Having a good grasp of the Forex market can have a profound effect on your trading results. An informed trader will always find more success than a random gambler. The difference between an amateur and a professional trader lies in their ability to understand the market and make informed trading decisions. Therefore, we have created a short FX trading guide for rookie traders, which should help you get a complete picture of the market dynamics.
Forex trading is all about buying and selling currency pairs, where the profits (or losses) are determined by the amount of investment and the scale of price movement. Trading currency pairs are subject to certain basic conditions, or trading specifications, which form the underlying rules of the entire process of investing in the spot currency markets. Let us take a look at the various elements of currency trading. How to Enter the Exciting World of Financial Markets?
The currency of any nation is severely regulated by its central bank. Its value is influenced by a host of regulatory policies such as interest rate, Forex reserves, and other economic conditions. However, due to the global nature of FX transactions, the Forex market is decentralised, which provides a great way for investors, speculators, speculators, and even merchants (those who produce goods or render services) take advantage of the currency fluctuations. The various market dynamics, such as demand and supply, determine the pair's value, which constantly fluctuates during live market hours. The movements in the markets are calculated using a pip value, a measure of points of currency value. Let us assume that the current hypothetical value of EUR/USD is 1.1750. If the value moves up to 1.1760, the difference is noted as 10 pips. The pip value differs for different currency pairs and can vary as per the trading specifications. Therefore, if we are long (buy) on the EUR/USD pair, we make a profit of 10 pips, but if we are short (sell) on the pair, we make a loss of 10 pips. Typically, the currency fluctuations may be used to make profits or to hedge against any downside risks. Such a requirement led to the introduction of a spot, forwards, futures, and options market, where currency pairs are available for trading in different asset classes and derivatives. We will take a closer look at the types of Forex instruments in the next section.
Forex instruments are primarily offered as a combination of two, and only two, different currencies. We cannot create a Forex instrument with three currencies, but rarely would anyone require such an option, as most currencies are pegged against each other, or the US Dollar. Therefore, it provides the option to change any global currency into the US Dollar, and then convert it to another currency at the prevalent market rates. Most currency trading options are offered as forwards, futures, options, or CFDs.
Forex currency pairs are predominantly divided into Major, Minor, and Exotic currency pairs. Major currency pairs involve the most actively traded currencies, such as the EUR, the USD, the GBP, the JPY, the AUD, the CHF, and the CAD. However, not all of these currency pairs are considered as major pairs. For instance, Major currency pairs are the EUR/USD, the GBP/USD, the USD/JPY, and the USD/CHF, while the AUD/USD, the USD/CAD, and the NZD/USD are also sometimes considered as the major pairs. On the other hand, the EUR/GBP, the GBP/JPY, and similar pairs are considered Minor currency pairs. Exotic currency pairs are not frequently traded, such as the EUR/TRY and the USD/ZAR.
There are several costs of Forex trading, but we will take a look at it from the retail traders' perspective. The primary cost is the spread, which is the difference between the bid and the ask price. The bid price is the lower value of the pair, which is offered to sellers, while the ask price is the higher value of the pair offered to the buyer. Spread is always high for a market maker or CFD broker, as orders are mostly filled internally or within their network of liquidity providers.
On the contrary, direct market access brokers offer better quotes by lieu of a global network of liquidity providers. These brokers offer tighter spreads by accessing quotes from a global liquidity pool. However, to make a profit, these brokers will charge a commission, usually a percentage of the trade size. These commissions are automatically deducted as soon as a position is opened and closed, and traders will also have to pay spreads as quoted by the broker alongside the commission.
Finally, traders must also account for SWAP for overnight trades, which are charged for long-term traders. SWAP is usually calculated every Wednesday, and as per the interest rates of the individual currencies that constitute the currency pair. The SWAP can be positive or negative, which means that a positive SWAP is paid to the trader, while a negative SWAP is deducted from the trader's account for overnight positions.
Forex trading has built up a notorious reputation of being one of the world's riskiest financial markets. Although Forex pairs indeed see massive swings at any given time of the day, the risk is compounded by the insane amount of leverage offered by retail brokers. In the traditional sense, opening a position of 1 standard lot of EUR/USD requires 100,000 units of the base currency (EUR in this context), which is quite substantial. Contrary to popular belief, trading with a standard lot and low(or zero) leverage is not as risky as trading with high leverage.
To circumvent this problem of high margin requirements for standard lot trading, Forex brokers offer anywhere from 1:50 to 1:2000 leverage to attract smaller retail traders. It simply means that for leverage of 1:100, the broker will stipulate a minimum margin requirement of just $1000, which is quite manageable. However, on the flip side, even a small move of 100 pips can wipe out the entire account, which is why the use of leverage can be quite risky for retail traders. It, therefore, becomes imperative for traders to use sound money management strategies for risk aversion.
There are primarily three different types of trading lot specifications, the Micro (1000 units), the Mini (10,000 units), and the Standard lots (100,000 units), which offer different trading specs and leverage for retail traders. The leverage is usually higher for Micro accounts, where accounts are offered for initial deposits as low as $10, while Standard accounts offer the lowest leverage that stipulates higher minimum deposit requirements. Several regulators have put forward several restrictions on the maximum leverage that brokers can offer in a bid to minimise risk exposure to retail investors.
This article aims to provide the underlying attributes of Forex trading. While the information provided here can indeed help massively in your trading pursuits, you should still understand the role of the different price mechanisms, trading strategies, tools, and trading terminologies in trading. Of course, the experience is always key to developing a good trader, and in a nutshell, you need to place quite a lot of trades and experience the emotions of the market and yourself to be able to trade at a professional level.