If you are a fan of Leonardo di Caprio, you have watched his movie, The Wolf of Wall Street. It depicts the life of a broker and the large sums of money (and scandals) involved in the world of trading. No doubt, you were curious about the realities of the trading industry. Here you will learn about forex trading in the simplest way possible. Think of it as forex trading for dummies.
What is forex?
Forex or FX is short for foreign exchange. It is the conversion of one currency to another. If you have traveled abroad, you have seen shops at the airport or downtown that offer to change your money to the local currency. It is a must to do this since businesses only accept local currency notes. When you ride the train, buy food, and book a hotel, you need local currency. But forex is not only for travelers. You may not realize it, but it is vital for our daily life. Every day tons of products are imported and exported between countries. When you eat that apple from Japan or use those chopsticks from China, you benefit from international trading. And forex plays a central role in all this.
But the physical exchange of currency is just a tiny percentage of the large volume of forex happening today. There are trillions of dollars being traded in forex every day. And most happen electronically, without the need to visit the bank or money exchange shop. Unlike stocks that get trades in the stock exchange, forex happens online through over-the-counter or OTC transactions. It is under supervision by an international network of banks that operate from four cities: New York, London, Tokyo, and Sydney. Since these hubs are spread all over the world, so forex trading happens 24 hours a day.
The objective of forex trading is to buy and sell currencies to make a profit. When the value of a currency is high, traders sell it, and when it is low, they buy it. But you don’t have to buy and sell physical notes in forex trading. Instead, you speculate on the price difference between currencies. Yes, you need two currencies in forex trading. After all, the objective is to trade when the exchange rate of one currency is high versus another currency. Let’s take the EUR/USD currency pair as an example. When you take a position in the Euro, you are at an advantage when the Euro value goes up while the US dollar goes down.
In the example above Euro is called the base currency, and the USD is the quote currency. If the forex rate is 1.43, it means that you will need 1.43 US dollars (the quote currency) to buy one Euro (base currency). Flipping the currency pair will give you USD/EUR. Taking the same example at 0.43, you will need 0.43 Euro (the quote currency) to buy one US dollar (base currency).
Have you noticed in the example that the currencies are written in three letters: USD and EUR? It is the standard naming convention in forex. The first two letters represent the country or region name, and the last letter is the currency name. So, USD is from the US (the country), and D is for the dollar (currency name). Other currencies include:
- GBP or Great Britain pound
- JPY or Japanese yen
- CAD or Canadian dollar
- AUD or Australian dollar
Why does the value of currency change?
The factor that affects the value of a currency the most is supply and demand. When more people are buying, there is a high demand, but the supply is low. It results in higher value. When people are not buying, it goes down. But this is not the only factor to consider. Currencies are also affected by central bank policies, political changes, market sentiments, economic indicators, and health concerns like the covid pandemic.
Central bank policies like the decrease in interest rates can increase the value of a currency, but when the government decides to print more money, the value goes down. For big economies like the US, a presidential election can trigger the rise or fall of the USD. Positive news reports can also help the currency gain value, but negative news brings it down. Market sentiment represents the speculation of most traders. If they think the currency is about to go down, they sell it. If they convince more traders to follow suit, then the forex value will be affected. And most recently, the covid pandemic has demonstrated that currencies are vulnerable. Health policies like lockdowns, cash assistance, and vaccination program affect the value of the local currency.
How can you trade currencies?
Since forex trading happens online and gets controlled by big banks, an ordinary person cannot participate in this activity. Not until there is a middleman between the banks and the retail trader. It is where the broker comes in. It connects the retail trader to the network of big banks. Once they are in the network, they can start to buy and sell currencies.
Brokers also receive the money of traders through individual accounts. And because it is easy money, some brokers turn out as scammers. So, to protect the people, countries started to pass laws and created agencies to regulate and monitor the activities of brokers. These include the following:
- FCA or the Financial Conduct Authority in the UK
- CySEC or the Cyprus Securities and Exchange Commission
- FCSA or Financial Sector Conduct Authority in South Africa
- ASIC or Australian Securities and Investments Commission
- CFTC or Commodity Future Trading Commission in the US
- NFA or National Futures Association in the US
These regulators ensure that the brokers follow strict rules on trading. It includes protecting your money by separating the trader’s capital from the company’s funds. There are also cash deposit and insurance requirements and full disclosure of the fees and commissions charged to the trader.
