There are two issues with most of the forex guides out there. First, they can be generic to the point that you leave with way more questions than you came in with. The other problem is the exact opposite, but it too has the same effect. Some guides are so focused on a specific strategy that has worked for some traders.
For these reasons, a guide that is appropriate to beginners by both giving the necessary background and directing them to the next step that most fits their needs was in due time.
Here, at Sortter, we will help you learn how to trade forex by introducing the practice of forex trading for you in a down-to-earth manner.
We will also help you decide what method, time frame, and level of risk will be appropriate for you based on your interests, goals, and risk tolerance.
First, let us start with some basics.
What Is the Forex Market?
The forex market consists of individuals, banks, and institutions that trade currencies and is responsible for the prevalent foreign exchange rates of all currencies. For that reason, you can consider the forex market consisting of many other sub-markets.
For example, the trading between the euro and the United States dollar is a market by itself. But we usually refer to these sub-markets as “currency pairs.”
The forex market started in the same period that international commerce did, back in ancient times. Money-changers would charge a fee for helping traders convert their currency to some other, the same thing that forex trading platforms do today.
The year 1880 is likely to be the first year that modern forex trading started. But there were many restrictions across countries around the world. The forex market definitely wasn’t exactly as we know it today yet.
Fast forward to today, the year 1973 was the time that state control of forex was removed, and the free market of modern times began. In 1981, the US had the first trade of a currency pair. Shortly afterward, more pairs became available.
What Influences Currency Prices?
Before you dive into the intricacies of forex trading, you must have a basic understanding of why a currency’s value fluctuates. In other words, you must know what makes the currency prices go up and down.
Of course, the list of factors is too long and maybe even unnecessary for a non-academic person to know. But as a soon-to-be trader, there are some “pillar” factors that you need to be aware of.
The first is inflation. It’s the general increase in the prices of goods and therefore the decrease of your purchasing power. In other words, the more expensive products get in a country, the less value that country’s currency has.
One could argue that all of the factors that influence currency prices are centered around the concept of inflation. That’s because another very important factor is interest rates, which have a close relationship with inflation.
For example, if banks in a certain country increase interest rates, this can attract foreign capital, which can boost the value of that country’s currency.
Another factor linked to inflation is governmental intervention. If, for instance, a government starts printing more money, the increase in the money supply will increase inflation, and therefore the currency’s value will fall.
Forex Trading Risks
Forex trading is extremely risky, especially for beginners. Even brokers emphasize that when they disclaim that CFD trading, in general, is very risky and a large portion of traders lose money in that market.
So, before you get into it, you should be aware of all of the risks involved to make sure you don’t use more money than you can afford to lose. Being informed could also help you manage those risks to the extent that they’re manageable.
Some of the main risks in forex trading are:
- Leverage-related. As you may know, forex trading involves the use of leverage a lot of the time. That can help you make a great return if things go your way, but if not, it can result in huge losses.
- Volatile exchange rates. Some currencies can have very volatile rates putting in danger your investment in the short term.
- Lack of liquidity. If some currency pair doesn’t have enough trading volume to provide you with fast order executions, then you could lose money just by failing to limit your losses early enough.
So, make sure that you keep these main risks in mind as you proceed with forex trading. Risks shouldn’t discourage you from trading, but they should encourage you to go forth equipped with the knowledge of what could happen.
Let us now view a couple of terms that are most commonly encountered in forex trading:
- Currency Pair - This is simply the price quote of the exchange rate between two currencies. In other words, it’s an indicator of the relative valuation of one currency against another. An example is the EUR/USD 1.1576 (the price here is just an example, of course, and not based on the actual exchange rate)
- Bid / Ask Price - In forex trading, the bid price is the highest price that a trader is willing to pay for a currency pair. The ask price is the lowest price that a trader is willing to sell the price at.
- Percentage In Point (PIP) - The PIP is the fourth decimal in every price quote. Take, for example, the example we used above for the EUR/USD 1.1576. The number “6” is the PIP, and if it goes to “8”, for example, we’d say that the rate moved by 2 PIPs. When trading JPY pairs, the PIP is the third decimal.
- Lot Size - The lot size is a measure of a forex transaction’s size and is calculated in currency units. There are 4 most commonly referenced lot sizes: Standard, Mini, Micro, and Nano, and they consist of 100,000, 10,000, 1,000, and 100 units, respectively.
How to Analyze Forex Before Trading
There are two ways that forex traders use to analyze the related markets: technical and fundamental analysis.
Some traders even use both to forecast future price movements. With that being said, they are completely different approaches to currency valuation.
Let’s dive a bit deeper into what each involves.
Simply put, technical analysis is about studying historical price movements and identifying patterns in order to predict future price movements. It’s supposed to help with decision-making regarding when to enter/exit a trade.
