1:52

Forex Trading: A Beginner’s Guide

Forex Trading: A Beginner's Guide

Trading currencies can be risky and complex. The interbank market has varying
degrees of regulation, and forex instruments are not standardized. In some parts
of the world, forex trading is almost completely unregulated.

The interbank market is made up of banks trading with each other around the
world. The banks themselves have to determine and accept sovereign
risk and credit risk, and they have established internal processes to keep
themselves as safe as possible. Regulations like this are industry-imposed for
the protection of each participating bank.

Since the market is made by each of the participating banks providing offers
and bids for a particular currency, the market pricing mechanism is based
on supply and demand. Because there are such large trade flows within the
system, it is difficult for rogue traders to influence the price of a currency. This
system helps create transparency in the market for investors with access to
interbank dealing.

Most small retail traders trade with relatively small and semi-unregulated forex
brokers/dealers, which can (and sometimes do) re-quote prices and even trade
against their own customers. Depending on where the dealer exists, there may
be some government and industry regulation, but those safeguards are
inconsistent around the globe. 

Most retail investors should spend time investigating a forex dealer to find out

whether it is regulated in the U.S. or the U.K. (dealers in the U.S. and U.K. have
more oversight) or in a country with lax rules and oversight. It is also a good idea
to find out what kind of account protections are available in case of a market
crisis, or if a dealer becomes insolvent.

How to Get Started with Forex Trading

Trading forex is similar to equity trading. Here are some steps to get yourself
started on the forex trading journey.

1.    Learn about Forex: While it is not complicated, forex trading is a project of

its own and requires specialized knowledge. For example, the leverage ratio of
forex trades is higher as compared to those for equities and the drivers for
currency price movement are different from those in equity markets. There are
several online courses available for beginners that teach the ins-and-outs of
forex trading.

2.    Set up a brokerage account: You will need a forex trading account at a

brokerage to get started with forex trading. Forex brokers do not charge
commissions. Instead, they make money through spreads (also known as pips)
between the buying and selling prices.

For beginner traders, it is a good idea to setup a micro forex trading account with
low capital requirements. Such accounts have variable trading limits and allow
brokers to limit their trades to amounts as low as 1,000 units of a currency. For
context, a standard account lot is equal to 100,000 currency units. A micro forex
account will help you become more comfortable with forex trading and determine
your trading style.

3.    Develop a trading strategy: While it is not always possible to predict and

time market movement, having a trading strategy will help you set broad
guidelines and a roadmap for trading. A good trading strategy is based on the
reality of your situation and finances. It takes into account the amount of cash
that you are willing to put up for trading and, correspondingly, the amount of risk
that you can tolerate without getting burned out of your position. Remember,
forex trading is mostly a high leverage environment. But it also offers more
rewards to those who are willing to take the risk.  

4.    Always be on top of your numbers: Once you begin trading, always check

your positions at the end of the day. Most trading software already provides with
a daily accounting of trades. Make sure that you do not have any pending
positions that need to be filled out and that you have sufficient cash in your
account to make future trades.

5.    Cultivate Emotional Equilibrium: Beginner forex trading is fraught with

emotional rollercoasters and unanswered questions. Should you have held onto
your position a bit longer for more profits? How did you miss that report about low
GDP numbers that led to a decline in overall value for your portfolio? Obsessing
over such unanswered questions can lead you down a path of confusion. That is
why it is important to not get carried away by your trading positions and cultivate
emotional equilibrium across profits and losses. Be disciplined about closing out
your positions, when necessary.    

Forex Terminology
The best way to get started on the forex journey is to learn its language. Here are
a couple of terms to get you started:
Forex account: A forex account is the account that you use to make currency
trades. Depending on the lot size, there can be three types of forex accounts:

 Micro forex accounts: Accounts that allow you to trade up to $1,000 worth
of currencies in one lot.
 Mini forex accounts: Accounts that allow you to trade up to $10,000 worth
of currencies in one lot.
 Standard forex accounts: Accounts that allow you to trade up to $100,000
worth of currencies in one lot. 

Remember that the trading limit for each lot includes margin money used for
leverage. This means that the broker can provide you with capital in a pre-
determined ratio. For example, they may put up $100 for every $1 that you put up
for trading, meaning you will only need to use $10 from your own funds to trade
currencies worth $1,000.

Ask: An ask is the lowest price at which you are willing to buy a currency. For
example, if you place an ask price of $1.3891 for GBP, then the figure mentioned
is the lowest that you are willing to pay for a pound in US dollars. The ask price is
generally greater than the bid price.

Bid: A bid is the price at which you are willing to sell a currency. A market maker
in a given currency is responsible for continuously putting out bids in response to
buyer queries. While they are generally lower than ask prices, in instances when
demand is great, bid prices can be higher than ask prices.

