Forex is a mixture of two different terms, which are foreign currency and exchange. Forex is the process through which one currency is exchanged into another currency for many different reasons. These reasons can be pertaining to tourism, trade, or eCommerce. This is not a form of a centralized exchange and happens only through the interbank market.
You may already be a part of the forex through many different means, the most common one being buying any imported item. If you are interested in trading forex, then the first thing you need to do is gain proper knowledge about the forex market.
If you are a beginner in the forex trading market, this guide will help you figure out the ins and outs of trading forex with ease. We would recommend opening a demo account with either IC Markets or XTB so you can try out trading without any risk to your money.
What Is The Forex Market?
The forex market is similar to the other marketplaces, that is, where transactions take place based on demand and supply. For example, if a European citizen is holding Euros and wants it exchanged to US Dollars, then the forex market will exchange the Euros with Dollars.
The value of the currency will decrease or increase based on the currency that you are exchanging it to. In this case, the US Dollar value will increase, whereas the Euro value will decrease. When any other currency pair is used, such as the US Dollar and Japanese Yen, this might not be the same.
The same goes for business deals or trades between different countries. The best thing about this market is that you will not find a central marketplace. All of the transactions that occur are done over the counter through electronic means.
The forex market is open for five and a half days every week. So, you will not face any problem in exchanging currency even if there is a time difference between the two countries. There may be fluctuations in price quotes every minute. These changes make the forex market a very busy place at certain times of the day.
History Of Forex
The concept of the forex market emerged in 6000 BC, when the barter system was followed to exchange goods and services between people. With new technologies and strategies, the forex market that we see today is a more modern invention of the old barter system. The first transformation of the forex market occurred during the end of WWII. At that time, it was known as the Bretton Woods System, which later failed and gave way to the free-floating system.
Since then, there have been some major changes in the system of foreign exchange, which has led to the current foreign exchange market. There are investment banks as well as commercial banks who conduct the forex market trading these days.
The current forex market is one of the world’s largest markets, which is active all the time. The whole structure is very systematic. It will provide you with huge opportunities if you wish to engage in this market.
Two Things to Know When You Start Trading Forex
There are many reasons why you might want to become a part of the forex market. If you wish to become a full-time professional trader, then you need proper strategy and dedication. There are two things that you should know if you are willing to become a part of the forex market.
It Is Not a Short-Cut for Becoming Rich Quickly
Contrary to popular belief, engaging in forex trade will not increase your bank balance overnight. Though forex does provide you with ample opportunities to make good money, it takes time and proper planning to achieve that goal. You may have to spend months testing your strategy until you find the one that is perfect for you. Even then, it might not always work, and you have to be ready with a backup plan.
Excessive Leveraging Is Not a Winning Strategy
One thing you need to be very cautious about when you get into forex trade is not to get too greedy. People often go for excessive leveraging in the hope of winning more money. But this can be a losing strategy and may ruin a good plan where you could have got a good amount.
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Different Types of Forex Analysis
The basic technique of forex trade revolves around the analysis of the value of the currency pairs. You need to analyze the market and ensure that the market movements are in sync with your trading plans. There are certain ways through which you can analyze the market movements and create your trading plan accordingly.
Fundamental Analysis
The analysis method mostly focuses on the interest rate of the currency. The interest rate plays a very significant role in the forex market and is taken into account while analyzing trades. However, there are also other fundamental factors that come into play while conducting the analysis. These fundamental factors are manufacturing, gross domestic product, economic growth activity, inflation, etc.
Though these factors are not as important as the interest rate, they need to be considered when conducting extensive analysis.
Technical Analysis
Technical analysis is more of a structural method that focuses on past patterns of prices. You will have to check the pattern that has emerged in the particular time frame and see if it is a good time to ender the trade or take an exit from the trade. Technical analysis is highly recommended by professional traders as a very concrete way of analyzing the market.
Sentiment Analysis
Sentiment analysis is another very highly used form of analysis. Here you will have to check the sentiment of the traders towards a position. You can use this technique if you are a beginner to see where the more professional traders are inclined towards. This is because people who are in this trade for years have a sense of the market and uses more advanced techniques to access it.
Types of Forex Traders
There are different types of forex traders, and each trader has their own approach and trading styles. The kind of approach that you follow will make you fall under the kind of trader that you are. Since there is no right and wrong approach while forming a trading plan, there are certain features and styles that differentiate these traders from each other.
Scalper
Scalpers are those traders who focus on holding positions for a short term, which can be even for a few seconds. They do not have a focus on a big win, but rather concentrate on small wins throughout the day. This is why none of their holding position is for more than a few minutes.
They are more cautious about the frequent changes in the market and make changes in their trading approaches as well. These types of traders are very quick on their feet and observant of the changes around them.
Day Trader
Day traders are more or less similar to the scalpers but try to finish off their trading before the end of the day. A day trader will operate within a fixed timeframe and does not support the holding of overnight positions. If you want to become a day trader, then you will have to adapt to the changes very quickly and make sudden decision changes.
Swing Trader
Swing Traders are those who hold their positions overnight, maybe even for a week. These traders focus on technical analysis for their trading plan rather than on fundamental analysis. Since they hold the position for a significant amount of time, they do have to keep their eyes open about the fluctuations occurring due to fundamental factors.
Position Trader
Position traders hold their trades for a long duration, which can range from weeks to several years. They are more focused on the performance as a whole than on any short time fluctuations that might occur in this time frame.
