The term forex or FX refers to the foreign exchange market that allows traders to buy and sell different currencies. Traders choose this market because of its size, the wide variety of currencies, the possibility of high volatility that can be translated in profits and the low transaction costs that are charged by some of the brokers.
Beginners who want to conduct forex trading should realize that this is a market like so many others that is subject to demand and supply. If the demand for a currency such as the US dollar is high, people will exchange their other currencies for it and cause it to increase in value or appreciate. It is also possible that depending on the amount and currencies traded, the US dollar could appreciate compared to the Euro and depreciate compared to the British pound or GBP. This is why when predicting the movement of a currency pair it is important to consider both currencies and the countries or regions from where they are issued.
The forex trading strategies can be complex, but they are based on some simple principles that are obvious. If you anticipate that the value of a currency will increase, you buy it or take a long position as it is also called. If you predict that the value of a currency will decrease, you sell it or take a short position on it.
Forex Trading Terminology
Some basic terminology should be clarified next, to make currency trading less intimidating and more approachable to people who want to try it. A currency pair is composed of a base currency that is stated first and a variable or quote currency that is stated second. Looking at the EUR/USD currency pair, the Euro is the base currency and the US dollar is the variable or quote currency. This currency pair shows how many dollars does a Euro cost. A trader taking a long position on this pair will anticipate an appreciation in the dollar or a depreciation in the Euro. In a similar way, a trading taking a short position on this pair will predict an appreciation in the Euro or a depreciation in the dollar.
Once it has been determined what is bought and what is sold, the next consideration will be the price charged for this transaction. The bid price is the highest price a forex trader will get from selling as it represents how much the buyers are prepared to pay. It is usually placed on the left of the quote and is in red. The ask price is the lowest price that a trader will be allowed to buy at, as it is the lowest price a seller is willing to accept. It is usually placed on the right and is colored in blue. The spread is the difference between the ask and the bid price and is composed from the actual forex market spread plus the additional spread of the broker. This is why different brokers will have different spreads and this price is a real criterion when choosing between them.
Another consideration of conducting forex trading is leverage. This leverage allows the trader to invest only a fraction of the trade as opposed to the full amount. For example, if a trader deposits an initial margin of $1,000 and has a 100:1 leverage, by doing the multiplication it results that his trading position is $100,000. Without leverage only financial institutions and big companies would have access to the forex market, as traders would have to put down the full amount of money they want to trade with. The leverage allows to have a big trading position and register profits and losses quicker by starting with an initial margin. This margin is the amount of money needed to open a leveraged position. All the profits and losses are added to or subtracted from this margin account.
It is particularly important to choose a leverage that is suited to you when starting with currency trading. The leverage should be high enough that you are well compensated if the price moves as predicted. However, a disproportionate leverage is a liability as it can contribute to a substantial loss of capital. A good trader should know how to balance risk and return and select a suitable leverage that is closer to 10:1 as opposed to 100:1. A high amount of losses can determine a margin call. This means that the capital has decreased below a certain level and more funds are required to continue trading. This is a situation that should be avoided through money management and by choosing a moderate level of risk.
Traders who are just beginning to activate on the forex market should realize that the price of a currency depends on a multitude of factors such as the interest rate, GDP, debt or the rate of inflation in the corresponding region. Studying factors such as these, (sign up for our free currency trading for dummies here) reading economic news and being informed of other events is called doing a fundamental analysis. Looking at mathematical indicators of the price is called technical analysis. Both of these approaches should be considered by traders as anticipating price movements is a complex procedure that requires good reasoning.
Forex Trading Tips
Beginners should also know and conform to the following forex trading tips. First of all, it is a good idea to start trading on a demo account. This will be a good opportunity to see how your predictions compare to the currency pair movements and the real market conditions. The second tip is to create a trading plan that should include profit goals and a risk tolerance amount. Once the plan is in place, you should stay disciplined and follow it, by closing positions to take profit or to cut losses. If positions are left open for too long the price can move in a way you have not anticipated and you are relying on luck instead of following the initial plan. The third tip is to choose a trading broker that is right for you and that has good pricing, features, quality customer service and a friendly interface that can help you in your trading activity.