How Does Forex Trading Work?
Forex Signal Trading is the process of converting one currency into another. Usually, you exchange money for a good or service. In stock trading, you exchange money for shares in a company. In the Forex market, when we trade we exchange one currency unit for another currency unit. The American Dollar, Euro, and British Pound are all among the most commonly traded currencies.
Forex traders trade with one another through a structured group of dealers and computer networks that act as market makers for their own customers. They place orders of currency pairs (or pairs of currency that you plan to swap). These currency pairs have different exchange rates associated which are where the arbitrage comes in.
For example, if the price of the EUR/USD exchange rate is 1.1150 it suggests that we can get 1 euro for every 1.1150 US dollars.
How to Trade Forex for Beginners?
The basic foundation of trading in the foreign exchange market consists of understanding how currencies are quoted and what the exchange rates represent. In the Forex market, all currencies are quoted in pairs. This is why the act of Forex trading involves simultaneously buying one currency against another currency, which is sold.
Let’s now examine how many types of currency pairs you can encounter in the FX market.
Type of Currency Pairs
Depending on how much trading volume a currency is carrying out, we can split currencies into three major categories:
- Major Currency Pairs: These are all the currencies that are traded against the US Dollar, the world’s reserve currency. Eg: EUR/USD, GBP/USD, and USD/PY. The major pairs offer the biggest liquidity with EUR/USD being the most liquid currency pair.
- Minor Currency Pairs: Also referred to as cross pairs and are currency pairs that don’t trade against the US Dollar. Eg: EUR/GBP or EUR/CHF. They offer less liquidity for trading.
- Exotic Currency Pairs: Also referred to as minor pairs, are currencies linked to the emerging economies around the world. Eg: South African Rand, Brasilian Real, and Turkish lira.
As you can see, the American Dollar plays a major role in the forex market.
Next, we need to clarify how to read currency pairs and why we use a three-letter quotation system.
How to Read and Understand Forex Quotes
The standard quotation system uses a three-letter abbreviation system and will always involve two currencies where the first currency listed on the left is the Base currency while on the right is the quote currency. The quoted price indicates how much of Quote currency is required to buy/sell one unit of Base currency.
The next thing to understand is that currency pairs always have two prices: the Bid price and the Ask price. This is the two-way quote system used for buying and selling of currencies. In simple terms, the Bid price is the price at which you can sell while the Ask price is the price at which you can buy.
How to Use Forex Orders
Generally speaking, a Forex Order is a command given to your broker that shows:
- What currency pair to buy/sell.
- The direction of your trade (Long or Short).
- The price to buy/sell.
- Where to Take Profit.
- Where to Exit.
- How much quantity to buy/sell.
- The type of order.
Direction wise, a Forex Order can be used to do two things:
- Buy (Long) – If you expect the currency pair to rise, we use a buy order that is executed at the Ask price and closed at the Bid price.
- Sell (Short) – If you expect the currency pair to fall, we use a sell order that is executed at the Bid price and closed at the Ask price.
This is the process to learn how to trade Forex for beginners. Once you are more familiar with the forex market, you will be able to use the London Breakout Strategy and various other forex trading strategies.
How to Open Your First Forex Trade
The first step you need to undertake is to open a practice account with your favorite Forex broker. This will give you a trading platform from where you can access the Forex market.
You can instruct your trading platform where your stop loss, take profit and how much quantity you want to trade aka the position size. Your trading platform will do the rest.
Leverage, Volume and Margin Requirements.
To invest and trade in the Forex market, you need to understand how margin trading works. Basically, whenever you open a trade you only need to put up as collateral a certain amount of your balance.
This means that you don’t have to cover the full position size, but only deposit a fraction of it to cover the possible losses. As long as your trade is active, your FX broker will lock up the required margin and only free it back to you once the position is closed. This enables traders to execute much larger trades than they could otherwise afford.
