Embarking on your forex trading journey might seem daunting at first, but fret not! We’ve put together all the information you need to get started.
This guide is your friendly companion, packed with real-world examples, easy-to-grasp basics, newbie-friendly strategies, handy tips, and a step-by-step roadmap to kickstart your forex adventures.
Contents
Introduction to Forex Trading
How the Forex Market Works
Getting started in Forex Trading
Developing a Strategy
Practical Tips for Beginners
Resources for Further Learning
Introduction to Forex Trading
Foreign exchange trading, or forex trading,is the process of buying and selling currencies in the global financialmarkets. It is one of the largest and most liquid markets in the world, with anaverage daily trading volume estimated to exceed USD$7 trillion. Unliketraditional stock markets, forex trading operates 24 hours a day, five days aweek, allowing traders to participate in the market at any time.
Understanding currency pairs
Forex trading involves the exchange of onecurrency for another at an agreed-upon price. This is done with the aim ofprofiting from fluctuations in exchange rates. Currencies are traded in pairs,where one currency is bought while the other is sold. The most commonly tradedcurrency pairs, or ‘the majors’ as they’re more commonly referred to, includeEUR/USD (Euro/US Dollar), GBP/USD (British Pound/US Dollar), AUD/USD(Australian Dollar/US Dollar), NZD/USD (New Zealand Dollar/US Dollar), USD/JPY(US Dollar/Japanese Yen), USD/CAD (US Dollar/Canadian Dollar), and USD/CHF (USDollar/Swiss Franc).
Examples of other currency pairs, mostoften referred to as “crosses”, are AUD/JPY (Australian Dollar/JapaneseYen), GBP/NZD (British Pound/New Zealand Dollar), EUR/CAD (Euro/CanadianDollar) and so forth.
And finally, less-traded currency pairs arereferred to as “exotics”. Examples of these include USD/TRY (US Dollar/TurkishLira), USD/HUF (US Dollar/Hungarian Forint). It’s important to note that exoticpairs tend to have wider spreads and higher volatility compared to major andminor pairs.
Uses of the forex market
The forex market is used by many players,for many different reasons. Retail traders aim at buying or selling a currencyto take advantage of short-term fluctuations in price, whereas corporates whoconduct regular international trade often use the forex market to hedge againsttheir local currency weakening.
Large-scale players such as hedge funds orinvestment firms, will use the foreign exchange market to take advantage of divergencesin interest rates between two nations in the form of a carry trade.
For more information on the types of forextrading, head to Part Four.
Reading Currency Pair Quotes
Currency pair quotes consist of two prices:the bid price and the ask price. The bid price represents the price at whichyou can sell the base currency, while the ask price represents the price atwhich you can buy the base currency. The difference between the bid and askprices is known as the spread, which represents the broker's profit margin.
In forex trading, currency pairs are quotedin pips, short for "price interest point," representing the smallestpossible price movement. For most major currency pairs, prices are quoted withfour decimal points, indicating a change of 1/100 of one percent or 1 basispoint. However, the Japanese Yen is an exception, trading with only two decimalpoints.
For instance, if the bid price for theEUR/USD pair is quoted as 1.19040, this breakdown refers to the five decimalplaces displayed on the market watch.
How the Forex Market Works
In order to trade the foreign exchangemarket effectively, you need to understand the nuts and bolts of how it works.
The forex market is decentralised, meaningthat there is no central exchange where all transactions take place. Instead,trading occurs over-the-counter (OTC) through a global network of banks,financial institutions, and individual traders. Some of the larger players inthe forex market are Deutsche Bank, UBS, Citi Bank, RBS and more.
Prices are determined by supply and demanddynamics, with exchange rates fluctuating based on economic indicators,geopolitical events, and market sentiment.
How the system works
Market makers are key players in the forexworld. They establish both the buying (bid) and selling (ask) prices, which arevisible to everyone on their platforms. Their role extends to facilitatingtransactions with a diverse clientele, including banks and individual traders.By consistently quoting prices, they inject liquidity into the market. Ascounterparties, market makers engage in every trade, ensuring a seamless flow:when you sell, they buy, and vice versa.
