At some point, we've all examined currency pairs, seeking to maximise the value of our money, especially when planning a vacation. But did you know that currency pairs can serve a greater purpose beyond holidays? Believe it or not, you have the potential to generate a significant income by becoming a successful forex trader.
With this in mind, we will guide you through the process of learning forex trading and getting started on your journey.
Open a brokerage account. Find a forex broker suitable for beginners.
Find a currency pair. They vary greatly in terms of volatility, make sure to do your research beforehand.
Deposit funds. Fund your account to open a position, and make sure to not invest more than you can afford to lose.
Decide whether to go long or short. Depending on whether you think a currency will increase or drop in value, decide either to "sell" or "buy".
Place your first trade. After you place your trade, make sure to monitor your investment.
Forex Trading Explained
Forex trading, or foreign exchange trading, is similar to trading on the stock market. However, rather than trading stocks, FX is where investors trade currencies to turn a profit.
It’s a very popular way of trading: $6.6 trillion of transactions take place on the foreign exchange market every single day – that’s over 2x the UK’s annual GDP.
Risks and benefits associated with forex trading
Some of the advantages and disadvantages of forex trading include:
- The Forex Market is open 24/7 – You can start forex trading regardless of where you are based in the world. You are not restricted by the trading times of specific markets such as London or New York.
- Market volatility can help you make large profits – While volatility can play a role in losing money, it can also lead to large gains in a short space of time.
- You can bet on a currency increasing or decreasing in value against another – The ability to bet on both price directions gives you flexibility in deciding your trading strategy and provides more opportunities to make money.
- Potential for losses with leverage – Forex is commonly traded using leverage, which increases an investor’s buying power significantly. While allows traders to increase their gains, it also magnifies the losses.
- Volatility – This is a double edged sword: the more volatile currency markets are, the greater the chance of losing money in a short space of time.
- Lack of regulation in trading platforms – While there are plenty of brokers and trading platforms out there, they are not all reliable. Different trading platforms can have varying levels of regulation, and some may not be regulated at all. To be on the safe side, you should enquire about your preferred platform’s adherence to regulatory bodies, most notably the FCA in the UK, to minimise your chances of losing money.
How Are Currencies Traded?
Currency pairs, or forex pairs, are traded against each other on the forex market, with each currency having a three-letter acronym to distinguish it.
You might think you’re buying and selling actual currencies, but in reality, you’re not. Whilst trading forex, you are not buying or selling anything tangible, you are simply speculating on the currency exchange rate.
Some popular currency pairs to start forex trading with include the US Dollar against the Australian Dollar (USD/AUD) or the US Dollar against the Japanese Yen (USD/JPY).
On the whole, currencies are divided into ‘major’, ‘minor’, and ‘exotic’ currencies.
For any forex pairs to be regarded as ‘major’, they must include the US Dollar (USD). A commonly traded currency pair is the US Dollar against the Pound (USD/GBP).
‘Minor’ currency pairs are those that do not involve USD but still involve other well-known currencies such as the Pound or Euro.
Exotic currency pairs involve currencies that are not widely traded. However, this is not solely related to liquidity. While some exotic currencies, such as the Malawian Kwacha (MWK) are highly illiquid, other exotic currencies like the Hong Kong Dollar (HKD) are very liquid.
Please note that trading exotic currencies are not very suitable for beginners as they can be unpredictable and volatile.
Managing risk when trading forex
When opening and closing trades on the forex market, there is a potential for things to go wrong. Fortunately, there are ways for forex traders to manage risks when they buy and sell currencies, regardless of their trading strategies – the most basic of which is to use different order types.
Order types | Description | Advantages | Disadvantages |
|---|---|---|---|
Normal stops | These close your position automatically if the market moves against you. | This can help cut your losses before they get too big. | You may still lose money with a normal stop. |
Guaranteed stops | These close your position at the points you specify. | Reduces your exposure to market volatility. | Most brokers will require you to pay a premium if a guaranteed stop is triggered. |
Limit orders | By placing a limit order, you ensure that your position will automatically close when a trade hits the level you have chosen. | Prevents you from losing more than you can afford. | It may prevent you from bigger gains if a trade continues to move in your favour. |
While risk appetites vary from person to person, it is important to note that every trader will experience losses at some point, and it is important to avoid chasing those losses.
How to read a forex quote
A currency pair is made up of base and quote currencies. An example would read like this: GBP/EUR = 1.151.
In this case,
GBP is the base currency, which is always equal to 1.
EUR is the quote currency, which reflects the exchange rate for a single unit.
A forex trade example
When you trade forex, you have the option to either ‘go long’ or ‘go short’. When you ‘go long’, you are betting on a ‘base’ currency to increase in value against a ‘quote’ currency. However, if you believe a currency will lose value, you would choose to ‘go short’.
Using the forex trading examples above, if you decided to ‘go long’ on the pound when you trade forex, meaning that bet that the pound will gain value against the euro, you would benefit if the value increased to €1.2. However, if you chose to ‘go short’ on the pound, meaning that if you bet that pound will lose value against the euro, you would end up losing money.
What are some common forex terms, and what do they mean?
When you start forex trading, it can be quite easy to become confused by the terms used to describe trading. Here is our guide to some common forex terms and what they mean:
Pip – Pip stands for ‘percentage in points’. As it is quoted within at least four decimal places, it is the lowest possible form of price change when trading.
