The forex (short for foreign exchange) market is the world’s most traded financial market with a daily global trading volume of (US dollar) $6.6 trillion and a constant fluctuation in currencies means the forex market offers great opportunities to profit from these price movements.
Here are 4 steps on how to trade forex:
Step 1: Learn how the forex market works
The basic concept
Forex trading involves simultaneously buying and selling two currencies. For example, if you are buying the GBP/USD, it means you’re buying GBP by selling USD and if you’re selling the pair, you’re buying USD by selling GBP.
In the foreign exchange market, forex pairs are divided into three main groups – majors, minors, and exotics:
The main difference between the groups is their liquidity, with the majors being the most liquid and the exotics the least.
How forex traders make profits
The objective of forex trading is to buy a currency cheap and sell it later at a higher price. Forex Traders also use a technique called ‘short-selling’ to profit when prices fall, so there are opportunities to make profits whether the market is rising or falling.
Note: A pip (point in percentage) is the second smallest amount by which a currency quote can change. It’s usually $0.0001 for USD-related currency pairs but for other currencies, like JPY it’s denoted as $0.001.
How the currency market is analysed
Without market analysis, forex trading would resemble gambling and so forex traders use technical and fundamental analysis to study the market.
Technical analysis involves analysing price charts based on the assumption that history tends to repeat itself and price patterns that have worked in the past will likely work in the future.
Fundamental analysis involves measuring the fair value of a country’s currency by looking at the country’s unemployment and inflation rates, interest rates, economic growth, and other macroeconomic data that can impact the supply and demand of the currency.
Step 2: Choose a broker and open an account
Choosing the right broker to trade forex online will allow you to devote time to analysing the market and developing your forex trading strategy instead of worrying about getting scammed.
Search for a broker who:
- Is regulated so that your money is better protected
- Has tight spreads and low commissions.
- Has good customer service, especially after you open an account. You can find out by evaluating other experienced traders’ reviews or through your experience with a demo account.
- Has a good trading platform. For example, MetaTrader 4 (MT4) is one of the best forex trading platforms in the world.
Step 3: Build a trading plan
Discipline is one of the common traits all successful traders have and a trading plan will help you maintain this discipline. Your trading plan creation process should include:
- Setting trading goals so that you have realistic expectations of returns.
- Assessing your capital at hand and determining how much you will start trading with.
- Deciding how you will analyse the markets.
- Determining the currency pairs you will trade.
- Determining your risk profile. Are you a conservative, moderate, or aggressive trader? Creating an overall forex trading strategy.
Step 4: Start trading
When you understand how the forex market works and you have a robust trading plan and strategy, you can start trading.
- Decide if you’re going to buy or sell (take a short position or long position)
- Once you’ve determined the currency pair you want to trade, you need to know the current price the pair is trading at
- All forex is quoted in terms of one currency against another, with each currency pair having first a base currency and second a quote currency.
Example: Buying a pair
Let’s say that the signals in the market are indicating that the EUR will go up against USD. You open one mini lot (10,000 units of EUR/USD), buying with the EUR and then you wait for the exchange rate to increase.
If the EUR/USD is trading at 1.1280, you will have just bought €10,000 which is worth US$11,280. If your prediction is correct and you close the position at 1.1360, you will earn US$80. Should the position move in the opposite direction you could lose $80.
Note: Every trade has a cost known as the spread. The spread is the difference between the buy price (ask price) and sell price (bid price) and is counted in pips. In other words, it is the cost of trading. For example, if the EUR/USD buy price is 1.1280 and the sell price is 1.1275, the spread is 5 pips.
The spread charged for a trade is the spread multiplied by the size of the position. For instance, using the example above and the 5 pips spread, your trade would cost $5 (each pip in a mini lot is worth $1). Other costs that may affect your overall profit or loss include commission charges or overnight swap fees or credits.
- Add your orders
An order is an instruction to automatically trade at a point in the future when prices reach a specific level predetermined by you. A stop-loss order closes out a trade at a price worse than the current market level to minimise losses and a take-profit order closes out a trade at a price that’s better than the current market level to help lock in profits once a price target is reached.
Using stop-losses and take-profit orders is not compulsory but given the volatility of the forex market, understanding and using risk management tools such as these two orders is important.
- Monitor your trade
After entering your trade and adding orders, you can track market prices in real-time and attach orders to open positions (like the take-profit order in the previous example).
Opening and closing trades is relatively straightforward, however, you need to avoid common pitfalls to help ensure you that you make sizable profits and minimise losses.
When approached correctly, forex trading works and can be a profitable and rewarding venture. Nonetheless, you need to be willing to put in the work. Learning about forex trading is not very hard but finding winning strategies takes a lot of practice, discipline, and patience. Avoiding common trading mistakes and focusing on learning and refining your strategy continuously will help you become a successful trader.