How to Trade Forex – Master the Art & Skill of Forex Exchange Trading
Financial markets have become interesting for retail traders ever since online trading sprung onto the scene. With the ever-increasing availability and penetration of the internet comes the expansion of the retail trading community. Forex, or foreign exchange trading, is the biggest and the most popular trading arena. Over five and a half trillion dollars changes hands worldwide daily.
Traders from all over the world buy and sell currencies for various reasons. Some, like central banks, to implement their monetary policies. Others, like commercial banks, execute their clients’ orders. And then there are some people who speculate on the value of a currency. They are known as traders.
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Learn How to Trade Forex from the Experts
Traders come to the forex market for various reasons, but with the same purpose: to make money. They start trading forex expecting a currency pair to move, and to make a profit from that move.
Unfortunately, the forex industry is advertised as an easy way to profit from the currencies’ swings. As such, retail traders come unprepared, and more often than not, they end up losing the funds in their trading account before realizing what happened.
Statistics don’t lie: over 85% of retail traders lose their first deposit.
Only after that happens, do people start investigating how to trade foreign currencies. For some, it is too late, and they never try again. Although, others like the way the market moves and the endless possibilities that exist to make a profit.
Moreover, they like the adrenaline and the fact that that every day is different. Understanding financial markets comes with a price (e.g., the market never sleeps), but it also has some great rewards.
What is Forex Trading?
There is no one single currency in the world. Countries have currencies with different values. There are strong and weak currencies, as well as those which fluctuate a lot.
Traders use various tools to understand how a currency’s value changes, and to profit from that change.
What would you do if you found out the euro will move up in the next six months? You’d want to buy it, of course.
If indeed, it appreciates over the course of the next few months, you can sell it at a higher value. The difference represents the profit.
However, this is a two-way street. The risk is that you might be wrong, and the euro, in fact, will depreciate, or lose value. Here the outcome is that the trading account will reflect that difference by showing a loss.
The purest form of speculation comes from traders that go in and out of the market multiple times a day. They use beginner or advanced currency trading strategies to buy and sell a currency pair.
Because the forex dashboard presents the currencies paired against another, the move on one is reflected in the value of another. Using the same example as above, the euro may rise, but against what currency?
If it rises against the U.S. dollar, then the EURUSD pair moves to the upside. Traders bought the EURUSD pair and sold it in the aftermath of a rising movement. As such, they made a profit.
But the same can be said about the U.S. dollar. It fell against the euro, and traders that spotted that move made a profit too.
Factors That Influence the Forex Market
The process of learning how to trade forex starts with understanding its driving forces.
Why do currencies move?
They move for a reason, and there are two main categories: technical and fundamental.
Some traders believe the truth behind a currency pairs move lies within its chart. They analyze the part prices to forecast future ones.
In doing that, they use technical analysis tools like indicators and oscillators, but also trading theories developed in the past. Traders identify places or areas where to buy or sell a currency pair based on the technical analysis interpretation.
Fundamental traders, on the other hand, interpret the economic news. Because the currencies are paired, the value of a pair reflects the strength and/or weaknesses of the two economies.
Therefore, traders compare the two economies in a currency pair to spot the stronger or, the weaker one. Based on their findings, they buy or sell that respective currency, via the desired currency pair.
Lets not forget real money flow, companies and people buy and sell goods from eachother all over the world and this makes currencies move also. Lets take a merger for example. If Fox or Comcast want to buy SKY they may need to do it in the local currency. This would make GBP/USD move as the order would need to be factored in the market.
But the retail trading size in the overall forex market is literally insignificant. Only about six percent of the daily trading volume belongs to retail traders.
It means other players in the market move the price of a currency pair. Do they use technical and fundamental analysis too?
Some of them do. Large investment firms have huge trading departments dedicated to the currency market.
They analyze the market from both a technical and fundamental point of view and express the result by buying or selling currency pairs.
Central banks are important players. Through the decisions they implement, they influence the value of a currency.
The main tool they have is the interest rate. When central banks meet to examine the state of an economy, they set the so-called monetary policy for the period ahead.
In plain English, they set the interest rate. Higher rates imply a stronger currency; lower rates result in a weaker one. Therefore, traders monitor central banks’ activity to buy or sell a currency based on the interest rate evolution.
Finding the Right Broker
Besides the entities mentioned above, forex brokers are significant players in the industry. Depending on their structure, they actively buy and sell on their own, more than once – many times even.
There are many types of forex brokers, depending on the technology they use and the way the brokerage house is organized. From market makers to ECN (Electronic Communication Network), brokers represent the middle-man between the retail trader and the interbank market.
