Types of Forex Market

There are three different ways to trade forex:

Spot Market

This is the most popular way to trade forex. Currencies are bought and sold according to their trading price.

The trading price takes supply and demand into account, but it is also based on other factors like economic performance, interest rates and ongoing political issues. Although the spot market deals with transactions ‘on the spot’, these usually take two days to settle.

Forwards and Futures Market

Forwards contracts are private agreements made between two parties. They are made in advance. Currency is purchased on a predetermined date for a pre-agreed price.

Futures contracts are standardized agreements made between two parties. One party takes delivery of a currency on a pre-agreed future date in exchange for a predetermined sum.

Forwards and futures are both binding. They are usually settled for cash at the relevant exchange when they expire – however, they can be bought and sold prior to their expiry.

Forwards and futures trading can provide protection against risk. Large international firms often use these trading types to hedge against future exchange rate changes, but they are used by speculative traders too.

In the United States, the currency futures market is regulated by the National Futures Association. Futures contracts must include certain information, such as the number of units to be traded, pre-agreed delivery and settlement data and non-customizable minimum price increments.

Pros and Cons of Forex Trading

Learning to trade forex can bring many benefits. Being a global market with high liquidity, there are opportunities to make a profit. Traders buy and sell currency pairs throughout the day and night, with more than $4 trillion being exchanged on the average day.

If you want to trade as a hobby, forex currency trading is a good choice. You do not need a significant initial investment, and the market is reasonably easy to enter. Demo accounts enable you to practice trading forex without risk.

There are few additional fees to consider when compared to other types of trading. Transaction fees tend to be low, but your broker might charge a commission fee, which may be variable according to your trading activity.

Technology makes trading forex easy, with a range of different platforms available. Mobile apps, algorithms and connectivity means you can make trades in real time, wherever you are.

As there is no centralized exchange system for forex trading, each country is responsible for regulation. Using a regulated broker is vital – this will give you reassurance that it is transparent, fair and closely monitored.

Like any form of trading, forex trading involves risk. It should not be viewed as a get-rich-quick scheme. To be successful, you must build up your knowledge and commit to understanding the market and global economies.

Forex Trading Risks

The main risks of forex trading are:

• Leverage – This can affect your trades positively or negatively. The higher the leverage, the bigger your profits or losses.
• Interest rate changes – When an interest rate goes up in a country, their currency may become stronger. Investors may choose to invest more money in the country’s markets, as this could bring them higher returns. In contrast, when an interest rate falls, the currency may become weaker, meaning more investors choose to sell their investments.
• Transaction risk – This risk is linked to time differences between different countries. It can happen at any time between the start and end of a contract. During the 24-hour settling period, exchange rates might change. This type of risk is more likely when there is a significant time difference between entering and settling a contract.

Forex Automated Trading

Many automated forex trading systems are available to purchase. They are popular because they can react to information much faster than a human could. As the forex market is open 24 hours per day, they are also able to keep on top of your trades when you are unavailable.

Forex robots use computer code and algorithms to carry out trading activities. Forex robots are legal, but traders should be cautious when considering using one. The marketplace is not regulated, so there are many scams to be wary of.

Forex robots can be fully or semi-automated. Some are free, whereas others are very expensive. Choosing a robot to complement your trading strategy may be helpful, but trading successfully will require human input and effort too.

Robots allow traders to test out potential trading strategies against historical data. Carrying this activity out manually can be very time-consuming and complicated. They are easily available, but it is important to do your research before choosing one.

When choosing an algorithmic trading strategy, consider your own trading style. A news-based trading system considers world and economic activity, such as natural disasters, elections, war and political unrest. It involves holding positions for short timeframes and uses algorithms that react to news stories and generate trade signals.

A trend-based strategy follows market activity and trends. It considers how a price has moved in the past. If an upward trend is identified, the automated system may recommend a long position where the trader buys in anticipation of a future price rise.

On the other hand, when a downward trend is identified, the system will recommend the trader go short, which means selling the security with a view to buy it again for a lower price.

