Forex trading is one of the most popular forms of investment. The foreign exchange market is the world’s largest financial market, with a daily trading volume of $7.55 trillion in 2022.
In this article, you’ll learn about foreign exchange, how forex trading works, the benefits of trading currencies, and how to set up your first forex account with a reputable broker.
What is Forex Trading and How Does it Work?
What is forex? Foreign exchange (forex, or FX) is a global financial market that allows you to trade currencies. Many investors are drawn into forex trading for several reasons, such as high liquidity, ease of access, and the availability of leverage.
Unlike the stock market, forex does not have a centralized exchange to host all the transactions. All transactions are done over-the-counter (OTC), allowing buyers and sellers to directly engage with each other over the Internet or phone networks.
Well, then, what is forex trading? Simply put, forex trading involves buying and selling currencies to profit from price fluctuations. Brokers have an important role in this aspect, acting as intermediaries between buyers and sellers. As a retail trader, you need to sign up with a broker to start trading forex.
How the Forex Market Works
Although you exchange currencies in airports and currency kiosks, in reality, only a small percentage of currency transactions happen in this setting. The majority of currency transactions happen in the global forex market, where exchanges are done for speculative reasons.
In the forex market, trading currencies is done in pairs, as in major currencies like EUR/USD, USD/JPY, GBP/USD, AUD/USD, and USD/CAD. The first is the “base” currency, followed by the “quote” currency. For example, in the EUR/USD pair, the euro is the base currency while the US dollar is the quote currency.
For forex currency trading, you click “buy,” when you expect that the base currency will increase in value against the quote currency. Whereas, you expect it to decrease in value relative to the quote currency when you click “sell.”
Forex currency trading is open 24 hours a day and five days a week. It has four major sessions: Sydney, Tokyo, London, and New York. The market opens on Sunday at 10:00 PM GMT, when the Sydney session starts, and closes on Friday at 10:00 PM GMT, along with the end of the New York session.
The Benefits of Trading Forex
There are many reasons why millions are drawn into forex trading. Forex is known as one of the most liquid markets in the world, making it easier to enter and exit positions without worrying about demand. As a forex trader, there is less likelihood of price slippage, allowing you to maximize profit potential.
Another benefit if you trade forex is the 24/5 operation. One common criticism about traditional asset classes like stocks is that traders often lose great opportunities over unexpected market events due to the limited trading time. If you’re someone with a full-time job, taking advantage of these events can be tricky. With forex, you can trade at any time of the day regardless of your timezone, granting greater flexibility.
Leverage is another major benefit. Many forex brokers offer leverage to their clientele, which starts at 10:1 and can go as high as 1000:1 or more. This allows you to make larger positions from a small amount of capital, maximizing your potential profit (and loss!).
Lastly, when you trade forex, you generally get lower transaction costs compared to other financial markets. Many brokers offer tight spreads, especially on major currency pairs, while others do not charge commissions on certain account types.
Getting Started with Forex Trading
How to start forex trading? The process is quite simple. You simply have to create an account with a reputable forex broker, verify your details, and fund the account. You can do the entire process in five minutes.
After account creation, you can install third-party electronic trading platforms such as MetaTrader4, MetaTrader5, and cTrader to start trading. Some brokers have their proprietary trading terminals where you can execute all the trades, so you don’t have to worry about being familiar with the MetaTrader platforms in this case.
It’s crucial to know how the market works before getting started. Knowing some forex terms such as currency pairs, pip, spread, lot size, leverage, and margin will also be helpful. As mentioned, trading in this market is very liquid, which means you can lose your capital within minutes if you don’t know what you are doing.
It is always advisable to start with a demo account before doing the real deal. Major brokers such as Pepperstone, IC Markets, and Eightcap offer free demo accounts with a certain amount of virtual funds. This allows you to test strategies and master your instruments before using real money.
Effective Forex Trading Strategies
With forex investment, there are many effective strategies that you can use. Scalping is one, and it is used by many traders. This strategy allows you to make small and frequent trades to take advantage of minimal price movements.
Scalping works very well for forex since the market is characterized by fast price movements. Also, this strategy completely protects you from incurring swap fees for holding a position overnight, as some brokers charge such fees for holding a position past a specific time, typically 5 PM New York time.
Trend-following is another popular strategy in trading forex, where you simply follow the direction of an ongoing market trend. The idea is to go long (buy) when the market is in an uptrend and go short (sell) when it is in a downtrend.
Managing Risks in Forex Trading
Here are some effective ways to manage risks when forex trading online:
- Always set take profit and stop loss levels
- Determine a proper position sizing. As a common rule, only risk a maximum of 3% of your capital on a single trade
- If you’re a beginner trader, start with small leverage (10:1) until you fully understand how leverage works for your positions
- Do not put all your money in one basket. Diversify and trade multiple pairs
- Strictly stick with your strategy when trading forex online. Many traders lose their capital over emotional trading
Choosing the Right Forex Broker
As a forex trader, you want to find the best broker in the market. However, making a choice is not a walk in the park since you have a lot of providers to choose from. Here are some tips to choose the right broker:
- Regulation. Go for brokers that hold licenses from top finance regulators such as the United Kingdom’s Financial Conduct Authority (FCA), the Cyprus Securities and Exchange Commission (CySEC), and the Australian Securities and Investment Commission (ASIC).
- Trading Platforms. Check for compatibility with top trading platforms to make sure that you are equipped with reliable and user-friendly tools. Brokers offering MetaTrader4, MetaTrader5, cTrader, and TradingView are preferred.
- Spreads and Commissions. Spreads and commissions are crucial to your profitability. Go for brokers that offer competitive spreads, ideally 1 pip or less per trade. Alternatively, going for a provider with a no-commission policy is also a smart move, especially when you’re using a RAW account.
FAQs
What is Forex trading?
In forex trading, you buy and sell currencies to make a profit. The forex market is the largest financial market in the world, with a daily trading volume of $7.55 trillion in 2022.
How does Forex trading work?
Forex trading works by simply exchanging one currency for another. Trading currencies always come in pairs, as in EUR/USD. In this case, EUR is your base currency and USD is your quote currency. You “buy” when you expect the EUR to strengthen against the USD. Conversely, you “sell” with the expectation that the euro will weaken against the US dollar.
What are the main benefits of Forex trading?
Forex trading comes with many benefits, including high liquidity, 24/5 market access, access to leverage (starting at 10:1 up to 1000:1 or more), and low transaction costs.
How do I start Forex trading?
Simply open an account with a reputable forex broker, fund your account, and begin trading. If you’re a beginner trader, it is highly advisable to start with a free demo account to practice strategies and master trading tools without risking real money.
What strategies can I use in Forex trading?
Two very popular strategies that you can use in forex trading are scalping and following the trend. Both work well on highly volatile markets like forex, where prices change within a second. Each of these strategies has its own risk and reward profile, which suits some trading goals and risk appetite more than others.
What are the risks involved in Forex trading?
Forex trading involves a significant level of risk, particularly market volatility and leverage risks. The key to threading through this is to take calculated risks. The general advice is to not risk more than 3% of your capital on a single trade.
How do I choose a Forex broker?
When choosing a forex broker, the presence of regulation (licenses from top finance regulators such as the FCA, ASIC, and CySEC), trading platforms (MT4, MT5, cTrader, TradingView, and a proprietary trading platform), and tight spreads and no commissions should be looked upon.
