Forex Market – The Definitive Guide of How the Forex Market Works
Forex Market – The Definitive Guide of How the Forex Market Works
Table of Contents
- What is Forex?
- What is the Forex market?
- What is Forex trading?
- History of Forex trading
- Three ways to trade Forex
- How to make a profit from Forex trading
- What is a carry trade?
- What do Forex brokers do?
- What are currency pairs?
- What are cross currency pairs?
- What is an exotic currency pair?
- Forex for hedging
- Forex for speculation
- What is a trading strategy?
- What is your trading personality?
- What is a trading position?
- Why Forex trading is popular
- Is Forex Trading risky?
- Can you get rich trading Forex?
- Common mistakes Forex traders make
- Start trading Forex with a demo account
- In summary
Foreign currency offers investors one of the richest trading environments but also one of the most dangerous holes to fall into. Forex trading is not easy and it is risky. The big question you need to ask yourself before you learn to trade forex is whether you have the appetite for risk and capacity to absorb losses.
1. What is Forex?
Forex or FX is short for foreign exchange. Foreign exchange is the process of changing or trading one national currency for another one in what is known as currency pairs.
The EUR/USD (Euro/US Dollar) – nicknamed Fiber – is the world’s most traded currency pair. The pair commands over 20 percent of all forex transactions. The Euro and US Dollar represent the two largest economies in the world which is the economy of the United States of America and the European Union. Trading EUR/USD is popular because it trades at tight spreads.
Foreign exchange is one of the fastest and most volatile financial instruments you can trade and money is made and lost in rapid time. Foreign currency pairs present obvious or significant trends that last anything from a few days to weeks, months and years. Successful traders learn to read the market trends on currency price movements and practice disciplined trading to limit losses.
2. What is the Forex market?
The forex market is the virtual marketplace where investors and traders from around the world come to trade foreign currency. Foreign currencies are traded every day for the export and import market and global travel but now with high-speed Internet connectivity, forex trading for profit has become one of the most popular forms of trading.
In simple terms, if you live in South Africa and want to import agricultural equipment from the United States, you need to exchange South African Rands for US Dollars for the transaction. This is the traditional forex market and at the end of the transaction, the South African businessman takes ownership of the equipment and the businessman in America pockets his or her profit in US Dollars.
Typically, this type of forex transaction is done through the foreign exchange divisions in a bank. A foreign exchange rate is quoted a currency pair (ZAR/USD) and the bank charges a transaction fee for the trade deal.
The forex market changed overnight when Internet arrived and the marketplace went electronic. A unique aspect of the forex market is there is no central marketplace for foreign currency. Instead, foreign currency is traded over-the-counter (OTC).
OTC means all forex transactions happen via computer networks between traders across the globe. The market is open 24-hours a day, five and a half days a week. It’s traded in every corner of the world with forex epicenters in New York, London, Zurich, Tokyo, Hong Kong, Singapore, Paris, Frankfurt and Sidney.
As the trading day ends in the United States, it starts up in South Africa, Sydney and Tokyo. You can literally trade on the forex market every hour of every day of the traditional working week. Price movements are constantly changing and the forex market is one of the most active of any financial instrument in the world.
According to the Bank for International Settlements, over US$ 5.1 trillion in forex volume is traded every day on the forex market. Bank of International Settlements is a global bank for national central banks and releases triennial reports on global financial instruments.
3. What is Forex trading?
Forex trading is the process of buying, selling and speculating on foreign currency pairs. Macroeconomic factors and trading activities affect price movements which determine the foreign exchange rate.
An exchange rate in finance is the rate at which one currency will be exchanged for another. In other words, it’s the value the world market puts on one currency in relation to another currency. You’ll hear statements such as “the US Dollar has strengthened against the British Pound” or “the South African Rand has lost value against the US Dollar”.
Forex trading happens through the so-called ‘interbank’ market. This is a decentralised online platform used by financial institutions to trade currencies between themselves. In other words, interbank transactions bypass the central stock exchanges.
The Internet is used for the commercial turnover of currency investments as well as large amount of speculative, short-term currency trading. According to the Bank of International Settlements, approximately 50 percent of all forex trades are interbank transactions (online forex trading).
