Forex for Beginners: An Introduction to Forex Trading
Forex is a shorter term for foreign exchange. It is an exchange of different foreign currencies. The term market is associated with forex as the value of each currency is different and they are traded with each other for a certain value at that certain point in time. The market where all these trades happen is open 24 hours a day on all weekdays (from Monday to Friday).
Different types of participants are involved in the forex market. The major role is played by governments, central banks, smaller banks, and financial institutions. They are the main contributors to the market and also connect other participants to the forex market. The remaining participants such as big companies, hedge fund institutes and traders do not directly communicate with the market but have significant roles in the foreign exchange market.
Different 3 letter codes have been assigned to all the countries’ currencies that are involved in the forex market. For example GBP for British Pound, CAD for Canadian Dollar and USD for US Dollar. These currencies are traded in pairs like GBP is traded for USD. So, these codes are combined in pairs like USDCAD, EURUSD, etc. The major pairs that account for more than 70 percent of trading are:
The first 3 alphabets refer to base currency and the next three refer to quoted currency. For example the exchange rate for EURUSD will represent the amount of quote currency (EUR) needed to buy the base currency (USD).
The supply and demand of currencies decides the currency price in the forex market. Other than that news related to national/international policies, economies and political activities also have influence over the currency prices.
Forex Trading Platforms
A software designed to let the user enter, exit or hold a position in the market is known as a trading platform. Trading platforms are usually offered by brokers to the traders for free or at nominal charges. These brokers work as an intermediary between the trader and the market to offer various features to the trader while trading.
Trading involves a lot of tasks which are made easy as some very useful features are provided by brokers through trading platforms. Some of these features include indicators, chart tools, and even market sentiment. These features become quite important when you are monitoring your trades. These tools can help you decide the entry and exit levels.
When deciding a trading platform, do consider looking at the features they provide, their working efficiency like speed and performance, and last but not the least the charges for using it. There are some trading platforms which are almost free but they are not reliable. Also, there are some which have great features but cost too much. Choose the one that suits your trading style and your budget.
Techniques built for profit making as a major focus while minimising the risks are known as trading strategies. These trading strategies straight away offer a chance to make profit in forex trading without the understanding of complex forex working involved behind it. There are a number of strategies that can be chosen by a trader according to different requirements. Some of the strategies are:
1. Position Trading Strategy
This is a long term trading strategy in forex in which a trader holds on to a position for a time period of a few months to years. The time required to use this strategy in a trade is very less and the risk reward ratio is high but it can be used only in a limited number of scenarios and fundamental analytic skills of the trader should be strong.
2. Day Trading Strategy
In day trading strategy, all the positions opened by a trader on a day are closed on the same day. There are a huge number of situations to trade using this strategy but a lot of time needs to be invested and good technical analysis is needed.
3. Swing Trading Strategy
Swing trading strategy involves trading according to the highs and lows of a currency pair and the position can be closed anywhere between a couple of days to within a few weeks. This strategy is also frequently usable and the time required is lesser than that of day trading strategy.
This strategy is also famous among traders and includes multiple trades that are opened and closed within a time span of minutes. The amount of each profit is small but total profit increases according to the number of profitable trades.
Leverage and Margin in forex trading
Leverage is borrowing of money from the broker to profit from even small movements in the currency pair prices. The currency pair price movements are usually quite small and a retail trader with a small account cannot profit if only capital belonging to the trader is to be used. So, to gain bigger market exposure, brokers offer borrowing of this money referred to as leverage.
Margin in forex trading is also related to leverage as it represents the ratio of leverage being offered to a trader. For example, as 100:1 is the most common trading margin offered in the forex market meaning that a trader with a capital of $1 can trade for a currency worth $100. From this perspective leverage seems to be beneficial for traders.
As the leverage has the ability to enlarge your profits, it also can increase your losses. The higher the leverage, the quicker it will deplete your capital. So, leverage is a useful tool but it is to be handled with care. Once you learn how to safely use leverage, you can use it to your benefit in forex trading.
Spread in forex trading
A spread in forex trading is simply the difference between the bid price and ask price of a currency. The bid price is the price at which you can sell the base currency and the ask price is the price at which you can buy the base currency.
Spreads are denoted by a unit termed as pips which is also the smallest unit of currency pair price movement. 1 pip = 0.0001 value of currency pair. For example, if bid price of AUDUSD is 0.7150 and ask price for the same is 0.7153, then the spread is 0.7153 – 0.7150 = 0.0003
Spread is of two types:
Fixed Spreads: The spreads which remain constant and do not change due to any market situation are fixed spreads. These spreads are good for traders with small capitals but slippage is a common problem in fixed spreads.
Variable Spreads: The spreads that fluctuate due to change in volatility in the forex market are variable spreads. These spreads allow traders to buy and sell at specific prices easily when the market is volatile.
Lot in forex
A lot in forex is a specific amount of currency units that are bought or sold in a forex trade. All the orders placed in forex trading are measured in lots. A single lot contains 100000 units of a currency. Since a single lot is too big, most retail traders use smaller lot sizes termed as mini, macro and nano.
A mini lot size means 0.1 lot which equals 10000 units. Similarly, macro at 0.01 lot and nano 0.001 lot equals 1000 units and 100 units respectively. To understand the effect of lots on pip value, here is an example:
If the currency pair EURUSD is having an exchange rate of 1.1930 and the lot size we trade is the standard(100000), then the pip value will be (.0001 / 1.1930) X 100,000 = 8.38 x 1.1930 = $9.99734. So, with each pip gained or lost, we make approximately $10 of profit and loss respectively.
The measure taken to lessen the effect of a bad trade and make it manageable is termed as risk management. People often misunderstand risk management as a way of completely avoiding losses. Losses could still occur but since proper measures are in place, the losses are controlled and could not exceed a certain level.
The major risks in forex trading are currency based risks related to changes in currency prices, liquidity risk affecting the ability to buy or sell a currency, leverage based risk as losses are also amplified when we trade on margin and risk of increasing or decreasing interest rates in an economy which affects the volatility.
Risks mentioned above can be managed through some methods. First of all, the trader should have a good understanding of the forex market. The working of sell orders and buy orders should be clear. If you want to use leverage, it is important to become familiar with it as it not only magnifies the profits but also does the same to the losses. The next important thing is to have a good trading plan. Do not try to copy a plan but try to find or create a plan that you find suitable as per your decision making and trading style. Usage of stop losses and take profits is also crucial in a trading plan.
Other than this, maintaining a good risk reward ratio in a trade and managing your emotions while trading is also important. Also, keep an eye on the news and events that occur globally to consider while choosing currency pairs and making other decisions. Use a demo trading account to practice before jumping to a real account.
Customer service is often not given the importance that it requires. Every business requires a separate effort for customer service to make sure that the customers do not face any problems and are satisfied with the delivery of product or service. In forex too, brokers need to provide good customer service to ensure that traders are able to place orders and trade without any problems.
There are different ways a customer should be able to connect with the company:
- Chat: Customers can reach the company through text messages on a platform. This way is also quick but needs a dedicated workforce to provide customer service.
- Email: This method is used through email service. This process is slow but does not require much effort which is why it is mostly used by small businesses.
It is important to use a broker that offers good customer support.
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