In other words, technical analysts are concerned about historical price data, and they will try to see if they can foresee some future price movement based on the assumption that history repeats itself.
When you do technical analysis, you usually look for trends in the market. But identifying such trends is more of an art than science, and it takes time to get it right to the degree that forex trading yields profits.
Fundamental analysis is supposed to predict the directions of currency prices based on fundamental data like broad economics and politics.
That’s based on the fact that banks and governments indirectly influence the value of currencies through the role they play in interest rates, inflation, and money supply/demand.
Fundamental analysts keep a close eye on:
- Economic Indicators - These are reports that are released by governments regarding the country’s economic performance.
- Industrial Production - This involves indicators that measure the country’s production via the use of factories, utilities, and mines.
- Gross Domestic Product - This is the main measure of a nation’s annual market value based on the goods/services production.
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Popular Forex Trading Strategies
Let us now take a look at the most common forex trading strategies out there. We will also examine each one’s strengths and weaknesses, so you can determine what strategy is best for you to learn.
Trend trading is perhaps the most popular and basic forex trading strategy. It’s technical analysis-based, and it attempts to generate returns through the momentum a currency may have in a certain direction.
For example, a trader may identify that a currency is in an uptrend and thus would place a buy order. But it works the other way too. A trader could find out that a currency is in a downturn and thus would short (bet against) it.
Before you determine whether that strategy is for you, consider the following pros and cons, though.
- There’s already a lot of research done for you out there based on this strategy
- Some trends last for a long time, so you won’t have to be that active if you don’t want to
- Since this strategy is slow-paced, you can incur lower transaction fees
- There’s usually enough time to capture the momentum of an uptrend and exit the trade before a downtrend starts
- Since it’s a simple strategy, traders may underestimate the need for sticking to a plan (as is the case for all strategies) and being consistently profitable
- Because this strategy relies on those few trades that will yield outsized returns, you must be on your guard to not miss the next big opportunity
Range trading is a strategy that aims to profit from predicting that a currency pair will trade through the same price range multiple times in a row.
For example, if a trader predicts that the EUR/USD will trade between 1.1500 and 1.2000 many times over a certain period, they will attempt to buy at the first price point and sell at the latter over and over again.
The opposite can be profitable too. A trader could profit from shorting the pair at 1.2000 and exit the position at 1.1500; then, wait till it gets to the former price point again, rinse and repeat.
This strategy is for you if you’re willing to put in the time to study and experiment a lot. On top of that, it requires quick decisions and high-stress tolerance.
- You can start with a relatively small fund
- You can have more predictable results than with the other strategies
- More liquidity since you’re not supposed to hold a position for long
- You need to be very active and watchful to be profitable
- It’s more expensive because the profits are often small, and spread costs can eat up a large portion of them
Price Action Trading
Price action trading is a strategy that examines the movement of currency prices in relation to past ones to predict how they will move in the future.
This strategy relies a lot on technical analysis, but it also requires close observation of what’s happening in the present. Thus, if you want to employ it, you will have to learn the ins and outs of technical analysis and be active. It’s definitely not a set-it-and-forget-it kind of strategy like trend trading.
- Not much research is needed compared to other strategies once you have learned the ins and outs of technical analysis
- You can use simulators to test your hypotheses before you risk your hard-earned cash
- Great variety in approaches according to your risk tolerance and temperament
- Greater margin for error
- You cannot automate your trades
- Not suited to those who prefer a more relaxed trading routine
The scalping strategy is supposed to help you make small but frequent profits through entering and exiting multiple trades in very small periods (a few seconds to 1 minute). For that reason, the trader employing this strategy will require real-time price data and be on the lookout for any small price movement.
That active trading style, of course, doesn’t mean that the trader will trade without a plan. On the contrary, the prices at which the trader will enter/exit a trade should be predetermined based on technical analysis (see above).
This strategy is best suited to those who prefer immediate results (albeit not outstanding ones) and have the patience to actively trade for long periods at a time.
- You can have more successful trades
- Can be a more satisfying strategy for those who can afford to be active enough
- You can generate regular profits
- It’s easier to use only a portion of your capital to trade and be profitable; thus, limiting your risk exposure
- You only need a currency to move a few pips in your favor to make a profit
- It’s more difficult to correctly predict where and how far a price will move in such a short period
- One big loss could account for more than all of your small profits combined
Swing trading aims to profit from buying at support levels and selling at resistance ones.
For context, a support level is the price of a currency pair won’t fall below within a specific time frame. At the same time, a resistance level is the price of a currency pair that won’t go above in a specified period.
So, as you can imagine, swing trading requires a good knowledge of technical analysis and it’s ideal for those who can afford to be active enough to read charts and make multiple trades during a session.