If you want to use a scalping strategy, an automated system will be able to work considerably faster than you could, processing thousands of trades in under a second.

How to Become a Forex Trader

Learning to trade forex is time-consuming and complicated. You will need to:

Invest In the Necessary Equipment

You will need a high-speed computer with a stable internet connection. Some traders choose to download their chosen trading platform to their tablet or smartphone, but this is not essential.

Learn Trading Terminology

Taking a forex trading course is a good starting point for learning the basics, including terminology. As you begin to learn FX trading, you will encounter several common terms, including:

Pips

This describes the base unit in the price of the currency pair – or 0.0001 of the quoted price for currency pairs that do not include Japanese yen (JPY). When the bid price for the GBP/USD pair moves from 1.17778 to 1.17788, there is a difference of one pip.

Spread

The difference between the ask price and the bid price is referred to as the ‘spread’. When you look at popular currency pairs, the spread is usually very low. For currency pairs that do not trade so often, the spread is usually higher.

For a forex trade to be profitable, the value of the currency pair will need to be higher than the spread.

Margin

This term refers to the money remaining in the trading account at the point of opening a trade.

Since retail forex traders do not usually have the required margin to trade at volumes needed for significant profits, forex brokers often give clients access to ‘leverage’.

Leverage

This term refers to the capital granted by a forex broker to raise the volume of trades that their customers are able to make.

For example, the face value of a lot is equivalent to 100,000 units of the base currency. For GBP/USD, this would be £100,000.

The trader uses a 1:10 leverage rate and has £1,000 in their trading account. Leverage allows them to trade a currency pair with a £10,000 position size.

Should the trade be successful, the leverage will increase the trader’s profits by a factor of 10. But they will need to bear in mind that leverage will multiply any losses in the same way.

Whether you are a novice or expert trader, leverage should be used cautiously.

Should your account balance drop below zero, you can ask the broker to invoke their negative balance policy. This protection is available from European Securities and Markets Authority (ESMA) regulated brokers and means your balance cannot drop below zero.

Bearish Markets

When the prices of stocks are falling, the market is referred to as bearish. When a stock price drops rapidly, this is considered to be very bearish.

Bullish Markets

A bullish market is the opposite of a bearish market. When the prices of stocks are rising, the market is referred to as a bull market. When a stock price increases quickly, this is considered to be very bullish.

Trading Platform With Demo Account

A trading platform enables you to trade independently. It also provides access to useful trading resources.

There are many different trading platforms to choose from, so it is important to research what is available and choose the one best suited to your requirements.

Forex Trading Strategies

Many different strategies can be used to trade forex.

Strategies for Beginners

As a beginner, consider using one of the following strategies:

Breakout

The breakout strategy identifies breaks as trading signals. Consolidation describes a market that is swinging between support and resistance bands.

A breakout describes a situation when the market moves outside of the limits of that consolidation, either to new highs or new lows. A breakout often takes place before a new trend begins.

Traders should bear in mind that a breakout does not always lead to a new trend, so setting a stop-loss order is sensible.

Simple Moving Average (SMA)

A moving average is a lagging indicator that is influenced by historical price data. They can help traders to confirm trends and make decisions accordingly.

Donchian Channels

Traders can modify the parameters of the Donchian Channels to suit their needs. Invented by Richard Donchian, it involves establishing the highest high and lowest low during a user-defined timeframe.

Breaks in the Donchian Channel can be used to make trading decisions. If the market price is higher than the highest high during the specified timeframe, the trader should buy. If the market price is lower than the lowest low during the specified timeframe, the trader should sell.

Strategies for Experienced Traders

For experienced forex traders, possible strategies include:

Hedging

Hedging involves ‘hedging your bets’ as a form of risk management. It offers protection for open positions against possible negative movements in the market.

This technique is often employed in response to news and world events that may make the market more volatile.

Carry Trades

Carry Trades involves borrowing a financial instrument at a low interest rate, then investing what you have borrowed in a second financial instrument with a high interest rate.