4. History of Forex trading
The forex market’s roots do not run as deep as other financial instruments. It’s a relatively new market that exploded with the advent of global Internet connectivity. Of course, converting one foreign currency for another to buy and sell goods and for travel purposes has been around since currencies were first minted but the forex market as we know it today is a modern invention.
In the middle ages, currency in the form of gold and silver was used to buy and sell commodities between the different countries. Then came the introduction of the Gold Standard Monetary System in 1875, followed by the Bretton Woods Agreement which created a collective international currency exchange regime.
The Bretton Woods Agreement lasted from the mid-1940s to the early 1970s. The system of monetary management basically set the rules for commercial and financial relations between the United States, Canada, Western European countries, Australia and Japan.
In 1947, the International Monetary Fund (IMF) was established. The organisation comprised 189 countries and served to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth and reduce poverty around the world.
When the IMF began operating, the US Dollar served as the price of gold, fixed at $35 per ounce. This meant the United States agreed to maintain that price for buying and selling gold. Eventually, the market economies of the world were set to the Dollar standard. The US Dollar essentially served as the world’s principle currency.
During World War I, the Gold Standard Monetary System broke down and by 1971, the Bretton Woods Agreement fell away. This meant that the system that was put into place to prevent the free exchange of currency across nations was abolished and the modern foreign currency exchange was born.
Over two decades, foreign exchange trading has grown expontially; from $70 billion a day in the 1980s to over $5 trillion a day in the 2020s.
5. Three ways to trade Forex
There are three ways investors, traders, brokers and banks trade foreign exchange in the modern forex market: the spot market, the forwards market and the futures market.
In the past, the futures market was the most popular instrument for traders because it’s available to independent investors for a longer period of time. The advent of electronic trading changed the dynamics and there has been a surge in the spot market. In fact, the sport market has surpassed the futures market as the preferred trading market for individual investors and speculative traders.
Traders who are new to the forex market will trade the spot market. The futures and forwards markets are popular with corporates and financial institutions with large funds and use these financial instruments to hedge their foreign exchange risks out to future date.
The spot market
The spot market or cash market is a public financial market in which financial instruments or commodities are traded for immediate delivery. It contrasts with a futures market, in which delivery is due at a later date.
Foreign currency is bought and sold according to the current price. The price is determined by supply and demand and is a reflection of a country’s current interest rates, economic performance, political-economical stability and the market’s perception of how a national currency will perform against the major global currencies.
The forwards market
The forward market is the informal over-the-counter financial market by which contracts for future delivery are entered into. Standardised forward contracts are called futures contracts and traded on a futures exchange.
The futures market
A futures exchange or futures market is a central financial exchange where people can trade standardised futures contracts. A futures contract is used to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future.
6. How to make a profit from Forex trading
Investors and traders profit from the difference between two interest rates in two different economies. They do this by buying the currency with the higher interest rate and shorting the currency with the lower interest rate.
Shorting a currency is where a trader speculates one currency will go down against the strength of another currency. When a trader ‘goes short’, the trader thinks the currency will decrease in value compared to another currency. ‘Going long’ means the trader thinks the currency will increase in value compared to another currency.
There are two ways you can make a profit on the forex market:
Earn the interest differential between two currencies
Interest Rate Differential (IRD) is the difference in the interest rate between two currencies in a pair. If one currency has an interest rate of 3% and the other has an interest rate of 1%, it has a 2% interest rate differential (IRD).
This is known as the currency carry trade. In a currency carry trade, the intermediate and long-term trader hopes to profit from the interest rate differential paid between the currency pairs.
Profit from changes in the exchange rate
This is where new traders start in the forex market. It’s where a trader bets that the value of one currency will increase relative to another currency. The prices of foreign currency rise and fall and investors and traders make money when the price of currency pairs move in the right direction for them.
Forex is traded and priced in pairs and the base currency is worth one unit. For example, the ZAR/USD is currently 1 South African Rand equals 0.052 US Dollars. The base currency is the ZAR (South African Rand) and the USD is the quote currency.
