Nowadays, people are increasingly interested in investing. Although working from 9 am to 5 pm is still a common thing, investing in something new can help you save more money for the future.
Similarly, more investors are diving into the world of financial markets. If you’re one of them, you might also be interested in forex trading. As it’s one of the most popular financial markets, it can also be interesting given that we encounter foreign exchange news almost every day. However, before you start, it’s essential to get to know the basic concepts and ways how to trade forex .
In this article, we’ll help you get started in forex trading.
1. What is Forex?
Forex, also known as foreign exchange or FX, is a market for buying and selling currencies. Unlike other financial markets, currencies are traded 24 hours, five times a week. Additionally, this is perceived as the biggest financial market in the world.
Usually, foreign exchange operates over the counter, so individuals can trade anytime. Meanwhile, apart from individual traders, it’s also used in businesses, hedge funds, and banks.
2. Currency Pairs
Currencies are paired in forex trading. You can’t trade using only one, and you need to rely upon another currency when considering the trades you place.
Currency pairs are composed of the base currency and the quote currency. For instance, in the USD-to-EUR currency pairing, USD is the base currency and the quote currency is the EUR. Understanding the difference between the two is vital, especially when trading.
The currency pairs are also categorized into three—major, cross, and exotic. The major currency pairs are the most traded currencies, which contribute a lot to the market. This includes USD/EUR, USD/JPY, and AUD/USD.
Meanwhile, cross-currency pairs are also popular currencies (aside from USD), such as AUD/CAD, GBP/AUD, and JPY/CAD. These are currency pairs that are usually converted to USD first before being converted to the quote currency. Unfortunately, this double conversion can cause trade losses.
Lastly, the exotic currency pair is when one currency is popular, while the other one is rare. Some examples of exotic currency pairs are EUR/TRY, CNH/JPY, and USD/SGD.
3. Exchange Rates
The exchange rate is the value of one currency to another. For instance, if the USD/EUR rate is 1.30, it means that for every US dollar, there’s a corresponding amount of 1.30 euros. However, this exchange rate fluctuates most of the time, so you can never be so sure. Besides, you must know that the forex market is the most volatile of them all.
So before you dive into knowing how to trade forex, it’s best to be aware of what you’re going into.
4. Bid and Ask Prices
Since currencies often cost a lot, there’s usually an asking price and a bid price when executing a trade. The asking price represents the lowest amount a seller is prepared to take, while the bid price indicates the highest amount a buyer is ready to offer for the currency pair.
In the forex market, the asking price and bid price together form the bid-ask spread, which is the difference between the two prices. The bid-ask spread represents the transaction cost or the broker’s profit margin.
Leverage is when traders are allowed to trade using a small capital, specifically, it allows you to borrow money to trade. Traditionally, you’ll have to pay for the full price of an underlying asset before you’ll be able to place an order. Fortunately, forex is one of those financial markets where there’s leverage.
However, although leverage may seem to be a good deal, it can also become the end of your trading journey. So, keep in mind that while leverage can magnify your profits, it can also magnify losses.
Usually, brokers provide a reasonable percentage of leverage, so if you want to take it slow, you can do so by placing a small amount of trades at a time.
6. Risk Management Practices
In forex trading, it’s essential to implement risk management practices to avoid losing your capital. Some of the basic ways to prevent losses are market orders and limit orders.
Market orders include stop-loss orders and take-profit orders. The former is when a trade automatically closes once it reaches the predetermined price, while the latter is when a position closes when the currency pair reaches the profit level specified initially.
Other risk management practices you should incorporate in your trades are knowing your risk tolerance, diversifying trades, and staying updated about the current state of the forex market.
Forex trading can be an exciting yet challenging venture you can try this year. However, similar to other investments you’re going to try, you should first be aware of the basics concept and other relevant information. Additionally, when trading forex, you should be careful about every decision you’re going to make.
ABOUT THE AUTHOR
Aliana Baraquio has over 5 years of experience as a writer and market analyst. She specializes in developing beginner-friendly trading techniques and tutorials. Additionally, she suggests FP Markets as the top broker for trading CFDs and Forex.