How to Start Forex Trading

So, you’re looking to start trading forex.

It’s not the easiest market to understand, but it might be the most underrated.

More than half of American households are involved in the stock market. It’s safe to say though, that the average person would scratch their head in confusion if you asked them about forex trading.

But you have legitimate reason to enter the market: The amount of money traded per day in the forex market is about 25 times higher than what is traded each day in all global stock markets combined. That’s a pretty large market just waiting for you to get involved!

It’s easy though as a beginner to get bogged down by all the information you’ll need to know to begin forex trading. Pips, currency pairs, futures market. These are all terms you must be familiar with as a forex trader.

Various estimates put the number of forex traders that actually make a profit in the 10 to 30% range. These are trades who jump in unprepared, and you shouldn’t be one of them. 

To make sure you’re ready to turn a profit in forex, we made this guide that will tell you all about the basics of trading, explain some common terms, and demystify the whole concept of forex trading. In this short guide, you’ll learn the foundations you can build upon and enter the markets one step ahead of most new traders.

What is Forex Trading? 💡

Basically, forex trading involves buying one currency with another currency. For example, you could buy Australian dollars with US dollars. If you’ve ever visited another country and exchanged your home country’s currency for the local currency, you’ve participated in forex trading.

Instead of exchanging currencies for vacation, though, the goal of a forex trader is to make a profit by trading currencies. The simplest way to do this is to buy a currency cheap, and then sell it once it has risen in value.

For example, you buy CNH using USD because the Chinese retail investors are starting to invest in foreign securities, and this might strengthen China’s economy. As a consequence of this, the CNH gains value compared to the USD which is still impacted by high unemployment rates—now you can sell you CNH for more USD than you bought it for. And that’s how you make money in forex.

What Exactly is the Forex Market? 🌎

Unlike stock markets, there is no centralized forex exchange for the forex market. When you trade a stock in the US, your stock broker runs the trade through the New York Stock Exchange. With forex, you’re dealing with a conglomeration of international banks and organizations that make up the forex market.

Because there’s no central exchange, the forex market’s working hours are actually from 5:00 PM EST on Sunday to 4:00 PM EST on Friday, 24 hours a day. All the major exchanges including New York, London, and Tokyo are scattered across time zones, so there’s almost always activity going on. 

And this activity is good for traders. With over $6.6 trillion being traded daily, you can expect a lot of people will be interested in what you’re buying and selling. This means you can always find someone to trade with and can open and close positions quickly—this is key for making profits on small price fluctuations. But how do you actually start forex trading?

How Do I Begin Forex Trading? 🔓

Aside from knowledge of the markets and currencies, a forex trader needs tools. The entire toolkit you need to trade via your computer or phone is provided for free by your broker—this includes a trading platform with research features and multiple types of customizations to help you trade. 

Choose Your Forex Broker 🗂

There’s a wide variety of brokerages out there but not all of them are great, and some are even downright unreliable and can’t be trusted with user money—scams are also very common in the space of forex and digital currency. That’s why it only makes sense to narrow down your search to the top established forex brokers that will not only insure your funds, but also give you the best trading tools and prices.

A few popular forex brokers for beginners are the following:

Open an Account with a Forex Broker 🤝

Opening an account with a broker nowadays is very easy, can be done online, and usually takes about 15 minutes. At a minimum, brokers are going to require information like your address and Social Security Number, but some more strict ones will ask you to mail some documents to them as well. 

Fund Your Trading Account 💳

You’ll usually have a couple of options here, including an ACH transfer, mailing a check, or completing a wire transfer to the broker. The most common way to fund your account is via credit/debit card but some brokers also allow e-wallets like PayPal and Skrill. 

Payment methods can differ widely, so it’s always a good idea to check the review of the broker you’re eyeing to see if you can fund your account the way you want. It’s also a good idea to have an account with multiple base currencies—for example, if the USD weakens against CAD and you want to trade this pair, it’s better to make a deposit in the CAD so that you don’t lose out on the opportunity to buy USD while it’s cheap.

Download Trading Platform 👨‍💻

Brokers will differ when it comes to compatibility with your preferred trading platform, like OANDA or MetaTrader 4. A well-designed platform though will get you the information you need quickly and easily so that you can execute trades accordingly. 

Some traders like to set up their computers with multiple screens to trade with maximum efficiency, however, this isn’t necessary in the great majority of cases. Nowadays, mobile trading platforms have the same level of functionality as their desktop counterparts—the top apps for forex trading are used for serious and casual users alike because they are a handy tool for traders on the move.