Electronic Communications Networks (ECNs)play a crucial role in forex trading by aggregating prices from various marketparticipants like banks, market makers, and fellow traders. They showcase themost competitive bid and ask quotes on their platforms, drawing from this poolof prices. While ECN brokers also act as counterparts in trades, they differfrom market makers in their settlement approach rather than fixed pricing.Unlike fixed spreads, ECN spreads fluctuate based on market activity, sometimeseven hitting zero during peak trading times, especially with highly liquidcurrency pairs like the majors.
Direct Market Access (DMA) empowersbuy-side firms to directly access liquidity for securities they aim to buy orsell through electronic platforms offered by third-party providers. Thesefirms, clients of sell-side entities like brokerages and banks, maintaincontrol over trade execution while leveraging the infrastructure of sell-sidefirms, which may also function as market makers.
Straight Through Processing (STP)represents a significant leap in trading efficiency, transitioning from thetraditional T+3 settlement to same-day settlement. One of its notableadvantages is the reduction of settlement risk. By expediting transaction processing,STP enhances the likelihood of timely contract settlement. Its core objectiveis to streamline transaction processing by electronically transmittinginformation, eliminating redundant data entry and enabling simultaneousdissemination to multiple parties when necessary.
Getting Started in Forex Trading
Choosing a Broker
When selecting a forex broker, it'sessential to not only consider the fees, but also regulatory compliance,trading platform, and customer support. Look for brokers regulated by reputableauthorities such as the Financial Conduct Authority (FCA) in the UK or theCommodity Futures Trading Commission (CFTC) in the US.
Here at Fusion Markets we’re dedicated to offeringa quality service with an affordable fee structure. You can learn more about trading forex or view our licences.
Setting Up Your Trading Account
Once you've chosen a broker, the next stepis to open a trading account. This typically involves completing an online application,submitting identification documents, and funding your account. Forex brokersoffer various account types to suit different trading preferences, includingstandard accounts, mini accounts, and demo accounts for practice trading.
Before risking real money, practice trading witha demo account to familiarise yourself with the trading platform and test yourtrading strategy in a simulated environment. Demo accounts allow you to gainvaluable experience without the risk of financial loss. We also offer demo trading for those who want to test the water first.
Developing a Strategy
Identify Your Trading Style
Before developing a trading strategy, it'sessential to identify your trading style, whether it's day trading, swingtrading, or position trading. Your trading style will dictate the timeframe youtrade on and the types of setups you look for in the market.
Below are the types of pros and cons ofeach trading style:
Types of Analysis
Fundamental Analysis
Unlike technical analysis, which primarilyrelies on historical price data, fundamental analysis examines economicindicators, monetary policies, geopolitical events, and other macroeconomicfactors to gauge the strength and direction of a currency's movement.
Central to fundamental analysis is theunderstanding that currency prices are ultimately driven by supply and demanddynamics, which in turn are influenced by broader economic conditions. For example,factors such as interest rates, inflation rates, GDP growth, unemploymentlevels, and trade balances can all impact a currency's value.
One of the key concepts in fundamentalanalysis is interest rate differentials. Central banks use interest rates as atool to control inflation and stimulate economic growth. Currencies with higherinterest rates tend to attract more investors seeking higher returns on theirinvestments, leading to an appreciation in their value relative to currencieswith lower interest rates. Traders closely monitor central bank announcementsand economic reports to anticipate changes in interest rates and adjust theirtrading strategies accordingly.
Another important aspect of fundamentalanalysis is the assessment of economic indicators. These indicators provideinsights into the health of an economy and can influence currency prices. Forexample, strong GDP growth and low unemployment rates are typically associatedwith a robust economy and may lead to appreciation in the currency. Conversely,high inflation or rising unemployment may weaken a currency.
Geopolitical events can also have asignificant impact on currency prices. Political instability, conflicts, tradetensions, and other geopolitical factors can create uncertainty in the marketand cause fluctuations in currency prices. Traders must stay informed aboutgeopolitical developments and assess their potential impact on currencymarkets.
