THE COMPLETE GUIDE TO FOREX TRADING
Are you looking to Trade Forex? Then you are going to need to know what Forex is, how it is traded, and which platforms are best. Forex Trading Masters’ easy to follow Forex trading strategies detailed here as a guide.
It will provide knowledge of Forex signals in order to help you to start making the most out of Forex Trading and earn a consistent profit.
What is Forex?
Forex is short for foreign currency exchange. It can also be shortened to FX but, in essence, it is the marketplace in which currencies are traded. This, of course, is an extremely broad description of it. These encompass something as simple as exchanging your local currency to a foreign one for a holiday trip, or something even more complex!
Forex trading involves the trading of one currency against the other. Similar to other financial markets, the goal in any forex trade is to make a profit.
The forex market is the largest trading market in the world, boasting a daily volume of approximately $6.6 trillion. The global forex market completely dwarfs the world’s equity markets, which trade around $200 billion each day.
In the stock market, a trader will buy and sell the stock of a particular company, such as Amazon or Facebook. However, in the forex market, traders buy and sell currency pairs; a single currency cannot be traded ‘by itself’. Examples of a currency pair are EUR/USD (Euro Dollar), GBP/USD (Pound Dollar) or USD/JPY (Dollar Yen).
Reasons to do Forex Trading
Forex trading is a skill that can be developed, mastered, and put to good use. To become a successful forex trader, you must be willing to educate yourself, work hard and adhere to certain guidelines, which we call a trading strategy. Trading will inevitably have its ups-and-downs, but as you develop your trading techniques, you are learning an important skill that will last you a lifetime. As a trader, you will develop attributes such as patience, mental toughness, and adaptability. These traits are certainly beneficial in all aspects of life.
Time vs. Money
Every day, each of us must deal with the issue of time vs. money. Time is a finite resource, so when you are paid for your job, you are trading (no pun intended) time for money. The income that you are earning is limited by the number of yours that you work. As a trader, however, your profit on a single trade could be as much as your income from hours of work! Thus, forex trading enables you to increase your money at a much faster rate than if you were working. Trading has its risks of course, but as you develop a successful trading strategy, you will increase your earning potential.
Extra Source of Income
It is no secret that many workers do not like their jobs, and it is certainly a blessing if you wake up with a smile as you think about the workday. Even if you do enjoy work, it is always a good thing if you can develop an additional source of income. Do not expect to get rich off forex and quit your day job, even if you pass a forex course with flying colours. At the same time, if you become successful at forex trading, you will have developed an additional source of income and become more financially independent.
Pips, Points, and Ticks
A pip is the basic measurement used in forex. On most currency pairs, a pip would be referring to the figure in the fourth decimal place (X.XXXX), however on other currency pairs, such as those involving the Japanese Yen, this refers instead to the second decimal place (XXX.XX).
A lot of brokerages now offer quotes to the fifth decimal place, this fifth decimal place is then referred to as a ‘fractional pip’ (X.XXXXx).
A Point is like a Pip; however, it is not used within the Forex Market. It is a term which is used in trading Futures, Commodities, and Indices. Some may refer to a Pip in a currency pair as a ‘Point’, however this is an incorrect use of trading terminology.
A Tick is the very smallest change that can be measured in a quote. Many markets have different ‘tick sizes’, for instance some markets may have price fluctuations measured in increments of 0.25, while others may have price fluctuations measured in increments of 0.1 or 0.01, all of these would be considered Ticks so long as they are the smallest change possible within that specific market.
Forex vs Stocks: Which is better?
There are many global markets to choose from when it comes to trading; two of the most tradeable markets are Forex and Stocks.
It is particularly important to understand these two markets before jumping in blindly as both markets may follow similar technical trends but are vastly different when it comes to the fundamentals that are behind their market fluctuations, and therefore inherently different when it comes to financial risk.
Below, we will try to briefly lay-out the major differences between these two markets.
From a purely monetary standpoint, the Forex Market is a behemoth when compared to the Stock Market.
Forex Market Vs. Stock Market
The Forex Market’s total world-wide value as of 2019 is worth $2,409,000,000.
The Daily Trading Volume of the Forex Market as of 2019 is valued at $6,600,000.
The Stock Market’s total world-wide value as of 2019 is worth $90,000,000.