Start Forex Trading 🏁

After everything is set up, you can begin forex trading. But before you put your own money on the line, it’s a good idea to practice with your broker’s demo account—this is an account that allows you to trade the markets with virtual money so that you don’t risk your cash just as you’re getting used to the platform.

However, using a demo account isn’t a real preparation for trading—it is just there to help you get a feel for the platform and test your theoretical know-how. The emotional impact of trading with real money is huge, and brings a whole different aspect to your strategies and performance.

Important Forex Market Terms Defined 📚

Before you hit the ground running with trades, you’ll need to know some important trade terminology. Here are the terms that you can use for most of your trading activity, and that you need to get started fully prepared.

Currency Pair 💱

A currency pair is the combination of the base currency (currency you are buying) and the quote currency (currency you are selling). In the forex market, this reads as base currency/quote currency.

For example, a common currency pair is GBP/USD. This means that you would be using US Dollars to purchase the British Pound. To read a forex quotation properly, just think of it like this: The currency on the left is 1 and you’re buying it with the currency on the right. In this case, you’re buying 1 GBP with 1.1432 USD.

Exchange Rate 💹

The exchange rate is how much of one currency you can buy with another currency. Let’s say that the exchange rate for EUR/USD is 1.2253 USD per 1.00 EUR. Therefore, you’ll need to pay 1.2253 USD to receive 1.00 EUR. A forex broker would display the exchange rate as follows:

Forex market conventions hold that with exchange rates, the base currency is always 1. This means that the number you see is always the amount of quote currency you will need to purchase one unit of the base currency.

Understanding Pips

So, you’re not sure what a pip is? No worries, the majority of people outside of forex have never heard of pips before.

Most currencies have two decimal places. That’s why we have pennies, nickels, dimes, and quarters in the US. But take a look at quotes issued by forex brokers and you’ll quickly notice there are more than two decimal places for each quote.

That’s because forex brokers generally quote to the fourth decimal place for currencies. A pip (percentage in point) is 1/100^th of one percent, or simply 0.0001. One pip is the smallest amount that the value of one currency can change against another.

Let’s say at the beginning of your trading day, you’re given the following quote:

And at the end of your trading day, you sell at the latest quote:

An important exception to the pip rule is the Japanese Yen (JPY). Whenever the Yen is the quote currency, the broker will only quote to the second decimal point. Therefore, a pip, in this case, is 0.01.

Bid/Ask Price 👇

Things get a bit trickier here because when you make a forex trade, there are actually two prices. One is called the bid price and the other is the ask price. Let’s stick to the EUR/USD currency pair as an example.

A forex broker may give you the following quote for the currency pair:

In this example, the broker is willing to sell you one euro for $1.2205 but will only pay you $1.2200 for each euro they buy from you. Normally, they want to buy from you cheap and sell for a higher price—that’s how your forex broker makes money, after all.

To keep things straight, remember that when you make a forex trade, you are dealing with a forex broker and the bid/ask prices are from the perspective of the broker. You are paying the broker’s ask price and the broker is buying at the broker’s bid price.

So what’s up with the 5 pip difference in the example? Well, that brings us into our next important forex trading term!

The Role of ‘Spread’ in Forex 🧈

Like you spread butter on your toast, a forex spread is the forex broker’s bread and butter—and yours. The bigger the spread, the bigger the difference between the buying and the selling price. This means that if you make a good trade with a large spread between the price you bought at and the price you sold at—you made a lot of money.

Quite simply, the spread is the difference between the ask and bid price quoted by the broker. So in our above bid/ask price example, you would calculate the spread accordingly:

This 5-pip difference between the bid and ask prices is pocketed by the forex broker as a commission. It’s important to note that for currency pairs traded in high volumes, like EUR/USD, the spread is usually quite small. But if you’re trading on a currency pair that is traded in low volumes, like TRY/HUF (the Turkish Lira and the Hungarian Forint), the spread could be significant.

Volatility in the Forex Market 📉

As soon as you switch on any financial news show, you’ll see at least one person screaming about volatility like it is something bad. In fact, volatility is neither good nor bad—it just means that prices move up and down more quickly and aggressively.

Forex trades make money by using these price swings and the bigger the swings, the more money they can make—and lose. All in all, a volatile market means more opportunity but it also means more risk. That’s why today’s market isn’t too gentle with newcomers who don’t want to hedge risk and start off their forex career by playing it safe.

Keep in mind that the levels of volatility of a single currency pair or the market as a whole might also change. The market might be hectic one week but go into a nonvolatile slump the next—it’s always best to plan for both scenarios.