To become a position trader, you will have to be very patient and remain not affected with any short term losses or obstructions that you might see in the duration of your holding. The overall focus should be on the long term benefits that you can reap from the trade.
Algorithm Trader
As you can already understand from the term, algorithm traders are those whose dependency lies on the computer program through which they place their trades at the best price. There are high-frequency algorithms involved that are used by these traders.
This kind of trading strategy is perfect for people who are comfortable with using technology to make their trading decisions. Due to the nature of their trading strategy, algorithm traders follow technical analysis as a basis of their trading decisions.
Event-Driven Trader
Event-driven Traders are the ones who focus more on the fundamental factors than on the technical charts to make their decisions. If there is an increase caused due to economic crisis or political agenda, then they will try to benefit from that. This trading style would be suitable if you are quite knowledgeable about the latest events occurring in the world.
In such a scenario, all you have to learn is about the effect that these events would have on the currency value. Once this is determined, you will have no issues with the trading strategy.
What is Buying and Selling in Forex Trading?
The forex market is liquid; hence the buying and selling of forex are also different from those of the other markets. The first part of this whole transaction involves knowing the depreciation or appreciation of the value of one currency against another currency. There are certain factors that will affect the value of the currency pairs.
Factors such as political events, economic policy, and technical analysis are essential to take into consideration when trading. These factors will either be beneficial for you or have an adverse effect on your forex trading. You will have to estimate the situation and access the factor properly before you buy or sell forex.
There are risks involved in this transaction, which is why you must understand the market properly. The mechanics that are present in the buying and selling of forex are quite complex. As a beginner, you need to study the market extensively and understand the levels of value fluctuation before you can venture to the actual buying and selling of forex.
Importance of PIP in Forex Trading
PIP or Point in Percentage is the measuring unit that is used by traders to see even the smallest of the changes that occur between any currency pairs. The change is in the fourth decimal place and can be even a single digit. For example, if the value of any two currencies changes from 1.2603 to 1.2604, then it is said to be one PIP.
Calculation of the PIP value is done by multiplying the specific lot by one pip. This calculation helps traders to understand the profit target and prevent losses in their trading. If you calculate the pip, you will not just have to analyze the value change, but you can get a concrete value of the fluctuation that will occur in the market.
One thing to keep in mind is that one PIP may have different values for different currency pairs. The variable currency depends on which currency pairs you are evaluating and which is the central currency that is being calculated.
What is Forex Rollover?
The interest that you pay or earn on any currency that has been holding a spot overnight is known as rollover. There is an interest rate of every currency mentioned in the interbank. Since the forex trade occurs between two different currencies, the interest rates are also different for each currency pairs. The rollover is charged to the trader who holds the position overnight.
When the position for forex is available, then you either have to pay or earn the interest rate difference of the two currencies. This is known as the currency rollover rate or the forex rollover rate. This position that is held can earn you a credit if the interest rate of the long currency is higher than the interest rate of the short currency.
In the same way, the position holder will pay debit if the interest rate of the long currency is lower than the interest rate of the short currency. To calculate this rollover rate, you will need three things, which are the position size, currency interest rates, and currency pairs.
Why is Liquidity in Forex Trading Important?
Liquidity is a very important aspect of the forex market and is essential for carrying on the trade with ease. The definition of liquidity in the forex market is the ease with which you can buy or sell a currency pair on demand.
When there is an easy trade between two major currencies, then it means that the market is extremely liquid. This does not mean that all currency pairs would be liquid. In reality, there are varying differences in the liquidity levels of different currencies. It would also depend on the kind of currency pair that is being traded – major, exotic, or minor.
Major currency pairs such as AUD/USD, EUR/USD, and NZD/USD, etc. offer high liquidity because the exchange rate for these pairs would not vary much when traded in large sizes. On the other hand, a currency pair such as PLN/JPY, which is an exotic pair, provides low liquidity because you cannot trade these pairs in large sizes without getting an increase in the exchange rate.
Risks of Forex Trading
Forex trading is an uncertain market, and there are several risks that are involved in this trading form. These risks need to be accessed when you make a trade. The better way to avoid these risks is to have a better understanding of them. There are different regulations of the interbank market, and the instruments that are used here are not constant.
Since there are numerous banks that deal with the trading of the foreign exchange market, they have come up with different kinds of strategies and processes. This is done to keep themselves safe from the risks. If you are an individual trader, you will have to face these risks at one time or the other, but the intensity of the risk will depend upon your trading plan.
One of the major risks that you can face is a wrong guess when you are making a trade. Apart from that, the market fluctuations could also have a major impact on your decision. Some of the most common types of risks are as follows:
- Exchange Rate Risk
- Country Risk
- Risk of Ruin
- Liquidity Risk
- Interest Rate Risk
- Marginal or Leverage Risk
- Credit Risk
- Transactional Risk
Summary
Forex trading involves risk as much as it involves money. If you can make a successful plan, then you will be able to make a lot of money. However, like any other field, the money does not come easily to you. As a beginner, you will have to be ready to face the losses, which is why it is better to focus on short trades.
You will slowly get to understand the market and also gain benefits in time. Focusing on long term trading as a beginner could be a huge risk. Make sure that you find your comfort zone when it comes to choosing the kind of analysis that you would conduct. Though it may take time to choose your trading style and analysis method, you will find it along the way.
