Forex Trading may seem like a complex topic to learn, especially for beginners, but that doesn’t have to be always the case. This step-to-step guide contains everything you need to know about the forex market, including how it works.
Many perceive forex trading as the easiest money-making opportunity but in the real sense, it’s much more complicated, yet highly engaging. Especially because the market is the largest, and most volatile and liquid in the world.
And though it’s different from trading in stocks or other securities, with its high liquidity, 24/7 schedule, and accessibility, foreign exchange trading has proven to be a successful career for many people, especially those with financial backgrounds.
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By the end of this article, you’ll understand:
Let’s dive into the article right away, shall we?
What is Forex Trading?
Forex trading is a process through which traders speculate the currency prices to potentially make a profit. And since currencies are traded in pairs, by exchanging one currency for another, traders predict whether one currency will rise or fall in value against the other.
Simply put, forex trading is the buying and selling of foreign currencies for profit. Though it’s more than ‘buying curencies when prices are low and selling when they are high.’
You have to understand how the market works before venturing in, else, you’ll be risking your hard-earned money.
And despite being highly volatile, the market plays significant roles like:
- Enabling the currency conversion
- Offering tools to manage forest exchange risks
- Allowing traders to make a profit by speculating the market
- Boosting the international trade and travel
And now, let’s learn what the forex trading market is:
What is Forex Market?
A forex market (also known as foreign exchange or FX market) is a global marketplace where traders exchange (buy and sell) national currencies. Simply put, it’s where people trade currencies.
This market is by far the largest and most liquid financial market in the world, with an estimated average global daily turnover of more than US$6.5 trillion — which has risen from $5 trillion just a few years ago.
And one unique feature about it is that there is no physical or central location, as all the trading is done electronically through computer networks.
The trading started way back in the 1970s when the United States allowed its currency to float freely in the forex market. However, forex trading has been in existence for centuries since the emergence of international trade.
For instance, the FX market enables individuals and firms to exchange currencies while importing and exporting goods and services.
How Forex Market Works
Think of it this way: if you’re in Kenya, but want to import laptops from the US, you have to convert (sell) your local currency (KES) to US currency (USD) of equivalent value, to pay the American seller.
And if you were the one exporting the laptops from Kenya to the US, you’ll be paid in USD, which you’ll then convert to local currency (KES) to use locally. You can exchange the currencies through intermediaries like commercial banks or brokers.
That’s generally how the forex market facilitates international trade, got it?
Now, as you may have noticed, you have to trade a currency for another (currency pair). That’s how trading for profit comes in – you predict whether a currency’s value will fall or rise compared to another, and then make the buy, sell or hold decision.
For instance, at the time of writing this article, 1 USD is equivalent to 116.50 KES. Thus, the value of the KES/USD pair is 0.0086 (1/116.50) – buying 1 KES will cost you USD 0.0086.
Assuming the value of KES/USD will reduce to 0.0083 (KES 120/USD) soon, you can sell the KES to avoid making a loss when the value falls.
And in such a scenario, the USD becomes expensive for importers (spend more KES to buy 1 USD), while exporters receive more KES for 1 USD.
Similarly, if you predict that the value of KES/USD will increase to 0.0091 (KES 110/USD), you can buy more KES at USD 0.0086/KES and sell when prices go up.
Meaning, that if you can predict the currency prices, which are majorly affected by multiple factors like inflation, economic and political stability, and balance of trade, you can buy and sell the currencies for profit.
That’s what the forex market is all about – making market speculations.
How to Start Trading Forex
The process of trading in forex is similar to that of shares – learn how the stock market works.
And to get started with it right away, follow these steps:
1. Learn how Forex Trading Works
As for any form of investment, don’t jump into forex trading before you understand how it works.
For instance, comprehend basic terms like leverage ratio and currency pair, what affects the forex market, how to minimize risks, what types of currencies to buy, most reliable brokers, and many more.
Lucky for you, there are lots of resources on how to get started. And I want you to be careful with forex trading ‘experts’ out there, a good number are scammers.
The market is highly volatile, and you have to train yourself how to gather reliable data, analyze it and use it while making transactions, rather than letting emotions control your trading.
2. Create an Account with a Broker
Again, just like stock trading, you’ll have to find a reliable forex broker and create a trading account with them, to get started.
And the good thing with this investment is that the brokers do not charge any commission. They make money through spreads (or pips) between the buying price and selling price.
Based on the lot size you chose, there are four main types of forex accounts:
- Nano forex account – for trading curencies worth up to $100 in one lot.
- Micro forex account – for trading currencies worth up to $1,000 in one lot.
- Mini forex account – for trading currencies worth up to $10,000 in one lot.
- Standard accounts – for trading currencies worth up to $100,000 in one lot.
