So you were probably on Youtube watching your favorite youtuber when that cursed ad interrupted the best part of the video. As you anxiously awaited the timer for the skip button to reach 0, a handsome, charismatic man said something about “learn how to trade forex”. You have seen these types of commercials all the time and always skipped it so you could get back to your video. But this time it was different, you out of 50,000 people that day listened to that guy.
Instead of dismissing what he said, you did your on research, and it brought you here. No, you found this on a random Google search? Well, either way you are at the right place. Hopefully, this article can demystify terms you may or may not have heard of that has or probably will scare you a little without a little of foreknowledge.
What Is Forex?
How to trade Forex? Learning begins with understanding what it is. Forex is short for “Foreign Exchange”. The forex market is a $5.8 trillion dollar market that includes many market participants such as the Government, Hedge funds, and Banks. The forex market is responsible for the floating exchange rates between currencies, but you may not have known was that floating exchange rates has not always been here.
What Is an Floating Exchange Rate and How Did It Come to Be?
Before the onslaught of WWII, every central bank in the world backed their currency to gold. This was known as the “Gold Exchange Standard”. After the rise of Nazi party in Germany, many European nations feared that Hitler would plunder their central banks for gold to finance Germany’s campaign if they were invaded. Many nations then sent their gold abroad to protect it from Nazi occupation.
At war’s end, The United States had accumulated two-thirds of the world’s gold through trade. This meant the world had to share the rest and this would lead to nothing short of financial instability. In 1944, the United Nations met in Bretton Woods, New Hampshire towards the end of World War II and agreed to peg their currency to the US Dollar which could be convert which into gold at $35/ounce. This would become known as "The Bretton Woods Agreement" and would set the US Dollar up to be the World’s Reserve Currency as it was a “fixed exchange rate” to gold.
The forex market would not come into existence until shortly after President Richard Nixon “temporarily” suspended the convertibility of the US Dollar into gold in August of 1971. This unpegging of gold made the US Dollar and every other currency in the world a “fiat” Currency. These sequence of events led to the Forex market which now sets these “floating exchange rates”.
Is Forex Trading a Sound Investment Tool?
Now that you have a little understanding of how the Forex market came to be, you may ask yourself “Is forex trading a sound investment tool”? Before learning how to trade forex, investing first starts with the investor. You must educate yourself on the financial product you wish to invest your hard earned currency with. The forex market like any other financial market requires knowledge; lucky for you, you are about to build a solid foundation with this article.
There are 7 major currencies in the forex market. These currencies are the most heavily traded by volume. They are:
If you want to learn how to trade forex, you have to begin with what you want to trade within the market. Currency pairs are exactly what they sound like; A pair of currencies that have a floating exchange rate between them. Among these currency pairs you have different types: Majors, Minors, and Exotic pairs.
Major Currency pairs are currency pairs that include US Dollar. Some examples include:
Minor currency pairs( sometimes referred to as Crosses ) are any other pair that does not include the US Dollar. Examples are:
Exotic currency pairs are pairs that are paired with a high volume currency. Examples include:
What Is a Pip?
A pip is the unit of measurement to express change in value in the market. A pip is the fourth digit after the decimal.
If we look at 1.2024 for example, the ‘4’ is the pip. In Forex, we do not calculate profits by dollar amounts; We count profits by pips.
What Is a Pipette?
Some brokers offer prices that may go up to five decimal places for a more accurate quote. The fifth digit after the decimal is considered the “pipette”. Using the example from earlier, if that broker offered the same quote up to five decimal places instead of four set at 1.20249, the ’9’ is considered the pipette.
Reading Forex Quotes:
While learning how to trade forex, reading forex quotes is essential. Take the following currency pair as an example:
In a currency pair the first currency listed is the base currency and the next one is the quote. Now looking back at our example, EUR is the base currency and USD is the quote currency. EUR is 1.1222 while USD is 1.1224. The bid is the price set by the base currency. The ask is set by the price of the quote currency. The spread is the difference between the ask and the quote price. So we take 1.1222 -1.1224 = 0.0002 or 2 pips. The spread is 2 pips.
Long and Short Positions
When buying and selling a currency pair, you are either betting that the currency will go up or down in price. In the forex market this is called being long and short. When you take on a long position, you are betting on a currency going up in value. Conversely, If you are short, you are betting that currency will go down to buy at a cheaper price.
One of the most imperative concepts in learning how to trade forex is leverage. Leverage can be your biggest friend or your worst enemy. Leverage is a strategy that uses borrowed capital to increase potential future returns. Before the internet, you needed large pools of money in order to set up a forex account. Now with the help of digital brokers, leverage can help retail investors like you and I control large large sums of capital without actually owning it.
Margin is your down payment needed to set up your account. This is non-leveraged money.
Candlesticks is a form of data entry used to tell the story of a trading period. You can view candlesticks on higher and lower time frames but all have four components: High, Low, Open, Close. These four components tell you how the market feels at that given time. Body color also indicates whether it is going up in price (Green) or going down (Red).
Analysis and Risk Management
To become a successful trader, you have to take your foundation and build on it. Every successful trader to some degree has mastered technical and fundamental analysis as well as risk management.
Technical and Fundamental Analysis
Fundamental analysis is a method of analysis that gauges political, social and economic news to gauge how the market will react. Technical analysis focuses on chart analysis. Learning basic technical analysis is the core of forex. Technical analysis teaches you how to interpret the market by reading various forms of data on the chart.
Perhaps the biggest skill in learning how to trade forex is risk management. Risk-management is very imperative. Leverage can increase your Return on Investment (ROI) and this is why forex is ideal for the everyday investor and those with smaller pools of capital. Many brokers offer various amounts of leverage in the forex market from 10:1 to 100:1, but it is how you manage your account that makes all the difference. Before you open a trading account, fully understand the intricacies of risk management.
Selecting Your Broker
It is a good idea to do thorough research on a potential broker as there has been incidents of non-reputable companies advertising online.
Rule of thumb: If it sounds to good to be true, it probably is.
Conclusion on How to Trade Forex
Remember, you are the captain of your ship. How you stock it with knowledge and skills is how far your ship will take you. There are no short cuts to investing. You must learn the skills necessary in order to keep your ship afloat and sail the waters of investing.