Investors and traders make money in forex by appreciation in the value of the quoted currency (USD) or by a decrease in value of the base currency (ZAR). Currencies appreciate against each other for various reasons; the most common being political-economic stability, government policy, interest rates, trade balances and business cycles.
7. What is a carry trade?
Carry trading is one of the most simple trading strategies for forex trading. A carry trade is when an investor buys a high-interest currency (GBP or Euro) against a low-interest currency (USD).
For each day that you hold that carry trade, you pay the interest difference between the two currencies. This is as long as you are trading in the interest-positive direction.
Example of a carry trade
If the British Pound (GBP) has a 5 percent interest rate and the US Dollar has a 2 percent interest rate, and you ‘go long’ on the GBP/USD… you are making a carry trade.
Every day you hold the GBP/USD long position, your broker pays you the difference between the interest rates of those two currencies which is 3 percent. The interest rate difference adds up over time.
8. What do Forex brokers do?
Forex brokers facilitate forex trading by providing investors and traders with access to a trading platform that allows them to buy and sell foreign currencies. They are more formally known as retail forex brokers or currency trading brokers.
The average man-in-the-street cannot access the forex market without going through a forex broker. Brokers also provide very substantial leverage which means an investor or trader can borrow a certain amount of the money needed to take a position on a forex trade. The broker takes a margin on the trade.
Brokers mainly make money on the bid-ask spread. This is the difference between the prices quoted for an immediate sale or purchase of a currency pairs (buy and sell forex).
What to look for when choosing a broker
- Speed and reliability of trade executions
- How stop-loss and take-profit orders are filled
- What is the commission structure
- How much leverage does the forex broker offer
- Quality of their trading platform
- Tools and resources offered by the broker
- Does the broker offer 24-hour customer support
- Is the firm regulated by the Financial Services Board
- Who runs the broker firm
9. What are currency pairs?
Forex involves speculating on the value of two currencies where one is the base currency and one is the quote currency. The most widely-traded currency pair in the world is the Euro against the US Dollar (EUR/USD), where the Euro is the base currency and the USD is the quote currency.
The first currency listed in a currency pair is called the base currency.
The second currency is called the quote currency.
South African Rand = base currency
US Dollar = quote currency
The major currency pairs are:
- EUR/USD (Euro/US Dollar) – nicknamed Fiber
- GBP/USD (British Pound/US Dollar) – nicknamed Cable
- AUD/USD (Australian Dollar/US Dollar) – nicknamed Aussie
- NZD/USD (New Zealand Dollar/US Dollar) – nicknamed Kiwi
- JPY/USD (Japanese Yen/US Dollar) – nicknamed Gopher
- CHF/USD (Swiss Franc/US Dollar) – nicknamed Swissie
- CAD/USD (Canadian Dollar/US Dollar) – nicknamed Loonie
The minor currency pairs are:
- EUR/GBP (Euro/British Pound) – nicknamed Chunnel
- GBP/JPY (British Pound/Japanese Yen) – nicknamed Guppy
- CAD/CHF (Canadian Dollar/Swiss Franc) – nicknamed Loonie Swissy
- EUR/JPY (Euro/Japanese Yen) – nicknamed Yuppy
- NZD/JPY (New Zealand Dollar/Japanese Yen) – nicknamed Kiwi Yen
What is the base and quote currency?
The base currency is always represented as 1 unit.
The exchange rate represents the base currency relative to the quote currency. In other words, how much of the quote currency is needed to get one unit of the base currency.
ZAR/USD is 1.0052
ZAR = base currency
USD = quote currency
This means 1 South African Rand = 0.052 United Dollars
An American visiting South Africa only needs USD 5.25 to get R 100.
USD/ZAR is 1.19046
USD = base currency
ZAR = quote currency
This means 1 US Dollar = 19.046 South African Rand
A South African visiting America needs R1 904 to get USD 100.
What is the bid price?
The Bid price is the price a forex trader is willing to sell a currency pair for on the forex market.
What is the ask price?
The ask price is the price a trader is willing to buy a currency pair for on the forex market.
