Beginner’s Guide to Forex Trading
As the biggest financial market in the world, more than 1.9 trillion dollars is traded every day on the Forex. This means that this one financial market is roughly four times the size of the New York Stock Exchange. The Forex—or Foreign Exchange—market involves either buying or selling different kinds of currency.
To trade on the Forex market, individuals must either use a dealer or a broker. A dealer is generally the other party in the exchange. Brokers operate as a kind of middleman between the two parties and facilitate the transfer.
Why Trade the Forex?
The biggest reason for trading on the Forex market is its liquidity. This currency exchange market is open 24 hours a day and can be accessed from anywhere around the world. In the past, trades were limited to wealthy individuals, banks and stock brokers. With the rise of the Internet, any average trader can learn how to trade at the click of a button.
On May 6, 2010, a flash crash caused the stock market to shut down. People could not unwind positions and were stuck with their investments. Unlike the stock market, the Forex very rarely has this happen. Currency tends to change at a very slow pace so investors are always able to unwind their positions.
Using the foreign exchange market is also ideal for new investors. Instead of long listing of stock prices, business reports and financial journals, an investor merely has to look at the two pairs being traded. Although the price of the currency might be determined by economic conditions, users still have far less financial mumbo jumbo to read through to determine their investments.
Additionally, new investors can start trading with very little capital. Instead of the large investments required in real estate or stock markets, users can begin with just an investment of $250 or $300. Although this means the investor will make less of a profit, it also protects them from exceptional levels of risk as they learn how to trade.
Another reason people commonly choose to trade on the Forex market is because of leveraging. Since most trades involve very little risk, a broker will allow the investor to buy or sell in greater quantities than their deposit. For example, if an investor gives the broker $100 of capital, the broker may allow them to control a large position. At a 100 to 1 rate, an investor with just $100 invested could be leveraging $10,000. This means that the investor could make a significant amount of profit. Unfortunately, if the currency rate falls the investor may also lose their entire investment.
If the price drops too rapidly, the broker may make a margin call. The investor will either have to input an additional amount of money into the deposit or lose their investment.
Terms to know
When trading on the Forex, the current prices of currency are listed in a table. The bid price is the amount that the investor can sell a pair to a dealer. An ask price if the amount that an investor can buy from a dealer. When selling a pair, the investor is either buying long or taking a long position. Buyers of a currency pair call it selling short or are taking a short position.
The lowest amount that a stock price can change is called a pip. This is the last digit listed on the currency table. In real money, it accounts for 1/100th of a cent. If the exchange rate of United States dollars (USD) and Swiss francs (CHF) is 1.1572, the pip is the 2 at the end. If this changes to 1.1573, the pip will have increased by 1/100th of a cent.
Multiple brokers exist online that investors can use to buy or sell currencies. In general, these services are very inexpensive. Currency brokers as a rule do not charge a fee to investors. Instead, they add a marginal amount to the cost the buyer pays or subtract a small amount from the seller. This marginal amount is called the bid-ask spread.
Before an investor does there first trade, they should try doing paper trades first. Many brokers and Forex websites offer programs that let the investor do pretend trades to get used to how the market works. Once the investor is confident in their ability, they can move to doing real trades. As soon as money is deposited in the account, investors can get started with their Forex purchases.