Learning to trade in the Forex market can seem like a daunting task when you're first starting out, but it is not impossible. Here we will cover the preliminary steps you need to take to find your footing in the FX market.
The Eight Majors
In no specific order, the eight currencies every currency trader should know are the U.S. Dollar (USD) or "greenback", British Pound (GBP) or "cable", Japanese Yen (JPY), European Euro (EUR), Swiss Franc (CHF), Canadian Dollar (CAD) or "loonie", and the Australian/New Zealand Dollar (AUD/NZD). Currencies must be traded in pairs, and there are 18 different currency pairs that are conventionally quoted by forex market makers, including USD/CAD, EUR/USD, USD/CHF, AUD/USD, GBP/USD, NZD/USD, and USD/JPY.
Yield Drives Return
In every fx transaction, you are simultaneously buying one currency and selling another. Since every currency in the world is attached with an interest rate set by the central bank of that currency's country, you are obligated to pay the interest on the currency that you have sold, but you also have the privilege of earning interest on the currency that you have bought. For example, assume that New Zealand has an interest rate of 8% (800 basis points) and that Japan has an interest rate of 0.5% (50 basis points). If you decide to go long NZD/JPY, you will earn 800 basis points in annualized interest, but have to pay 50 basis points for a net return of 7.5% or 750 basis points.
Low Spreads Save Money
The difference between the price at which a currency can be purchased and the price at which it can be sold is called the spread. It is calculated in "pips", and this difference is how Forex brokers make their money, since they don't charge commission. In comparing brokers, you will find that the time spent shopping around is worth it, as the difference in spreads can by very large. Read How To Pay Your Forex Broker.
Look For A Reliable Institution
Forex brokers are usually tied to large banks or lending institutions because of the large amount of leverage they need to provide. Also, forex brokers should be registered with the Futures Commission Merchant (FCM) and regulated by the Commodity Futures Trading Commission (CFTC). You can find this and other financial information and statistics about a forex brokerage on its website or on the website of its parent company.
Proper Tools = Success
Forex brokers offer many different trading platforms for their clients - just like brokers in other markets. These trading platforms often feature real-time charts, technical analysis tools, real-time news and data, and even support for trading systems. Before committing to any broker, be sure to request free trials to test different trading platforms. Brokers usually also provide technical and fundamental commentaries, economic calendars and other research.
Keep Leverage Options Open
Leverage is necessary in forex because the price deviations (the sources of profit) are merely fractions of a cent. Leverage, expressed as a ratio between total capital available to actual capital, is the amount of money a broker will lend you for trading. For example, a ratio of 100:1 means your broker would lend you $100 for every $1 of actual capital. Many brokerages offer as much as 250:1. Remember, lower leverage means lower risk of a margin call, but also lower bang for your buck (and vice-versa).
Avoid Shady Brokers
Sniping and hunting - or prematurely buying and selling near preset points - is used by shady brokers to increase profits. Of course, no broker will admit to committing these acts, and there is no blacklist or organization that reports such activity. Secondly, when you are trading with borrowed money, your broker can buy or sell at its discretion, even if you had enough cash to cover. If your position takes a dive before rebounding to all-time highs, some brokers will liquidate your position on a margin call at that low. The only way to determine which brokers do this and which brokers don't is to talk to fellow traders.
Fundamental Analysis Vs. Technical Analysis
Every Trader is different, but the best trading style is probably a combination of both technical and fundamental analysis. Smart traders will always be aware of the broader fundamental picture while using their technicals to pinpoint good entry and exit levels. Fundamental indicators include the consumer price index (CPI), retail sales, and durable goods. In addition, meetings held by the Federal Open Market Committee can cause market volatility. Technical analysis is most popular among forex traders, common forms include the Elliot Waves, Fibonacci studies and pivot points. For more, see The Fundamentals Of Forex Fundamentals.
Define A Forex Strategy
The FX market offers multiple avenues to trading success, but in order to take advantage of these opportunities, you must first understand your strengths and weaknesses. Are you more comfortable with short-term or long-term time frames? How will you use fundamental and technical analysis? For more on devising a forex strategy, read Trade To Your Taste.
Practice Makes Perfect
Forex is a decentralized market in which dealers distribute their own price feeds through proprietary trading platforms. As such, it's important to learn the features of each type of trading software before committing real funds to an account. Open a demo account and paper trade until you can make a consistent profit. Many people jump into the forex market and quickly lose a lot of money (because of leverage). It is important to take your time and learn to trade properly before committing capital. The best way to learn is by doing. For more, read Demo Before You Dive In.
Trade Without Emotion
Don't keep "mental" stop-loss points if you don't have the ability to execute them on time. Always set your stop-loss and take-profit points to execute automatically, and don't change them unless absolutely necessary. Make your decisions and stick to them.
The Trend Is Your Friend
If you go against the trend, you had better have a good reason. Because the forex market tends to trend more than move sideways, you have a higher chance of success in trading with the trend.
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