This article is a beginner’s guide to forex trading. It tells you everything you need to know about how to get started trading the forex market.
Forex trading was once almost exclusively the province of banks and large institutional traders. But since the turn of the century, it has become readily accessible to individual retail traders and quickly become very popular with small investors.
With an average daily trading value of nearly $7 trillion, the forex market is overwhelmingly the largest financial trading market in the world – ten times bigger than the US stock market.
This step-by-step guide to forex trading will give you all the following information:
- What the forex market is
- The major currency pairs traded
- Understanding forex pricing (pips and lots)
- How to choose a forex broker
- Forex trading strategies
Understanding the Forex Market – What is it?
Forex is short for “foreign exchange” – more precisely, foreign currency exchange. The forex market is the financial market where different currencies are traded.
Buying forex is different from buying stocks. There are no centralized exchanges for forex trading.
Forex is an over-the-counter (OTC) market – specifically, the interbank market, which is a network that connects forex traders across the globe. The interbank market enables banks, nations (through their central banks), and companies to exchange currencies, such as exchanging British pounds for US dollars. It also enables speculative currency trading by both institutional traders and individual retail traders.
One of the aspects of the forex market that makes it attractive to traders is the fact that it’s open for trading 24 hours a day, from Monday morning in Australia to Friday afternoon in the United States. Throughout each trading day, the center of the action in forex trading gradually shifts from east to west across the globe, moving from Sydney to Tokyo, then Tokyo to London, and, finally, London to New York. The biggest price changes and highest trading volume commonly occur in the time frame where afternoon trading in London overlaps morning trading in New York.
Beginner’s Guide to Forex Trading – Currency Pairs
What exactly do you trade in the forex market? – Currency pairs. Currency pairs provide the opportunity to trade the value of one currency relative to the value of another currency. For example:
- The currency pair Eur/Usd trades the value of the euro relative to the value of the US dollar
- Gbp/Jpy trades the value of the British pound against the Japanese yen
- Eur/Aud trades the euro versus the Australian dollar
If you think that the value of the British pound is going to go up relative to the US dollar, then you would aim to profit from buying Gbp/Usd. If, instead, you think the pound is going to lose value relative to the US dollar, then you’d aim to profit by selling the Gbp/Usd pair. In essence, you’re buying or selling the first currency of a currency pair (known as the “base” currency – the second currency in the pair is referred to as the “counter” or “quote” currency).
The second currency in a currency pair is called the quote currency because the price quoted for a currency pair represents a quote of how much of the second currency it takes to equal one standard unit in the base currency. For example, if the price of Eur/Usd is quoted as 1.1050, that means that it takes $1.10 (and one-half cents) to equal one euro (€1.00).
The Major Pairs in Forex Trading
There are dozens of currency pairs you can trade. However, more than 80% of the daily trading in the forex market is usually comprised of trading in what are referred to as the major forex currency pairs, the following:
- Eur/Usd – Euro versus US dollar
- Gbp/Usd – Great British pound versus US dollar
- Usd/Jpy – US dollar versus Japanese yen
- Usd/Chf – US dollar versus Swiss franc
Some traders also include Usd/Cad, Usd/Aud, and Usd/Nzd among the majors, while others add to the list Eur/Gbp and Eur/Jpy. Note that the US dollar is the most commonly recurring currency among the major pairs. That simply reflects the fact that the dollar is the most widely-held and widely-traded currency in the world (for the moment anyway – many analysts expect the Chinese yuan/renminbi to eventually supplant the US dollar as the world’s preeminent currency).
Forex Trading – Pips and Lots
To understand the pricing of currency pairs, you have to understand what a “pip” is. It’s the smallest amount of price change that can occur in forex trading. A pip is usually represented by the fourth decimal point number in the price quoted for a currency pair. For example, a price change in Eur/Usd from 1.1232 to 1.1238 is a price move of 6 pips.
Moving from the largest to the smallest, forex contracts are available in the following lot sizes:
Standard lot: $100,000 of the base currency; pip value = $10
Mini-lot: $10,000 of the base currency; pip value = $1
Micro-lot: $1,000 of the base currency; pip value = $0.10
Nano-lot: $100 of the base currency; pip value = $0.01 (not all forex brokers offer trading in nano-lots)
The smaller lot sizes make forex trading more accessible for small investors. Depending on the amount of leverage your broker offers, you could, for example, trade micro-lot contracts with as little as a $2-$3 margin deposit per contract.
How to Choose a Forex Broker
To get started trading forex, you need to open a trading account with a forex broker.
Here are the most important factors to keep in mind when you’re looking for a good forex broker:
- The trading platform
- Trading costs
- Whether the broker is regulated or unregulated
Leverage is a key aspect of forex trading because it’s what enables traders to get started in forex trading with as little as $50-$100. Also referred to as “margin trading”, leverage enables you to control a high dollar value investment with only a small margin deposit, just a fraction of how much money you’d need to make the same trade without the use of leverage.