What is a spread?
Spreads are based on the buy and sell price of a currency pair. In other words, the difference in price between what a trader buys a currency pair for and what the trader sells it for on the forex market.
Buy price (EUR/USD) is 1.13398
Sell price (EUR/USD) is 1.3404
The spread is 0.0006 (buy price minus sell price)
The pip value is the 4th digit after the decimal. Therefore, the final spread is 0.6 pips.
What is a Pip?
Pip is short for Point in Percentage. It’s the most fundamental unit of measure that’s used in foreign exchange trading.
A pip is a very small measure of change in a currency pair. It is measured in relation to the quote currency or the underlying currency. It’s the smallest amount by which a quote currency can change.
A pip is a standardised unit and the size helps protect investors from huge losses. For example, if a pip was 10 basis points, one-pip change would cause volatility in currency values.
10. What are cross currency pairs?
A cross currency is any currency pair that does not use the US Dollar as either the base or quote currency. The most widely-traded cross currency pair is EUR/JPY (Euro/Japanese Yen).
At the end of World War II, the United State’s economy was the strongest in the world and its currency was fixed to gold. It made sense that the rest of the world pegged their currency against the strength of the USD.
Today, cross currency pairs have grown in popularity as the forex market has taken off and non-USA currencies have strengthened.
11. What is an exotic currency pair?
An exotic currency pair usually consists of one major currency (USD, EUR or GBP) that is coupled with a thinly-traded and highly-illiquid currency, typically from a developing or emerging market.
An illiquid asset is not easily converted into cash; there are few participants and a low volume of activity on the markets.
Examples of exotic currency pairs include:
- USD/TRY (US Dollar/Turkish Iire)
- USD/MXN (US Dollar/Mexican Peso
- EUR/HUF (Euro/Hungarian Forint)
Exotic currency pairs are fairly popular, mainly because they offer higher potential returns due to the wide price fluctuations. However, on the whole, exotic currencies are inefficient and expensive to trade because they lack liquidity and tend to have higher spreads.
The South African Rand paired with a major currency is an example of an exotic currency (ZAR/USD).
Some of the most commonly-traded exotic currencies are:
- Mexican Peso (MXN)
- Chinese Yuan (CNY)
- Russian Ruble (RUB)
- Hong Kong Dollar (HKD)
- Singapore Dollar (SGD)
- Turkish Lira (TRY)
- South Korean Won (KRW)
- South African Rand (ZAR)
- Brazilian Real (BRL)
- Indian Rupee (INR)
12. Forex for hedging
Forex provides businesses with a way to hedge currency risk by fixing a rate at which the transaction will be completed. This is more relevant for companies doing business in foreign countries and risk losing money due to currency fluctuations when they buy and/or sell goods and services outside of their domestic market.
Hedging allows a forex trader to buy or sell a currency pair in the forward or swap markets in advance. This locks in the exchange rate.
13. Forex for speculation
The supply and demand of global currencies is affected by factors such as interest rates, trade flows, economic strength and political stability.
These factors create daily volatility in the forex markets and opportunities present themselves to make a profit by speculating on price movements that may increase or decrease the value of one currency against the value of another currency.
Forex is traded in currency pairs so a trader will speculate that one currency will weaken and/or another currency will strengthen. For example, the South African Rand will weaken against the US Dollar during volatile political-economic periods and it will strengthen in stable times.
Traders make money when the currency price moves in the direction they speculated on; increased or decreased in value against the other currency. Traders lose money if the price movement doesn’t work in their favour.
14. What is a trading strategy?
One of the most important disciplines a new trader must concentrate on is developing a trading strategy that suits their trading personality and/or circumstances.
A forex trader makes rapid-time decisions to buy and sell currency pairs; whether this is taking a long position or ‘going short’. With advanced forex trading tools, it’s easier than ever to access technical and fundamental analysis and create price charts for every currency pair. However, the more information you have access to, the more overwhelming the forex market can appear.
A focused and effective trading strategy helps you process the information and create a set of rules or methodology to guide your trading decisions. The most successful forex traders are disciplined about sticking to their trading strategy.
