What Is the Forex Market?
Forex (FX for short) is the market where currencies are traded against each other. It is one of the most popular markets to trade, especially for a beginner. It is easy to start trading with a relatively small account with a wide range of brokers that offer competitive trading commission.
Additionally, the market is open 24 hours a day from 22 GMT on Sunday until 22 GMT on Friday. This allows trading no matter what part of the world you are located in. The busiest hours, however, are considered to be the overlap of the London trading session and US trading session from 1 pm GMT until 4 pm GMT. Read more about trading sessions here.
The forex market is mainly used as a tool to exchange value in order to do international trade between countries with different currencies. An easy example would be a purchase from a US-based company while living in Europe and earning euros. First, you purchase the US dollar by selling your Euro and only then you purchase the good. On a larger scale, this is done by large multinational companies and banks.
Furthermore, the forex market as we know it today is relatively new, however, it has a long history in the most basic form of exchanging one currency against others. A significant event in the development of the modern Forex market was the collapse of The Bretton Woods System in 1971. Once President Richard M. Nixon temporarily suspended the dollar’s convertibility into gold, the system collapsed and an end was put to controlled exchange rates. Hence, the current system of Forex trading was established around 1973 with the exchange rate set by market participants from then on.
For additional reading on what is Forex, visit: https://www.forexpeacearmy.com/forex-books/42/chapter-1-part-i-forex-what-is-it-forex-military-school
Forex vs Stock market
First of all, Forex offers a much lower barrier to entry as you can start with as little as 50 USD on some brokers. This is a great opportunity for trading beginners as they can practice while still having little money on the line.
Additionally, Forex market trades 24 hours from Sunday to Friday and eliminates the need to wait for the market open every day at a specific time as in the stock market. Another great way for beginners to practice their trading skills in a much more dynamic market.
Further, the transaction costs are much lower and amount to around 0.02-0.05% on major pairs and slightly more on less known pairs. Most brokers only take a bid-ask spread as their only way of income from providing you access to the market. In contrast, the stock market brokers usually take an additional fee in addition to having a much larger spread.
Another huge factor is the size of the market – it simply cannot be manipulated in a way that a stock market can as there are so many different market participants that trade every day. Large market participants such as multinational companies are not trading to make money in the market, they do it to hedge their currency reserves.
Types of Forex Pairs
Forex pairs are typically divided into 3 categories: Majors, minors, exotics.
When considering Forex trading for beginners, the best option is to stick with the majors at first as they are the most traded and offer the best trading conditions such as: tighter spreads, higher liquidity, and better execution times.
Majors currency pairs consist of USD traded against other popular currencies. The four majors are usually considered to be the EUR/USD, USD/JPY, GBP/USD, USD/CHF as each of the respective currencies are among the most traded. Additionally, 3 more so-called “commodity pairs.” Are added to the list and consist of: USD/CAD, AUD/USD, and NZD/USD.
Next, the minors or cross pairs are made up of previously mentioned major currencies, however, without the use of USD. These are pairs such as AUD/JPY, GBP/CHF, EUR/GBP among others. These pairs are great to trade without having to think about what the USD is doing. This allows to look for additional trends among other major currencies and offers a much more variety. Mostly, however, these pairs have a slightly higher cost of trading.
Exotics are the most difficult to trade profitably as they consist of only one major pair and one less known “exotic” currency. This means trading pairs such as EUR/SEK, USD/ZAR or USD/HKG among others. The difficulty arises from the fact that the spreads and volatility are much larger and liquidity is much lower. Combine this with excessive leverage and you can ruin your trading account quite fast.
How do quotes work and what is spread?
When looking at the trading terminal, both ‘Bid’ and ‘Ask’ prices are quoted. The bid is effectively the price that the broker will buy a position as, while the Ask is the price at which the broker wants to sell you the currency pair.
The difference between these prices is called Bid/Ask spread or simply spread and it is how the broker makes money. This often is the only commission that you pay to open a trade as you have to pay, therefore, as long as the spread is not too high, it is perfectly fine.
Factors such as trading volume, volatility and liquidity of the market are factors that influence the spread that you are getting offered at any time. During increased volatility be prepared for a sharp increase in the spread offered, especially among pairs that are less traded by volume such as previously mentioned minors and exotics.
Order types in FOREX
Market order – the simplest and fastest order to use. It’s used to immediately buy or sell at the best market price or above it. Usually used at the moment when the price has already reached a specific price level. This, however, requires to manually wait for the price action development.
