Author: Eduardo Montero
Last Updated on February 24, 2023
What is forex trading?
Forex is the short form of foreign exchange and it is about trading currencies. Currency trading market is identified as the world’s largest market with a trunover of over GBP 2 trillion. As far now, there is no fixed exchange for currency trading like what we have for trading stocks. Currency trading market is rather considered as over-the-counter market.
Like stock trading markets, forex trading market is also completely electronic and all the trades can be executed using internet or phone. Before 10 years, the currency trading was carried out only by the financial institutions such as banks etc. But with the introduction of internet, and with the growing interest of the individual investors in the currency trading market, it has almost become a way to make money for everyone out there.
Following is the process how currency trading works.
1. In stock market, you pay the money and get the shares. When the price goes up, sell it and take the profit. But in currency trading, you get the profit through another currency. Then you have to trade the other to make profit in your currency, which means currency trading should be done in pairs. For example, a currency pair would look like GBP/USD (GB Pounds over US dollars). In this currency pair, the first currency GB pounds is called the base currency. The second currency US dollars is called the counter currency. This is a representation of how many units of counter currency is required to buy one unit of base currency.
2.Which means if you want to buy one US dollar, you have to pay sufficient amount of GB pounds. Once you see the markets going in favour of GB pounds you can buy it back using the US dollars you have and take the profit. This might look like a confusing subject but once you get involved directly you will find it very comfortable to understand.
3. Once you start analysing, you will find the currencies going up and down against each other. Once such recommended currency pair to trade is GBP/USD because of their stability. If you think GBP is doing better than USD, then you buy GBP using USD. Once you find GBP is going down, then you sell GBP and get your USD back. I do understand trading two currencies might be a bit difficult to understand. But with experience anyone can be a good currency trader in no time. Let me explain with an example..
4.In this example i am going to use GBP/USD pair. If you have a look at any forex trading platform, you might find the numbers as shown here 1.4322/1.4320. In this the first price is called bid price, which means if you want to buy GBP, you must pay 1.4322 USD. The second price is called the selling price, which means if you want to sell GBP, then you will get 1.4320 USD in return for 1 GBP.
5.The difference between the buying price and the selling price is called the spread. The spread in the currency is normally between 3 to 5 pips. This symbolises the strength of the currencies you are trading. If the spread is too high, its not worth trading as you have to wait long because of low volatility. If the respective price of GBP/USD moves from 1.4320 to 1.4322 it is called one pip. A pip is nothing but the last decimal value of a quotation. For example in above mention values, 1.4320 and 1.4322, the last digits 0 and 2 respectively are referred as pips. Most of the currencies use four decimal points with the exception for japanes yen where the decimal is quoted only upto 2 positions. for eg 132.44.
6.The term pip is an exclusive forex trading term and you must get used to it as the currency traders signify their profit with this term say “it moved 10pips and i made GBP 2000”. You will hardly find traders saying the full number.
7. Trading in forex is carried out in lots or even referred to as contracts. Standard size of the contract could be from GBP 100,000 depending upon the country you are trading from. In the recent day, lots small as GBP 10000 has been introduced in order to attract new currency traders. Currency trading is done with leverage, with some brokers offering upto 1%.
8.It means you can handle a lot worth GBP 100000 with just GBP 1000. You might need an amount of GBP 1500 to GBP 2500 depending upon the brokers and the leverage offerred.
9.Using mini currency trading accounts would be good for a beginners as the amount required for opening a new account is as low as GBP 250. So new traders must make use of this account to get intial idea about the currency trading.
Analysis of forex trading
Forex or currency trading is basically an easy form of trading but people don’t spend much time in studying the basics principles involved in currency trading. Whether you are experience or not, currency trading is very much like we buy and sell everyday but done online. If you have already traded stocks, then you have an added advantage as the platforms and transactions are similar.
1. So lets do some close analysis as how this forex trading really works. If you are trading stocks, you will look for the company’s long term future, its managment competence, the confidence of investors and their past record.
2. But when you are trading currencies, instead of looking at company, you are looking at a country, which means you are considering the long term stability of the country and its currency.