The four most-common trading strategies are:
These are very short-lived trades, sometimes only lasting a few minutes. A scalper aims to rapidly beat the bid-offer spread and skim a few points of profit before closing the position.
The scalping strategy uses tick charts.
Day trading involves making trades that close at the end of the trading day. It’s a less risky trading strategy for beginners, particularly those trading on a part-time basis.
Day trading does away with the risk of large price moves that happen overnight. Remember, the forex market trades 24-hours a day on the days it’s open.
Day trades last anything from 5 to 8 hours and price charts are set to one or two minutes. The 50-pips a day forex strategy is an example of an efficient day trading strategy.
With a swing trading strategy, positions are held for several days and a trader aims to profit from short-term price patterns. A swing trader typically uses bar chart to analyse the market by the hour or half-hour.
With a positional trading strategy, a trader looks at the long-term trend of currency pairs and aims to maximise profits from major price movements. A long-term trader looks at the end of day charts and typically makes decisions based on a wealth of knowledge regarding market fundamentals.
Positional trading requires discipline, experience and immense patience. This trading strategy is best left to the forex trading professionals.
15. What is your trading personality?
Before you develop a trading strategy for the forex market, it’s important to understand your trading personality. In other words, what type of trader are you and how much risk can absorb.
Let’s look at the personalities of different forex traders:
A scalper looks for quick opportunities for lower gains. They tend not to have the patience or the appetite for risk to hold a position for a long period of time.
A scalper might be a beginner who’s excited by the thrill of forex trading but doesn’t yet have the capital or the confidence to keep trades active for long.
A scalper doesn’t like to lose money on a trade but most often, it isn’t a big financial blow because the scalper strategy involves smaller amounts of money.
A swinger typically stays in the trade for a few hours to maybe a few days, and enjoys the excitement while it lasts. Swing traders enjoy analysing every aspect of the forex trade and like to identify patterns and trends that he or she uses to develop their trading strategy.
Swingers take a bigger hit financially than a scalper but if they stick to their trading strategy, they can play out the highs and lows to make a profit. Sticking to their trading plan is key because they’ve done the work and know the market well enough to make informed decisions on price movements.
A swinger tends to be a beginner who has advanced to an intermediate level.
A position trader
A position trader holds on for much longer than scalpers and swingers. They tend to be in a forex trade for months and even years. Position holders rely on a combination of their skill and instinct to ride out the highs and lows of currency price movements for the big payout at the end of the trade.
Position holders make extensive use of technical and fundamental analysis and spend a lot of time studying the forex market, looking for any hints of factors that will affect supply and demand.
A position trader has the capacity to hold on for longer and can afford to absorb losses until the trade turns and the price moves in the right direction.
16. What is a trading position?
A position in forex is the term used to describe the traders commitment or exposure to the size and direction of the trade.
An open position means the forex deal is in progress and a trader is either currently able to incur a profit or a loss. A closed position means the trader has cancelled the trade.
Positions are the way a trader makes a profit (or loses money). A position is either profitable or unprofitable depending on whether the price movement went in the direction the trader thought it would go or in the wrong direction.
A position varies depending on the quantity of the asset and whether a trader is buying or selling the asset. There are two types of positions: long positions and short positions.
Every forex transaction involves a short position (a bet that the value will decrease) in one currency and a long position (a bet that the value will increase) in the other currency.
A long position means you are buying an asset or speculating that the asset will increase in value.
When forex traders execute a buy order, they hold a long position in the underlying instrument they bought. For example: USD/JPY. Here the trader expects the US Dollar (USD) to increase against the value of the Japanese Yen.
A short position means the trader aims to make a profit when the price of the asset decreases.
A trader will short a currency at a certain price in the hope that its price will go down in the future. This will allow the trader to buy the same currency back at a lower price at a later time. The trader makes a profit on the difference between the higher selling price and the lower buying price.
Forex is traded on leverage and in this instance, a short-seller borrows money for a currency, sells it at the current market price, waits for the price to fall and buys the currency later at a lower price in order to return the loan. Hopefully, the trader makes a profit on the trade deal.
