In most instances, commercial banks and investment agencies trade Forex for their clients. However, there is space in the market for individual trading opportunities. For individual traders, the best place to trade is the spot market where currencies are exchanged for their current market price.
At present, when anyone refers to the Forex trading market, the spot market is what they are referring to. Deals finalized in this market are called spot deals. Do note that this spot deal may take up to two days to be settled and for you to receive your agreed upon amount in cash.
To trade Forex as an individual, it is best to begin by creating a demo Forex account on a trading platform. The most popular platform is forex.com that lets you practice with fake currency. Once you get the hang of the trade, you can begin trading in actual currency pairs.
There are also the forwards and futures markets but these are typical platforms for traders and corporations. These organisations want to secure their ventures against risks associated with foreign trade.This practice is called hedging.
To make money through Forex trade, you may instead be interested in spot markets. This article refers largely to spot markets. Read ahead to know how to go about trading in the Forex market.
How to Make Money Trading Forex?
While thinking of making money through Forex trading, it is wise for you to first categorise yourself. If you are an individual with limited funds, the Forex market is a great place for what is called day-trading or swing trading. As a day-trader, you pay attention to short-term market fluctuations and inefficiencies as opposed to any long-term view of economic fundamentals.
Swing traders anticipate changes in the market that can be acted on between a few days and a couple of months but not longer. Both are relatively short term trading. However, if you want to invest huge sums, you may want to engage in trading strategies that favour long-term market presence.
Once you’ve categorised yourself, the terms in this article like lots and orders can be customized to suit your goals.
Money Making Rules
The gist of making money through trading is anticipating market conditions where the currency you bought will increase in value to the one you sold. When the conditions are favourable to you, you earn a profit.
As a simple rule, you should buy a currency if you think its value will increase relative to the currency you are selling. For instance, if you predict that the USD will strengthen relative to the CAD in a USD/CAD pair, you should buy USD units. In this way, you stand to make a profit in the future when you sell the strong USD for more CAD. Similarly, if you now predict that the USD will depreciate, it is wise to sell USD units for more CAD.
“Bid” Price and “Ask” Price
Note that your broker will pay the ‘bid’ price for the currency that you sell. This is the price for a unit of currency quoted by your broker in exchange for your money. In addition, there is the ‘ask’ price which is the market price at which your broker sells currency.
The difference between the two is measured in pips. The pip is better explained later in this article. Larger the number of pips between the bid price and the ask price, larger is the spread.
How to Know When to Sell or Buy a Currency pair?
Forex markets are volatile and depend on various external factors like the economy and the political environment. Hence, money is best made in this trade by analysing and forecasting political and economical conditions which affect interest rates. This is done for both the currencies in a pair as values of currencies fluctuate in pairs.
A key element to take into notice while trading in Forex is the interest rate of the currency pairs. This is done by buying the currency with the higher interest rate and shorting the currency with the lower interest rate. This can be done in the following way.
- Keep track of the economic fundamentals of the economies of the currency pair you plan on trading. Take note of their interest rates, inflation, Gross Domestic Product (GDP) and trade balance surplus and deficits. These will help you keep an eye out for the interest differentials between currencies. Hence, you can predict the best time for going long on one and shorting another.
- Use an economic calendar to predict periods of high interest rates. There are several calendars available online like the one by dailyfx.com. These will let you follow economic events that will lead to exchange rate fluctuations between currency pairs.
- Follow political news of the countries in your currency pair. For instance, in a EUR/USD pair, if you think that the EUR will hike interest rates, it may be a good time to purchase EUR units in exchange for USD units.
- Pay attention to the histories of successful traders to note patterns that may work for you. You can do this by using demo accounts that allow you to access others’ trading histories.
What is a Pip in Forex?
A Pip is the fundamental unit of measurement when you trade in Forex markets. It determines the basic difference between a currency pair. Further, Pips serve as a guide to profit in Forex exchange by allowing you to determine how much you can gain if you leverage the currencies held long and shorted.
In general, a Pip is an indication of the change in price measurement between two currencies. It is usually expressed as 1/100th of 1%. This means that the value difference between the currencies is expressed accurately to four decimal points. However, a few currency pairs do not adhere to this general rule.
