Forex – short for foreign exchange – simply means trading one currency for another.
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If you’ve ever been on holiday and swapped your pounds for foreign currency or sold back your leftover notes on return, you have traded forex.
Currencies are the world’s economic lifeblood and allow governments and businesses to buy goods and services across borders and support foreign trade or international supply chains.
You’ll see a forex calculation on your bank statement every time you buy something from an overseas website. Your bank calculates the cost in Sterling, depending on the exchange rate at the time.
This concept is where forex trading starts – making predictions about expected changes in currency values and what you can sell or buy the currency for in the future.
This guide runs through forex trading basics for beginners.
Trading Currencies 101
Forex can become highly complex and risky, with variable regulation applying to different aspects of the interbank market. That interbank market comprises worldwide banks, trading currencies between each other.
Much depends on the demand for particular currencies and what the participating banks are willing to pay, so forex operates on a supply vs demand basis.
However, forex isn’t solely a straightforward process of buying currencies at optimal times and cashing in assets during high demand periods; there are multiple variables to consider.
Things to evaluate before you invest include:
- What account protections are in place if your forex broker or dealer goes bust?
- Are traders regulated in your home country?
- What happens in a market crisis if your invested forex drops suddenly?
One of the crucial factors for a first-time forex trader is that there is no standardisation between products, and regulation is patchy, at best, so you’re out there on your own to an extent.
Pros of Forex Trading
One of the big draws is that you can trade forex without significant capital investment, and it’s much easier to enter or exit a position with a major currency, like Sterling or US dollars.
Traders can adapt quickly to market conditions and buy and sell when they wish, spreading investments across several currencies to ensure solid diversification.
- Forex is a highly liquid market and manages the largest global daily trading volumes, with 24-hour transactions, beginning in Australia at the start of each day and closing in New York.
- Major forex markets centre around several cities, from London to Hong Kong, Singapore to Sydney and Paris to Tokyo, so it’s a truly international market that anyone can invest in.
- Automation means you can adopt a dynamic trading strategy without monitoring movements around the clock.
The decentralised nature of forex means that you don’t need to go through any centralised exchange that may manipulate pricing or transaction costs.
However, the drawback is that it isn’t as easy to research inside information to inform your trading decisions without a level of oversight.
Cons of Forex Trading
Market volatility is the biggest potential pitfall of forex trading. Currencies can change direction incredibly fast and lose most of their value in minutes, so there is a potential for considerable loss.
You should be careful not to invest everything in one currency because an unanticipated collapse could render your entire forex portfolio worthless.
Other downsides of forex include:
- The lack of regulation – while this does make forex more dynamic, it also means there are few protections available when trades go wrong or rules that brokers must follow.
- Payouts aren’t automatic, so you won’t receive a regular dividend as you would with many more conventional investment structures, like stocks and shares.
- Banks and dealers allow high leverage, even up to 100:1, which means they can maintain significant positions without any risk – understanding the outcomes of leverage is essential for new forex traders.
In essence, forex is a lot more involved than might appear on the surface.
It’s vital to get to grips with the indicators that should influence your decisions and comprehend the big picture economics that feeds into currency performance to stand a chance of success.
Trading Forex as a Newbie
If you’re interested in dabbling in forex trading, you should get familiar with equity trading and the risk vs return calculation.
The first step is to invest time into gaining the specialised knowledge that will stand you in good stead.
For example, grasping forex leverage ratios is important since they tend to be higher than equities markets. The factors that drive price movement are also different.
There are tons of online courses, some free, some paid-for, such as:
- Udemy – Forex Trading From A-Z.
- FX Academy, with various classes for traders and newbies.
- ForexSignals, including a live training room.
Once you’re confident you have a basic understanding, you need a forex trading account with a broker. Brokers don’t charge commission but are paid usually through spreads against buying and selling costs.
As a beginner, it’s worth using low capital investment to start with or using a micro trading account.
These accounts have trading limits, which the broker could set to 1,000 currency units compared to 100,000 units on a standard forex brokerage account.
From there, you can work on your trading strategy, set guidelines for what you’d like to achieve, and consider how much you’re willing to invest in trades and how much risk you are ready to take.
All You Need to Know About Forex Trading FAQ
What is forex, and how does trading work?
Forex is an abbreviation of foreign exchange and means the transactional trading of currencies, also shortened to FX.
Trading structures vary, but the most common are spot markets, where you buy a currency for the value at that moment in time.
Forwards and futures markets are more complex and depend on forecast movements and estimated value changes.
When you trade forex, you’ll see that the price is quoted in pairs, where you see how many units you can buy in the quoted currency with your base currency.
Can you earn money from trading currencies?
You can win or lose massive amounts of money through forex trading. But, of course, the more risk you take, the more you stand to make.
However, it is also possible to lose everything due to the volatility of this liquid market.
Traders and companies use forex to speculate – so they can make an earning when currencies rise or fall in price.
Hedging is another application whereby businesses forecast currency movements to confirm manufacturing or product prices in international markets trading in alternative denominations.
Why are the forex markets so volatile?
Forex volatility is the most significant advantage and the highest risk for investors.
That said, property can be equally turbulent, so it’s always a case of assessing the risk inherent in a transaction and spreading exposure.
Forex twists and turns so quickly because there are countless influential factors, such as political instability and economic uncertainty – so a political news report could have an immediate impact on your forex asset value.
If you get into forex trading, you should keep up to date with the financial news and political events since these all contribute to deciding where you’re likely to find the largest potential profit.
How does regulation work in forex markets?
If you’re in the UK, trades and brokerages are monitored and regulated by the Financial Conduct Authority (FCA), which dictates rules about things like responsible selling and product advertising.
However, if you’re trading in China or India, you might find that the rules are far less strict, although there are limitations on the capital you can use in forex trading.
Is forex trading suitable for beginners?
It can be, yes. For example, you can begin forex trading with a relatively small financial investment and enter the market at any stage given the 24-hour trading window, five and a half days a week.
Forex markets can be highly profitable, with the opportunity to increase investment stakes many times over in one day, which is attractive compared to stock markets where you may have to wait months or years to realise a return.
The issue is that there is little certainty, and your forex trades can be costly as well as lucrative, so a baseline of knowledge is essential to mitigate the risk of heavy losses.
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