Learning how to trade forex is one of the best ways to tap into the financial markets. Forex, or foreign exchange, trading is the buying and selling of currencies in order to profit from their fluctuations in value.
The foreign exchange market is the largest and most liquid market in the world and has a plethora of opportunities for trading.
In this article, we will learn how to trade forex. We will explain the basic concepts, give you real-life examples, and look at the top 10 forex currency pairs.
Whether you are just starting out or want to refresh your knowledge, this guide will help you find your way in the exciting world of FX trading.
How to Trade Forex: Understanding the Basics
Before venturing into the details of forex trading, it is important to know the basics: trading forex is all about currencies, which are traded 24 hours a day, five days a week.
This means that any trader can buy or sell currencies at any time.
Currencies are traded in pairs: for example, in EUR/USD, EUR is the base currency and USD is the quote currency.
The Size of the Forex Market
The foreign exchange or forex, market is the largest financial market in the world, with an average daily turnover of more than $6 trillion.
This sizeable liquidity allows a trader to enter and exit positions easily. It also means that the market is harder to manipulate, making it a relatively even playing field for all participants.
How to Trade Forex: Key Terms You Need to Know
1. Currency Pair
A currency pair consists of two currencies, one called the base currency and the other the quote currency. For example, in the currency pair USD/JPY, the base currency is the USD and the quote currency is the JPY.
The exchange rate tells us how many units of the quoted currency are needed to purchase one unit of the base currency.
Real-Life Application
If you believe that the price of the euro in dollar terms will rise, you will buy the EUR/USD pair.
You would sell the EUR/USD pair if you believe the price of the euro in dollar terms will fall.
2. Pip
The pip (percentage in point) is the smallest unit of price movement for a currency pair. It is normally quoted to the fourth decimal place, so if the EUR/USD pair moves from 1.1200 to 1.1201, it has moved one pip.
Real-Life Application
For example, imagine you had bought the EUR/USD pair at 1.1200, and then sold it at 1.1210.
The difference of 10 pips is your profit.
3. Leverage
Leverage means a trader can control a larger position with a smaller amount of capital. So, if the brokerage offers 100:1 leverage, you can control $100,000 with $1,000.
The higher the leverage, the greater the potential for profit and the risk of ruin.
Real-Life Application
Trade $10,000 with 50:1 leverage and it requires only $200 in margin. A small price movement against your position can wipe out much of your money.
How to Trade Forex: Getting Started
Choosing a Broker
Choose a good broker with a good reputation. They should offer competitive spreads and a decent trading platform, and they should be regulated by a good financial regulator. This will increase the chances that you will be able to make a profit and that you won’t lose your money.
Once you decide on a broker, you will have to open a trading account where you will need to provide your personal information, identify yourself, and fund the account.
Many brokers will also give you a demo account that will allow you to practice your trades on virtual funds before using real money.
Developing a Trading Strategy
The key to success is to develop a viable trading strategy and stick to it. Your strategy should include rules for entering and exiting trades, as well as specific rules for managing your risks, and also the type of analysis you’ll use.
Common strategies include those employing technical analysis, whereby prices and price patterns on a chart are analyzed, or those that employ fundamental analysis, which takes into account economic indicators and news events.
How to Trade Forex: Top 10 Currency Pairs
1. EUR/USD (Euro/US Dollar)
– The most traded currency pair, known for its liquidity and tight spreads.
2. USD/JPY (US Dollar/Japanese Yen)
– Popular for its low volatility and significant trading volume.
3. GBP/USD (British Pound/US Dollar)
– Known for higher volatility and potential for substantial moves.
4. AUD/USD (Australian Dollar/US Dollar)
– Influenced by commodity prices, particularly gold and iron ore.
5. USD/CAD (US Dollar/Canadian Dollar)
– Affected by oil prices due to Canada’s oil exports.
6. USD/CHF (US Dollar/Swiss Franc)
– Considered a safe-haven pair, especially in times of economic uncertainty.
7. EUR/GBP (Euro/British Pound)
– Reflects the economic relationship between the Eurozone and the UK.
