The forex market has been around for quite some time now. Exchanging currencies have been useful for decades, and people have started to take advantage of the many opportunities that the forex market brings. Whether you’re hedging or speculating, it is important to know the essentials of forex trading before engaging in the forex market.
Therefore, this article covers everything you need to know before you start trading in the forex market.
What is Forex Trading?
Trading in itself entails risk since you can lose as much as you can win. With forex trading, you are trading currencies in a decentralized OTC market. Hence, the forex market is fair, but at the same time not regulated.
Forex became more widespread when banks began trading currencies to protect the interests of their customers as well as potential profit from the trades. All the banks trade in the interbank market, where they have both sovereign risk and credit risk. These risks have made the interbank market slightly more regulated since a large portion of the money in circulation is at stake.
The forex market is purely driven by supply and demand forces. With a higher supply of a certain currency, the price may decline. On the other hand, an increase in demand sees an increase in the price.
This applies to both the interbank market and the unregulated market for retail traders. While the retail forex market is unregulated, there are still several procedures that one may undergo due to various government policies since forex dealers may live elsewhere.
Before trading, though, traders must know the rules of the country they operate in, but also know how to be protected during various economic conditions.
Starting as a Forex Trader
There are several aspects that you should keep in mind before you begin:
Learn and research
First things first, you have to learn about the forex market. Not only that you need to know how to trade, but you should also learn about the nature of the market. Depending on both fundamentals and technical factors, you need to research before engaging in forex trading. You should analyze all the price factors, and you should be able to estimate how a certain currency may perform given a change in the market.
Set up an account
Once you learn the basics of forex, you need to create a forex trading account. There are no fees for creating an account or for brokers. If you are a beginner, you should start with micro accounts, where you trade only with smaller amounts. Not only that you will riskless, but you will also gain more experience in forex trading with a micro account.
Come up with a strategy
Almost each forex trader has a unique strategy. Even if you and a friend of yours followed the same forex course, it is likely that you may have slightly different approaches to your trades. Hence, after getting enough experience, you will begin to have a similar trading pattern that is a result of the approaches that you learn. It may take months until you master a certain trading strategy. However, with enough experience, if you develop an efficient strategy, you may inevitably start to see profit piling up.
Check your positions
It is of much importance to constantly check where you stand with your trades. Once the day ends, check on how your trades went, and make sure that there are no pending positions. Moreover, always make sure that you still have enough funds to continue with your trades for the coming days.
Be prepared emotionally
Last but not least, one of the biggest players when it comes to forex trading is the emotional factor. Trading entails high risk, and losing on trade could be an emotional wreck for you. While your research and analysis might be top-notch, the market can be unpredictable. Hence, do not let emotion get the best of you. Consecutive losses could lead to less rational decisions, which may aggravate your approach. Therefore, if necessary, take breaks and remember to be very disciplined, both on losses and profits.
Forex Trading Strategies
Perhaps you have already heard of long trades and short trades. If not, then here is the simplest explanation:
In a long trade, the trader expects that the price of a currency may increase and enters a buying position. A short trade, on the other hand, is where the trader estimates that the price of a currency may decline, so the trader enters a selling position.
Nevertheless, there are multiple trading strategies, whether they are in the spot market, futures or forwards market, or options market. Here are the main four types of trading strategies in the forex market based on their duration:
Scalp trades are trades that happen in a short amount of time, with multiple positions in various positions. Hence, the profit for a specific trade is small, but the profit may get large as the profits from each position are accumulated. These trades are most efficient during high trading volumes.
Day trades are also short-term trading, but relatively longer than scalp trades. These trades are usually closed within the day, whether the trader holds for minutes or hours. Day trading requires good technical analysis skills and requires constant attention of traders.
Swing trades are trades that usually last longer than a day. To illustrate, swing traders hold their positions for many days and even weeks. These trades rely more on fundamental factors, including announcements by central banks, governments, etc. Nonetheless, technical factors also play a role when it comes to swing trading.