3.You must also decide whether you are going to be a long term forex trader or a short term forex trader. Long term currency traders carry out lots of technical analysis using the advanced analysis tools available. Short term currency traders tend to invest based on the short term movements of the currency value without doing much analysis.
4. But as the time goes on, long term currency traders get enough experience to plot mini trends, which is very useful to trade currencies in short time.
5. Economic indicators such as Inflation Rate, Unemployment Rate, Interest Rates, Gross National Product (GNP), Retail Sales, Consumer Price Index (CPI), Non-Farm Payroll, and the sales of Durable Goods are the main aspects which forex traders include in their fundamental analysis.
6. Even though fundamental analysis is carried out perfectly, currency traders must track the political and other factors involved in the country’s economy. For example, war, riots and natural disaster seriously damages a country’s economy. As i previously said, forex and stocks have close links. With the recent recession, we saw the collapse of two banks in united states crashed the stock market and eventually the country’s economy saw a sharp fall.
7. I do understand analysing a company is easy when compared to analysing a country. But there are some positives. Company’s can fail easily but the country’s don’t. Even though forex trading seems to be boring and complicated, with experience you will find you have found the golden egg.
Benefits of forex trading
The prominent advantages of trading currencies are:
1. Superior liquidity :
Liquidity is the superior factor which makes forex market the most lucrative form of trading compared to others. More than a trillion pounds is traded everyday through currency trading. Because the volume of trading is too high, it also becomes very difficult to manipulate the market unlike stock trading.
2. Market for 24 hours:
The factor which makes currency trading more attractive is that it can be 24 hours a day starting from 3.00 am at new zealand EST to 10.00pm san francisco EST. In stock trading, you normally start in the morning and ends in the evening. But in currency trading since it can be traded round the clock, investor can choose the time they want to trade currencies.
3. Trading with leverage :
The next advantage in trading currencies is trading with leverage. For instance there are currency trading brokers who offer a leverage of 400:1 which is just a requirement of 0.25% in margin. For example, if your currency trading broker is offering a leverage of 100:1, it means in order open a position of GBP 100000, you need only GBP 1000. And in currency trading, it is broker commission free and all you have to pay is for the spread (difference between the buying price and selling price). Another point is you are allowed to trade to lowest limit of 1 pip in some currency pairs.
4. Investment required is low:
The investment required for currency trading is very low and it depends upon the leverage provided by your forex trading broker. With maximum leverage offerred, you investment in currency trading could be as low as GBP 300.
5. Specialized trading :
Because of the superior liquidity of currency trading, most of the investment is concentrated in seven major currencies. This makes the investment pretty comfortable because the instrument which needs concentration is less and investors can be more vigilant of their investment.
6. All round the world trading :
Currency trading is a major advantage for those who spend most of their time in travelling. Since forex market is not controlled by any exchange, its neutral platform gives the edge of trading currencies from any part of the world with the same account. But it must also be noted that currency trading also requires a lot of experience and risk taking attitude as the volatility of the currency trading is too high.
Pros and cons forex trading
1.Forex trading might appear to be one of the best way to make quick money. But you must be aware that its not a quick money making strategy for everyone. The fact whether currency trading is an advantage or disadvantage depends on the way you approach it.
2. Let us look some of the advantages. While starting to use currency trading, you will learn to analyse different aspects in the business world. You will learn to analyze the technical aspects of currency trading such as charts, trading platform etc.
3. In currency trading, you will be given a demo account to trade with virtual money. This is one of the greatest advantages available in forex trading. This demo account gives you access to the latest and live charts, news and developments which you can use to trade currencies effectively. But you must also remember that you should not spend too much time in trading the demo account as you might not be able to follow the trend of currency trading market. You must also use this opportunity to learn the ups and downs of the market and the factors that influences forex market.
4. As currency trading is closely linked to a country’s internal and external affair, you will also learn to follow a country’s aspects very closely. For example if you are trading GBP / USD pair, you will invest when the currency of the united states dollar goes down and sell when it goes up. In order to know when the USD goes down, you must carefully analyze the political factors of united states. Factors like war, floods, riots always has good impact on the country’s currency value. So you will be able to pick the right time to invest in currency as you come across these factors.