So, if you are a beginner trader, a micro or nano account will help you master the art before you can consider increasing your trading capital. Just don’t get greedy, and upgrade your account only when you have grasped how exactly the trading works.
For complete beginners, you can open a demo account and trade with virtual money to sharpen your knowledge of how the market works, and how to use an online broker.
3. Have a Trading Strategy
Having opened a trading account, you need to define your trading strategy, based on your expertise and finances. Four of the most common ones include day trading, forex scalping, swing trading, and position trading.
The trading strategies also have several techniques like time frame, entry or exit methods, and forex signals used. You have to master these techniques, one by one.
A good strategy should consider the amount you’re willing to invest in trading, as well as the amount of risk you’re willing to take. They say, the higher the risks, the greater the returns. But don’t ignore the possibility of a loss when taking risks.
Don’t get me wrong, please; I don’t mean you shouldn’t risk, just take some precautions and avoid risking what you can’t afford to lose should your speculations go wrong. I want you to learn different forex trading strategies and techniques, and then select the most appropriate one for you.
4. Balance your Emotions
Trading experts reveal that when individuals experience stress or excitement, their emotions influence their trading results significantly.
So, to maximize your returns, take control of your well-being and understand how inevitable emotions are in forex trading.
Similarly, according to trading psychology, if you remain rational, you have better chances of getting larger payouts, or at least, not losing much more funds, than when you’re driven by fears or greed.
That’s why you should base your trading positions on information, rather than emotions.
All you have is to follow these four steps and start trading as soon as you can. But before I confuse you further with unfamiliar terms, let’s understand the forex language:
Mastering Forex Trading Terminologies
If you are a complete beginner, forex terms may confuse you. So, let me define the most common ones for you:
A currency pair is a quotation of two currencies, with the value of one currency being quoted against the other. An example of currency pair is: USD/GBP.
Where the first listed currency of the pair (USD) is referred to as the base currency and the second currency (GBP) is the quote currency.
So, if USD/GBP = 0.8007, it means 1 USD is equivalent to 0.0008 GBP.
But if GBP/USD = 1.2489, it means 1 GBP is equivalnt to 1.289 USD.
As earlier mentioned, you have to trade one currency for the other in forex. Remember, you’re estimating whether the value of USD will rise or decline against the USD, and vise versa.
Ask, Bid, & Spread
Ask is the minimum price that the forex trader is willing to sell (to you) a currency pair for.
Bid, on the other hand, is the minimum price that a broker is willing to buy (from you) the currency pair at.
Spread is a small cost, the difference between the buy (bid) and sell (ask) price of every currency pair trade.
Let’s get practical, here’s an example:
In this case, the ask price for EUR/USD is 1.05614 and the bid price is 1.05654. Therefore, the spread, in this case, is 0.0004.
A pip means a ‘percentage in point’ or ‘price interest point.’ It is the minimum price move, equal to four decimal points, made in currency markets. And a single pip is 0.0001, which means the spread above is equivalent to 4 pips.
And the value of 1 pip varies depending on the lot size:
- If you have a nano lot size of $100, one pip equals $0.01 ($100*0.0001)
- For a micro lot size of $1,000, one pip equals $0.1 ($1,000 * 0.0001)
- For a mini lot size of $10,000, one pip equals $1 ($10,000 * 0.0001)
- And for a standard lot size of $100,000, one pip equals $10 ($100,000 * 0.0001)
In forex, currencies are traded in standard sizes known as lots. The four most used lot sizes include standard (100,000 units), mini (10,000 units), macro (1,000 units), and nano (100 units of currency).
However, not all brokers offer the lot size of 100 units of currency, or $100.
Please note that the higher the lot size, the higher the opportunity to make huge profits (or losses).
Bear & Bull Markets
Bear Market: a bear market signifies an investor’s pessimism, resulting in a deep market sell-off. It is a sign of market downtime, resulting from depressing economic conditions or major catastrophic events like natural disasters or financial crises.
Bull market: a bull market is one in which the currency prices are increasing. It conveys global market uptrends, resulting from optimistic global economic news.
In forex trading, traders have a chance to borrow more capital (leveraging) to maximize their returns. The market is characterized by high leverages, which you can use to boost your positions.
So, leveraging allows you to maximize your profits (or losses).
Forex is a highly volatile yet profitable opportunity – and is more than buying currencies when their prices are lowest and selling when the prices are high.
Just like stock trading, you need to learn how the market works, adopt a reliable forex trading strategy and keep improving your skills.
Congratulations, you just learned:
And to get started with this income opportunity, you’ll need to:
- Understand how the market works
- Find a broker and create a trading account
- Develop a trading strategy
- Avoid trading based on emotions
Let me know if you have any concerns in the comment section.
By the way, are you planning on starting forex trading anytime soon?