Legit brokers should have registration numbers to prove that they can offer trading activities in your country of residence. It should be prominent on the official website of the broker. But having a registration number is not enough to trust a broker. The list of authorized brokers is on the website of the regulator. For UK forex traders, for example, you can check with the Financial Conduct Authority or FCA if the broker is listed or not. Also, the brokers must get registered in the country where you are currently residing. Or at least in the same Region. If you are from Greece, a CySEC or FCA approval allows you to operate in all countries within the European Union.
Congratulations on finding a regulated broker! Next, you must identify the system offered by the broker. A trading platform is a program or software that lets you trade. It allows you to open and close a forex position and also manage your trading activities. Some brokers have developed their trading systems. Others use a tool available for free downloads such as the MetaTrader 4 and MetaTrader 5.
The trading platform must be simple and easy to navigate. Many brokers prefer the MetaTrader 4 or 5. The MT4 and 5 are best for newbies and advanced traders. If your chosen broker has its trading platform, check first if the design is user-friendly. Also, don’t forget to find out what devices are compatible. The best platform is the one that works on the web browser, desktop, and mobile apps.
Another vital factor to consider when choosing a broker is the efficiency of customer support. Since forex trading happens 24-hours a day, the helpline offered by your broker should be round-the-clock too. Problems like forgetting passwords, incorrect credit card charges, withdrawals over the limit, and system failures happen to all traders. And once you raise your concerns, your broker must be able to recommend solutions immediately. A sign that the broker is not a match includes a customer support team who doesn’t respond. Also, if he keeps on passing the call to other people, that is not a welcome gesture. Afterward, check for the channels where support is available. Do they have social media accounts? Is there a live chat feature? Is there a toll-free number that I can call for technical support? Do they have agents that speak my native language?
In addition, the best brokers also offer free training and education programs for their clients. Newbies in forex trading benefit the most from this. Look for materials that are high quality and more in quantity. Most brokers have interactive videos, webinars, and other reading materials. Some even broadcast live streams of their daily trading activities. Make full use of these sessions as they provide real-life lessons suitable for all types of traders.
What type of accounts is available for forex traders?
Brokers will have several account types available for their clients. Decide which one is best for you after considering your trading habits. Other factors such as deposit amount, trading volume, platform availability, fees, and commissions are also vital considerations. The most basic account will give you access to trading activities but has higher commissions. The advanced trading account will allow you to use more features of the platform. It includes copy trading, where you can mirror the trading of more advanced traders. And overall, they charge lower fees for premium account holders. Some even offer zero commissions per trade.
But before you sign up for an account with your broker, ask for a free demo. It is a test account where you get virtual funds that you can use on real-market conditions. It is the best possible way to test your trading skills without the risk of losing your real money. Some brokers offer as much as $100,000 to get yourself familiar with the platform.
To get started with your demo account, you need to select one currency pair. Don’t worry since you can add more currencies once you are more comfortable with trading. You can choose the EUR/USD currency pair since these are the most traded currencies in the world. Since everyone wants to buy and sell this currency pair all the time, selling your positions will not be a problem once you reach your profit targets. Observe the movement of the currencies and check the events and other factors that affect the dips and rise of the currency value. Buy and sell using the guideline you have set in your trading plan. Try different trading strategies and see which one will give you higher chances of success. If you fail at first, try again using a different technique. Remember that some brokers will allow you to use copy trading techniques. If you qualify for this, select experienced traders that have high profit to loss performance. Now is the time to make mistakes. Once you use your hard-earned cash, there is no room for error.
Can I teach myself to trade forex?
Yes, brokers offer many training materials to get you up to speed in forex trading. You can choose to watch instructional videos, attend webinars, listen to a podcast, and read customized lesson plans. Some even have trading academies and classroom-type lectures. But remember that you need more than just education programs. Self-discipline is also very much desirable. And lots of hands-on experience.
How do I start trading forex?
First, you need to find a broker. Then you must test the company based on standards such as regulation, platforms used, fees and commission rate, and customer support. After you get a legit broker, it is time to trade. Deposit money to your account and then open a trading position. Check how the currencies move. Once you find a winning strategy, exit the trade, and start again. For dummies and beginners, start with one currency pair first so you can focus on making a profit. You can slowly add more currencies once you have developed the winning forex trading strategy.