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To enter the most significant financial market, a beginner should understand the depth of the forex market, how it works, and the basic terminologies which are used regularly. Below is an essential guide to impart knowledge on how to make money trading forex for beginners.
The 101 Guide to Forex Trading for Beginners
- The 101 Guide to Forex Trading for Beginners
- Bottom Line
What is Forex Trading?
Forex is one of the biggest financial markets in the world with over a $5 trillion daily turnover compared to the securities market whose daily turnover is about $22.4 billion.
Forex is a term used for foreign exchange, and it is not limited to the trades executed electronically. If you have ever traveled to a foreign land, then you have entered the forex land though unknowingly. Exchanging your money for local currency is a foreign exchange transaction.
Example: if you are traveling to Europe for a holiday, you will sell Dollars for Euro at an exchange rate for that day. Unlike, the security market which is traded on exchanges, the currency is traded over-counter (OTC), and the transaction is processed electronically between banks and brokers.
In simpler terms, ‘Forex Trading’ is buying and selling of one currency for another at an exchange rate on the foreign exchange market. Unlike the securities(equity) market, the risk-reward is much higher, but at the same, time it is not for the faint-hearted.
The risk involved is higher than any other financial market and the chances of inexperienced losing money are also high. Therefore, knowledge and learning are highly essential to make money trading forex.
Make Money Trading Forex – Size of the Market
The total amount of money traded in the forex market is more than the entire GDP of some countries with a strong economy in the world. The liquidity and volume of the forex market make it ideal for trading.
The forex market mainly comprises of banks. The interbank transactions contribute to the largest volume in forex trading in currency space which includes trading between banks, trading for clients, or by individuals desks. The U.S banks dominate the market followed by central banks, hedge funds, investment managers, corporations, and retail traders.
Therefore, to do forex trading for beginners, it is important to comprehend the enormity of the forex market and the presence of different components in the market and their interaction with each other on a large scale.
Volume and Time Zones
Unlike security markets where trades happen over exchanges, the currency market has no central marketplace for trading but is completed electronically over-the-counter. This means all trades from any part of the world are conducted on a computer.
Forex trading operates 24*7 and all day long during business days. If you are on GMT+8, then here are the time zones of trading sessions. Currency pairs involving U.S dollar tends to have large volume during the U.S business hours from 16.00 – 24.00 GMT.
European majors include Euro, Pound, Swiss franc and the business hours are from 8.00- 16.00 GMT. Australian Dollar, New Zealand and Japanese Yen business hours are between 0.00- 8.00 GMT.
It starts with the Sydney session, followed by London and New York sessions respectively, and back to the Sydney session again.
The biggest forex trading volume is in US Dollars (85%), followed by Euro (40%) and Japanese Yen (20%). This makes major currency pairs.
So, Currency is always traded in pairs and not alone. Also, Currency pairs are the main ingredient of the Forex market.
Any price movement in the currency pair measures the value of one currency against another. The common currency pairs are based on the big five economies of the world.
Currency pairs are classified into 3 main categories:
1. Major currencies of the biggest economy and commonly traded are:
- USD– U.S Dollars
- CAD– Canadian Dollars
- EUR- The Euro
- GBP– British Pound
- CHF– Swiss Franc
- JPY– Japanese Yen
- AUD– Australian Dollar
- NZD– New Zealand Dollar
All major currencies are mostly paired with US dollars, i.e. EUR/USD, CAD/USD, GBP/USD and more.
2.Minor Currencies: These pairs do not include US Dollars, they are EUR/GBP, EUR/CHF, AUD/NZD and so on.
3. Exotic Currencies:
This includes currencies of emerging economies. There is a difference in liquidity when compared with others.
- HKD -Hongkong Dollar
- THB – Thailand
- SGD– Singapore Dollar
- SEK– Sweden
- DKK– Denmark
- NOK -Norway
- TRY -Turkish Lira
- MXN– Mexico
- ZAR – South Africa
- Chinese Yuan
In forex trading, major currency pairs are commonly preferred because of its high volatility and spread. What does it mean?
