The forex (FX) market has many similarities to the equity markets. However, there are also some key differences. This article will show you those differences and help you get started in forex trading.
If you've decided to take a stab at forex trading, the good news is that access to the currency markets has never been easier. A wide range of online brokerage platforms offer everything from spot trading to futures and CFDs.
- To settle on a forex broker, do your due diligence and make sure you choose one who can meet your trading needs now and over time.
- Look for low spreads and fees from a provider in a well-regulated jurisdiction.
- Compare the types of trading platforms, trading and analysis tools, access to leverage, and more.
- Before trading, study basic forex strategies and learn how to analyze currency markets properly.
- Consider starting with a demo account to try out and backtest your strategy before risking real money in the market.
Foreign Exchange (Forex) Definition
Choose a Forex Broker
There are many forex brokers to choose from. Here are some things to look for in a forex broker:
Look for Lower Spreads
The spread, calculated in pips, is the difference between the price at which a currency can be purchased and the price at which it can be sold at any given point in time. A high spread indicates a big difference between the prices for buying and selling. A low spread indicates a narrow difference.
Forex brokers usually don't charge a commission. Instead, they make their money on the spread. So look for a lower spread. When comparing forex brokers, you may find a large range of spreads.
Choose a Broker Who's Backed by Regulatory Agencies and a Reliable Institution
Unlike equity brokers, forex brokers are usually tied to large banks or lending institutions because of the large amounts of capital required (leverage that they need to provide).
Also, a forex broker should be registered as a Futures Commission Merchant (FCM) and regulated by the Commodity Futures Trading Commission (CFTC). You can check on this and other financial information and statistics at a forex brokerage website, the website of its parent company, or through BrokerCheck at the Financial Industry Regulatory Authority (FINRA) website.
Get the Tools You Need to Succeed
Forex brokers offer different trading platforms for use by their clients—just like brokers in other markets. These trading platforms usually feature real-time charts, technical analysis tools, real-time news and data, and even support for trading systems.
As part of your broker selection process, be sure to request free trials to test the different trading platforms. Brokers will also provide technical and fundamental information, economic calendars, and other extensive research.
Leverage Your Bets
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 a ratio of 250:1. So give leverage some thought. Bear in mind that while less leverage means lower risk of a margin call, it also means less bang for your buck.
If you have limited capital, consider a brokerage that offers high leverage through a margin account. If you have plenty of capital, any broker with a wide variety of leverage options should do. A variety of options lets you vary the amount of risk you are willing to take. For example, less leverage (and therefore less risk) may be preferable for highly volatile (exotic) currency pairs.
Choose a Broker With Appropriate Leverage, Tools, and Services for Your Capital
Many brokers offer two or more types of accounts. The smallest account is known as a mini account. It requires you to trade with a minimum of, say, $250 and offers a high amount of leverage (which you need in order to make money with this size of initial capital).
The standard account lets you use different degrees of leverage, but has an account minimum of $2,000. Premium accounts, which often require significantly higher amounts of capital, let you use different amounts of leverage and often offer additional tools and services.
Forex Broker Actions to Avoid
Sniping and Hunting
Sniping and hunting are the premature buying or selling of currency near preset points. They are inappropriate activities used to increase profits. The only way to determine the brokers that do this is to talk to fellow traders. There is no blacklist or organization that reports such activity.
Suspect Margin Rules
When you are trading with borrowed money, your forex broker has a say in how much risk you take. As such, your broker can buy or sell at their discretion, which can affect you negatively.
Let's say you have a margin account, and your position suffers a sudden drop before rebounding to all-time highs. Even if you have enough cash to cover the change in value, some brokers will liquidate your position on a margin call at the low. Their action can cost you a significant amount of capital.
Be sure to conduct thorough due diligence prior to selecting a broker. Once you've made your selection, signing up for a forex account is similar to getting an equity account.
The only major difference is that for forex accounts, you are required to sign a margin agreement. This agreement states that you will be trading with borrowed money and, as such, the brokerage has the right to intervene in your trades to protect its interests. That said, once you sign up and fund your account, you'll be ready to trade.
