HOW TO LEARN FOREX
So you’ve heard about Forex Trading online and think that it could be a great way to build a new income stream? Getting started in forex can be a steep learning curve, so it’s very important to get the right advice about how to learn forex trading. There are many different things to be informed about before you should start live trading, from understanding risk to selecting the right forex broker.
How To Get Educated About Forex Trading
To trade forex successfully it's absolutely essential to be properly forex educated. As with any profession, both time spent learning and gaining experience practicing are integral to successful trading. You’ll quickly learn that nothing beats experience for learning, and making mistakes along the way is something that most successful traders have done themselves. That said, getting a proper education of how to trade is important, so we’ve compiled a list of our top forex trading education providers. Read it here!
Get Familiar With Forex Trading Basics
Before jumping into the forex markets with both feet, or following someone's forex trading signals, you should understand the basics of the forex market. This means learning forex jargon, which we’ll discuss in more detail, understanding different types of trading, and much more.
What Is Forex
Forex is short for foreign exchange, and is simply the act of exchanging one currency for another. For example if you have 10 British pounds (GBP) and changed them into US dollars (USD) this would be a very basic example of a forex trade. To exchange two currencies there must be a forex exchange rate, to calculate how many USD your 10 GBP purchases. These exchange rates fluctuate depending on which currency is in higher demand, which is influenced by economic factors, global events, and international politics. In this example your 10 GBP might buy around 14 USD, as the British Pound is seen to have a higher worth than the US Dollar.
One of the reasons many people prefer trading forex is that the forex market is regarded as the most liquid financial market in the world. This means that unlike the stock market the forex market is open 24 hours a day, 5 days a week, to be accessible through all global trading sessions. It also means that the forex market rarely ‘gaps’, a phenomenon that occurs when price jumps from one price to another without trading at prices between the two.
How Does Forex Trading Work?
Financial markets have evolved drastically over the last 100 years, giving traders various different ways to trade forex. The example above of GBP to USD is what is called a physical forex trade. Physical forex trades occur when one currency is actually exchanged for another, as you might do when travelling to another country.
The most popular forex market for retail traders to trade their own money with is the CFD forex market. CFD means Contract For Difference, and means that rather than actually trading the underlying currencies you are simply buying a contract that makes you liable for the change in exchange rates, based upon the contract size. CFD’s can be used to trade forex, stocks, futures, and other financial assets. Typically one standard contract in forex gives the trader liability for changes in the FX rate based upon purchasing 100,000 units of currency. Still with me?
This concept can be quite confusing at first, however we’ll try and help you understand. When you sign up with a forex broker and deposit in your local currency you may be wondering how you can trade the FX rate of two currencies that you don’t own. CFD’s allow the broker to calculate the difference between the two currencies exchange rates based upon your contract size. The broker then converts this value into your account currency, and puts the loss or profit into your account.
Forex Contract Sizes Explained
In forex you will hear about contracts / lots. This is an interchangeable term used for discussing the amount of money you want to trade. Below we’ve outlined the different lot sizes available at most forex brokers.
1 standard lot / contract is the equivalent of trading 100,000 units of currency. One standard lot looks like this in a trading platform: 1.00.
One mini lot / contract is the equivalent of 10,000 units of currency and looks like this in a trading platform: 0.10.
One micro lot / contract is the equivalent of 1,000 units of currency and looks like this in your trading platform: 0.01.
So say you wanted to trade 7,000 units of currency you would need an order size of 0.07 lots / contracts.
For another example let's say you wanted to trade 2,743,000 units of currency (2.743 million!). For this order you’d need to trade 27.43 lots / contracts.
Understanding Forex Symbols
In the financial markets an asset is given its own ‘symbol’ or ‘code’, so that it can easily be referred to. In the example above with GBP and USD the symbol is GBP/USD. Pretty easy right?
In a forex symbol there is a base currency and a quote currency. In forex the base currency is the first currency mentioned in the symbol (the first 3 letters). The quote currency is the second currency mentioned in the symbol (last 3 letters). The base currency is being given a 'quote' in the quote currency quite simply, saying that if you hold one base currency you will receive x amount of quote currency, making the exchange rate.
