Learning Forex currency trading can seem like a daunting task – I know it was for me when I first started! So that’s why I am doing this Forex currency trading series of posts aimed at beginners. I am not sure how many posts there will be in this series as there is quite a bit to cover, but by the end of it I hope to show you all the ins and outs so that you too can get started trading Forex currencies.
What is Forex
Forex also known as FX, is short for foreign exchange market. It is the market where all open currencies are traded. So if you are watching the news at night and you hear the financial person on the TV say the US Dollar (USD) has gotten stronger or weaker against the Euro, what they are talking about is the global currencies market known as Forex.
The foreign exchange market is the most liquid financial market in the world. Traders include large banks, central banks, institutional investors, currency speculators, corporations, governments, other financial institutions, and retail investors.
The average daily turnover in the global foreign exchange and related markets is continuously growing. According to the 2010 Triennial Central Bank Survey, coordinated by the Bank for International Settlements, average daily turnover was US$3.98 trillion in April 2010 (vs $1.7 trillion in 1998). Of this $3.98 trillion, $1.5 trillion was spot transactions and $2.5 trillion was traded in outright forwards, swaps and other derivatives.
Who Can Trade Forex
Trading in the Forex markets is open to anyone with a Forex account. Accounts are provided by Forex brokers and normally require that you signup with a minimum amount like $500 or $1,000.
Selecting the right Forex broker can be very important as each one will have different advantages over their competitors (I’ll go into more on this later). Regardless of which broker you decide to go with, it is always a good idea to sign up for a free trial so that you can get a feel for how to trade the market before putting any real money on the table.
What Types of Markets are There to Trade?
One of the great things about Forex trading is that there are so many markets to trade. Most brokers offer all the major currencies with some providing access to other interesting markets like commodities and stock market indices.
Here are just a few of the most common markets:
- USD (US Dollar)
- AUD (Aussie Dollar)
- EUR (Euro)
- GBP (Great Britain Pound)
- CAD (Canadian Dollar)
- JPY (Japanese Yen)
- CHF (Swiss Franc)
Then there are commodities like:
And the stock market indices:
- Dow Jones (US)
- Nikkei (Japan)
- FTSE (Britain)
- DAX (German)
- SPI200 (Australian)
- SP500 (US)
What is Leverage and how does it Work?
The way most retail investors trades on the Forex market is by using leverage. Leverage allows you to turn your investment into 10, 100 or even 1000 times what you first invested. So that means that if you invested $1000 you could potentially turn that into $1,000,000 to play with when trading currencies.
Now obviously you aren’t going to want to start off by buying and selling at 1000 times leverage, so depending on your trading style you might be more interested in starting out small and going for longer term trades rather than taking quick profits.
Many people get confused with leverage in the Forex markets and think they might have to end up owing the broker more than their initial investment like can happen with CFDs. This is not true! Your account has a thing called a free margin, and whenever your free margin gets to zero the broker will automatically cut off your account. Your original investment will be gone, but you will not owe anything to the broker.
The people over at investopedia do a far better job of explaining leverage than I ever could, so I encourage you to read their detailed write up here.
How are Currencies Measured?
Currencies are measured with what is known as a Pip.
So, what’s a Pip I hear you asking?
The word Pip stands for Percentage in Point and it equates to 1/100 of a cent (pretty small hey). The reason why leverage is so popular is because Pips are so tiny, and without the use of leverage it would be very difficult to make any money with Forex trading as the currencies trade in such small movements.
Spreads and Broker Profits
Another term you will need to become familiar with if you want to trade currencies is “the spread”. The spread is the difference between the buy and the sell price on any given currency pair. As an example (see the image below) I am currently trading the AUD / USD and the spread is 1.5 pips. The blue line is the ask price and the red line is the bid price.
So if I wanted to buy I would have to pay 1.02862 (the blue) and if I wanted to sell I would have to pay 1.02847 (the red).
Let’s say I decided to buy – this means that I payed 1.02862. For me to now make a profit the bid (red line) has to go above 1.02862 before I will be able to sell at a profit. This is because of the gap in the middle (the spread) between the bid and the ask price.
Note: The spread is also where the brokers make all their money. No matter what spread the broker offers you when you are trading, the broker will always be getting a small percentage each and every time you place a buy or sell order.
Buying and Selling
There is often a lot of confusion when it comes to trading currencies. Many people relate it to the stock market where you have to own stock before you can sell it, therefore you always want the price to rise. Forex is a little different, when you buy or sell you are simply saying which direction you think the price will go. So if you select sell, you want the price to go lower. If you select buy, you want the price to go higher. You don’t have to “own” any of the currency, you just have to pick a direction and then click buy or sell – it’s that easy.
There are hundreds of Forex brokers who would all love for you to sign up with them, and sometimes it an be difficult to tell which broker will best suit your needs. When selecting a broker consider the following:
- What is their average spread per market?
- Will the broker charge you a fee to trade?
- Are there any subscription costs?
- What leverage do they offer?
- How long have they been in business for?
- How many markets do they offer?
- How many servers do they have for you to connect to if one is down for maintenance?
- Do they have any special sign up deals available?
- What do other people say about their service?
- How easy is it to get your money back out again?
Stay tuned for part 2 where I will take you through the application I use to trade Forex as well as the signals I use to help me decide which way to trade.
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