5. Currency trading market cannot be manipulation like stock exchange because the currency values are pegged straight to a country and not to a company. So people who want to manipulate the currency value find it almost impossible.
6. No some of the disadvantages: Most of the investors enter the currency trading market just out of greed instead of treating it as an ethical business. This is the main reason why most of them end up as losers in currency trading. Most of the traders execute trade just by looking at the movement of the numbers and not looking at the factors that influence the movement. This means these investors fell prey to the high volatility of the forex market and loose their within hours.
7. Most of the people loose confidence in currency trading and it even affects their personal life. So it is always advisable to take advise of the people who had already traded currencies and you can get better about the trading aspects instead of just trading using the demo account.
Mistakes of forex trader
Systematic trading is the key in forex trading. Most of the currency traders loose their money just because they don’t have the exact system to trade instead carry out trading with the movement of numbers alone. Trading is full of profits and loss and currency trading is not an exception. You must keep yourselves open to any outcome from the currency trading.
2. Stick to the system:
As you start getting experienced in currency trading, you will have your own system. Next mistake done by the currency traders is they don’t stick to the system what they had developed in the past. Most of the investors get carried away just by rumours and unconfirmed news, which turns out to be a huge loss. So investors must develop confidence in their own system and stand strong.
3.Keep yourself educated :
No matter how much you get better or how strong your systems are, there are always new things to learn. Everyday there are new technologies and new tools to be used and learnt. Most forex traders are reluctant to learn these new techniques and stick to their old. But it doesn’t mean you have to leave your old strategy on the whole. But still you must consider how these new tools in currecy trading can be integrated into your old strategy.
4.Managing you money:
Any investor who is thinking about investing in forex must learn to maintain account and manage the investment. Because its easy to loose track of investments. For instance it should be evident since the currencies are traded in pairs, its very easy to forget the exact amount what you use to buy and sell the currencies. Investors must understand that this step is more important than looking at the charts as you might loose money where you can easily gain.
If you know to control yourselves, you can be the best forex trader. Most currency traders don’t take profit and loss equally. People must understand that it always happens in currency trading. Successful traders use the loss as an opportunity to analyze what went wrong and how it could be avoided next time. So this data is use to plan the investment next time. This strategy is always missed by the new traders as they loose all the money within a short span. This can be avoided by minimizing your investment and splitting into parts.
Risks in forex trading
Most of the forex traders don’t understand the real risks behind the currency trading and it becomes one of the main reason why most of the currency traders get out at the early stages without even understanding what the forex market is all about and how it really works. The first thing every investor must learn is to take profit and loss with positive approach and not get disappointed.
The main risk taken by the forex traders is
1. By the way the forex prices moves, it is crystal clear that it is the world’s most volatile market. The traders who trade stocks, don’t really understand the pace in which the forex market lose. So they simply give away their investment only by the sheer pace of the currency market. It is the greatest risk.
2. Even though currencies cannot be manipulated, still there exist a risk to losing out the moment of trading when the time is right. Because currencies are pegged to their respective countries and every news emerging from the country has a considerable influence in the currency value. So investors must be ready to seize the opportunity else they risk losing out to their competitors in currency trading.
3. Most of the traders don’t understand that you buy currency using another currency. So when you find the currency you bought is losing its value, you must be ready to find another currency so that you can buy the other currency by selling the currency what you hold. This quick strategy must be practised by all the forex traders because most of the currency traders lose out this main factor.
4. Currency traders must learn to use new options and tools available in the currency trading market. Stop loss is the best technique available for now, with which you can reduce the risk of loosing money due to unstable forex market.
5. If you are new to currency trading, you will tend to listen to more people to get some practical idea about the forex market. Some traders don’t realize that they are being influenced by false traders who are there to mamipulate new investors. So this is risk which every trader has to overcome and improve themselves so that you trade less based on others advise.
Interesting forex trading facts
As discussed in the previous articles, currency trading better known as forex trading has lots of benefits and advantages. This trading industry grew from GBP 40 billion in the 1980’s to GBP 1 trillion today. Listed are some of the interesting facts of forex trading.
Forex at first was traded only by the large financial institutions such as banks etc. but today it is available for individual traders due to the advent of internet and exposure to the potential currency investors. You can trade with very high leverage unlike other market, something like a lot of GBP 100000 with just GBP 1000, which is 100:1 leverage.