8. NZD/USD (New Zealand Dollar/US Dollar)
– Influenced by commodity prices and New Zealand’s trade relations.
9. EUR/JPY (Euro/Japanese Yen)
– Offers opportunities from both the euro and yen movements.
10. GBP/JPY (British Pound/Japanese Yen)
– Known for its volatility and significant price swings.
How to Trade Forex: Analyzing the Market
Technical Analysis
Technical analysis is the study of charts and the use of indicators to extrapolate future price trends. The most common tools used are moving averages, relative strength index (RSI) and Fibonacci retracements.
Real-Life Application
If a currency pair forms a ‘head and shoulders’ pattern, you might expect the trend to reverse, and you could trade accordingly.
Fundamental Analysis
Fundamental analysis attempts to determine currency value by looking at economic indicators, political events, and public mood.
Indicators include gross domestic product (GDP), employment, and interest rates.
Real-Life Application
For example, if the US Federal Reserve announced that interest rates were going up, then the US dollar would probably strengthen. You could trade pairs such as USD/JPY or EUR/USD to profit from the likely change in these currencies.
Sentiment Analysis
Sentiment analysis can assess the mood of traders and investors in the market.
For example, the Commitment of Traders (COT) report published by the Commodity Futures Trading Commission (CFTC) tracks the positioning of large traders informed and (such as speculators and hedgers) across various futures contracts.
Social media sentiment is another potentially useful indicator.
Real-Life Application
For example, if sentiment indicators show that traders have become overwhelmingly bullish on a currency pair, that could suggest a reversal, or it could simply mean that the trend is likely to continue.
How to Trade Forex: Managing Risk
Setting Stop-Loss and Take-Profit Orders
With such stop-losses in place, you won’t lose many times your stake. And what about all those profits? They’re locked in with a take-profit order. You determine your perfect selling point, and the trading platform executes the order for you.
Real-Life Application
If you buy the pair EUR/USD at 1.1200, you might put a stop-loss at 1.1150 to cut the loss at the level equivalent to 50 pips, and another level at 1.1250 to secure the profit.
Position Sizing
Position sizing is setting the amount of capital you want to risk in a single trade. A common rule is to never risk more than 1-2% of your trading capital per trade.
Real-Life Application
So, if you have a trading account of $10,000, you decide to risk 2% per trade. This means that you risk $200 per trade. Again, it all boils down to risk management to preserve your capital.
Diversification
Diversify your trading across currency pairs. If you were to put all your capital into just one, and that market moves against you, you could lose all of your money.
Real-Life Application
To diversify your risk, you might decide to trade not only EUR/USD, but also USD/JPY and GBP/USD.
How to Trade Forex: Staying Informed
Keeping Up with Market News
While trading forex, a trader must stay abreast of the latest news from the market and any economic events taking place. This information can be found in economic calendars and on news websites.
Real-Life Application
Imagine you look at an economic calendar and notice that a Non-Farm Payroll (NFP) report is scheduled for the next day; You would likely adapt your trades to this report, which often causes substantial market disruptions.
Continuous Learning
The forex market is always dynamic, and you have to learn continuously, to be successful in the long-term. Attend webinars, read books, and be part of a trading community.
Real-Life Application
For instance, if you attend a webinar presented by a professional trader, you will pick up some useful tips on a new style of trading and get an insight into the state of the market.
There are also people who learn how to trade forex, have amazing results, and feel incredibly good about themselves. It’s a lot of fun. You either love it or hate it, but it’s certainly not boring.
Learning how to trade forex can be risky, but it doesn’t have to be. If you learn how to do it the right way, with the right mindset, you can really enjoy trading forex. And you can even make some money doing it. But if you want to start learning how to trade forex, you need to know how to avoid some of the common pitfalls.
You need to know what you’re doing, and you need to do it right. Hopefully, you now have a better idea of how to trade forex. If you follow the steps outlined in this article, you should be able to avoid the common pitfalls of forex trading and start on your journey of learning how to trade forex successfully.