How ‘Leverage’ Works ⚖️

The exchange rates of currencies only change by miniscule amounts during the trading day—hence, you need to invest a ton of money to make a decent living with forex. Luckily, you don’t need a huge starting capital because forex brokers offer leverage.

Leverage means you can borrow money for a trade (with no interest) based on how much money you have in your account balance. For example, if you have $1,000 and you broker offers a 1:100 leverage, which is a common number, you can control a $100,000 position with just a thousand bucks.

This means your profits will be increased a hundredfold but also your losses. Becoming overleveraged and trading a risky pair is the most common way new traders lose money—be careful with leverage as it can wipe your balance if you’re not careful.

Example of a Forex Trade 💡

There are two different types of trades you can make in the forex market. You can either make a long trade or a short trade.

Long trades are the easiest to understand. Basically, you buy one currency in anticipation that it will increase in value and you can sell it for a profit later.

For example, let’s say Brexit is set to go according to plan and you expect the British Pound (GBP) to strengthen against the US Dollar (USD) as the day goes on. You make a GBP/USD trade at 5:00 AM for 1.3365. At 3:00 PM, you sell once GBP/USD has reached 1.3385 and pocket 30 pips.

Short trades can be a bit more difficult to understand. You basically sell a currency before you actually purchase it in hopes that it goes down in value. Any decrease in the value of the shorted currency is a profit in your pocket.

Let’s say you hear the Eurozone is expected to enact new lockdowns in response to COVID-19 and you think the Euro will weaken against the US Dollar. You make a EUR/USD trade at 1.2205 early in the morning. Later when you check your account, EUR/USD is trading at 1.2185, and you pocket pips when you buy the Euro.

Spot, Forwards, and Futures Markets 🔎

Within the forex market, you’ll have three different types of markets. These include the spot, forwards, and futures markets.

Spot Markets ⌛️

In a spot market, you agree to purchase a currency based on its current value. You’re trading one currency for another currency at the specified exchange rate right now.

This is similar to any trip you take to the grocery store. If a jar of peanut butter is labeled for $2.99, you agree to give the store $2.99 in exchange for your peanut butter immediately.

Forwards Markets ⏳

Within the forwards market, you’re actually entering a contract with another party to buy a currency at a future date according to terms you decide on together today.

Using our peanut butter example, it would be as if you and the grocery store manager negotiate that you’d pay $2.99 for a jar of peanut butter a month from now. No matter if the price of peanut butter goes up or down, you’ll pay $2.99 regardless in a month.

Futures Markets 📅

Futures markets are similar to forwards markets, except you don’t negotiate the terms of the contract with another party. They’re pre-determined and you simply buy into them.

Still sticking with peanut butter, it’s similar to the grocery store displaying a sign on the street saying that you can agree to buy peanut butter for $2.99 a month from now. You never negotiate directly with the store manager, but you still enter a contract with the store to buy at a later date.

Forex Trading Strategies 🎓

So you’ve made it this far and have your forex trading account setup. You know that a good strategy is essential for success, but which forex strategy do you follow?

Hedging 🦺

One route you could take is that of the forex hedging strategy. With hedging, you attempt to limit your losses by investing in a position contrary to the one you currently hold. 

Let’s say you executed a long trade for EUR/USD. You get news, however, that leads you to believe the Euro may actually weaken against the US Dollar because US treasury yields increased. You could simultaneously execute a short trade to profit in the event the Euro decreases in value. 

Then, in the event the Euro does weaken, you’ll at least profit from your short trade even though you lost in the long trade. Keep in mind that while a hedging strategy may decrease your losses, it does so at the expense of lowering your maximum profit.

Speculation 🚀

Here’s where a speculative strategy takes a 180-degree turn from hedging. Instead of taking contrary positions, speculators try to maximize profits by guessing what direction a currency’s value will move in and investing accordingly.

For example, a speculator that gets wind of a strengthening Euro would probably execute a EUR/USD trade. Unlike the hedger, the speculator makes no short trades in the event the Euro actually weakens.

Speculating pays off big when you’re right but can cause some serious damage if done without skill. For beginners, it’s best to start with moderate speculation and move into riskier ventures once you’ve become more experienced. 

You might’ve seen a lot of young traders making impressive profits through highly speculative trades, but keep in mind—young doesn’t mean inexperienced. Some prominent millennial traders started their forex careers in their teens, which gives them a substantial level of experience at a very young age.

Pros and Cons of Forex Trading 👍👎

Forex trading and it’s fast-changing opportunities for profit and loss are not for everyone. Therefore, it’s important to carefully consider the pros and cons before venturing down the path of a forex trader.