Lastly, position trades are trades that can be lost for months. Sometimes, position trades could go on for many years. These trades do not require technical skills as much as a fundamental understanding of what is going on. To illustrate, position traders usually have a reason to believe that a certain currency may appreciate or depreciate in the long run, given the political and economical conditions of the nation with that currency.
Forex Trading Charts
Another thing you need to know when it comes to forex trading is the trading charts. Different charts are used for different purposes. Here are the three main trading charts used in forex trading:
As the name suggests, bar charts showcase the price of a currency using vertical bars. Each bar represents a certain period (i.e. one day). While these charts could prove to be useful in determining the general nature of the trend (whether it is in a downtrend or uptrend), it is hard to accurately predict what can happen with bar charts.
Another feature of bar charts is the colors that it uses. Usually, green is associated with increasing prices, while red associates with decreasing prices. A bar chart includes the opening price, highest and lowest points, and closing price.
Line charts are much simpler charts, showing the price movement by using a single line. These charts are more often used to back up the hypothesis on technical analyses. This is because line charts do not necessarily showcase all the technicals regarding the price movement of a currency pair. Nonetheless, it is relatively easy to identify how a currency is performing by looking at its line chart.
Candlestick charts are the most sophisticated charts and the most used ones by expert traders. These charts date back to the 18th century, and they are relatively easy to be understood. As the name indicates, these charts include candlesticks. Each candlestick has a body and two wicks, and each candlestick includes a specific amount of time (i.e. 4-hours, 1-day, 1-week, etc). The upper wick shows the highest point during that timeframe, while the lower wick shows the opposite. If the candlestick is green (default), the lowest point of the body (not the wick) is the opening position, while the highest point of the body (not the wick) is the closing point. If the candlestick is red (default), the opposite applies.
Candlestick charts provide a lot of technical indicators. There are hundreds of different price movements and common formations that can be witnessed in a candlestick chart. These patterns usually indicate how a currency pair may perform in the coming hours or days (depending on your position type).
Advantages and Disadvantages of Forex Trading
While forex trading could be highly profitable and a good way to generate income, there are still many disadvantages that come with it. Here are the pros and cons of forex trading:
- Easily accessible: Since the forex market is one of the financial markets with the highest daily trading volume, it is widely supported, making it easy for people worldwide to join the forex market.
- Starting small: Even if you are inexperienced, you can begin trading with small amounts without risking a lot of your finances. This also allows you to gain valuable trading experience.
- Decentralized: The forex market, like the crypto market, is decentralized. No central authority controls the trades. While there are centralized entities that regulate some of the procedures, the market is decentralized.
- Various trading centers: There are nine main centers of the forex market, namely Frankfurt, Hong Kong, London, New York, Paris, Singapore, Sydney, Tokyo, and Zurich. With that said, while the market may close in one center, it opens in another one, allowing traders to be active 24 hours a day.
- Profitability: Once gaining valuable experience, you may start generating huge profits through your trading strategy.
- Highly volatile: Similar to commodities and other assets, currencies are volatile as they are affected by many external factors. Hence, more volatility entails more risk.
- Requires experience: As suggested, before engaging in forex trading, you should learn how forex works. Moreover, you should research current economic conditions and how those conditions can affect the currency pairs that you are willing to trade. This takes a lot of time and effort.
- Emotions: As much as you can practice discipline, there may come a point where your emotions get the best out of you, leading to an irrational approach in your trades. Hence, you should be prepared to expect losses the same way you expect to profit.
Conclusion: Is Forex Trading Worth It?
Even though trading currencies can be risky, if you are willing to put a lot of effort into learning about the forex market and trading, then forex trading could definitely be worth it. Either way, make sure to do your own research before beginning to trade.
- The forex market involves buying and selling currencies.
- The forex market is driven by demand and supply factors.
- To start forex trading, you must first learn about forex trading and research before every trade.
- Anyone can set up an account in the forex market. Make sure to develop a good strategy and check your positions at the end of each day.
- Forex trading can affect you emotionally.
- Some trading strategies are scalp trading, day trading, swing trading, and position trading.
- Main forex trading charts are bar charts, line charts, and candlestick charts.
- While there are many advantages to forex trading, there are also some disadvantages.