Base Currency – This is the first currency you select to trade with.
Quote Currency – This is the second currency in a trading pair
Leverage – This allows you to increase the amount of money you are trading with by borrowing money from your broker. While leverage offers the ability to increase your earnings, you will also be faced with increased losses if your trade goes against your favour.
Lot – Currencies are traded in ‘lots’, with the standard ‘lot’ size being 100,000 units. However, you can also trade ‘mini’ and ‘micro’ lots, which have respective values of 10,000 and 1,000 units.
Forex trading strategies
There are numerous ways to begin trading on the forex market, with each strategy having its benefits and drawbacks.
Overview | Advantages | Disadvantages | |
|---|---|---|---|
Scalping | Lots of trades are made in a short space of time. | Potential for higher returns due to the high number of trades. | Scalping increases the risk of losing money in a short period of time |
Day trading | Similar to scalping but trades are closed within the same day as opposed to hours. | Smaller drawdowns can prevent you from losing confidence in a good strategy. | Day trading is very time-intensive, and many retail investors can’t commit to it. |
Trend trading | Predicting whether a currency will trend upwards or trend downwards in value over time. | Trends can be identified quickly and can last for a long time, giving the potential to make large profits. | While you make a lot of money successfully riding a trend, historically, the hit rate is very low. |
Different Ways of Trading Forex
There are multiple ways to start trading forex, with the main two methods being spread betting and trading CFDs.
Spread betting
This involves betting on the movement of a currency’s value over a fixed time frame. This means that you agree to close a trade at a specific time. While this leaves you more exposed to fluctuations in the market, it also means that any potential losses or gains stop when you close the trade.
Spread betting is exempt from CGT or stamp duties as it is classified as gambling - but you still have to pay tax on other types of forex trades.
Contracts for difference (CFDs)
CFD trading also involves betting on the price direction of a currency. However, there is no fixed expiration date, you can close the trade when you choose to. While this can increase your chances of riding out changes in the market, it can also increase your chances of losing money.
Step-by-Step Guide to Start Forex Trading
Entering the forex market in the UK is fairly easy. All you need to do is follow these simple steps:
Choose a forex trading platform.
As the foreign exchange market is so large, you should have no problem finding UK forex brokers. Don’t forget to run essential checks whilst hunting for investing platforms. Ensure that:
It’s regulated by the Financial Conduct Authority (FCA),
Have reasonable trading costs, also known as commissions,
Have minimal currency conversion fees,
Have a minimum deposit requirement that you can afford.
Open a forex trading account
To become a forex trader, you will need your ID, personal information, and contact details. We would advocate that you use a demo trading account before you start trading forex online with real money.
Do your research
Researching the financial markets is essential before you start trading forex – without it, you will never achieve your profitable trading goals. While some more experienced forex traders will try and time the market, this is not usually advisable for beginner traders.
The three biggest influences on a currency’s value and exchange rates are:
Inflation – it’s the general rise in prices in an economy, like that of goods and services. When inflation is high, it usually weakens a country’s currency.
Interest Rates – A country’s central bank usually sets the base interest rate, which determines the amount charged for borrowing money. A country’s currency usually rises in value when interest rates are high as it would attract more foreign capital.
Political Stability – Political instability usually deters foreign investors to invest in the country, thereby weakening its currency.
When none of these factors are in a country’s favour, it can cause the currency to lose vast amounts of value. For example, at the time of writing, £1 is worth 3,214,870 Venezuelan Bolivars (VEF).
Deposit Funds
If you feel you’ve got a better understanding of how to trade forex, it’s time to start trading currencies. The amount required to get started as a forex trader can vary depending on which trading account you use, so it’s important to check.
Whatever you choose to invest in, it’s important not to deposit more than you can afford to lose.
Choose a currency pair to trade, and decide whether to ‘buy’ or ‘sell’
Depending on your trading strategy, choose from ‘major’, ‘minor’, and ‘exotic’ currencies.
Your research can help you determine what direction you believe the currency is headed in, and stake your trading position accordingly. If you choose to ‘buy’ a currency, you are betting that it will increase against the other currency. On the other hand, if you choose to ‘sell’ a currency, you are expecting the base currency to fall in value against the second currency.
Open your first trade
After you’ve done your research and decided on your trading strategy, it’s time to place your trade. This is where you will find out if your research has quite literally paid off as you start trading forex for the first time.
Tips for Beginner Forex Traders
Forex can result in traders losing money quickly if they don’t know what they are doing. Fortunately, there are several things traders can do to ensure they can trade forex without losing more than they can afford.
Start small
One of the most important things when getting started with something as volatile as forex markets is to start small. The prospect of fast and grand returns can be tempting, but you must not let it cloud your judgement.
Use trial and error
No one gets everything right on their first attempt. The road to success is paved with failures, and trading is no different. This is where a demo trading account is worth its weight in gold, as it allows you to find the right trading strategy and make mistakes without costing you anything.
Be rational
Emotions are counterproductive to trading, and this is. This is particularly true in currency trading. While it can be tempting to try and chase a loss, this can ultimately end up costing you more and more money.
Take a break
When you get stuck in your head, it can prove very difficult to act rationally. This is especially the case when money is involved. Taking a break is vital as it can allow you to step back and view a situation with objectivity rather than emotional reasoning. This can lead to better decision-making and risk management strategies, and allow you to make any necessary changes to your forex trading strategies.