Define Your Method of Analysis
Technical analysis and fundamental analysis are two methods used by forex traders to help them determine when to enter and exit the forex market. Technical analysis is by far the more commonly used.
If you think it's difficult to value one company, try valuing a whole country. Fundamental analysis in the forex market is very complex. It's often used only to predict long-term trends. However, some traders do trade short term strictly on news releases. Fundamental indicators of currency values are released at different times. These include:
- Non-farm Payrolls
- Purchasing Managers' Index (PMI)
- Consumer Price Index (CPI)
- Retail Sales
- Durable Goods
These reports are not the only economic announcements to watch. News coverage of, and press releases from, relevant government agency meetings can also move markets. For example, the Federal Reserve chair's comments on interest rates can cause market volatility.
These regular gatherings involve discussion of monetary policy, interest rates, inflation, and other issues that affect currency valuations.
Therefore, it's important that forex traders be aware of the various economic reports to Congress including those made by the Federal Open Market Committee (FOMC) and the Humphrey-Hawkins Report.
Reading the reports and examining the commentary can help forex fundamental analysts gain a better understanding of long-term market trends. Short-term traders may learn to profit from extraordinary events.
If you choose to use fundamental analysis, be sure to keep an economic calendar handy at all times so you know when these reports are released. Your trading platform or broker may also give you real-time access to the release of economic data.
Forex technical analysts analyze price trends, similar to their counterparts in the equity markets. The key difference between technical analysis in forex and in equities is timeframe. Forex markets are open 24 hours a day.
As a result, certain technical analysis tools that factor in time must be modified for the 24-hour period. Here are some of the most common forms of technical analysis used in forex:
Many technical analysts combine these studies to make more accurate predictions (e.g., the common practice of combining Fibonacci studies with Elliott Waves). Others create trading systems to repeatedly locate similar buying and selling conditions.
Develop Your Forex Trading Strategy
Most successful traders develop a strategy and perfect it over time. Some focus on one particular study or calculation, while others use broad spectrum analysis to determine their trades.
Experts suggest trying a combination of both fundamental and technical analysis in order to make long-term projections and determine short-term entry and exit points. That said, individual traders must decide what works best for them, often through trial and error.
- 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 due to taking on too much leverage. It is important to take your time and learn to trade properly before committing capital.
- Trade without emotion. Avoid 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. Don't change them unless absolutely necessary.
- The trend can be your friend. If you go against the trend, make sure you have a good reason. That's because you have a higher chance of success when trading with the general trend of the forex market.
What Is Forex Trading?
Forex trading is the exchange (or trading) of currencies on the foreign exchange market. Trading occurs in currency pairs such as the EUR/USD (the euro versus the U.S. dollar) and the USD/CAD (the U.S. dollar versus the Canadian dollar). The foreign exchange market is the most actively traded market in the world.
What Does the Spread Represent?
The spread is the difference between the price at which you can buy a currency pair and the price at which you can sell it. The spread is what's quoted for traders. More liquid markets (such as the EUR/USD) will have narrower spreads than less liquid markets. A spread is also one way that a forex broker makes money. The spread the trader pays the broker is more than the spread the broker will, in turn, pay when placing the trade.
What's a Forex Demo Account?
It's an account offered by some firms that let traders and investors test out their trading or investing skills in a no-pressure atmosphere without real money. A demo account lets you simulate real trades and test strategies without the fear of actual financial loss. You also have the chance to get used to the broker's trading platform technology. Beginning and experienced traders and investors use demo accounts.
The Bottom Line
The forex market is the largest financial market in the world with a daily volume of $6.6 trillion. Individuals have become increasingly interested in earning a living trading foreign exchange.
However, there's a lot to consider before you begin trading. You want to be sure that your broker meets certain regulatory and financial criteria. You need to find the right trading strategy for your objectives. Bear in mind that one way to learn to trade forex is with a demo account. Use one to practice trading until you're confident enough to use real funds.