The Daily Trading Volume of the Stock Market as of 2019 is valued at $250,000.
As you can see, from a purely monetary standpoint, the Stock Market can barely hold a candle to that of the Forex Market.
How Traders Make Money
In the forex market, traders buy and sell currency pairs. A currency pair can also be defined as the rate of exchange between two currencies.
So how do we trade a currency pair? Let’s look at an example using GBP/USD:
Suppose the current exchange rate for GBP/USD is 1.2500. If you purchase 100,000 British pounds, this would cost $125,000. If later in the day GBP/USD rose to 1.2560, the value of your 100,000 British pounds would now be worth $125,600. This means that if you decide to sell your pounds back into dollars, you would make a profit of $600. This example illustrates how forex traders make a profit.
It is important to understand that any trade on the forex market will involve a pair of currencies. This is different than trades on the stock market, where a trader can purchase or sell a single stock. In the forex market, traders simultaneously buy one currency and sell another. This means that currencies are always traded in pairs – unlike the case with stocks, a currency cannot be traded ‘by itself’.
The major currency pairs are those that are most frequently traded. Note that all of the major pairs include the US dollar, which makes up 88% of all forex transactions.
EUR/USD is the most traded currency pair, making up 25% of all daily forex trades. The pair’s popularity is due to the fact that it represents two of the largest economies in the world – the Eurozone and the US.
USD/JPY is the second most traded currency pair and makes up 13% of all forex transactions. This pair is characterized by less volatility than other pairs, as the Japanese yen tends to be quite steady.
AGBP/USD accounts for 11% of all forex trades, making it the third most popular currency pair for traders. This pair is considered one of the best to trade with using technical analysis because of how it responds to key indicators. As well, GBP/USD often moves in a similar manner to EUR/USD, so a popular trading strategy involves taking positions with both pairs.
The Swiss franc is considered one or the world’s top safe-haven currencies, meaning that is highly in demand during times of uncertainty and crisis. Although there is limited need for the Swiss franc in terms of trade, the currency is attractive because Switzerland is a model of stability in a turbulent world. USD/CHF is the sixth most traded currency pair in the forex market and generally shows limited volatility.
Commodity Pairs are the currency pairs that are most sensitive to fluctuations in the prices of various commodities. This is due to the fact that these currency pairs will often involve countries which have vast amounts of commodity reserves.
AUD/USD tends to show significant volatility. Australia has a commodity-based economy and is a major producer of iron ore, gold and oil. This means that changes in global economic conditions or fluctuations in commodity prices can have a significant effect on the Australian dollar. AUD/USD is attractive to traders looking for a pair that exhibits strong movement.
Canada is an enormous country with an economy that relies heavily on the exports of commodities. The largest of these is Oil. If you look at the price of Oil and the quote price of the USD/CAD, you will often see that changes in one heavily influence changes in the other.
The Canadian dollar is also sensitive to economic conditions in the US, as Canada sends 75% of its exports to its southern neighbour.
The New Zealand dollar tends to show considerable volatility and the currency is sensitive to global economic conditions, since New Zealand is highly dependent on international trade. As New Zealand has close economic ties with Australia, NZD/USD often shows correlation with AUD/USD.
The Cross Pairs are typically denoted as the currency pairs that include the major world currencies such as the Euro (EUR), Great British Pound (GBP), Japanese Yen (JPY), Swiss Franc (CHF), Australian Dollar (AUD), Canadian Dollar (CAD), and New Zealand Dollar (NZD) quoted against each other as opposed to being quoted against the USD. EUR/GBP, AUD/JPY, and CAD/CHF are all examples of Cross Pairs.
The Exotic Pairs are currency pairs that involve less-traded currencies. For example, these currency pairs might involve the Turkish Lira (TRY), the South African Rand (ZAR), the Mexican Peso (MXN), or the Norwegian Krone (NOK) along with many others.
These currency pairs will often experience extraordinarily little in the way of liquidity, and therefore will be costlier to trade, with higher bid-ask spreads being prevalent across the board.
So why would traders bother with trading these exotic pairs?
While it is true that there is a higher risk-factor, there is opportunity for higher returns as there can be major differentials in interest rates between the two currencies, or more frequent fluctuations in the quotation price. These are not pairings you will often find in the portfolio of an average trader; however, you may find them in the portfolio of a trader who has decades of experience behind them.
