Forex is the world's largest and most liquid market, with a daily trading volume of over $3.2 trillion. Governments, banks, international corporations, hedge funds, and individual traders trade fx 24 hours a day.
Professional fx traders take advantage of fluctuations in currency prices to make a profit. They analyse the market to work out whether a forex pair will go up, down or sideways, and place trades accordingly.
This trading guide covers the important topics and principles you need to understand in order to trade fx.
Forex trading with leverage
Most forex traders use leverage, also known as margin trading, to maximise their capital. When trading on margin, the fx trader places a deposit, or margin payment, with their broker, in return for greater market exposure. This is useful when trading fx because currencies generally only fluctuate by very small amounts. In order to make large profits, forex traders need to open large positions.
The amount of margin required depends on the broker and the size of the position. Typical leverage ratios include 50:1, 100:1 or 200:1. For example, to trade forex valuing $100,000 with a leverage ratio of 100:1, the trader puts up 1% of the total trade value, or $1,000, as margin. This gives the trader full exposure to any profits or losses on the trade.
FX currency pairs
All successful forex traders need a solid foundation of knowledge and research upon which to build. One of the most important aspects of this is an understanding of forex pairs and how you will use them in your trading.
Fx trading means exchanging one currency for another - and for this reason, all currencies are quoted pairs. Every forex pair has a base currency, which is listed first, and a quote currency (which is listed second. An fx quote shows you how much of the quote currency you need to purchase one unit of the base currency. For example, the GBP/USD exchange rate indicates how many US dollars can purchase one British pound, or vice versa. If you see the quotation GBP/USD 1.5727. This means that that one British pound is worth 1.5727 US dollars.
There are several types of currency pair, including majors, minors and crosses.
To trade fx successfully, you need to develop an understanding of the fundamentals that make currency prices fluctuate. Currency values are closely related to the economic welfare of the countries that issue them. For example, if the economic forecast for the United States is improving, it's likely that the U.S. dollar (USD) will strengthen as forex traders purchase dollars. However, if U.S economic fundamentals in the United States are declining, the U.S. dollar is likely to weaken as forex traders sell their dollars.
There are three groups of important fundamental economic indicators:
- Interest rates - the interest rates set by a country's central bank dictate a currency's yield, and its attractiveness to investors
- Economic strength - the stronger the economy, the higher the interest rates and the more attractive its currency becomes to investors
- Capital and trade flow - trade flow dictates whether foreign companies need to purchase a currency in order to conduct business transactions
By watching these economic indicators closely and comparing them across currencies, you will be able to make informed decisions about which currency pairs to trade.
Trends tell you where prices will most likely be going in the future. You can use the charting package in your trading platform to examine previous trends and identify highs and lows. This will help you decide whether to buy or sell your currency pair.
Support and resistance
These are areas where prices may stop and turn around in the future. Knowing support and resistance levels helps you enter and exit trades at the most profitable times.
- Support is the price level at which a forex pair tends to stop moving down before turning around to start moving back up.
- Resistance is a price level at which a forex pair tends to stop moving up and before turning around to start moving back down.
Online and mobile trading platforms
Most forex traders opt for online trading platforms, such as MT4.
You can download MT4 for free and start your forex trading immediately. MT4 is one of the best-known trading platforms in the world, and is recognised for its advanced charting package and user-friendly interface. It is particularly well-suited to fx trading as it allows you to download raw data, indicators, and charts. You can also integrate quotes into Excel, range bars, databases and custom charts/indicators.
Another increasingly popular way of trading is mobile trading. You can download an MT4 app onto your mobile phone and trade fx wherever you are.
Placing a forex trade
Placing a trade in the foreign exchange market is simple: once you have done your research and decided whether you expect your chosen currency pair to rise or fall, you simply log on to your web trader and select the currency you wish to trade.
You will notice that all forex quotes are quoted with two prices: the bid and ask. The bid is the price at which your broker is willing to buy the base currency in exchange for the quote currency. The ask is the price at which your broker will sell the base currency in exchange for the quote currency.
So, how do you know whether to buy or sell? Well, if you believe the base currency will strengthen in relation to the quote currency, you should buy. This is also known as taking a "long" position. If you think the base currency will weaken relative to the quote currency, then you should sell. This is also known as taking a "short" position.
When trading forex on margin, you are exposed to both large profits and losses. To minimise the effects when the market moves against them, experience forex traders use stop-losses. A stop-loss is an order that exits your trade if the forex pair reaches a specified price point, protecting you if the market moves any further against you.
For example, if you buy an fx pair, placing a stop-loss order somewhere below the current price will protect you in the event the forex pair starts moving lower. If you sell a forex pair, placing a stop-loss order somewhere above the current price will protect you if it starts moving higher.