No other market in the trading industry offers this high leverage except forex. Forex is also the most volatile market of all so within clicks and seconds you might gain or lose money. Stop loss is also available in forex trading. The main purpose of stop loss is you don’t have to wait before your pc. You can simply set the price and the software does the job for you.
With currency trading, you can trade 24 hours for 5 days. With the market starting from newzealand and ending at sanfrancisco, currency trading continues as the investors are active all the time.
One great advantage of the currency trading is there are no commission. All you have to pay is a small transaction fee. But when you compare with the profit can be made with the currency, this small transaction fee would be nothing. But you must be aware of the quick changes in the market because of the high volatility.
As i said, even a small change in the market could end up disastrous, either in positive direction or in negative. So you must be vigilant all the time. There are lots of onlin currency trading platform who offer demo account which can be used to trade currencies with virtual money. But you must remember that without losing money you will never recognize the real strategy behind the forex trading.
Forex trading scam and fraud
Many wonder if there are any scams and frauds in forex trading. The bad news is there are a lot. Many have lost their hard earned money believing this fake forex brokers. These scam brokers are in every trading industry and forex trading is not an exception. These scammers build the most good looking and high profile website to attract the potential investors. Its a pity people always get attract to good looking website as they find it very believable. First step to find out a scammer is to identify the i.p address of the website. You will find that most of the scammer operate from a low profile and poor countries.
There are honest brokers everywhere but its not worth in believing in someone just by the website and not by reputation.
Forex trading companies, brokers who are located in the USA, UK, France, Germany, Japan are generally trustworthy because of the presence of strict laws and protection offerred to the investors. But it doesn’t mean that everyone is honest. Whenever you enter a forex or stock broker website, you must look for a license number as the countries mentioned above always requires the brokers to be registered. If they have one, the next step to verify with investment watchdogs in your country. Generally these watchdogs have a list of blacklisted websites and brokers who are already accussed of scam and fraud.
You must also note that there are fake watchdogs as well which is set up to help these fraudsters. The best way is to look for reviews and attend the forums where you will find people who have already invested and look out for their experience with the brokers. You will definitely get the good one. Following are some of the point to identify the fraudsters.
1. Don’t believe any one who say they can make an unbelievable amount of money in a short time as a profit. These scammers mainly target the people who have drawn lots of money mainly pensioners because its the general intention of the pensioners to multiply their money with low risk. These scammers also have attractive offers to blind the pensioners. So one must realise that they should not lose their hard earned money just like that.
2. Everyone must understand that any kind of trading is not easy. All the trading on the planet involves some amount of risk in it. Whether it is forex or stocks or mutual funds, everything is linked to the business outside the market and loss in the business will reflect wherever you have invested. So don’t believe anyone who says they can make profit even when the market goes down. But there are some very reputed brokers who offer these kind of schemes, but the point there is they will take the extra profit they make and cancel it when they run your investments in loss.
3. There are other advertisements made such as make GBP 10000 a week with just GBP 5000 as the intial investment. There is a general human tendency you must think about. No true businessman will share his secret and help others to make money. They always keep it to themselves. So never believe these too good to believe stuff.
4. Beware of those companies who claim they have access to interbank market. The name interbank market might sound odd or attractive. But interbank market is not a market or a bank, its a building where the banks and big companies make their transactions. So they don’t get carried away by these trading scams.
5. There are also scammers who want you to invest a big amount and promise that they can double or triple within a year or two. Well there are no schemes like that. Forex and stocks are high risk investments and nobody can guarantee anything. If so, everyone would be a millionaire by today.
6. The most important thing is if you find something wrong or misleading, never hesitate to make a complaint or atleast alert other through a forum or a blog posting.
Learn to analyze forex trading chart
Charts are pictorial representation of share prices and currency prices with their rise, fall and the time frame. If you see a typical chart, most of charts have time in the horizontal axis and price variation in the vertical axis. Then the variation is plotted in the form of line, candlestic or bars. These types are explained as follows.