As we can see, there are many currencies pairs that can be traded. Which is the best one? There is no simple answer, of course. EUR/USD and USD/JPY are excellent pairs to trade for novice or “lower risk” traders, as generally they are not all that volatile, and usually set out “smooth” trends. Currencies with more volatility offer greater opportunities to profit, but also entail more risk. These would include currencies such as the Australian and New Zealand dollars and exotic currencies. As a trader, you may want to try trading different currency pairs and determining which ones you prefer.
Types of Forex Trading
There are various methods to make a trade on the forex market. It is important to keep in mind that whatever the method chosen, the transaction between the two parties is a binding contract. A spot forex transaction is a contract in which there is a physical exchange of one currency against another currency. In a spot contract, one party agrees to buy or sell a foreign currency at a certain price which is the “spot rate”, also known as the current exchange rate. For example, a trader might wish to purchase EUR/USD at a spot rate of 1.2150. In order to purchase 10,000 euros, she enters into an agreement to pay 12,150 dollars in exchange for the euros. Spot contracts are sold over-the-counter (OTC). This means that the contract is a private agreement between the two parties, usually through an electronic trading network. There is no centralized exchange in an OTC transaction.
Currency futures are contracts to buy or sell a currency at an agreed-upon price at a future date. A futures contract is traded on an exchange, whereas such a transaction in forex, which is over-the-counter, is called a forward contract. Suppose that on June 1, a company knows that it will need 100,000 pounds in three months time. The company wants to lock in a price on June 1, so that it knows exactly how much the transaction will cost in dollars. The company would enter a GBP/USD futures contract with three-month duration. If the rate for the contract is 1.41, this means that the company has entered a contract as of June 1, whereby the company is obliged to pay 141,000 dollars and the seller is obliged to sell 100,000 pounds on September 1. Unlike spot transactions, future contracts are traded through centralized exchanges.
Forward Options Trading
A forex option is type of trade in which the buyer has the right or the option to buy or sell a currency at a specific price upon the option’s expiration date. The buyer does not have any obligation to make the purchase. On the other hand, the seller of the option would be obligated to buy or sell the asset at the specified price on the expiration date, if the buyer wishes to exercise his option. Similar to future contracts, options are traded on a centralized exchange. There is a disadvantage in options trading, in that markets hours may be limited and the liquidity is smaller than that of the spot of futures market.
In an FX swap, the parties make two simultaneous trades – one is a spot contract and one is a forward contract:
- The exchange of one currency for an equal amount of another currency, based on the current spot rate.
- The parties agree to give back the original amounts at a later date at a specific forward rate.
Swap trades are used to protect companies such as exporters from potential fluctuations in exchange rates.
Types of Forex Trading Accounts
Funded Trading Accounts
Any type of trading in the financial markets entails risk, and forex trading is no exception. Forex traders may be hesitant to risk capital, especially as beginner traders. One solution is to first practice on a demo account before actually executing real trades.
Another method for a trader to ease into forex is with a funding trading account. This allows an individual to make real trades, using an account which is funded by the company. The major advantage is that an individual can trade with a portfolio which is much larger than if they had to use their own capital. For the company, this arrangement is beneficial because it is able to locate best traders through its program, and it then takes a fee and/or a share of the trading profits.
The company will require the trader to enroll in a training course or program and pass a final exam. These programs do, of course, cost money, so a trader should always do their due diligence and ensure that the company is providing a legitimate service before signing up.
Forex Trading Brokerages
Choosing a Forex Broker
Most forex traders make use of a broker, who provides traders with access to a trading platform that allows them to buy and sell currencies.
Your broker should meet all of the following requirements:
- Accredited by a regulatory authority. If your broker operates in the UK, it should be accredited by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
- Low transaction costs. Your broker should not be charging high commissions or spreads. These costs can eat up your profits, especially if you are making a lot of trades. Don’t be shy about asking for lower transaction costs than those advertised on the broker’s website.
- Easy Withdrawal Process. Make sure that the deposit and withdrawal process is smooth and seamless.
- Comprehensive Trading Platform. Make sure that your platform is user-friendly and offers you the tools that you will need for your trading, such as charts, a demo account and a newsfeed.
- Execution of Trades. Since the forex market is constantly fluctuating, its essential that your broker fills your orders at the market price you see when you made the order, or very close to it.
