How to Trade Forex – for Beginners
Beginners Guide to Forex Trading
Trading in foreign exchanges is buying one currency and selling in another. Lots of different terms are used when it comes to forex trading but the key ones you need to know are forex, FX and foreign exchange.
Forex trading can mean going to the local money changer or bureau de change ahead of your holiday and swapping your GBP for EUR, and realizing a bit too late that the price you got was a little different to what you saw online!
If you are looking to trade FX, typically this won’t mean you can spend the currency you have bought on your holiday, but rather you are looking to trade on the price fluctuations and price differences between the two different currencies, often referred to as currency pairs.
A currency pair is two currencies, often quoted in 3 letters, with the “buying currency” quoted first. For example GBPUSD is British Pound Sterling buying US Dollar currency pair.
Many brokers will have a buy and sell price or bid and ask price for the currency pair. The two prices together are called the quote.
The bid price is what the market is willing to pay for a position in the currency pair, ie what you can sell your position for. Whilst the ask price is price the market is looking for, ie what you will need to pay to open a position.
The difference between the two is called the spread. Many online brokers will not charge a commission for trading in forex, but will make money on the spread between the currencies as you buy and sell your positions. The smaller or tighter the spread the more profit you can keep for yourself on successful trades. This is why you see such a different between the bid and ask price at the bureau de change at the airport!
What affects Forex Market?
- Stability in Politics. If there has been a recent change in government or the market no longer trusts the government currently in power in a country you may see fluctuations in the value of the underlying currency.
- National Debt. If a country is going further into debt typically the value of the currency falls as the market’s faith in the currency may fall
- Inflation Rates. Countries with a lower inflation rate than another will see the value of their currency appreciate against the country with a higher inflation rater. When the country and demonstrate consistently low inflation rates the value of goods and services
- Interest Rates. When a central bank announces the interest rate this can also have an impact on the strength of the currency, as it attempts to limit inflation. A cut in rates typically pushes more money into the economy lowering the strength of the currency whilst an increase demonstrates a feeling in confidence and increases the strength of currency
- Recession. If a country has a number of months in negative growth and enters recession, the economy of that country has lost some of its strength and the value of the countries currency will have also lost some of its strength.
- Global Pandemics/Events. The COVID-19 virus is the first global pandemic of modern times and will impact some countries and economies more than others. This can present opportunities for savvy traders, but isn’t something there are textbooks or courses for just yet.We recommend extreme caution when trading these types of opportunities..
Types of Forex trading
Advantages to Forex Trading
- Forex trading is open for access 5 days a week, 24 hours a day.
- The market is very susceptible to geo-political events. Often politician decisions have a large impact on a currencies buying power. Just look at how much value Brexit wrote off the British Pound the moment the results were known.
- Traders with some brokers can take advantage of leverage to increase the size of their positions. This is often a double edged sword and can harm your positions inexorably with a 24 hour market.
- Due to the liquidity in the market spreads between currency pairs
What are Pips?
Pips are the smallest amount of a currency pair that available to trade, another way of looking at is the smallest move an exchange rate can change, agreed by traders for years.
For most currency pairs one pip is 0.0001 or one hundredth of 1% and the spread is often quoted in pips.
Japanese Yen (JPY) is an exception to this rule with pairs quoted with 2 decimal places.
The spread between the bid and the ask price is often given in pips.
Lots are often used in reference to pips with brokerages in Europe. A lot is the number of currency units you are wanting to buy or sell, with a “standard lot” being 100,000 units. Smaller lot sizes exist down to “nano lots” of just 100 units. Some brokers will use lots rather than the actual currency unit. The use of a standard lot, it could be argued, simplifies the trading of forex with a price per pip depending on the currency pair and current market price
Forex Trading a worked example
A trader is looking to make money from the turmoil caused by Brexit and is buying EURGBP and will make money if the Euro increases in value against the British pound. Our trader bought GBP 0.8716 and sold again at 0.8719. From this trade our trader made 3 pips (0.8719-0.8716).
If he used €1000 in this trade he made €0.3 on this price change. Now this might not seem like a lot of money, however the forex industry is worth trillions and trades can often be very large. Many individual traders use leverage to increase amounts they can trade with, but this comes with some additional level of risk.