The Step-to-Step Guide to Forex Trading for Beginners
All global currencies have their own value, usually, one that is “free floating”, i.e. determined purely by market sentiment. For example, the value of the Euro relative to the US Dollar, known as EUR/USD in forex markets, might be 1.22.
This means that it costs $1.22 to purchase a single Euro on the global market at current rates. If a person was to buy a large number of Euros and then sell them for dollars after the value of the pair went up to, say, 1.24, then they could stand to make a substantial profit by pocketing the price difference.
Although this sounds simple, this is the activity that constitutes an immensely complicated $5 trillion a day global market. Investors, businesses, and retail traders are constantly buying and selling currencies on the global forex market in an attempt to predict price trends and make a profit, in much the same way that people invest in stocks and commodities on the global financial market.
Recent changes in technology now mean that anyone can get started in forex trading, as long as you have an internet connection. If you are looking to join the growing forex trading phenomenon as a means of bolstering your portfolio and generating some income, you have come to the right place.
Forex trading beginners; read on to find out everything you need to know.
Get to know the forex market
First, let’s break down what it actually means to trade forex and explain the factors that influence currency prices, thereby affecting the profits and losses that you stand to make as a trader. All currencies on earth are traded via over-the-counter (OTC) trading, meaning that trades are executed electronically in every corner of the globe on a 24-7 basis.
A lot of the currency trades that occur on a daily basis are not specifically done with the intention of making a profit from price changes. Many transactions are simply the result of one currency being used to pay for goods in another currency, for example.
It is important to forex trading beginners to know why people trade currencies for profit. As we have explained, the price of one currency relative to another will change over time, usually due to myriad market factors.
When you take a “position” on a currency pair, you are speculating that it will either rise or fall in value. If the price shift does move in your favour, you have already made a profit. The value of a currency relative to another is generally underpinned by macroeconomic factors.
For example, the value of the British Pound relative to the Euro is often affected by UK-EU relations, as well as UK GDP data. The value of the US Dollar relative to, say, the Japanese Yen is greatly influenced by the release of key data such as US Labor Market Reports, or a decision by the Bank of Japan to raise interest rates.
Understanding this is the most important first step towards putting together a successful and sustainable forex trading strategy.
Base currency explained
One of the most important terms to remember in forex trading is “base currency”. This is the first currency that you will see mentioned in any forex pair. It is the currency against which the value of the pair is measured. For example, in GBP/USD, GBP, or the British Pound Sterling, is the base currency. GBP/USD would denote how many US Dollars are currently needed to purchase a single British Pound at current market prices.
Quote currency explained
In any currency pair, you have the base currency, followed by the so-called “quote” currency. The quote currency is always the second currency that you see in a forex pair, without exception. For example, in that same GBP/USD forex pair, USD would be the quote currency. Any forex pair price describes how much of the quote currency is required to purchase a single unit of the base currency. For example, if GBP/USD is trading at 1.42, then it costs $1.42USD to purchase £1GBP on the market.
Pip is an acronym that stands for “percentage in point” and is one of the most important things to understand in forex trading. It is a unit of measurement, one that denotes the smallest possible amount by which a currency pair can change in price. A standard pip in most currency pairs is 1/100th of 1%. For example, if USD/NZD is quoted as 1.3701, that final “1” digit represents a pip. If the price moves up to 1.3705, then USD/NZD has moved up in price by four pips. It is crucial to understand the pips that a broker will offer on a currency pair and what the value of a pip is to your bottom line, as this describes how much profit you stand to make.
In currency trading, there is always a broker or some kind of middleman that facilitates the trade on your behalf. Although most brokers do not charge direct commission fees, they will usually quote a spread. This is simply the difference between the bid (sell) price and the ask (buy) price of a given currency pair. Spread is added to the actual market price of a currency, meaning that you will pay slightly more than the market price to actually purchase a currency. Although this spread usually amounts to one or two pips, they can add up to substantial trading costs as the size of your portfolio grows.
In forex trading, the goal is to capitalise on tiny price changes to rack up significant profits, usually via day trading. In order to do this, you would need to invest substantial amounts into a forex trade. Most traders do not have tens of thousands of pounds to invest in daily trades, which is where leverage comes in. Leverage is essentially a sort of loan provided by a broker that allows you to open and control a much larger position. For example, a broker offering 100:1 leverage would allow you to open a $100,000 position on USD/JPY for only a $1000 deposit. This initial deposit is known as “margin”.
Find the right forex broker – what are the best forex trading platform for beginners?
No matter your motivations and goals for trading forex, it is absolutely essential that you know how to choose the right broker. Your broker is an online platform that will facilitate your forex trades for you and provide you with the resources you need to make genuinely informed trades.
It is crucial to know exactly what to look out for when choosing a broker, which is why we have compiled a detailed list of the best and most trusted brokers on the market right now. Top brokers such as eToro, Skilling, and AvaTrade are all great places to start. Make sure to consult our detailed forex broker guides to find out which platform is also suitable for trading forex for beginners.
Start with a demo account
For forex trading beginners, it is best to get some practice in before you start using real money to conduct trades. This is why you should always use a quality demo account to get to grips with trading. Most forex brokers allow you to open a demo account and trade forex with dummy money, using real-time market data.
This is an ideal and totally free-of-charge way to get a feel for a particular broker, as well as learn more about how forex prices change throughout the day. Always use a demo account before committing to the real thing, especially if you are a beginner.
Build a forex trading plan
Any professional trader will tell you that it is essential to have a plan before you start buying and selling forex. The most popular currencies tend to be the most volatile ones, meaning that you need to have a detailed contingency plan in place for when prices inevitably become unpredictable.
This means, above all, having a rigid exit plan and stop-loss in place to allow you to cut your losses and get out if a currency pair isn’t heading in the direction you wanted. Always have a trading strategy in place and make sure to not let your emotions get the better of you.
Stay on top of the news
As mentioned, the most popular forex pairs are those that are influenced by real-world economic events. This is why it is essential to stay on top of the news and make sure that your currency trades are informed by actual financial market data. A good broker will provide you with free economic news and analysis for all of the markets and countries that you are interested in, so make sure to make use of this.
The news sensitivity of forex pairs means that they can be immensely volatile. This can be a good thing, as volatility offers more opportunity for dramatic profits. However, volatility also means that all of your profits can be wiped out in a fraction of a second. This is why you should have a stop-loss in place.
Know your limits
Understanding the risks of forex trading is essential if you wish to build a successful portfolio. Just as volatility can result in dramatic profits, that same volatility can result in steep losses.
In addition, it is crucial to be aware of the risks of trading on margin, as doing so can expose you to huge positions that you cannot afford to maintain and can even leave you indebted to a broker.
Furthermore, you should always use a licensed, widely trusted broker, as a dodgy dealer can steal your money, data, and financial credentials.
Choose a broker that works for you
The most important thing you can do to boost your chances of success in forex trading is to choose the right forex broker. By consulting our in-depth and honest forex broker reviews, you can find a fully licensed broker that will offer you the resources and skills you need to succeed. When you know the business you will also learn best forex trading platform for beginners.