While fundamental analysis providesvaluable insights into the long-term trends and direction of currency markets,it is important to note that currency prices can also be influenced byshort-term factors and market sentiment. Therefore, traders often use acombination of fundamental and technical analysis to make informed tradingdecisions.
Technical Analysis
Technical analysis involves studyinghistorical price data and using various charting tools and indicators toidentify patterns and trends. Common technical analysis tools include movingaverages, trendlines, and oscillators like the Relative Strength Index (RSI)and Moving Average Convergence Divergence (MACD). Traders use technicalanalysis to make short-term trading decisions based on price action and marketmomentum.
Technical analysis is a cornerstone offorex trading, offering traders a systematic approach to interpreting marketdynamics and making informed trading decisions based on historical pricemovements and market statistics. Unlike fundamental analysis, which focuses oneconomic indicators and macroeconomic factors, technical analysis relies solelyon price data and trading volume to forecast future price movements.
At its core, technical analysis is based onthe efficient market hypothesis, which posits that all relevant information isalready reflected in an asset's price. Therefore, by analysing past pricemovements, traders believe they can identify recurring patterns and trends thatmay indicate potential future price directions.
One of the fundamental concepts intechnical analysis is that of support and resistance levels. Support representsa price level where buying interest is sufficiently strong to prevent the pricefrom falling further, while resistance is a level where selling pressure issufficient to halt an upward price movement. Traders use these levels toidentify potential entry and exit points for their trades.
Exampleof support and resistance areas on EURUSD Daily chart
Another key tool in technical analysis ischart patterns, which are formed by the recurring movements of prices overtime. Common chart patterns include triangles, flags, and head and shouldersformations. By recognising these patterns, traders attempt to predict futureprice movements and adjust their trading strategies accordingly.
In addition to chart patterns, technicalanalysts also utilise technical indicators to aid in their analysis. Theseindicators are mathematical calculations based on price and volume data and areused to identify trends, momentum, volatility, and other aspects of marketbehavior. Popular technical indicators include moving averages, oscillatorslike the Relative Strength Index (RSI) and the Moving Average ConvergenceDivergence (MACD), and trend-following indicators such as the AverageDirectional Index (ADX).
While technical analysis is a powerful toolfor forex traders, it is not without its limitations. Critics argue thattechnical analysis is subjective and prone to interpretation bias, as differentanalysts may draw different conclusions from the same set of data. Moreover,technical analysis does not account for fundamental factors such as economicnews and geopolitical events, which can have a significant impact on currencyprices.
Despite these limitations, technicalanalysis remains an indispensable tool for forex traders worldwide. Byunderstanding and applying technical analysis principles, traders can gainvaluable insights into market trends and dynamics, allowing them to make moreinformed trading decisions and improve their overall trading performance.
Risk Management
Setting Stop-Loss and Take-ProfitOrders
Stop-loss orders are used to limit lossesby automatically closing a trade at a predetermined price level. Take-profitorders, on the other hand, are used to lock in profits by closing a trade whenthe price reaches a specified target. By using stop-loss and take-profitorders, traders can manage risk and control their downside exposure.
Position Sizing
Position sizing involves determining theappropriate amount of capital to risk on each trade based on factors such asaccount size, risk tolerance, and the probability of success. A common rule ofthumb is to risk no more than 1-2% of your trading capital on any single tradeto preserve capital and avoid significant drawdowns.
Your Strategy
Once you’ve determine what style of tradingwould suit you best, you now need to develop a strategy. There are thousands ofdifferent strategies out there so you have the choice of learning one fromsomeone else, or developing your own.
Regardless, some common strategies include:
Trend Following Strategies
Trend following strategies in forex tradinginvolve identifying and capitalising on established market trends. Tradersemploying this approach aim to enter positions in the direction of theprevailing trend, whether it's upward (bullish) or downward (bearish), and ridethe momentum for as long as possible. These strategies typically utilisetechnical indicators, such as moving averages and trendlines, to confirm thedirection of the trend and determine optimal entry and exit points. The goal oftrend following strategies is to capture significant portions of a trend'smovement while minimising losses during market reversals.