Different forex brokers offer widely varying levels of margin, ranging from as little as 25:1 all the way up to 1,000:1. With 1,000:1 leverage, you can trade a standard contract – worth $100,000 of the base currency – with a margin deposit of just around $100.
Trading with leverage gives you two major benefits. First, as noted, it enables you to trade forex with a relatively small investment. Second, it significantly amplifies any profits you make.
However, it’s frequently noted that leverage is a two-edged sword. While it amplifies profits, it also amplifies any losses that you incur.
Let’s use the example of trading a standard lot contract with 1,000:1 leverage. Every one-pip price move with a standard lot is worth $10. So, let’s say you buy Gbp/Usd, and the price goes up 25 pips. With 1,000:1 leverage, you only had to put up $100 to trade one contract, and now, with a profit of $250, you’ve more than doubled your investment. But the flip-side is that if the price of Gbp/Usd had gone down 25 pips, the $250 loss you’d suffer would be 150% more than your original investment. Make sure you understand this: the risk with leverage trading is that you can lose substantially more than your original investment.
Different brokers offer different trading platforms and charting software. There’s no one platform that’s the best. The important thing is to make sure that you’re comfortable and satisfied with the trading and charting programs that your broker offers.
The most widely-used forex trading platform – available through many brokers – is MetaTrader, which comes in two versions, MT4 and MT5. MetaTrader brokers may offer one or both versions of the MetaTrader platform. One of the factors that make MetaTrader appealing is that the largest number of technical indicators are coded for MT4 charts.
Popular alternatives to the MetaTrader trading platform and charting software include Ninja Trader, TradingView, and cTrader, some of which also serve as stock trading platforms.
Trading costs reduce profits and add to losses. Therefore, you always want to aim to keep your trading costs as low as possible. The cost of trading can be an especially critical factor for forex traders because many traders are day traders, thus generating several trades and several trading costs.
Different brokers have different methods of charging trading fees. With some brokers, the trading costs are built into the bid-ask spread quoted for each trade. The bid-ask spreads they offer are typically higher than the bid-ask spreads offered by brokers who charge only commission fees per trade. Some brokerage firms combine bid-ask spread fees and commission fees.
You can estimate what your average trading costs with a given broker are likely to be, based on what currency pairs you commonly trade, the average bid-ask spread offered, how frequently you trade, and what contract size you usually trade.
Using a Regulated or Unregulated Forex Broker
Most forex brokers are regulated by government regulatory agencies such as the Financial Conduct Authority (FCA) in the United Kingdom. Other brokers operate in jurisdictions where forex trading isn’t subject to government regulation.
A broker being unregulated doesn’t necessarily mean that the broker isn’t legitimate or trustworthy. It does mean, however, that if you have a problem with the broker, you’re pretty much on your own as far as getting the problem settled. There’s no governmental body to appeal to for assistance.
Unregulated brokers typically offer greater leverage than regulated brokers. That makes them appealing to forex trading beginners who are starting out with just a small amount of trading capital.
Forex Trading Strategies
Short-term forex traders, whether they use a day trading forex strategy or a short-term swing trading strategy, tend to use technical analysis to guide their trading decisions. There are hundreds of possible technical indicators that can be applied to a chart, including trend indicators such as moving averages, momentum indicators such as the MACD, and volume indicators.
Long-term forex traders are more likely to favor fundamental analysis, basing trades on major economic trends. Fundamental analysis indicators are comprised primarily of key economic reports that governments periodically issue. Among the most important reports are the Consumer Price Index (CPI), gross domestic product (GDP), and employment reports such as the Non-farm Payroll report (NFP).
Especially if you’re a beginning forex trader, it’s a good idea to first test out any trading strategy before risking real money, using a demo account. Virtually all forex brokers offer demo account trading precisely for that purpose.
Forex Trading for Beginners – Summary
We’ve taken you through all the essentials you need to know to get started trading the forex market. We can’t cover everything that goes into becoming a consistently profitable forex trader in just one article. Fortunately, there are abundant online resources – many of them free – that offer information on forex trading and trading strategies. You can also make connections with other forex traders and exchange trading ideas and strategies at online forums such as Forexfactory.com.
Can you get rich trading forex?
Yes, you can. Thanks to the high leverage available in forex trading, even a small investor, starting out with just a little bit of money, can potentially make a fortune in just a few years. But becoming a master forex trader takes hard work, dedication, and persistence. Most people who try forex trading thinking that it’s going to be an easy road to riches end up losing money.
How much money do you need to begin forex trading?
With a forex broker that offers high amounts of leverage, it’s possible to start trading the forex market with less than $100 (however, that leaves little margin for error – just one or two losing trades could wipe out your account). Using a broker that only offers leverage around 50:1, a minimum starting deposit falls more in the range of $500-$1,000.