Limit order – used to open a position at a price that is than the current price. The main advantage of this is that you can enter a market once the price moves against the desired entry direction, therefore, providing a better entry. Usually placed at an important support or resistance level with the expectation that the price will reverse after t is tested. Take Profit Order is a type of limit order that effectively closes your position once the price reached a specified price level. Especially, good if clear target levels are seen.
Stop order – Usually used in order to enter once a breakout above or below a specific price level is made. Alternatively, this is used as a stop-loss and allows to quickly cut losses once a predetermined price level that invalidates a trade setup is reached.
More on this topic can be read here: https://www.forexpeacearmy.com/forex-books/63/chapter-5-part-v-order-types-in-forex
What is Leverage?
Leverage allows you to take a much larger position size than a regular purchase of the currency. Essentially, you borrow money to increase your position size and, therefore potential profit, however, also risk.
An easy example of this would be a 1:10 leverage which means that a trader can enter a position that is 10 times as large if he chooses to do so. Instead of having a deposit of 10,000 USD, the trader only needs to have 1,000 USD in his trading account. This means that you gain 10 times as much when looking at a percentage of capital that you have.
Leverage is best used in markets that are not volatile enough to provide a large return, otherwise, a large part of your bankroll can be lost as only a 5% move to the downside can wipe out 50% of your capital if 1:10 leverage is used. Therefore, this is an important factor to consider before the trade is made. The best approach is to calculate how much you would lose if your stop-loss is hit and adjust your position size and, therefore, leverage used accordingly.
Types of market analysis
Forex trading for beginners can be confusing. They are yet to learn how to analyze the market in a clear way that suits their own trading style. Having a good analysis of the market, however, is crucial. Therefore, the beginner should learn both technical and fundamental analysis as both have their benefits.
Technical analysis focuses on what the price action is doing by using charting tools. You can manually set important price levels by looking at what the market has done before. The basic charting tool that technical analysts use are support/resistance levels as well as trend lines There is great power in sticking to these easy to determine and use price levels, however, if additional help is needed, choose an indicator. One of the most popular indicators is the Moving average – it creates a line on the chart that displays the average price for a predetermined set of time. An example of this would be a 100-day moving average (MA) that displays the average price for the past 100 days.
Fundamental Analysis, however, tracks real-world events and news such as interest rate changes or economic indicators such as changes in the Gross domestic product (GDP) or Non-Farm Payrolls (NFP) among others. This can lead to both long-term and short-term price moves. News events usually cause large price moves and leads to increased spread that can reduce potential risk/reward. Additionally, slippage in the price and delay in trade execution adds additional hidden costs to trading during news events.
Trading timeframe that suits your style
Intraday trading focuses on daily price moves and usually means that the trade is opened and closed within the same day. Major trading sessions are usually where most of the price action takes place, therefore, those are the times that you should dedicate to the market. Trading this way requires a lot more time and effort, however, it can be quite rewarding as profits are made in just a couple of hours.
Swing trading, however, is a medium-term approach and is best suited for those who do not have the time to follow the market all day. Trader scans the market for past developments only daily or every few hours. This style, however, can be stressful if a large position is taken overnight.
Some things a beginner trader should avoid
Adding too many technical indicators – 1 or 2 basic ones will work the best
Trading against the trend – the probability of winning trade is much better when following the overall market movement, therefore, zoom out and take a look at what the bigger picture is telling you.
Not paying attention to the fundamentals – Important ones such as interest rates can cause markets to reverse in a major way.
Trading at the time of market news releases – increased spread, volatility and potential slippage in price are not worth it for beginners.
Using too much leverage – this can amplify your return, however, it can lead to an empty trading account very fast.
Additionally, keep a trading journal to learn from previous mistakes and successes.
Forex trading for beginners can cause a lot of question, hopefully, this article helped to clear some of them and guide you into further research. The foreign exchange market (FOREX) is a global round the clock marketplace for trading currencies against one another. It is the largest and most liquid asset class in the world. Therefore, a great opportunity for beginners to learn to trade as it only stops during weekends and major holidays.
The first place to start is usually a demo account or, alternatively, a small real money account that most brokers offer. There is no reason to start with a large account and lose all of it before you are familiar with the market. After you get more confident – slowly add more trading capital and increase your position sizes.