- Client Service. Look for a broker that provides excellent customer service and treats you like a person, not an account number.
Leverage is the use of borrowed funds to make an investment and is an important component in forex trading. Forex brokers offer their clients high leverage, which allows traders to put down a small deposit while controlling a much larger contract. For example, if a trader has leverage of 50:1, then for a small deposit of $100, a trader can control a contract of $5,000.
At the same time, the use of leverage involves considerable risk, and a successful trading strategy should utilize leverage with caution.
As we mentioned earlier, forex brokers make a small profit from the spread in an exchange rate (buy/ask spread). In order to protect themselves from a loss, brokers allocate a portion of the funds in your trading account which are set aside by the broker during a specific trade. The margin ensures that the trader can cover the potential loss of the trade.
It may be easiest to think of margin as a collateral or deposit which assures the broker that the trader can afford to keep the trade open. Once the trade is closed, the margin is released back into the trading account.
Margin requirements are expressed as a percentage of the full value of the position. The size of the margin depends on the currency pair being traded. For example, a typical margin requirement for EUR/USD would be 2%, while EUR/AUD, which is a pair with more risk, would have a margin requirement of 3%.
Fundamental analysis examines economic and other developments that can affect the movement of a currency pair. Key events which can move the markets include Gross Domestic Product (GDP), inflation, employment reports and interest rate moves. These events are known as fundamentals. If you are trading fundamentals, you should be paying close attention to events that are being released on that day (and several days ahead). An important tool for forex traders is the use of an economic calendar, which lists economic and political events that may have an impact on the forex markets.
What Moves Currency Pairs?
Forex traders are always on the hunt for movement in a currency pair, since volatility creates an opportunity to profit (buy low, sell high). For this reason, it is important for traders to keep up with the news, as there are various topics that can affect the direction of a currency pair. Those developments which can have a significant impact on a currency pair’s movement are known as major market movers.
MAJOR MARKET MOVERS
- Interest Rates – The central bank of each country sets interest rates, usually on a monthly basis. If a country raises interest rates, that country’s currency becomes more attractive to investors, since a holder of that currency is receiving more interest on his holdings. Conversely, an interest rate cut would likely push the currency lower.
- Employment – Employment data is one of the most important indicators of the health of a country’s economy. A strong employment report is bullish (positive) for a currency, while a weak release would be bearish (negative) for a currency.
- Business Sentiment –Business sentiment, or confidence, is measured in various surveys and indices. Higher business confidence is bullish for a currency, while a drop in business confidence would be bearish.
- Crisis – Unlike other movers, a crisis is almost always unexpected, and for this reason can have a sharp effect on a currency pair. A crisis could be political or financial in nature.
- Elections – Currencies often show volatility around the time of elections. A new government means uncertainty and change, and if the election winner was a surprise, it will likely have a significant effect on the movement of that country’s currency.
- Inflation –There are various inflation indicators, with the most important one being consumer price inflation (CPI). When inflation rises, the country’s central bank may respond by raising interest rates in order to keep inflation in check. As we mentioned earlier, higher interest rates is bullish for a currency.
- Central Banks – Central banks set interest rates, which we have seen has a direct effect on exchange rates. As well, central bank policymakers will issue statements about the economy, and investors place a great deal of significance to these views. Positive or optimistic statements can lift a currency, while negative comments can send a currency lower.
Technical analysis focuses on the price movement of an asset, which in this case is GBP/USD. Traders examine the historical movement of the currency pair through trends and patterns, with the aid of charts and graphs. The identification of patterns is then used to predict future price movement. Technical traders observe parameters such as support and resistance levels, as well as indicators which are based on price or volume.
There are many types of technical indicators, each of which is used to help forecast the future price of a currency pair.
Japanese Candlesticks form patterns that traders use to chart price movement. The candlesticks indicate the open, high, low, and close of a given time period.
Basic Chart Patterns:
Basic Chart Patterns
Advanced Chart Patterns
Triangle Chart Pattern
Ascending Triangle Chart Pattern
An ascending triangle pattern is when a line connecting higher lows merges with a horizontal line connecting the highs. Here, a breakout about the resistance creates opportunities for fresh long positions due to a long-term bullish pattern.
