Forex is short for “foreign exchange,” and it's often referred to as FX. Trading forex refers to the buying and selling of currency pairs on the official forex market across the globe. This is the biggest and most liquid financial market on the planet with a daily average volume of $7.5 trillion dollars.
A couple of decades ago the forex market was where governments, central banks, commercial banks and various financial institutions were trading currencies. As the technological revolution swept across the world and the Internet became an integral part of households, the forex market opened up to individual investors as well. Millions of retail traders have the opportunity these days to trade different currencies from the comfort of their home. All they need to do is open an account at an online forex broker and they can start their forex journey.
Essence
- The forex market is the biggest and most liquid financial market in the world
- The forex market is open 24 hours a day in different parts of the world
- Currencies are always traded in pairs on the forex market
- The value of a currency relative to another currency is expressed by the exchange rate
- Forex traders use leverage (borrowed capital) to increase the size of their trades
- Developing your own strategy is crucial in forex trading
The basics of forex trading
If you are a beginner investor embarking on the forex trading journey, the forex universe may seem confusing and difficult to understand. Learing forex is a long process, therefore you need to invest much time to be successful in this field. We are here to help you see clearly. Let's go through some basic concepts.
Where is forex traded?
Forex transactions are conducted on the foreign exchange market, which is a global decentralized market for the trading of currencies. By decentralized we mean the market is not controlled by any authority or government.
The forex market is open 24 hours a day in different parts of the world, from 5 p.m. EST on Sunday until 4 p.m. EST on Friday. This is a unique feature of the forex market; for instance the US stock market is only open 6.5 hours a day on weekdays.
Because it's a globally interconnected, the forex market is the largest financial market. The sheer size of the market and the fact that it's continuously open are attractive features for beginner investors. Regardless of where you are located in the world, you can trade forex; all you need is a stable Internet connection and the FX market is open to you through your broker. This gives you a high degree of freedom, which is also highly appealing.
The fact that the forex market is characterized by high liquidity also lends it a degree of security becasue it is difficult to manipulate.
How is forex traded?
When you trade forex you buy one currency and sell another currency at the same time. This means that in a forex transaction, you always trade a currency pair, never a single currency. Your profits are made when you “Buy” or “Sell’ a currency and benefit from movements in the currency exchange rate.
If you buy EUR/USD, you will buy EUR and sell USD. The first listed currency in the currency pair is called the base currency, and the second currency is called the quote currency.
There are three main categories of forex pairs (crosses): majors, minors and exotics.
- Majors consist of the world’s biggest currencies against the US dollar and make up around 85% of forex trading volume. The majors are EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF and USD/CAD
- Minors are all the other combinations of the world’s biggest currencies excluding USD, such as EUR/GBP and AUD/JPY. These are also often referred to as major cross pairs
- Exotics are pairs that include less-traded currencies, such as the Mexican peso (MXN) or Turkish lira (TRY) to name buit a few.
The value of a currency is expressed by the exchange rate. Think of it as the price being charged to purchase that currency. If the exchange rate of the EUR/USD is 1.10000, it means that 1 euro is worth 1.10000 U.S. dollars. When the exchange rate of the EUR/USD changes (i.e. it moves up or down), forex traders use a special unit of measurement to express the change. This is called a pip. Generally, one pip movement is a change in the fourth decimal of the exchange rate.
Here's an example to illustrate this:
Let's assume the current price of EUR/USD is 1.10000. If the price increases to 1.15000, you will be able to buy more USD with 1 EUR. In other words, the euro gets stronger against the dollar as the same 1 euro can now get you more dollars than before. Conversely, if the price decreases to 0.90000, it means the euro is getting weaker against the dollar. At this exchange rate, the same 1 euro can only get you 0.90000 dollars.
The exchange rate of most major currencies moves in a tight range within a trading day. This is because forex is the most liquid market. Exotic currency pairs have lower liquidity, therefore their exchange rates trypically move in a wider range.
When you open a position to trade a currency pair, you will see two prices: the bid price and the ask price. The bid price is the price at which you can sell a position. The ask price is the price at which you can buy a position. The difference between the two prices is called spread. In forex, spreads are generally spreads are lower than in stocks.
When you decide to open a forex position, you need to decide the amount of money you will invest in that single trade and this is given in lots. In other words, a lot in forex is the unit used to measure the size of a transaction amount.