- You can make a significant profit in fewer trades in contrast with some more active strategies
- You can have more liquidity than other less active strategies provide
- You will need to initially invest a lot of time to learn the ins and outs of technical analysis
- You need to be active to realize regular profits
How to Make Your Own Trading Plan
As you may already know by now, success in forex trading depends on the right level of discipline and patience to stick to a plan. But how exactly do you create a trading plan?
A plan must take into account your specific goals, temperament, and risk tolerance. And it must also be tailored to the strategy that you choose. Indeed, the biggest factor that will determine your plan is your preferred strategy.
With that being said, some simple steps will help you start defining your plan now.
Let us take a look at each one:
1. Determine your goals
What will keep your plan as concrete as possible and allow you to successfully stick to it is your motivation behind forex trading. Therefore, it is very important that you first define your reasons for trading forex.
This will be the foundation of your plan, so it’s a good idea to write down your goals that you wish to achieve through forex trading. It’s alright if your goals change over time. But you should make sure that you update your plan as necessary.
2. Determine how much time you can allocate
After you express your goals, try to determine how much time you’re willing to put into forex trading to make them a reality.
At first, learning how to trade forex using a specific strategy will take some time. So, pin down how much time you can allocate each day or week towards learning to see how long it will approximately take you to prepare for trading.
Once you’re ready to get into action, update that by determining how much time you can spend per day/week/month to trade. At this stage, it’s important to see if you can yield the results you’re looking for against the time you can invest.
So, it’s recommended to closely monitor your performance; if you think that you must spend more time to get better results, you need to update your plan as necessary.
But that’s not always possible with people who have a full-time job, a business to run, or a family to look after. So, you might have to pick and learn a different strategy that will afford you a more relaxed trading style.
3. Figure out how much money you are willing to start with
The next step is to decide how big your fund will be while starting. This may seem unimportant at first glance, but it can either make or break your plan.
A trading addiction can develop very fast if you’re not consistent with the amount you will be using to trade. It’s almost certain that you will have some losing trades at first. Placing a limit on how much you’re willing to use for trading each day/week/month will help you not lose even more.
Some traders prefer depositing funds periodically because they don’t have a big sum to start with right from the beginning. Consider doing the same regardless to form a habit that will help you avoid putting excess money at risk at any point in time.
4. Choose a strategy
Last but not least, you will need to select a strategy. This will be the heart of your trading plan.
We have already talked about various strategies that fit all kinds of traders above. Once you choose one, commit to it and be patient. It’s wise not to abandon it for the next big thing. Successful traders don’t abandon strategies to replace them with new ones over and over again.
So, you might need to practice with a strategy for at least a couple of months before you can determine whether it is for you or not, even if it results in losing money at first. There’s no way to succeed in forex trading before you experience some failure.
The reason we’re emphasizing that principle is that the strategy you choose will be the vital element that makes your plan yours. In other words, if it makes sense to stick to your plan that you make and update it as necessary, it goes without saying that your strategy needs to evolve but not get completely replaced by another one with the first taste of loss.
Update your plan as necessary
Circumstances and goals change. For that reason, it’s vital that you keep your plan up to date.
You may be able (or make more sense for you) to increase the capital that you allocate towards trading. Or you might become more experienced and successful enough that spending more time to trade is worth it.
In any case, your plan must evolve as you do.
As you can see, forex trading isn’t that complicated once you choose a strategy and learn it well.
The key is to create a plan based on your preferred strategy and stick to it no matter what happens. Successful forex traders are known to be stress-resilient and determined to lose some in order to have big, or enough wins to turn a profit in the end.
But it’s also very important to choose the forex trading app for your needs. Fees, customer support, currency, and country of residence are all basic factors that will determine the app you need.
That is why we created a free tool to help you select the broker that is most appropriate to your wants and tailor-made to your needs!
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Forex (foreign exchange) trading refers to the buying and selling of Contracts For Difference (CFD) that base their value on currency exchange rates.
First, you need to open an account with a forex broker (use our tool to find the best for you). Then, once you fund your account, you will have the option to choose a currency pair and either enter a buy or sell order.
After you go through our guide to cover the basics, you will need to choose the strategy that suits your needs best.
When you enter a forex trade, you speculate on a currency pair price to either increase or decrease.
You basically speculate on the price movement of a certain currency through a derivative security called CFD instead of converting your currency to another.
Since forex trading involves making a large profit off small market movements, most forex traders use leverage to make enough money.
Leverage in forex trading involves borrowing funds from your broker to increase your position beyond how large it would be if you were just trading with cash.
Note that using leverage can amplify both your profits and losses.
To be successful in forex trading and consistently make money, you need to invest time in learning a strategy, be disciplined, and be willing to lose some. As with anything, it has a learning curve, and you need to commit to it for a long time before it becomes profitable.