Descending Triangle Chart Pattern
A descending triangle pattern can be seen wherein two lines merge – a trend line connecting a series of low highs and a horizontal line connecting a series of flat lows. Thereafter, there is a sharp breakout below the support line which indicate a bearish phase. Short traders can initiate positions at this point.
Double Top/Bottom Chart Pattern
Double Top Chart Pattern
A double top pattern is a trend reversal with a bearish outlook. It has reached the resistance twice with support at the same neckline. However, a longer breakout downward below the support neckline than the initial rise indicates a trend reversal towards the negative side. Stop loss of any long position must be initiated at this point.
Double Bottom Chart Pattern
A double bottom pattern is a reversal of trend with a bullish outlook. It has rebounded from the support neckline twice and achieved a breakout point above the resistance level. Long positions can be initiated at this point.
Head and Shoulders Chart Pattern
Head and Shoulders Chart Pattern
The head and shoulder chart shows a bullish to bearish trend. A second breakout point below the neckline is deeper than the first upward movement for the first neckline on the left. This indicates a long-term bearish outlook.
Reverse Head and Shoulders Chart Pattern
The reverse head and shoulder chart indicate a bearish to bullish trend. The initial breakout above the neckline shows buying interest along with selloff pressure with the neckline forming the support. Thereafter, a strong upward movement indicates a long-term bullishness.
Triple Top/Bottom Chart Pattern
Triple Top Chart Pattern
It is a triple top pattern chart which means it has formed three peaks with similar resistance levels. However, the breakout below the support level indicates a trend towards the downside and traders should watch before taking any fresh positions.
Triple Bottom Chart Pattern
A triple bottom chart indicates formation of three lows with similar support levels but a strong breakout above the resistance in the third attempt is a sign of a bullish trend. Long traders may initiate positions at this point.
Symmetric Triangle Chart Pattern
Symmetric Triangle Chart Pattern
Two trend lines converging and connecting a series of small highs and lows before breaking out on the higher side. So, there is a period of consolidation before the breakout above the resistance level.
Ascending Channel Pattern with Breakout
Ascending Channel Pattern with Breakout at Upside
An ascending channel pattern with both upward slopes of support and resistance levels. A breakout above the upper line or the resistance indicates bullishness but can also be a stop loss indicator for investors holding short positions.
Ascending Channel Pattern with Breakout at Downside
An ascending channel chart with both upward slopes of support and resistance but a breakout below the lower line of support indicates selling pressure and can be used as a stop loss point for investors holding long positions.
Rectangle Channel Pattern with Breakout
Rectangle Channel Pattern with Breakout at Upside
A rectangle chart pattern with the support forming above past high and a breakout above the resistance. Moreover, resistance level of the rectangle pattern forming the new support level after the breakout indicates a long-term bullishness.
Rectangle Channel Pattern with Breakout at Downside
It is a rectangle pattern chart which indicates it is bound by equal support and resistance pressure. This can also mean indecision for a certain period. A breakout below the support level signals a bearish outlook.
Descending Channel Pattern with Breakout
Descending Channel Pattern with Breakout at Upside
A descending channel pattern with two lines connecting lower highs and smaller lows but a breakout above the lowest high is a sign of upward movement of the price. Long traders can initiate fresh positions at this point.
Descending Channel Pattern with Breakout at Downside
It is a descending channel formation with two lines connecting lower highs and smaller lows. The breakout point below the lowest support level is a sign of a bearish outlook. Short traders can initiate positions at this point.
Pennant Chart Pattern
Bullish Pennant Chart Pattern
A bullish pennant chart with a sharp upward movement in the price with strong volume thereby creating a flagpole and then a period of consolidation with low volume. The subsequent breakout in the same direction as the first flagpole indicate a bullish pennant chart formation.
Bearish Pennant Chart Pattern
A bearish pennant formation wherein there is sharp downward movement in the price which is called the flagpole followed by a period of consolidation. Thereafter, there is a sharp movement in the same downward direction as the flagpole. This indicates a bearish movement with intermittent consolidation.
Flag Chart Pattern
Bullish Flag Chart Pattern
A bullish flag chart pattern that is indicative of a strong bullish trend. There can also be a pennant with a period of consolidation as it refuses to fall significantly due to strong buying interest. The strong breakout above the resistance signals more long positions.