Pros of Forex Trading ✅

1. The Market Operates 24 Hours for Five Days Straight

Unlike the stock market, which operates Monday through Friday from 9:30 AM EST to 4:00 PM EST, you can make forex trades any time of the day for five days straight. The forex market opens at 5:00 PM EST on Sunday and doesn’t close until 4:00 PM EST on Friday. This makes forex trading particularly attractive for someone with a standard 9 to 5 job.

2. High Liquidity for Currencies

The large size of the forex market makes forex trading highly liquid, meaning that spreads are typically low, and orders are easy to place. In the stock market, which has less liquidity, it’s easier for large buy or sell orders to cause sudden spread increases. Forex trading typically involves tighter spreads and more predictable volatility.

3. Lower Capital Requirements

FINRA, the regulating body of stockbrokers, mandates that stock day traders must maintain an account balance of $25,000. Due to the lack of a central exchange, forex trading has much less regulation surrounding it. This means someone who couldn’t meet the capital requirements for stock trading could easily enter the forex market.

Cons of Forex Trading ⚠️

1. Complex factors determine prices

Remember, when you buy a currency, you’re buying legal tender of a country or group of countries. Political and economic choices affect how the rest of the world views a country’s stability and therefore affect a currency’s value. And it’s not just all politics and economics.

An unexpected natural disaster can easily send a country and its currency into turmoil. It can be very difficult to correctly predict how these things play out in a forex trade.

2. Lack of regulation

While lighter regulations make it easier for people to enter the forex market, the lack of rules can leave investors without protection if they aren’t careful. There is no FINRA or SEC for you to file a formal complaint with. 

This makes it vital to investigate the legitimacy of a broker before dealing with them and it is best to sign up with a trusted company. Nonetheless, breaking trading rules can cost you money, so you should always check up on the current forex regulation before trading.

3. Trouble with leveraging

Leveraging involves controlling a larger balance of money than what you actually hold in your account. Many brokers will allow you to do this. For example, you may deposit $1,000 into your trading account, but your broker could allow you to trade as if you actually have $10,000 in your account. With a succession of bad leveraged trades, you could end up in the hole.

Reading Forex Charts 🔎

By now you’re wondering, how do I actually make money doing this? Well, in order to do that you’re going to need to know how to understand a forex chart—and most importantly, how to understand the three main types of forex charts:

1. Line Chart

If you’re looking to get a general idea of where a currency is moving, a line chart is a great place to start. Line charts show you the closing price of a currency for a certain time period—but what they fail to capture is the movement of a currency within each time period.

As such, line charts are best used for getting a broad overview of a price movement, or for comparing price movements. That’s why you should use some of the other chart types if you want to analyze currency pairs in greater depth.

2. Bar Chart

With a bar chart, you can see not only a currency’s closing price, but also the highest and lowest values it reached during that period. Unlike line charts, bar charts show you how volatile a currency’s been recently.

However, bar charts still don’t show you the detailed jumps and drops in prices. It is easy to see the levels of volatility using these, but they aren’t the best tool for day traders who want to see when to execute a trade.

3. Candlestick Chart

What you’ll see from most brokers is the candlestick chart. For each time period, you’ll get to see the highest, lowest, open, and close values of the currency. They even usually color the body of the data point green if the currency closed higher and red if it closed lower for the day.

This is the most frequently used chart by day traders—it makes following price fluctuations very easy and allows for precise price analysis. Candlesticks allow you to precisely determine when the price had dipped and jumped.

Are There Risks Associated with Forex Trading?

Like any investment, it’s vital to keep in mind that you could lose money trading forex. Investing in anything involves trying to predict the future to a certain extent and that can never be done with 100% accuracy.

Take COVID-19 for example. Very few could have predicted in late 2019 how serious this pandemic would become. But how does that translate into market terms? Most people would expect a pandemic to destroy investments, but November 2020 was actually the S&P 500’s best November ever up until that point—and that’s just a few months after the crash in March.

And as US legislators battle it out over COVID relief bills, the US dollar reached a new 2 and ½ year low recently. So always remember as you make your trades that those are your hard-earned dollars getting swapped.

Conclusion

If you’re bored with stocks and bonds or are looking to diversify, forex trading could be the answer for you. You’ll get access to a 24/5 market covering currencies from all over the world. And now that you have the basics of forex trading covered, you should feel more confident in your abilities to turn a profit.

However, always exercise caution when jumping into a new forex trading venture. The promise of high returns is alluring but the great majority of traders actually lose money—a slow and patient approach works best for pro traders because they don’t lose much money that way.