For instance, the USD/YEN pair is quoted to two decimal places. Pips can simply be thought of as Forex market language that tracks movement in exchange rates. The exchange rate between currency pairs can move as much as 70 Pips or more in any given day. In technical terms, a Pip can be calculated by dividing 1/10000 or 0.001 by the exchange rate. In practical terms, a Pip works in this way.
The central rule of trading in the Forex market is that buying a certain currency will involve selling another. A Pip will help you calculate the spread between the currencies. In this way, you can determine the potential gains or losses you will incur by exchanging within the currency pair.
A Pip has great value in the Forex Market especially when leveraged. For instance, the USD/CAD currency pair may experience an increase of the USD by 76 Pips. This allows the trader to gain a basic profit of 76 Pips. Since, this is accurate to 4 decimal points, this profit would be expressed as 0.0076.
Note that this is the basic measurement. In the Forex market, larger sums are exchanged. If 10000 USD were exchanged, the profit would be 10000 * 0.0004 or 76 CAD. You can only imagine the kind of profit or loss you would incur if much larger sums are traded. Do note that Pips are an appropriate measure only under normal market conditions.
When economies are under crises like extremities of devaluation, the Pip itself collapses. This has occurred historically when the exchange rate between currencies was expressed as millions to one. This was seen in Germany’s Weimar Republic in November 1923 when the currency pair stood at 4.2 trillion marks per dollar.
In regular life, this is unlikely and Pips serve as excellent metrics to anticipate profits and losses in the Forex Market.
What is a Lot in Forex?
In the example on Pips, you read that huge sums are traded in the Forex market. It is precisely this that is standardised into what are called lots. This standardisation in exchange is often dictated by regulatory bodies in the market. In the spot forex market, where you are likely to trade, for a long time, lots of 100, 1000, 10,000 or 100,000 were traded. Off late, it is possible to also trade unconventional lot sizes.
In general, a lot is a measurement of the amount of the asset that one can buy and sell. In the Forex market, a lot would refer to the quantity of currency units that can be exchanged in a currency pair. As convention, three lot sizes are made available to traders.
First is the standard lot where 100,000 units of any currency will have to be exchanged within the currency pair. For a standard lot in dollars, a movement of one pip would result in a profit or loss of $10. The second lot size is the mini-lot which would involve 10,000 units of currency, Here, a movement of one pip for a mini-lot in dollars would reflect as a change of $1. The third is the micro-lot that accommodates 1000 units of any currency.
A movement of one pip for a currency expressed in dollars would translate as a change of $0.1. For traders who are new to the Forex market, it is recommended that you trade in micro-lots. This allows you to understand the market and better control the associated risks. As the change is expressed as 0.1 of the currency, risk management is relatively smaller.
In the micro lots, the risk would amount to $1 and in standard lots to $10, corresponding to pip movement. Micro lots also allow you to better manage your risk with large sums. For instance, for the same sum, you can trade 300 micro lots or 30 mini lots.
When divided into micro-lots, the same sum can be fine-tuned to explore trading positions. While these are conventional historical lots, the internet has changed the environment of Forex trading. This has resulted in the increase of online brokerage activity which led to increased competition and differentiation. Brokers now offer even nano lots that are represented as 100 units of currency. It is also interesting to note that the above standard lot is largely for the Spot market. In the Interbank market where banks trade currencies between themselves, the standard lot is instead defined as a million units of currency.
What are the different types of Forex Orders?
In the Forex market, an order is the way in which you enter and leave a trade deal. Using your broker’s platform, you will send out an order that specifies conditions of the deal. It also specifies the opening and closing of the transaction.
There are various orders in the Forex market. You now know that brokers offer differentiated lots in the market. Similarly, orders are also offered depending on the broker you are working with.
The first type is the market order where it is instantly executed corresponding to the current or market price. Here, transactions are made on the best available price. For instance, in a trade between USD/CAD, if the best price available was 1.2133, you would simply click on ‘order’ or a similar option on your trading platform.
Your trading platform would execute the order for you at the best available price that you have chosen. Do note that you have little control on the subsequent events in a market order. The price at which your market order will be filled will not be under your control.