17. Why online Forex trading is popular
The forex market has the highest liquidity due to the vast daily trading volumes in the world. This makes it easier to enter and exit on a trading position in any of the major currencies in rapid time for a small spread in both volatile and stable market conditions.
Liquidity relates to how easy it is for a financial asset or security to be converted into ready cash without affecting its market value. Financial assets fall along the liquidity spectrum but cash is considered the most liquid asset in the world.
Other examples of liquid assets are accounts or bills receivable, certificates of deposit, CFDs, promissory notes, government bonds, shares or stocks and marketable securities.
Assets such as property, automobiles, fine art and collectables are relatively illiquid, meaning it is not as easy to convert them into cash as other assets.
Brokers and banks allow a high amount of leverage on forex trading. This means that investors and traders can control large positions while putting up only a small amount of their own capital.
Leverage in forex trading basically means borrowing capital from the broker to take a larger or longer position on the forex market. Leverage increases your opportunity to profit from forex trading but the use of debt to trade forex also increases the risks.
Companies use leverage to significantly increase their returns on investments. Instead of using stock to raise capital, leverage allows companies to use debt financing to invest in trading and investment opportunities.
Be warned! Extreme amounts of leverage have led many traders and investors down a dark, deep pit into insolvency. As a new trader, you need to understand the use of leverage and the risks that leverage introduces into forex trading.
18. Is Forex trading risky?
Yes, forex trading is risky. Forex trading is also not easy. In fact, it’s highly complex. Typically, the forex market in most countries is not as strictly regulated as other financial markets and forex instruments are not standardised.
Forex regulations are industry-imposed which means the forex industry self-regulates itself. In fact, in some parts of the world, forex trading is almost completely unregulated.
Forex trading is a decentralised activity that operates over-the-counter in the interbank market. The interbank market is made up of banks that trade with each other around the world and have established internal processes to manage and mitigate sovereign and credit risk.
The forex market is based on supply and demand and participating brokers and banks facilitate offers and bids for a particular currency. Fortunately, because there are such large trade flows within the forex trading system, it’s rare for rogue traders to manipulate the system and influence the price of a currency. We’re talking about inside trading in this instance.
Choose the right broker to partner with you on your forex trading journey
Due to the fact that forex trading operates in an interbank environment that is largely self-regulated, it’s important that you choose who you partner with carefully. It’s essential that you use a broker that is regulated by a financial authority. In South Africa, this is the Financial Sector Conduct Authority (FSCA).
The FSCA is the financial regulatory body in South Africa. It was established in 2018 as the successor to the Financial Services Board (FSB). The FSB had previously regulated the financial services market in South Africa since 1990.
19. Can you get rich trading Forex?
Trading in forex and other financial instruments such as CFDs, spread-betting and future options involves substantial risk of loss and is not suitable for all investors.
Yes, you can make a lot of money trading in forex but you can also lose a lot. Trading carries risk regardless of the financial instrument and how successful you are depends entirely on the trading conditions.
In good trading conditions, you can make millions trading forex. In bad trading conditions, you can lose more money than you have at your disposal or were willing to invest in the forex market.
Trading forex requires immense patience and discipline. The three most important tips we can give you if you are new to trading forex are:
- Register for a forex trading course with a reputable training college and learn everything there is to know about forex trading under expert guidance and personal one-on-on coaching.
- Align yourself with a forex broker you trust and will partner with you on your trading journey; offering one-on-one coaching and mentorship.
- Open a demo account for free and develop a trading strategy that suits your trading personality before you start trading in real-time with real money.
20. Common mistakes Forex traders make
Forex offers investors and new traders one of the richest and most exciting trading environments in the world. The barrier to entry is low and the forex market attracts hundreds of thousands of new investors every year.
A good few make a success of forex trading but many leave with their finances in tatters because they got into forex trading without a thorough understanding of how the forex market works and the pitfalls.
Beginner traders can learn from the mistakes made by those that have gone before them in the forex trading world.
Here are the 6 most common mistakes made by new traders:
- They start trading with little or no trading education
The biggest investment any new trader can make is investing in their trading education. Preferably this is a forex trading course offered by a reputable forex training company as well as many hours spent online watching forex video tutorials and participating in forex webinars.