1. Line charts:
This is the most easiest type of charts to analyse as it shows the rise and fall of price with time frame. But the problem with this type chart is it doesn’t provide other details such as market behaviour or whether the market was bearish or bullish. Once you get experience in stock and forex market, you will find that line chart is not as useful as other type of charts such as bar chart or candlestick chart.
2. Bar chart:
These kind of charts have bars instead of lines. Compared to line chart, bar charts gives more details about the market situation. Every bar in the bar chart represents the high and low price at that hour, and its easy to determine whether the market was bullish or bearish.
3. Candlestick charts
It is the most popular charts among all the charts. They are mainly used in forex trading. Candlestick charts are almost same as the line and bar charts in concept, but the details the candlestick charts provide are more precise and detailed. Candlestick charts comprises of green candlestick symbolises the rise in price and the red candlestick indicates the fall in price. The shape of the candlesticks play and its colour plays an important role in the analysis of candlestick charts. Depending upon the rise and fall of the prices and according to the behaviour of the investors, the candlesticks are formed and market analysis are made as the candlesticks are formed.
4. Candlestick types:
If you start learning about candlestick charts, you will find lots of strange names like doji, hammer etc. Initially it might be a bit confusing, but with time you will find it very easy to analyze the charts and make the most out of it.
Stock trading vs forex trading
Stocks are issued by the companies to raise money to run the company. Each and every stock a person own represents his part in the company. It is one of the most popular form of investment as it is easy to understand and implement compared to other investment. Then how does it differ from the forex market.
1. Stock or share prices fluctuates depending upon the company fortune (ie) management, profit, competence in the market etc. so when the price rises, its all about selling the shares and taking the profit or wait for the next opportunity to get a better deal.
2. In stocks, there is a concept called dividend. Dividend is a small percentage of profit paid by the company. Only a few companies offer dividend. The advantage of dividend is that you will be paid the dividend even if the market fluctuates.
3. There are few companies which trade in all the markets like london stock exchange, new york stock exchange etc. Stock market can be used as a long term and short term strategic trading. Long term traders are those who invest in a reliable company and take part in its ups and downs. short term traders are mostly totally dependent on market for their living and they trade on daily fluctuations of a share.
4. There are few companies which holds the status of Blue chip stocks. These are the stock which have the long term trading value which in short means the companies which had earned reputation. With the advent of internet, now stock market offers daytrading which involves righ risk trading.
5 . Day traders use the fluctuations in the share price to trade. As i explained before, this type of trade involves high risk and brokers charge high commission as the option of leverage is available. One can expect upto 50% leverage which means you can trade with just half of the money required and the rest will be paid by the broker.
6. Forex might seem very similar to stock trading but the concept behind forex is a little bit different. Unlike stock trading, forex involves in trading currencies (ie) selling US dollar and buying GB pounds or vice versa or other currencies.
7. Like we have stock brokers in share market, there are no brokers in forex market. So you can execute as many trades as you want. Compared to stock market which only trades about GBP 100 billion, forex trades are about GBP 1 trillion. So forex trading is considered to be the most volatile in the world.
8. The fluidity of the forex market is justified by the currency trading happening all the time in the world. Some one is buying and selling at some moment at some part of the world all the time and all the currency pairs as well.
9. The stock market is not as fluid as forex because companies trade stock only in a certain exchange at a particular time and their amount is limited.
10. Stock exchanges are open only for a certain time but forex is open all the time for 5 days as there is no fixed market for currency trading. And the greatest advantage of the forex is it cannot be manipulated that easily as it is done in stock market as the forex is pegged to a country unlike stock which is pegged to a company.
Forex trading vs future trading
Futures is the worldwide market for all sorts of commodities including manufactured goods, agricultural products, and financial instruments such as currencies and treasury bonds. A futures contract states what price will be paid for a product at a specified delivery date. When the futures market is played by speculators, the actual goods are not important and there is no expectation of delivery. Rather, it is the futures contract itself that is traded as the value of that contract changes daily according the market value of the commodity.
a. In every futures contract there is a buyer and a seller. The seller takes the short position and the buyer takes the long position. The futures contract specifies a buying price, a quantity and a delivery date.