Pending orders are of kinds where your trading platform watches market conditions for you. It then executes the order for you based on your specified limits.
Another kind of order in the Forex market is the limit order where you define a price. Your order will be executed when the market fluctuates to conditions that allow you to obtain the specified price. You can specify a buy limit where you buy currencies at or below your defined price limit.
Here, you believe that the price will fall again on touching the price limit. A sell limit would sell currencies at a price that is at or above your price limit specified. Here, you believe that the price will rise again, once it falls to the specified price limit.
Note that the platform will only execute the order if the price reverses itself on hitting your price limit. This is done in cases of both the buy and sell limit. Use this order if you think that price reversal at the price limit is beneficial to you.
A limit order works best as it delegates the practice of waiting to the brokering platform. For instance, instead of waiting to see the fluctuations in the market yourself, your platform will do it for you.
When the price either dips or increases above your specified price limit, the platform will automatically execute the order for you. It will seek the best available price and close the deal.
Stop Entry Order
A stop entry order is similar to the limit order except for the condition of reversal. In a stop entry order, a price point is set. An order is executed only when the price continues to rise or fall beyond the stop point.
A buy stop order will let you set a price point above the current market price. When the market price increases to touch your specified stop, the order is triggered. If the price continues rising, the platform executes the order for you at the best available price.
In case of a sell stop order, you will have to set a price point below the current market price. When the market price falls to touch your specified stop price, the order is triggered. If it continues to fall, the platform then executes the order according to the best available price in the market.
Stop Loss Order
A specifically helpful order is the stop loss order. After identifying a price point beyond which you will incur losses, the platform stays alert to this position. On approaching this point, it ceases or stops transactions to prevent any further losses in trading. It may be a sell stop or buy stop order depending on the position you are in.
For instance, if your predictions were wrong, the market price may increase when you anticipated its fall. In this case, the trading platform will automatically execute an order to further minimise your losses. It will immediately sell or buy currency for you for the best available price. You can also specify a trailing stop order with a specific interval of pips. This will give time for the platform to take into account any uncanny fluctuations. Here, you may specify a pip interval, of say 30 pips.
If the market price falls below the stop loss limit, the platform lets the stop to expand up to 30 pips without executing an order. Beyond this, it aims at minimizing your losses and selling the currency at the best available price.
There are also a couple of other orders that exist. A ‘Good Till Cancelled’ order remains active until you cancel it yourself. A ‘Good for the Day’ order remains active only until the end of the day. Do note that all orders come at a specific price and each new day may bring further cost to the order. Depending on your broker, a ‘Good for the Day’ order may be a good call to save up on broker costs.
Opening a demo account
If the information you’ve read is too much to digest, don’t worry. There is a practical way for you to test the waters. For the same reason, several trading platforms allow you to learn first-hand by setting up a demo Forex account. Demo accounts are also a child of the internet-age and they have much to offer.
Demo accounts deal in fake money so that you can monitor market conditions and learn the tricks of the trade. For learners, it eliminates financial risk that is a part and parcel of dealing with real money. Demo accounts offered by trading platforms like forex.com let you trade with about eight currency pairs.
Another great platform is eToro that uses social trading. Here, you can pick up strategies from others’ trading histories and learn from them. Another advantage of a demo account is that it lets you pick the best broker for your needs. You may want to see if your broker offers the kind of lots and orders that you need for trading. Note that some demo accounts are offered at a nominal fee and others may offer a 30-day trial period.
You can also try opening a demo account with XTB or IC Markets and get a better insight!
Compare the best online brokers ready to help you trade Forex.
If you are a beginner in the Forex market, all of the above information may seem complex. The best way to navigate your way out and understand the market is to practice. Hence, demo accounts are a good place to begin.
Try multiple brokers’ demo accounts to see which broker and currency pairs best fit your needs. It would do you good to pay attention to the political and economic conditions of the countries in your currency pairs. This will enhance your forecasting capability and trading skills. When you begin trading with real currency pairs, use a nano or mini lot to get a feel for the market. Once you do, you’re well on your way to trading Forex.