Forex Made Simple: A Step-By-Step Guide
If you’re eager to give Forex trading a go, you shouldn’t jump in unprepared.
The risks are high.
Trading the world’s largest and most liquid financial market can certainly be profitable, so how can you increase your chances of Forex trading success?
You need to have a solid comprehension of how trading Forex works.
Understand which factors impact and move the currency market.
And you must have a trading system, including a solid risk management strategy.
Let’s delve into the vital aspects you need to understand so you can get on track to become a successful Forex trader for the long run…
Forex 101: The Basics of Forex Trading
One feature of the Forex market, which appeals to many traders, is the long trading hours.
Unlike stock markets, which open for trading during ‘normal’ office hours, the Forex market is open for trade from late on a Sunday evening straight through until late on a Friday night.
This gives you a lot of flexibility.
Currencies Trade In Pairs
Forex trading involves trading the world’s currencies. Unlike trading shares, you trade currencies in pairs.
For example, you could trade the US dollar against the euro, the pound against the rand or the yen against the Australian dollar.
There are three letter acronyms for all currencies.
For example, the US dollar is USD and the euro is EUR.
The outcome of a Forex trade depends on which currency strengthens and which one weakens in the pair you trade.
This is where exchange rates come in.
The exchange rate of a specific currency pair constantly changes according to supply and demand.
Where Pips Come In
To measure the movement and value of currencies we use pips.
The vast majority of currency pairs are quoted to four decimal places.
Let’s say the US dollar to the rand quote is 14.7203. If the quote moves to 14.7205, the US dollar strengthened by 2 pips against the rand.
If you trade the yen in your currency pair, you’ll notice that quotes are only to two decimal places.
The All-Important Spread
Just like when you trade shares, you also need to consider the spread when trading Forex.
The spread is the difference between the buy (bid) price and the sell (ask) price of a currency.
The bid price is always less than the ask price.
To make money from your positions, you’ll first need to cross spread to be in a money making position.
Or, to put it another way, if you enter a Forex trade and immediately exit your position, assuming the exchange rate didn’t change, you’d lose money.
The World’s Most Traded Currencies
Many Forex traders opt to stick with the major currencies.
The majors are:
- The US dollar (USD);
- The British pound (GBP);
- The Australian dollar (AUD);
- The Swiss franc (CHF);
- The Japanese yen (JPY); and
- The euro (EUR).
These currencies are the most liquid and due to that have the tightest spreads.
What Moves The Forex Market?
When you trade the Forex market, it’s vital to keep abreast of important economic indicators.
These factors have the potential to move currencies.
The economic indicators you need to watch out for include:
- Consumer inflation;
- Gross domestic product data;
- Interest rates;
- Consumer confidence;
- Employment data;
- Trade balances; and
- Retail sales.
Once you decide which currencies you’re going to trade, it’s easy to keep track of when these announcements are due for release.
You can use one of the plentiful online calendars to keep track of announcements that have the potential to affect your trades.
One calendar I find very useful is Daily FX.
Not only do these calendars detail when announcements are going to happen, they also tell you how important they are.
How To Trade Forex
One decision you’ll have to make is which currencies you’re going to trade.
If you want to trade the rand against a number of major currencies, you’ll need to use currency futures.
To trade currency futures you’ll need an account with a stockbroker offering this form of trading.
If you want to trade major currencies excluding the rand, you can use spread trading.
Spread trading appeals to many traders as the deposit to open an account is much less than what you need for currency futures.
And you can easily put on small trades.
Instead of trying to trade a large number of currency pairs, it’s a good idea to hone in on a few pairs.
This will make your research easier.
How To Pick The Best Forex Trading Strategy
Once you have a solid understanding of how Forex trading works, you need to find a strategy that’s going to yield results.
Not only does a trading strategy flag up potential winning trades, it ensures you don’t let your emotions interfere with your trading decisions.
Fear and greed drive many of the decisions you make as a trader.
Acting on these emotions can lead you to make decisions based on impulse rather than what your strategy is telling you to do.
This can cost you money.
That’s why it’s so important to have a solid strategy to follow.
It avoids your emotions getting in the way of winning trades.
Is Technical Analysis Worth Looking At?
Many Forex traders swear by technical analysis.
This is due to the currency market displaying trends over the long-term.
Even if you opt to use technical analysis, you still need to bear in mind the economic indicators we looked at above.
Technical analysis is a vast topic in itself, but start off by looking at charts showing the currency pairs you want to trade to see how they behave over different periods.
You may notice strong trends for particular currency pairs.
Many of the companies providing Forex trading have technical analysis tools for you to use.
The Most Important Part Of Your Forex Trading Strategy
Before you even consider trying to find potential trades, you need to ensure you cover risk management.
By prioritising risk management, you can prevent catastrophic losses and keep losses to a minimum.
This ensures that you can continue to trade and not decimate your trading pot on one poorly judged trade.
There are different strategies to consider.
The most simple include setting stop loss and take profit levels each time you trade.
A stop loss means you know what the potential loss could be if a trade doesn’t go as planned.
You could also consider position sizing. This involves only risking a predetermined amount per trade.
For instance, you may decide to risk 2% per trade.
If you had a trading pot of R10,000, you’d only risk R200 per trade.
If you make a loss you only risk 2% of your remaining trading capital.
In our example, this would mean risking R196 (2% of R9,800) on your next trade.
If you make a gain, you’d risk 2% based on the higher amount in your trading pot.
Once you get a strategy working for you, it won’t be long until the amount you’re risking on each trade rises, increasing your potential profits.
What To Include In Your Forex Trading Strategy
Before you begin trading, ensure your strategy includes:
- A clear and decisive way of selecting trades.
- Stop loss and take profit levels.
- Risk management strategies to preserve your trading capital.
And before you begin trading, it’s a good idea to paper trade before you commit your cash.
You may find the company you trade through has demo accounts you can use.
The Secret To Forex Trading Success
Don’t approach Forex trading as if it were gambling.
By having a solid trading strategy which includes risk management, you increase your chances of being successful, not just over the short-term, but for the long haul.
Stick to your trading strategy.
If it’s not working, make changes and paper trade to check your results.
Forex trading can be lucrative, but taking a slap dash approach could mean you lose a lot of money.
Until then, here’s to profitable Forex trading.
The Money Lab