Because retail traders can’t tap the interbank market on their own (it is too expensive), they agree to pay the forex broker a commission/fee for this service. On the other hand, the broker gives access to the interbank market and even lends traders some money.
The forex market is based on leverage. The bigger the leverage, the more significant the risk.
Leverage refers to the physical amount moved on the market. For example, in a trading account with a 1:400 leverage ratio, the trader moves four hundred times more money, thanks to the broker.
But forex brokers also trade against their clients. Not all of them, but some do.
While not illegal, it raises an ethical problem few retail traders like to live with. The right broker should have the following:
Low and Stable Spreads: Spreads are the difference between the ask and bid price (the price you buy or sell a currency pair), and they vary wildly. They represent a cost for the end-trader and a source of income for the broker. As such, some forex brokers use the spreads as a tool to trip some stops in a trader’s account or to earn some more when volatility rises.
Regulation: Unregulated brokers should be avoided. Forex traders must research a broker before opening a trading account and look for it to be regulated. In each part of the world, major regulators watch over brokers’ practices. To comply with a financial regulator’s conditions, they must follow some guidelines. The main idea is that the customer will be protected in case the brokerage business goes wrong. Typically, the funds are guaranteed by the financial authority up to a certain amount (e.g., 50.000).
Various Types of Trading Accounts: It should offer the possibility of trading small amounts of money, in a micro-account that uses micro-lots. Also, it should provide the opportunity for big traders to open trading accounts based on the latest possible technology (ECN, STP – Straight Through Processing, etc.).
Multiple Liquidity Providers: Liquidity is a problem for a forex broker because it comes at a high cost. Therefore, having more than one liquidity provider raises the operating costs, and limits the profitability. Moreover, the spreads will increase significantly during less liquid times in the market (e.g., at the end of the trading day when positions roll-over) if only one liquidity provider exists.
All the Possible Ways to Fund a Trading Account: Nowadays there are so many possibilities to fund and withdraw money from a trading account, and brokers should offer them all. Look for wiring options, credit and debit cards, and other online methods. However, check the associated costs, because this is an area where brokers add unrealistic fees to such operations.
Trading Strategies in the Forex Market
One of the best ways to test the potential of the forex market is to open a demo trading account. Brokers around the world allow the opening of a demo account to check their services.
And, in the end, this is good practice for the retail trader too. As such, traders become familiar with the spreads and their evolution during the release of an economic event, but also with the trading indicators offered.
Most of the brokers use MetaTrader4, which is the most popular trading platform for retail traders. In this case, getting familiar with the platform on one broker gives you the knowledge to use the same platform on another.
But some brokers (especially the big ones), have their own trading platforms. They’ve built the platform in-house and using a demo account can give you an insight into what it can do.
However, be aware of demo accounts as they have two main drawdowns:
The Psychological Component: That is, emotions don’t exist. Because traders know the account is not real, the fear of losing or the greed to close a position and book the profits doesn’t exist. But this is the main reason why trading is so hard, and why even after trading on a demo account, switching to a real one is tough for most traders.
Don’t Reflect Reality: Some demo accounts don’t reflect the real market, and many traders find out, that in a live account, conditions differ.
But both account types give access to a plethora of trading tools to use. Here are some of the most popular trading indicators and strategies to use in the forex market:
Trend indicators: Traders use indicators to spot a trend and to ride it. It is always a smart move to trade in the direction of the underlying movement. Examples of such indicators are moving averages.
Oscillators: All oscillators appear at the bottom of a chart. Their primary use is to identify fake moves made by the rise and fall of the price. An oscillator, for example, forms a divergence with the price at specific times, and that’s a signal to buy or sell a currency pair. Great oscillators are the RSI (Relative Strength Index) or CCI (Commodity Channel Index).
Elliott Waves Theory: The Elliott Theory was developed in the 1940s by Ralph Elliott, and to this day, it is one of the most influential strategies in the market. Elliott built a theory that considers human nature and emotions, on the premises that the market forms waves when it moves. As such, on the premises of an advance or decline, the move will unfold in steps or impulsive and corrective waves.
Technical analysis is such a vast area that we need much more than that to cover it. On top of technical strategies, the fundamental ones come to complement the perfect analysis.
In fact, in technical and fundamental analysis, one cannot exist without the other. The right trade should come at the end of a study that includes both.
To know how to trade forex means to know yourself as a trader and what you want from the forex market. Some traders do it for fun, as a hobby. If that’s the case, they don’t pay much attention to the details, and they just enjoy the thrill.
Some others trade for a living. They represent the pure breed of speculation, and they know human nature makes the difference between making a profit or not.
It is not by chance that the best traders in the world are contrarians, and use market psychology concepts to position themselves.