NZDUSD Daily Chart showing optimal entrypoints to go short during a bearish trend.
Range-bound strategies
Range-bound strategies in forex tradingfocus on exploiting price movements within defined ranges or boundaries.Traders employing this approach identify periods when a currency pair istrading within a relatively narrow price range, bounded by support andresistance levels. Instead of following a trend, range-bound traders seek tobuy near support and sell near resistance, aiming to profit from the price beingrestricted to the range highs and lows.
USDJPY 15min chart with optimal buy andsell signals for a range-bound strategy
Breakout Strategies
Breakout trading strategies in forexinvolve capitalising on significant price movements that occur when an asset'sprice breaks through predefined support or resistance levels. Traders employingthis approach wait for a clear breakout from the established range and thenenter positions in the direction of the breakout, anticipating continuedmomentum in that direction. Breakout traders typically use technicalindicators, such as trendlines, moving averages, and volatility measures, toidentify potential breakout opportunities and confirm the strength of thebreakout. The goal of breakout trading strategies is to capture rapid pricemovements and profit from the subsequent price trend.
Example of an opportune entry for a bullishbreakout trade on EURUSD 4-hour chart
The key to developing a strategy that worksfor you is by studying the charts and thinking about what makes sense to you.If you think patterns make sense as they identify areas of consolidation whichcan lead to a breakout, then pattern trading could be a good fit for you.
It’s important for any trader to stick withtheir chosen strategy and not switch strategies every time they encounter alosing streak.
Practical Tips for Beginners
Maintain a Trading Journal
Keeping a trading journal allows traders totrack their performance, analyse their trades, and identify areas forimprovement. A trading journal should include details such as entry and exitpoints, trade rationale, risk-reward ratio, and emotional state. By reviewingpast trades, traders can learn from their mistakes and refine their tradingstrategies over time.
Avoid Overleveraging
While leverage can amplify profits, it alsoincreases the risk of significant losses. Avoid overleveraging by usingleverage cautiously and only trading with capital you can afford to lose. Ageneral rule is to keep leverage levels below 10:1 to mitigate riskeffectively. The best position is cash. You should ensure you’re only takingthe most high-probability set-ups that are in-line with your strategy.
Stay Disciplined
Maintain discipline in your tradingapproach by sticking to your trading plan and avoiding emotionaldecision-making. Avoid chasing losses or deviating from your strategy based onfear or greed. Consistency and discipline are key to long-term success in forextrading. Sometimes it’s best to walk away from the charts and come back thenext day with a clearer head.
Manage Emotions Effectively
Trading can be emotionally challenging,with the potential for both euphoria and despair. Learn to manage your emotionseffectively by practicing mindfulness techniques, maintaining a positivemindset, and taking regular breaks from the market. Remember that losses are anatural part of trading, and it's essential to stay resilient and focused onyour long-term goals.
We highly recommend reading our article on theTop 10 Hidden Biases here.
Be realistic with your expectations
Trading can be very lucrative, but it canalso be very costly. Traders should be realistic in their expectations – what %will you aim for each month? How much are you going to risk? Risking 20% ofyour equity per trade will be great on winning trades, but it won’t take longfor you to eradicate your entire balance on a handful of losses. Whereasrisking 1% equity per trade will allow you to conserve as much capital aspossible, whilst still gaining 1%+ per winning trade.
Resources for Further Learning
To continue your forex trading education,consider exploring the following resources:
- Books: "Currency Trading for Dummies" by Brian Dolan,"Japanese Candlestick Charting Techniques" by Steve Nison, and"Market Wizards" by Jack D. Schwager.
- Online Courses: Investopedia Academy, Udemy, and Coursera offera variety of forex trading courses for beginners and advanced traders.
- Forums and Communities: Join online forums and communities suchas Forex Factory, BabyPips and TradingView to connect with other traders, share ideas, and learn fromexperienced professionals.
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