- They start to trade before they’ve developed a trading strategy
It’s easy to jump into trading. You can sign up for a free demo account and watch a few forex trading videos and Bob’s your Uncle, you’re ready to go.
What you’ve forgotten is you need a solid trading strategy that’ll act as your GPS on your trading journey. An effective trading plan is the difference between success and failure in the forex market.
- They don’t set their trading rules
Most beginners don’t understand how important it is to use the stop-loss order. This is an automatic order that notifies your broker to close your position when it reaches a certain level of loss. When a beginner ignores the risk management tools, he or she risks losing control and losing money.
- They don’t cut their losses when the going gets tough
Seasoned traders know when to cut their losses and let their profits run. Beginners often try to trade out of a bad trade by averaging down or up to redeem a losing position.
Beginners do this in the hope the forex market will change direction and that their current position will turn profitable and make them money. In almost all cases, it doesn’t so you’ve got to know when to quit.
- They use excessive leverage (margin trading)
In other words, beginners borrow more money to get into a trading position than they can afford to lose. Leverage and margin trading is a feature of forex and they have their advantages but they also introduce risk and can magnify your losses.
An excessive use of leverage can very quickly wipe out your trading capital so take it easy on what you borrow to trade currency pairs.
- They have unrealistic expectations of the forex market
The forex market is not a get-rich-quick scheme. If it was that easy to make money on the forex market, everybody would be doing it.
Forex trading takes time, patience and discipline to come close to being successful and making money. It’s important for a beginner to set realistic financial goals to stay motivated and disciplined.
21. START TRADING FOREX WITH A DEMO ACCOUNT
We’ve put this heading in capitals because we want to shout it out loudly and clearly,
“Trade forex with a demo account until you have developed a solid and profitable trading strategy before you use real money.”
The best brokers in South Africa offer excellent trading platforms and a free demo account. Use these ‘fake’ trading accounts to make or lose ‘fake’ money until you’ve developed the discipline, skills and confidence to start trading with real money.
The reason brokers offer free demo accounts is because they understand how risky forex trading is and they want you to learn to trade carefully and with caution before you stake your livelihood and home on the forex market.
There is ZERO risk with a demo account. The only thing that might be a problem when a forex trade goes wrong is a battered ego.
Fake it with a demo account until you make it
The forex experts recommend you trade with a demo account for anything from three to twelve months. One thing everyone agrees on is you should not open a live trading account until you are consistently trading profitably on a demo account.
A compromise is a mini trading account where you are only required to put up a small amount of capital. And with a mini trading account, concentrate on ONE major trading pair.
Trading multiple currency pairs gets complicated and messy. The major currency pairs are more liquid which means tighter spreads and less chance of slippage. Rather focus on your trading strategy and create good habits than worry about what the rest of the world’s currencies are doing.
22. IN SUMMARY
Forex trading is one of the richest trading environments in the world and there are virtually no barriers to enter. All you need is a computer, a fast Internet connection and access to a broker’s trading platform.
Wise beginners invest in their forex trading education and start trading with a demo account. The foolish beginner rushes in with only a basic understanding of how the forex market works and starts trading with real money too soon.
As they say, anybody can trade forex but forex trading is not for everyone.
Currently, more than $5 trillion is traded every day on the foreign exchange market so it’s no wonder so many want a piece of the action. Tread carefully and slowly into the world of forex.
Align yourself to a reputable broker who will mentor you through your trading journey and learn everything you need to know about online forex trading.
Start trading with a free demo account where there is ZERO risk and get expert tips and advice from forex specialists through one-on-one coaching. Watch forex video tutorials, participate in webinars and attend forex seminars.
Online forex trading platforms offer state-of-the-art tools to execute buy and sell orders, instruments to assess price movements, risk management tools, technical and fundamental analysis and advanced charting tools.
But remember, it takes discipline and patience to move through the beginner and intermediate levels to become an advance trader.
Don’t rush the process. Manage your expectations of the forex market and trade forex with care and caution.