The margin requirement depends on three things:
- Position size: This is the amount you buy or sell and it’s measured in lots. For example, 1 standard lot has a nominal value of $100,000 and it’s worth $10 for every pip movement. For example, if you want to trade $50,000 of EUR/USD that equates to 0.5 mini lots and it’s worth $5 for every one pip movement in the exchange rate.
- Leverage: Allows you to control bigger sums of money by borrowing from your FX broker so you can boost the profits of a trade. The standard leverage offered by most brokers is 1:50 and it can go as high as 1:500. Using a 1:50 leverage it means that you can control with every $1 from your account $50 in buying power. For example, if you invest $10,000 with a broker that provides you with 1:50 leverage it means that your total buying power is $500,000 (50 x $10,000).
The forex instrument, position size, and leverage you choose will depend on your working capital and your forex trading objectives.
How to Calculate Forex Margin
Margin Requirement = (Contract Size * Lot Size * Price) / Leverage.
For example, if you want to buy 0.8 lots of EUR/USD at the current market price of 1.1150 and using a leverage of 1:100 you need to have in your account at least $892 to open that position. In other words, with only $892 you can control a position size of $80,000 (0.8 lots) which is your buying power. Because of this, forex trading for beginners might be more affordable than you assumed.
Margin Requirement = (100,000 * 0.8 * 1.1150) /100 = $892
Let’s now study some of the market catalysts that can drive a currency pair.
What Drives the Forex Exchange Rate
- How well a country’s economy is doing?
- Geopolitical events and how stable is a government.
- Central Bank’s monetary policy.
- Interest rates
- News reports and economic data.
- Supply and Demand.
These are a few of the factors that can influence the value of a currency.
Best Forex Trading Platform for Beginners
The MetaTrader 4 is free and it comes with many built-in features. There are countless technical indicators that can help you analyze a Forex price chart. Additionally, you can use the MT4 to build your own automated trading strategy and backtest any kind of trading ideas you might have.
Learn how to backtest your trading strategies even if you don’t have any experience with our Beginners’ Guide to Effective Backtesting.
Alternatively, you can use the web-based trading platform TradingView, which is another free Forex trading platform that has the same features as the MT4 platform and much more.
Without a forex trading strategy to advance your trading skills, a trading platform is useless. This is why we want to also explore the wide range of forex trading strategies
Below you’ll discover what are the different types of forex trading strategies that work.
Forex Trading Strategies for Beginners
Forex traders employ different trading styles that mostly fit their own personalities. We can break down Forex market trading strategies into four distinctive trading edges that can be used in different market environments:
- FX scalping strategies
- The Forex day trading strategies
- i. Forex swing trading strategies
- k. Forex position trading strategies
While these are the most popular active FX trading strategies, Forex traders can use these concepts to innovate and develop well-versed Forex systems through the use of fundamental analysis and/or technical analysis. There are many tools a Forex trader can use to gain an edge in the FX market like Forex chart patterns, technical indicators, statistics and much more.
- 1 Forex trend trading strategies
- 2 Forex momentum trading strategies
- 3 Forex range trading strategies
- 4 Forex reversal trading strategies
- 5 Forex breakout trading strategies
- 6 Forex Carry Trade strategies
As a novice Forex trader, you have a wide variety of Forex trading strategies so you can take advantage of the currency price fluctuations. Since the market conditions are constantly changing, make sure you get familiarized with different types of Forex trading strategies.
Final Words – Forex Trading for Beginners
The basic mechanics of trading the forex market are similar to any other market. Buy low and sell high in the hope to generate a profit. Due to its unique characteristics, the forex market provides a wide range of trading opportunities that no other market does. The forex market, therefore, is very suitable for the novice trader that is looking to either make an extra income or a full-time trading career.
Forex trading for beginners can be extremely competitive. So, make sure you learn how to trade forex for beginners before you risk your hard-earned money.
How Does Forex Trading Work?
How Does Forex Trading Work?
How Does Forex Trading Work?