Forex traders do not trade only with their own money, they typically borrow money (called capital) from their broker so that they can execute larger transactions. The use of borrowed money to trade currencies is called leverage. The concept of leverage is very common in forex trading and the level of leverage available is higher than when you trade stocks, for example. At first glance, this sounds appealing but leverage is a double-edged sword: while it can significantly increase your profits, it can also multiply your losses.
If all this sounds confusing, do not despair: it's a lot of information but with time and practice you can learn forex trading. If you are a beginner, the best way to practice forex trading and sharpen your skills is to open a demo account at a forex broker and start trading with virtual money. You will not risk your own capital while you experiment with buying and selling currencies. Opening a demo account is free of charge. Check out our top list of the best forex brokers in the world, updated each year by our brokerage analysts after testing their services with real money. Most of these brokers offer a demo account.
Alternatively, take a look at our forex glossary to learn the most common forex terms.
Strategy building and risk management
Even as a beginner, it is essential to have a strategy when you trade forex. A forex strategy will tell you decide when or where they should buy or sell a specific currency pair. There are many different simple forex trading strategies, but there is no such thing as the “best” or most successful forex trading strategy, as each may work differently under certain conditions.
The three most popular forex trading strategies are trend following, scalping and carry trade.
- Trend following: Trend following strategies, as the name says, follow the main trends, or direction, in the value of an instrument. The goal of this strategy is to cut losses quickly while letting winning trades continue to run further.
- Scalping: Scalping strategies are about catching small market movements with large positions within a very short time. This is characterized by executing a large number of trades, so it is completely the opposite of holding positions for hours, days, or even weeks.
- Carry trade: Carry trade strategy is about buying a high-interest-rate currency against a low-interest-rate currency. The profit comes from the difference between the high interest you receive and the low interest you pay, plus the favorable exchange rate movement.
Here is step-by-step example for a trend following strategy.
Every strategy should be uniquely tailored to each forex trader, adapting it to the individual's risk profile, emotions, mental state, motivation, daily schedule and trading time. A strategy to trade forex cannot be simply copied from someone else: you have to use parts from here and there, and put it together like a puzzle, optimizing it into a forex trading strategy that works for you. This can be quite a long process.
Risk management in forex
Forex is a risky type of investment. There are many risks that you will be facing during trading: interest rates, inflation, volatility, the use of leverage, use of platform, etc. Every time you open a trade, you are faced with risks with should be managed. A basic means to manage the risks of your trade is to use Stop-Loss in order to cut your losses should the market go against your trade. As a beginner, we recommend being extremely careful with leverage, as using high leverage can lead to massive losses. Practicing with a demo account is a useful tool to simulate your trading activity without risk.
You can also manage risk by having a trading diary and a mental diary. A trading diary helps you record your trades and measure your performance. A mental diary helps you keep track of how you reacted to different trades emotionally. With time, your past performance and your psychological reactions will teach you a great deal about your own risk tolerance.
Pro tips for beginners
Here is a list of action steps you should take as a beginner to become familiar with trading currencies and to avoid the most common pitfalls:
- Learn the basic concepts of FX trading
- Choose a reliable FX broker with top-tier regulation
- Learn how to use the MetaTrader platform, which is the most common trading platform in the forex universe
- Use a demo account to practice and to develop your strategy
- Your demo account should have the same currency and capitall with which you will be trading in live so that you can get accustomed
- Write a trading diary to track your performance
- Keep a mental diary to manage your errors caused by psychological factors
- Always use Stop-Loss in your trades
FAQ
Is forex trading good for beginners?
Forex trading is a complex form of investment and it comes with a high number of risks. Beginners need to educate themselves before engaging in forex trading or they risk losing their moeny. Make sure you learn the basics of forex trading and understand a few forex strategies before you start trading. The best way to practice forex trading is to open a demo account at a forex broker and simulate trading with virtual money. Having a demo account is free of charge, you will not have to deposit real money into your account. Overall, exercise a lot of caution as the probability of losing money when trading forex is high.
Can you trade forex with $100?
You can definitely trade forex with as little as $100. If you are a beginner, it's probably best to get a start in forex trading with a smaller amount. Most forex brokers will allow you to open smaller positions. In addition, if you use leverage, you can multiply the amount you invest.
Can you get rich by trading forex?
Although forex trading can be highly profitable, it is by no means a guarantee that you will get rich. In fact, statistics show that the vast majority of people trading forex lose money. You will need to dedicate a lot of time and effort to become skilled at forex trading. Skilled traders do make money trading forex but this does not take place overnight.