If you take a buy trade (long) then you are effectively purchasing the base currency, expecting it to rise in value against the quote currency. Likewise if you take a sell trade (short) you are effectively selling the base currency into the quote currency, anticipating that the base currency will fall in value against the quote currency. If you buy one contract of AUDUSD you are effectively buying 100,000 units of AUD, expecting it to appreciate against the USD.
With CFD's you don't need to own either of the currencies to trade them, as the contract makes you liable for the value of change of the forex rate based upon the contract size (lot size). The broker will calculate this value, convert the amount to your forex trading account's base currency, and issue you with the profit or loss.
For example, lets say your account is in GBP and you buy one contract (1.00 lots) of EURUSD . The EUR appreciates against the USD by 10 pips, and your profit is 100 USD. The broker then converts this to GBP using the USD/GBP rate (currently 0.7040), making your profit 70.4 GBP! The broker issues this profit into your trading account.
Keeping up so far? If not it’s ok, it usually takes a while to get familiar with this concept.
Understanding Leverage And Margin In Forex Trading
Knowing about leverage and margin in forex trading is essential. So what are they, and what is the relationship between them?
Leverage: Leverage is the ratio between the amount of money you hold in your trading account and the amount of money you can trade with. Leverage provides increased buying power, meaning that you can take positions larger than the capital you have. The leverage is typically expressed as x:1, showing you how the ratio of buying power to your capital. For example 100:1 leverage shows that for every dollar you have you can trade up to a 100 dollar position.
Margin: Margin is used to create leverage. When trading with leverage, a trader is required to put up the funds for a fraction of the position. This means that rather than paying the full value of the position a trader only needs a small capital outlay to hold a larger position.
Without margin trading you would need 100,000 USD to buy 1.00 USDJPY contract. If you had 100:1 leverage however you would only need 1,000 USD to buy the same contract.
Why Trade Forex WIth Leverage / Margin?
In forex trading the change in prices are typically very small, typically around 1/10th of a cent, so it requires large position sizes to make worthwhile returns. If you only had 1000 USD to trade with then you would only be able to trade 0.01 contracts, which wouldn’t generate much in returns. Even a 100 pip move would only make $10 on a 0.01 contract! Leverage allows you to maximise the returns on your predictions, however it also magnifies the size of your losses. Leverage is referred to as a double edged sword for this reason.
Understanding Risk, Managing Risk & Emotions Trading
Understanding your market risk and managing your emotions in the forex markets are intertwined. Managing your risk and emotions in trading is crucial to long term success in financial markets. A wise trader once said “There are old traders and there are bold traders, but there are no old and bold traders”. Put simply, inability to effectively manage your risk and emotions inevitably leads to large losses.
Understanding Risk
Your risk in the markets is not strictly limited to you account equity. Trading leveraged positions can result in losing more than your deposit, and should be treated with the caution it deserves. Before opening any trading position you should ask yourself the following questions:
If the market does not move in my favour where will I exit the position?
What is the amount I’m willing to risk on this trade?
What’s the longest period of time I’ll hold this trade for? (Don’t underestimate time risk)
If my trade reaches my target price (TP) what is the return on risk? (Risk to reward)
If price gaps below my stop loss and I lose more than anticipated is my account able to handle the loss?
Knowing the answer to all of these questions is essential to every trade that you place.
Managing Emotions
Keeping a clear mind in the forex markets is necessary to prevent making bad decisions, such as risking too much or taking trades that you shouldn’t. The outcome of any single trade is unpredictable in the same way that the outcome of a coin flip is. Using risk management and a systematic edge a trader can use probabilities to profit over a sample of trades. Before opening a position a trader should make the following affirmations:
I accept that the outcome of this trade is unpredictable.
I accept the fact I may lose this trade.
I accept the fact that I may lose more than my stop loss outlines.
Winning this trade does not make me a good trader, and losing this trade does not make me a bad trader.
I am calm and confident that my trading strategy indicates that I should open this position.
If you are unable to truly embrace these affirmations then you should not open a position.
Learn The Currencies You Trade
Most new forex traders tend to just dive right in and try to trade every forex symbol out there. Every forex pair may move similarly, but every forex pairs also moves in its own unique way. Focus on a few currency pairs and get comfortable with how those forex symbols move.