Bearish Flag Chart Pattern
A bearish flag chart indicates a bearish trend with the breakout downward being longer than the flagpole. It also formed a small pennant which denote a period of consolidation or indecision but the long breakout below the support confirms the bearish trend.
Cup and Handle Chart Pattern
Cup and Handle Chart Pattern
A cup and handle formation wherein the cup has a perfect “U” which does not indicate a sharp rebound, but a breakout point from the upper half of the cup formation indicate a long-term bullishness. There are selling pressures while it is testing past highs as investors who bought at these levels look for exits.
Reverse Cup and Handle Chart Pattern
It is an inverted cup and handle pattern indicating a bearish long term, triggering a sell signal. The inverted base of the cup is a typical “U” which does not indicate any sharp rebound and the handle forms almost from the middle of the cup and breaks out from there.
It is important to become familiar with forex indicators. These indicators are your signals forecasting price changes in the market. There are many indicators out there (some can even be contradictory). You will want to choose a few and incorporate them into your trading strategy.
- Moving AverageMoving averages is a popular technical indicator. It is a calculation where you take the average closing price of a currency pair over a certain number of periods. Moving averages help smooth out price fluctuations and better determine the trend direction. In other words, moving averages smooth out price action.
- StochasticsThe Stochastic Oscillator is an indictor based on the theory that during an uptrend, prices will close the high, while in a downtrend, prices will close near the low. This method is useful for generating signals that a currency is overbought or oversold, which can represent an excellent trading opportunity.
- RSIThe RSI (Relative Strength Index) measures the strength or weakness of a currency pair by monitoring recent price gains and losses in comparison with the current price. RSI readings range from 0 to 100. Traders use RSI to indicate a new trend or to determine when a currency might be overbought or oversold.
- FibonacciFibonacci retracement levels are horizontal lines where support and resistance are likely to occur. These levels are based on Fibonacci numbers and in financial markets are based on a percentage. These levels are 23.6%, 38.2%, 61.8% and 78.6%. The theory is that when a currency touches a Fibonacci retracement level, there is an expectation that it will reverse directions, or retrace.
- MACDMACD (Moving Average Convergence Divergence) is a tool used to identify moving averages that indicate a new trend, whether in an upward or downward direction. On a MACD chart, there are two lines, the MACD line and the Signal line. The MACD Line is the difference between two moving averages, while the Signal line is the moving average of the MACD line. The purpose of the Signal line is to smooth out the MACD line. The MACD triggers a technical signal when the two lines cross. If the MACD line crosses above the Signal line, it is a signal to buy the currency. When the MACD line crosses below the Signal line, it is a signal to sell the currency.
- Bollinger Bands Bollinger Bands is a tool which measures the volatility of a currency pair. Bollinger Bands consist of three lines – an upper band, a middle line, and a lower band. The middle line is a simple moving average (SMA). Prices tend return to the middle of the bands, so traders will try to capitalize on this expectation when the price is at the top or bottom of a band.
Forex Trading Strategies
Day Trading Strategy: The Day Trading Strategy features trades that are exited before the day comes to an end. This is a safe strategy especially if you are just testing out the waters since it prevents you from incurring any damage that may occur through the night.
Trend Trading Strategy: The Trend Trading Strategy is straight to the point, and is also one of high-risk, high reward. If you opt for the Trend Trading Strategy, you will need to study the current trend so that you can predict the direction the prices are taking on.
Swing Trading Strategy: The Swing Trading Strategy is usually employed in trades that only last from a day to a week.
These three strategies take the forefront as the easiest to digest and master, ideal for someone starting out. However, more advanced trading styles can even depend on the holding period and time frame of every trade.
Create a trading plan
A crucial step for any business is to create a written business plan. Forex trading should not be treated any differently, which means that you need to have a written forex trading plan in order to maximize your chances of being a successful trader.
A trading plan should include the following items:
- Quick outline of your trading plan – summarize your trading goals and trading style.
- Trading strategy – size of your trade and type of asset (e.g. 10,000 EUR/USD)
- Trading routine – list your time frame and which trading sessions (e.g. 1-day time frame, US market
- Money management – the risk per trade, entry and exit strategies (e.g. stop-loss method)
In order to ensure that you stick to your trading plan, it is best to put it in writing. As you gain more experience in forex trading and determine which methods and strategies are successful, you can make changes to your forex trading plan.