If the pair is volatile means, there is a price movement, and the chances of making a profit are high. If there was no movement then how would you earn on it, isn’t it?
The most traded currencies are EUR/USD and JPY/USD and account 41% of all forex trades annually.
How to Read Currency Pairs?
Some examples of currency pairs are:
What do the above numbers indicate? How to read them? Where is it used in forex trading?
These are relevant questions, and a beginner might have in mind. The key to making money trading forex is to understand and read a forex quote.
In simpler words, it means 1 Euro is worth $1.1350. The currency on the left (EUR) is the base currency and is always equal to 1, i.e. 1 Euro. The currency on the right (USD) is the counter or quote currency.
As explained earlier, the counter currency is worth relative to one unit of the base currency.
If the value of the currency pair goes up, the value of the base currency has risen which means one unit can buy more of the counter currency. If the value of the currency pair goes down means the base currency has fallen down.
Understanding Lot Sizes
You can make money trading forex by the “lot.” There are 3 types of lot sizes:
- A Micro lot is 1000 units of currency.
- A mini micro lot is 10,000 units of currency
- A Macro lot is 100,000 units of currency.
Forex trading for beginners, a micro lot is recommended. Many reputed brokerage houses provide a demo trading account.
This can help a beginner gain experience and understand strategies to apply in reality. It would be safe to say, better to lose play money than real value money while learning the forex trading.
Bid and Ask Price
While making money trading forex, you will see two prices are quoted ‘bid’ and ‘ask.’
Sometimes it is confusing to comprehend because the price quoted represents the dealers position and not yours. It is important to have the concept clear.
Bid Price: The price at which you can SELL the base currency – in other words, the price at which dealer will ‘bid’ or pay for the currency.
Ask Price: The price at which you can BUY the base currency – in other words, the price at which dealer will sell it or ‘ASK’ the price. The difference between the asking and bid price is ‘Spread.’
Let us understand with the help of an example:
At the time of writing, the bid and ask price for EUR/USD is 1.1349 and 1.1353 respectively. It can also be represented as EUR/USD 1.1342/43.
The asking price is always higher than the bid price.
Also, the asking price tells you how much of the counter currency will be needed to buy a unit of the base currency.
The bid price tells you how much of the counter currency you can buy when you sell one unit of the base currency.
In the above example, you could buy 1 Euro for $1.1353 (ask price) and sell 1 Euro for $1.1349(bid price).
Bid Price (-)
Spread is the $0.0004 or 4 pips. In order to make money trading forex, the value of currency needs to cross the spread to gain profit. In the current example, if the trader entered a long trade, then the trade will become profitable if the value of the pair crosses 1.1353.
Long trades mean you are purchasing currency in trade and expecting the value of EUR/USD will rise and sell it at a higher value with the difference between the buying and selling price as profit.
On the contrary, Short trades are opposite where you are selling currency and expecting the currency pair value to fall down so you can buy the currency at a low rate and the difference would be the profit.
For minor currency pairs, the spread is wider. At the time of writing, the bid and ask price for EUR/ x cCZK is 25.693 and 25.716 respectively. The spread is 0.020 or 20 pips. Therefore, for the trade to cross the spread and have a movement in a day is uncommon.
The spread should be as small as possible to make a profit easily due to price movements. You can make money trading forex in the major currency pairs and favorable trading hours, so there is a number of buyers and sellers for thinner spreads.
Due to small spreads, the trades can be profitable quickly, a high volume of smaller trades rather than waiting for large trades to make money. Spread is where your broker makes money as they don’t charge official commission.
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What is Pip?
A complex term to understand but the most important part and a big deal in trading. Let us learn the basic definition and role of it.