b. For example: A farmer agrees to deliver 1000 bushels of wheat to a baker at a price of £5.00 a bushel. If the daily price of wheat futures falls to GBP 4.00 a bushel, the farmer’s account is credited with GBP 1000 (5.00 – 4.00 X 1000 bushels) and the baker’s account is debited by the same amount.
c. Futures accounts are settled every day. At the end of the contract period, the contract is settled. If the price of wheat futures is still at GBP 4.00 the farmer will have made GBP 1000 on the futures contract and the baker will have lost the same amount. However, the baker now buys wheat on the open market at GBP 4.00 a bushel – GBP 1000 less than the original contract, so the amount he lost on the futures contract is made up by the cheaper cost of wheat.
d. Similarly, the farmer must sell his wheat on the open market for GBP 4.00 a bushel, less than what he anticipated when entering the futures contract, but the profit generated by the futures contract makes up the difference. The baker, however, is still in effect buying the wheat at GBP 5.00 a bushel, and if he hadn’t entered into a futures contract he would have been able to buy wheat at GBP 4.00 a bushel.
e. He protected himself against rising prices but he loses if the market price drops. Speculators hope to profit by the daily fluctuations in the futures market by buying long (from the buyer) if they expect prices to rise or by buying short (from the seller) if they expect prices to fall.
1. Forex The foreign exchange market (forex) has several advantages over the futures market. Forex is a more liquid market – as the largest financial market in the world it dwarfs the futures market in daily exchanges. This means that stop orders can be executed more easily and with less slippage in the forex. The forex is open 24 hours a day, 5 days a week.
2. Most futures exchanges are open 7 hours a day. This makes forex more liquid and allows forex traders to take advantage of trading opportunities as they arise rather than waiting for the market to open. Forex transactions are commission-free. Brokers earn money by setting a spread – the difference between what a currency can be bought at and what it can be sold at. In contrast, traders must pay a commission or brokerage fee for each futures transaction they enter into.
3. Because of the high volume of trading forex transactions are almost instantly executed. This minimizes slippage and increases price certainty. Brokers in the futures market often quote prices reflecting the last trade – not necessarily the price of your transaction. The forex is less risky than the futures market because of built-in safeguards in the trading system. Debits in futures are always a possiblility because of market gap and slippage
Want to know the best prop firms to trade futures? Here is our comparison: Futures funding prop firms.
Forex trading tips and tricks
1. Understand volatility and have fun in taking risk:
Forex trading or any other trading is all about volatility. If there is no ups and downs in the price, forex trading will cease to exist. So anyone who wants to invest in forex must realise that its all about risk. Someone who is scared to take risk can never be a winner. This is the foremost reason why all the traders give up forex trading as they are too scared. Remember, if you are gaining there is someone losing and vice versa. This is the way forex trading works and investors must understand this.
2. Trade Infrequently
Most of the traders think that trading frequently makes lots of profits. But it doesn’t work like that. Big gains are made only at a particular time of the year and not every second. So spend some time in analyzing the currency and wait for the right time. While analyzing you will understand and you will know the right time to invest. When that time arrives, invest in the currency you think you can make that big gain. This is one important strategy which most of the forex traders miss out.
3. Avoid diversification.
Diversifying your investment is one of the trusted strategy. But you must remember that you are trading currency and not stocks. In stock trading, diversifying your investment will give you an edge but it the opposite in the forex trading.
4. Money Management
So long we discussed something general, but there are other ways available to reduce risk and increase your profit potential. Some of the strategies are to : 1. Buy options at or in the money, to give you power to stay in the market – and to prevent yourself from being stopped out from the market. Most of the forex traders lose out not by making a wrong move in the wrong direction but by getting stopped out due to volatility. 2. Most of the forex trading start trailing their stops and then they automatically get stopped out. But the price moves on and ends up in a spectacular gains. Don’t get inside this market trap. Leave your stop in the original position until you find the market is moving in the way you think. Once the forex price has moved, you can move up. Remember you are trying to big gain in short time. So enjoy the risk you are taking.
5. Advantage of Compound growth
In forex trading: If you are looking for long or short term strategy, understanding the compound growth in forex trading is very important. For example, If you are having a target of 50% profit in your currency trading, you can make an intial investment upto an amount of GBP 20000 and can make a million pound in 10 years.