Advantages and Disadvantages to Forex Trading
- Low transaction costs The purchase of a stock often entails exchange and brokerage fees. In forex trading, however, there are usually no fees. Instead, brokers are paid through the bid/ask spread, which is the difference between the buy and sell rates.Suppose the bid and ask for GBP/USD is currently at 1.2528/1.2532. If you decide to purchase pounds, you will pay $1.2532 for one pound. Conversely, if you are buying dollars (selling pounds), you will receive $1.2528 in exchange for selling one pound. In this example, the spread is 0.004 (1.2532-1.2528), which is how the broker makes money on each forex transaction.
- 24-hour market “The forex market never sleeps”. The reason is that the forex market is connected by computers across the globe. This means that forex, which is an “over-the-counter” market, can be traded day or night, across different time zones, 24 hours a day, 5 days a week. This is not the case with other financial markets. Stock markets, for example, are located in centralised exchanges, with set daytime hours in which trading takes place.
- High Liquidity The sheer size of the forex market means that it has high liquidity. Since there is always high demand for forex, a trader will almost never have a problem executing a trade, since there is always another trader willing to take the other side. Other markets may experience liquidity problems. For example, if you own a stock that is falling, there will be many sellers but not enough buyers. This means you could place an order to sell, only to see your order unfilled, as your stock loses value. This scenario is almost unheard of in the forex markets, which means you never have to worry about having your trade not being executed.
- Narrow Scope One of the benefits of forex trading that is sometimes overlooked is the scope of the market. Although the forex market is huge, almost all forex trading involves seven currency pairs. In fact, the U.S. dollar accounts for some 90% of all forex deals. In contrast, the global stock markets list thousands of companies. The New York Stock Exchange, for example, lists 2,800 companies. The narrow scope of forex makes it relatively easy to monitor, despite its huge size.
- Leverage The use of leverage, which we discussed above, means that you can trade forex with a small minimum account deposit. Some trading accounts require a deposit as low as $50.
- Lack of Regulation We mentioned earlier that the forex market is not traded on a centralized exchange. This means that forex is largely unregulated, because it is an international market. Therefore, the responsibility falls upon the traders to ensure that the counterparty will honour its contractual obligation.
- Leverage Forex markets provide maximum leverage, and this should be viewed as a “double edged sword”. Since the forex markets can be volatile, a trader could lose all of their investment in just minutes if their highly leveraged trades go in the wrong direction. It is imperative that traders be fully aware of the risks of leverage before executing actual trades.
- Lack of Transparency Since forex markets are deregulated and driven by brokers, there is the risk of lack of transparency. A trader is dependent on the broker for filling his order and has no control on how the order is being filled and whether he is getting the best price. It is strongly recommended to deal only with regulated brokers.
- High Volatility The forex market is highly volatile, and this can lead to huge movements in currency pairs which could result in significant losses. In order to mitigate risk, traders can use tools such as stop losses.
– value of one country’s currency versus the currency of another country.
– the trading of currencies.
– a method of evaluating an asset’s intrinsic value by examining economic and financial factors, in order to identify trading opportunities.
– a financial contract which obligates the parties to buy or sell an asset at a predetermined future date and price.
– an investment which consists of taking an offsetting or opposite position in a related asset, in order to reduce the risk of price movement.
– the use of borrowed funds for an investment.
– the collateral that an investor is required to deposit with a broker in order to cover the risk that the investors poses for the broker.
– a contract in which the buyer has the right, but not the obligation to by or sell an asset.
– the smallest unit of measurement of a currency pair.
– a contract in which there is a physical exchange of one currency against another currency.
– a method to identify trading opportunities by examining an asset’s historical price trends and patterns.
What is forex?
How do I get started trading forex?
Why is it important for a trader to have a trading plan?
What are the advantages and disadvantages of trading forex?
Advantages – low transaction costs, 24-hour market, high liquidity, leverage, narrow scope.
Disadvantages – lack of regulation, leverage, lack of transparency, high volatility.
The forex market is dynamic and can be highly profitable. At the same time, traders should be aware that forex carries significant risk, due to volatility and high leverage. In order to become a successful trader, it is important to study and gain a solid understanding of the forex markets. A trader should define their goals in trading forex and develop a trading strategy that fits their needs.
Are you ready to dive into the world of Forex Trading?
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