. Also, through CDFs, it is possible to trade on leverage, which means that your gains can be disproportionately large when compared to your initial investment.
Once you pick a reliable broker, opening a forex trading account should be a matter of minutes. After submitting some basic personal information, you’ll be asked to complete the KYC process in order to make the account functional. Then, all you have to do is deposit a certain margin and start trading.
The minimum age for trading forex depends on the trader’s home country. In other words, it usually ranges between 18 and 21. Still, this is a significant discrepancy, so before you ask how to start forex trading, it might be a good idea to check if you’re legally allowed to do so.