Understanding the movements of a select set of forex symbols will help significantly when it comes to building a forex trading strategy, which we’ll go over thoroughly. Many forex systems will only be profitable on a select few symbols, and not on all currency pairs.
Getting Familiar With Forex Trading
Now that you have a bit of knowledge about the forex market it’s time to get comfortable with how trading works. For this step, opening a demo trading account is a great idea, as it allows you to get comfortable with a live trading environment but with pretend money. This means that you don’t have the risk of losing money. Whilst you may be excited to dive right in and start trading, getting familiar with how to place trades and input order size, stop loss prices and Target Price levels is essential. Learning how to operate the trading platform and getting familiar with the symbols you want to trade will minimise the chance of technical errors down the road.
Technical Trading
Technical trading is the analysis of historical price data, believing that the future movements of price can be predicted through chart patterns, indicators, and price movements. Popular tools of technical traders include trendlines, support and resistance levels, and trendlines. Technical trading can be done on any timeframe.
As a wise trader once said, “Every shipwrecked boat had a charting table”... Make of that saying what you will.
Fundamental Trading
Fundamental trading is the analysis of factors that may impact price in the future. In forex these factors are typically economic data, global trade, and news events. Fundamental traders believe that the information or analysis they have has not yet been factored into the price. For example, a fundamental trader may conduct research on a nation's employment rate to determine employment growth prior to the government statistics on employment being released. Fundamental trading can also be done on any time frame, from short term trading around economic data releases, to long term trades based upon a country’s deteriorating economy.
Arbitrage Trading
Arbitrage trading is a style of trading that exploits the differences between prices for one asset. This involves buying the asset at the lower price and selling the asset at the higher price, and waiting until the prices become equal. This eventually leads to equilibrium in the market. Arbitrage traders must factor in the commission, spread and swap costs of the positions to calculate whether a profit can be made from exploiting the price difference.
Arbitrage traders typically have no risk to market volatility, and are focused entirely on the pricing of an asset.
Systematic Trading
Systematic trading is a rule based trading style, where the parameters to open a position are clearly defined, and a position is only opened when all criteria to open a trade are met. Systematic trading is most commonly based upon technical factors, however systematic trading can also be conducted using fundamental analysis. A basic example of technical systematic trading would be buying when price crosses to the upside of a moving average, and selling when price crosses to the downside of a moving average. Systematic trading has the advantage of leveraging technology - if you are able to define the rules to open a trade you can develop a trading robot / algorithm that opens positions when the criteria are met. Systematic trading can be conducted on any time frame.
Discretionary Trading
Discretionary trading is a style of trading based upon intuition and collating a number of reasons to open a position. The reasons for a trade may vary from trade to trade and may include fundamental or technical reasons to open a position. Discretionary trading can be conducted on any time frame, and like the name suggests, is utilised completely to the discretion of the trader.
Scalping
Scalping is a style of trading that involves entering and exiting a position in a very short amount of time. Scalpers will hold a position from a few seconds to a few hours. Scalpers usually set designated times to trade, such as the first hour of the NASDAQ open, however not all scalpers confine themselves to short trading windows. High leverage is typically used in scalping, as large positions are required to generate profits from small movements in price.
Day Trading
Day traders look to hold trades for a few hours usually, and have all positions closed by the end of the trading day. On rare occasions some day traders may hold positions during roll over. Typically high leverage is also required for day trading.
Swing / Position Trading
Swing or position trading involves holding positions for a longer period of time, from days to months. It is named “swing trading” as it involves holding a position that swings up and down, but capitalises on the longer term market trends.
Putting Your Forex Trading System Together
To put together a forex trading system you should choose whether you will use:
Fundamental trading / technical trading / both / Arbitrage trading
Discretionary trading / Systematic trading
Swing trading / day trading / scalping
Data is the most important aspect of developing your trading, as collecting data will allow you to see how your trading strategy performs across a long period of time. This will provide you with expectations for win rate, profitability, draw down periods, losing streaks and winning streaks. To collect data on your forex trading strategy backtest the strategy over previous data and forward test the strategy on a demo trading account. To help build a profitable trading strategy check out our list of top forex trading education providers here!