In stock trading, we know that a stock’s share price goes up or down to a point. Similarly, pip is a point in forex trading. Pip is the smallest price movement in a currency pair and people officially refer it to as a percentage in point or price interest point. They equal to one basis point but not always.
Most forex pairs, the smallest price movement happens in the 4th digit after decimal except JPY pairs where the smallest price movement happens in the 2nd digit after the decimal.
This infers that for every 0.0001 change in the price, pip is 1. Every 0.01 change in price, pip is 1 in JPY pairs. The value of a pip depends on the lot size and currency pairs.
EUR/USD is trading at 1.1342, and an hour later it is 1.1349.
What is the increase in price?
1.1349 – 1.1342 =0.0007 i.e 7 pips.
USD/JPY is trading at 110.76, and 45 mins later it is 110.54
What is the decrease in price?
110.76-110.56 =0.02 i.e 20 pips
Concept of Leverage
Leverage allows a trader to borrow money from the broker to trade more than your account value. It bolsters one’s trading volume. Many brokers offer leverage on major currency pairs up to 10:1, where one can trade up to 10 times larger than the balance in the account.
If you have $1000 balance in your trading account, you can trade for $10,000 worth of currency pairs. Your profit will maximize by a factor of 10. The currency movements are small but frequent up to 100 pips a day- leverage allows you to increase return if the currency you are buying goes up.
The same leverage will multiply your losses too by 10 if the currency you are buying goes down.
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Concept of Margin
A margin is the amount of money in your account that allows you to trades of given sizes. It is a good faith deposit that acts as collateral for trading. The amount of margin needed to trade and hold a position will depend on the trade size.
Often the margin required to trade high volumes and make money trading forex is low, and therefore brokers offer leverage.
Styles and Strategies
There are various strategies and styles to make money trading forex. Research well about each strategy and decide which fits your trading style. Here are a few common strategies used by traders:
- Day Trading Strategy: No holding position and closing the trade by the end of the day. Therefore any political or economic news overnight will not affect the trading. There are more perks than just making money when you choose day trading as an investment strategy.
- Trend Trading Strategy: This strategy helps you to determine trends with historic details and help to understand the direction of prices.
- Swing Trading Strategy: This strategy helps in trading that lasts for a day or week.
- Fundamental Trading: Develop your strategy on the basis of the fundamental analysis which you can determine on the basis of political and economic events. They mostly affect the strength and weakness of the currency. There are many government bodies that release data weekly and central banks that hints on policies.
There are several other styles depending on the time and holding period like position trading, intraday trading, or strategies based on technical analysis or moving average method.
Capital Needed to Make Money Trading Forex?
So, most of the beginners ask this question first, but there is no ‘one-size’ fits all answer. It depends on your risk appetite, personal finance, and circumstances.
Forex trading is an achievable goal but needs to be a lot cautious and not fall into the trap of leverage and handle your emotions. As much as the earning opportunities are high, money can be wiped off in one go too.
The best way is to try the demo trading first offered by brokers. Even though it is not real but can equally give you a chance to learn about strategies, allow yourself to be wrong, and move on after it. Practice on the demo session before entering the real world.
We’ll also suggest that you save money before investing it in forex trading. This way, it won’t affect your expenses and finances in any way.
Here are a few tips to decide on the money to invest:
- Invest money that you can afford to lose(not affecting your lifestyle)
- Half of the amount put it aside (maybe a bank)
- Other half put it in the trading account.
- If you are able to generate profit then invest the amount kept aside.
- This will help you not to lose your hard earned money together and get educated on your progress.
- This may not make you rich quickly but will grow slowly and remain in the market for the years to come.
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To make money in trading forex, it is necessary that you educate yourself about the nuances of forex trading. People fail at forex trading every day, so it is important to keep your head together while trading and tackle your emotions. Also, you should indulge too far in the glory of others success.
Also, there are many brokerage firms that offer services at affordable costs with robust platforms and a large selection of currency pairs. So, be honest to yourself and do your research well to help you succeed in how to make money trading forex.