Forex is the largest financial market in the world, with an estimated daily turnover of around $5 trillion according to the Bank of International Settlements. This makes Forex larger than the stock and bond market combined. Even if you’re not aware of it, you’ve probably already been a part of this exciting market. Whenever you had to exchange your domestic currency in a money exchange or in a bank, you directly participated in this exciting market. As you already guess, the Forex market is the marketplace of the world’s currencies, and companies, large banks and hedge funds, travelers and individual traders buy and sell currency on a daily basis. In this Forex trading guide, we’ll explain everything you need to know about Forex and show you how to trade Forex for beginners.
After reading this guide, you can come back to this YouTube video which summarizes again some basics of the Forex market.
Why Trade Forex?
Naturally, the first question of many beginners to the market is why should they start trading currencies and not stocks. The answer is simple: Forex has some notable advantages compared to the stock market. First of all, you can trade currencies every day around the clock, except on weekends when the market is closed. The stock market, on the other hand, can only be traded during the open market hours of the stock exchange.
Secondly, there are only eight major currencies and a handful of exotics compared to thousands of stocks on the New York Stock Exchange. Many traders choose Forex over stocks as it is more convenient and less time consuming to analyze a few currency pairs for trading opportunities than hundreds of stocks on a stock exchange.
Finally, opening a trade on the Forex market usually carries significantly less costs compared to stocks trading. There is no middleman in Forex, and the competition among Forex brokers keeps trading costs extraordinarily low. The only cost you have to pay is the difference between the buying and selling price – called spread – and there are usually no additional fees and commissions involved.
Major Currencies Explained
We’ve already mentioned that there are only eight major currencies in Forex, and now we’ll list them. The major currencies are the US dollar, euro, British pound, Swiss franc, Japanese yen, Australian dollar, New Zealand dollar and Canadian dollar. There are two more currencies if we expand our list to cover all G10 currencies, and they are the Norwegian krona and the Swedish krona. For new traders, it’s important to know that each currency has its own characteristics and specifics. For example, we can group these currencies into major reserve currencies (US dollar, euro and Japanese yen), safe-haven currencies that appreciate with political and economic turmoil (Swiss franc and Japanese yen), commodity currencies that track the price of oil or gold (Canadian dollar, Australian dollar, Norwegian krona), currencies that appreciate with a risk-on market environment (US dollar, Australian and New Zealand dollar), and so on.
Knowing the major influences that impact the mentioned currencies is pretty much like analyzing the financial standing of a company when trading stocks. It’s an important Forex trading lesson for beginners.
What Are Major and Cross Currency Pairs?
Whenever you’re buying or selling a currency, you’re doing so relative to another currency. In other words, all currencies are quoted in pairs, and the exchange rate reflects the price of the first currency in terms of the second currency. The first currency in a pair is called the base currency, and the second currency is called the counter-currency. For example, if the euro vs. US dollar (EUR/USD) currently trades at 1.20, this means that one euro (the base currency) costs $1.20 US dollar (the counter-currency). Forex traders try to anticipate the rise or fall of the exchange rate in order to make a profit on the price difference. If a trader expects that the euro will appreciate against the US dollar, he would look to buy (or go long) in the EUR/USD pair. Similarly, an expected fall in the exchange rate would trigger a sell (short) position.
Currency pairs can be grouped into major pairs, cross pairs and exotics. Major pairs are all pairs that involve the US dollar as either the base or counter-currency, such as EUR/USD, GBP/USD and USD/JPY. Cross pairs exclude the US dollar, but involve any other of the remaining seven major currencies in the pair. Some cross pairs are EUR/GBP, GBP/CAD and AUD/NZD. Finally, exotics include one of the exotic currencies which are not considered the majors. Those currencies are significantly less liquid and more volatile, and include names such as the Mexican peso, Chinese yuan or Turkish lira. You need to be careful when trading exotics, as they can easily fluctuate a few hundred pips in a matter of hours.
What is a Pip in Forex?
Now that you know that all currencies are quoted in pairs, it’s time to explain what is a pip in Forex. A pip represents the fourth decimal place of an exchange rate, except for a few JPY-pairs where a pip reflects the second decimal place. For example, if EUR/USD trades at 1.2050 and rises to 1.2058, this would equal to a rise of 8 pips. On the other hand, if USD/JPY trades at 110.80 and falls to 110.35, this equals to a fall of 45 pips. Understanding Forex trading for beginners starts with the concept of pips, as they’re often used to report a profit or loss of a trade.
Each pip also carries a certain dollar-value that depends on the size of your position. If you open a standard lot in Forex which is a position size of 100,000 units of the base currency, one single pip would be worth around $10. The exact amount a pip is worth depends on the currency pair that you trade.
Some Forex brokers report exchange rates in a format with five decimal places. In this case, the fifth decimal place represents a pipette, which is a fraction of a pip. Ten pipettes equal to one pip, or one pipette equals to 1/10 of a pip.
Transaction costs in Forex (the spread) are also usually given in the form of pips. Major pairs, being the most liquid ones, have very tight spreads which can be as low as 1 pip. For example, the bid price of EUR/USD could be 1.2050, and the ask price 1.2051. Good Forex brokers for beginners need to have tight spreads as it enables you to keep a larger portion of your profits.