Over time, traders hope to profit from the difference between the interest paid and interest received. This is known as the interest rate differential.

Scalping

Scalping involves skimming small individual profits from a large pool of trades.

Profit is acquired through buying and selling currencies within a short time frame. It requires intense concentration and a significant time commitment.

What to Consider

When choosing your strategy, consider the following:

What Is My Current Understanding of Trading? What Am I Good At?

Also, what affects my discipline, focus, patience and ability to follow through on actions?

Be aware of the potential hurdles you might face when forex trading, as well as your own behavioral tendencies. For example, you might be prone to trading impulsively or over-trading.

How Can I Improve My Knowledge of Trading and the Currency Exchange Markets?

Commit to continuous learning to optimize your performance and improve your expertise.

Keep a trading journal to help monitor your thoughts and feelings, as well as your progress and track record.

What Is My End Goal?

To work out how much capital you will need to meet your goals, you should:

1. Set a reasonable expectation for the amount you wish to make from trading annually.
2. Work out a reasonable expectation of return. An experienced trader could make between 15-25% each year, but if you are a beginner, then your return is likely to be much lower than this.
3. Use the following equation: Desired income / return % = capital required.

For example, if your desired income is $2,000 per year and you expect a return of 5%, you will need an initial capital amount of $400.

How Will I Manage Risk?

Initially trading on a part-time basis alongside your other commitments is a sensible way to start.

This will help you to perfect your trading strategy, learn how to work in line with your plan and build up your confidence. You will also enjoy the benefit of extra income to complement your salary.

How Will I Adapt My Trading Strategy to Fluctuating Market Conditions?

The best way to learn how to adapt your trading strategy is to make use of a demo account.

Using a demo account will not offer the same adrenaline rush you would get from risking real money, but it will teach you the importance of closely monitoring market conditions. It can also help you to understand how exchange rates move.

That said, you should be aware that using a demo account for virtual trading removes the psychological element of risk-taking, which can be the deciding factor as to whether you are a successful trader or not.

Although using a demo account will not provide an accurate assessment of your trading abilities, it is the ideal way to practice. It can also be used to look back on historical statistics of your trading plan.

As you build up your currency trading skills, you will learn methods for reading and interpreting changes in market activity. This will allow you to check how your chosen trades are performing, comparing this to external factors such as world events and the global markets.

How to Choose a Forex Trading Broker

With so many options, it is vital to know what to look for in a forex trading broker.

When choosing a broker, you should look for the following:

• Tier 1 regulated – When you trade, you will be entrusting your broker with money and your personal details. Choosing a regulated broker will give you peace of mind that your funds and information are protected.
• Fast execution speed – The execution speed is the time that elapses between sending your order to the broker and the order being fulfilled. Choosing a broker with fast execution speeds is especially important if you intend to trade using a scalping strategy or automated trading platform.
• Technical analysis tools – As a forex trader, you will need to learn how to analyze historical trading data. Using a broker with good technical analysis resources means you will be able to easily identify trends and patterns to assist your making decisions on your trades.
• Customer support – Your forex broker will support you through every step of your trading career. It is important to choose a broker that is easy to contact, efficient and able to offer high-quality guidance.
• Lower fees and commission – Some brokers work on a commission basis, but the majority make money through spreads. There may also be a minimum deposit, charges for holding an open position overnight, withdrawal charges and interest rates to consider. Always check the small print of your chosen broker’s service agreement to avoid unexpected fees.
• Educational resources – The top forex brokers want their traders to turn a good profit. To support you, many offer articles, webinars and tutorials that are included in the cost of your account.

Final Thoughts

Becoming a successful forex trader will not happen overnight. It will require commitment, dedication and planning.

You should always start with a demo account; this will help you to learn your way around the markets and build a trading strategy. Sampling several different demo accounts will help you to choose the trading platform that works best for you.

When you are ready to start trading real money, remember to start small and work your way up. You should also use stop losses to minimize risk.

Recording your trades and thoughts in a trading journal is a useful way to keep track of your learning and performance.

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