Bear Market: A bear market is one in which prices decline for all currencies.
Bear markets signify a market downtrend and are the result of depressing
economic fundamentals or catastrophic events, such as a financial crisis or a
natural disaster.

Bull Market: A bull market is one in which prices increase for all currencies. Bull
markets signify a market uptrend and are the result of optimistic news about the
global economy.

KEY TAKEAWAYS

 It is important to know the terminology related to forex trading before you

begin the actual trading process.
 While there is a significant overlap between standard finance terms, such
as leverage and bid/ask prices, there are some terms, such as pips, forex
accounts, and lot sizes, that are unique to currency trades.
Contract for Difference: Contract for Difference (CFD) is a derivative that
enables traders to speculate on price movements for currencies without actually
owning the underlying asset. A trader betting that the price of a currency pair will
increase will buy CFDs for that pair while those who believe its price will decline
will sell CFDs relating to that currency pair. The use of leverage in forex trading
means that a CFD trade gone awry can lead to heavy losses.

Leverage: Leverage is the use of borrowed capital to multiply returns. The forex

market is characterized by high leverages and traders often use these leverages
to boost their positions.

For example, a trader might put up just $1,000 of their own capital and borrow
$9,000 from their broker to bet against the euro (EUR) in a trade against the
Japanese Yen (JPY). Since they have used very little of their own capital, the
trader stands to make significant profits if the trade goes in the correct direction.
The flipside to a high leverage environment is that downside risks are enhanced
and can result in significant losses. In the example above, the trader’s losses will
multiply if they the trade goes in the opposite direction.   

Lot Size: Currencies are traded in standard sizes known as lots. There are three
common lot sizes: standard, mini, and micro. Standard lot sizes consist of
100,000 units of the currency. Mini lot sizes consist of 10,000 units and micro lot
sizes consist of 1,000 units of the currency. Some brokers also offer nano lot
sizes of currencies, worth 100 units of the currency, to traders. The choice of a
lot size has a significant effect on the overall trade's profits or losses. The bigger
the lot size, the higher the profits (or losses) and vice versa.

Margin: Margin is the money set aside in an account for a currency trade. Margin
money helps assure the broker that the trader will remain solvent and will be able
to meet monetary obligations, even if the trade does not go her way. The amount
of margin depends on the trader and customer balance over a period of time.
Margin is used in tandem with leverage (defined above) for trades in forex
markets.

Pip: A pip is "percentage in point" or "price interest in point". It is the minimum

price move, equal to four decimal points, made in currency markets. One pip is
equal to 0.0001. 100 pips is equal to 1 cent and 10,000 pips is equal to $1. The
pip value can change depending on the standard lot size offered by a broker. In a
standard lot of $100,000, each pip will have a value of $10. Because currency
markets use significant leverage for trades, small price moves, defined in pips,
can have an outsized effect on the trade.
Spread: A spread is the difference between the bid (sell) price and ask (buy)
price for a currency. Forex traders do not charge commissions; they make money
through spreads. The size of the spread is influenced by many factors. Some of
them are size of your trade, demand for the currency, and its volatility.

Sniping and Hunting: Sniping and hunting is purchase and sale of currencies
near predetermined points to maximize profits. Brokers indulge in this practice
and the only way to catch them is to network with fellow traders and observe for
patterns of such activity.

Forex Trading Strategies

The most basic forms of forex trades are a long trade and short trade. In a long
trade, the trader is betting that the currency price will increase in the future and
they can profit from it. A short trade consists of a bet that the currency pair's price
will decrease in the future. Traders can also use trading strategies based on
technical analysis, such as Breakout and Moving Average, to finetune their
approach to trading.

Depending on the duration and numbers for trading, trading strategies can be
further categorized into a further four types.

A scalp trade consists of positions that are held for seconds or minutes at most
and the profit amounts are restricted in terms of the number of pips. Such trades
are supposed to be cumulative, meaning small profits made in each individual
trade add up to a tidy amount at the end of a day or time period. They rely on
predictability of price swings and cannot handle much volatility. Therefore,
traders tend to restrict such trades to the most liquid pairs and at the busiest
times of trading during the day.

Day trades are short term trades in which positions are held and liquidated in the
same day. The duration of a day trade can be hours or minutes. Day traders
require technical analysis skills and knowledge of important technical
indicators to maximize their profit gains. Just like scalp trades, day trades rely on
incremental gains throughout the day for trading.

In a swing trade, the trader holds the position for a period longer than a day i.e.,
they may hold the position for weeks or days. Swing trades can be useful during
major announcements by government or during times of economic tumult. Since
they have a longer timeline, swing trades do not require constant monitoring of
the markets througout the day. In addition to technical analysis, swing traders
should be able to gauge economic and political developments and their impact
on currency movement.