How to Analyze the Forex Market?
The Forex market can be analyzed in a few different ways, each of which has its own advantages and drawbacks. Technical analysis is the most popular way of analyzing the market among retail traders, and involves studying the price-chart for specific price patterns that, according to technicians, tend to form in the market over and over again. In fact, one of the three basic premises of technical analysis states that “history tends to repeat itself”. The other two are that “price discounts all information” and “markets tend to trend”. As a result, all you need to make informed trading decisions and get started in Forex trading strategies is the price-chart and nothing else. Many trading platforms, such as MetaTrader which is one of the best Forex platforms for beginners, offer advanced charting tools to perform technical analysis on price-charts. Another easy to use Forex trading platform is cTrader, so you may want to look into it as well.
Technical analysis has proved to return very good results, as certain technical levels become self-fulfilling when a large number of market participants act based on them. Popular tools used by technical traders include trendlines and channels, support and resistance zones, technical indicators, chart patterns and Fibonacci retracements.
The second analytical discipline widespread among Forex traders is fundamental analysis. This way of market analyzing involves the study of fundamentals that impact the value of currencies. They can include changes in the monetary and fiscal policy of a central bank, economic growth, unemployment rate, inflation rates, trade balances and so on. Fundamentals are what creates trends and reverses them, so having at least a basic understanding of them could have a large effect on your trading performance. However, if you’re a Forex starter, you may want to learn technical analysis first.
Long-Term vs. Short-Term Trading
There is never-ending debate among Forex traders whether short-term or long-term trading is better. Many Forex trading newbies start with very short timeframes and get excited even with small profits. They don’t have the experience and patience of veteran traders and want to take as many trades as possible. This usually leads to trading mistakes, emotional trading and blowing up the trading account. Short-term timeframes such as the 5-minute, 30-minute or 1-hour timeframes reflect market noise to a large extent, and are unreliable for trading most of the time. While all technical tools can be applied on any timeframe, they tend to produce better results with higher timeframes such as the 4-hour, daily or weekly timeframes. That’s something you need to be aware about if you’re looking for Forex day trading for beginners.
Fundamentals also need time to develop, and can take many days, weeks or even months to produce an obvious price-move. This means that longer-term trading is less risky and has a higher probability of success compared to shorter-term trading. Many of the best Forex sites for beginners have a dedicated section for fundamentals which you can study, and the following picture shows the times of important news releases for each currency. You need to practice your patience when getting into a trade if you want to become a highly successful trader.
How Volatile is the Forex Market?
The Forex market is extremely liquid, which means that a large number of potential buyers and sellers hide at any given price-level. This is especially true with the major pairs that include the US dollar, as the currency is involved in around 80% of all Forex transactions. As a result, high liquidity tends to suppress volatility which makes certain Forex pairs less volatile than others. In fact, many pairs have a daily range of less than 1%, which makes it necessary to trade on leverage in case you have a relatively small trading account. The following chart shows the average daily range of the most-traded currency pairs.
The high leverage offered by Forex brokers is one of the main reasons why the Forex market attracts so many traders. Many brokers offer a 100:1 leverage, which means you can open a position that is 100 times larger than your trading account. Compare this to stocks where the leverage usually reaches up to 20:1, and you’ll notice the difference. However, be aware that trading on high leverage carries high risks, as both your profits and losses are equally magnified. That’s why strict risk management rules need to be a part of your trading plan.
The Trend is Your Friend
We’ve mentioned the three basic premises of technical analysis, one of which says that “markets tend to trend”. The Forex market is an ideal example, as currencies like to trend more than any other asset class. You’ve probably heard the saying that “the trend is your friend”, which refers to the exceptional results that trend-following strategies can generate in the Forex market. The following chart shows the construction of an uptrend with consecutive higher highs and higher lows, followed by a trend reversal shown by the lower low and lower high.
Knowing how to correctly identify a trend and a trend reversal is among the first things you need to learn before opening your first trade. Generally, trends can be grouped into primary trends that last from a six months to a few years, intermediate trends that can last from a one month to six months, and short-term trends that typically last from a few days up to a month. You need always to know whether those trends are uptrends or downtrends, and the best way to do so is by using multiple timeframe analysis. Use longer-term timeframes to identify primary and intermediate trends, and shorter-term timeframes to spot short-term trends. This approach helps if you intend to open trades in the direction of the trend.
Start with a Demo Account First
Almost all Forex brokers offer demo accounts which are a great way to practice trading in a risk-free environment. Before opening a real account and start risking real money, use a demo account to get familiar with the basics of Forex trading for beginners, the nature of the market and the trading platform itself. Only when you achieve consistent returns on a demo account should you consider moving on to a real account.
As this traders’ guide to Forex shows, investing in Forex offers an exciting entrance to the world of financial markets for beginners. It’s open around the clock and pushes you to be up-to-date with political and economic developments in the world. Learning the personality traits of the major currencies will help you tremendously on your trading quest, especially if you use a fundamental approach to Forex trading. If not, even technical analysis has a proven track-record of consistent profits if you get the Forex basics for beginners right. Now that you know how to get started in Forex trading, you’re able to make your first steps towards a successful trading career.