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What іѕ Fоrеx Trаdіng?

By Jeffrey Cammack Updated: July 4th, 2019
What is Forex trading?
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Forex trading is the buying or selling of currency pairs to profit from the shift in currency values as they change over time. 

Because of the large amounts of capital needed to make substantial profits from exchange rate fluctuations, Forex trading used to be the reserve of institutional investors and global banks.

But with the advent of online CFD Forex trading, the Forex market is now accessible to anyone with a few hundred dollars and a computer. There are now millions of individual (retail) Forex traders all over the world.

Over the last few years, it has become increasingly more common for retail traders to make a living from the Forex market.

How does Forex Trading work?

Before starting to trade (opening a position) a trader needs to decide.

  • Which currency pair to trade
  • The amount to invest in the trade
  • How much leverage to use in the trade
  • The direction of the trade

Currency Pairs

Currencies are always quoted in pairs because as you are selling one currency, you are buying another at precisely the same time.  The first currency in the pair is called the base currency, while the second currency in the pair is called quote currency.

Currency pairs are commonly split into three groups primarily based on how much market liquidity they exhibit. This is generally down to the level of interest that investors have in a currency pair. Usually, the more investors are actively participating in trading a currency pair, the more liquidity will be exhibited.

The Major Pairs

The major currency pairs are the set of currency pairs that are most commonly traded because they are the most volatile.  The major pairs all include the USD as part of the pair, and they are a good place for beginner traders to start.

  • EUR/USD – Euro / United States Dollar
  • GBP/USD – British Pound Sterling / United States Dollar
  • USD/CHF – United States Dollar / Swiss Franc
  • USD/JPY – United States Dollar / Japanese Yen
  • AUD/USD – Australian Dollar / United States Dollar
  • USD/CAD – United States Dollar / Canadian Dollar
  • NZD/USD – New Zealand Dollar / United States Dollar

The Minor Pairs

The minor currency pairs are not a fixed list like the majors.  They are generally currency pairs that do not include the USD.  Some examples might be:

  • EUR/JPY – Euro / Japanese Yen
  • GBP/AUD – British Pound / Australian Dollar
  • AUD/NZD – Australian Dollar / New Zealand Dollar

The Exotic Pairs

The final group are called exotics and are generally pairs containing currencies from a well-developed economy and a developing economy.  Examples could be:

  • EUR/BRL – Euro / Brazilian Real
  • GBP/ZAR – British Pound / South African Rand
  • AUD/MYR – Australian Dollar / Malaysian Ringgit

Trade Size

The size of a trade, or the amount of capital to invest in a trade, should depend on the certainty of winning the trade. 

While it is tempting for novice traders to think of trade size in Dollar amounts, experienced traders will advise considering trade size as a percentage of your account balance.

As a rule of thumb, traders should never risk more than 2% of their capital in a single trade.  If a trader has an account balance of 500 AUD, then never risk more than 500 AUD x 0.02 = 10 AUD in a single trade.

Leverage in Forex Trading

Forex and other CFDs are margin products.  To generate larger profits from trading Forex, traders will borrow money to invest using something called leverage.

Leverage is a financial tool that allows traders to borrow money to increase the size of a trading position.

Leverage is used because the movements in the Forex market are too small to make a significant profit from with a small account balance.

Leverage is either offered by your broker or a third party liquidity provider, often large banks.  Depending on the broker, the country of residence and the experience of the trader, brokers can make more leverage available.

While leverage can amplify profits, it will also amplify losses.  In a leveraged trade, the capital borrowed must be returned after the trade is closed.  If the trade is closed at a loss, the remainder of the lost funds will be collected from the trader’s account balance.

For this reason, a trader needs to understand their exposure to risk and how to manage it.

Trade Direction

Traders can buy (go long on) a currency pair expecting the value of the base currency to rise, or they can sell (go short on) a pair, assuming the value of the base currency will fall.  Here are two different trades where we are trying to predict if the market will gain or lose.

In the first example, the trader goes long, expecting the value of the currency to increase.

In the second example, the trader goes short, expecting the value of the currency to decrease.

In reality, the currency increased in value, and the AUDUSD gained 9 points during the time I was monitoring it.  So had the trader gone long and bought AUDUSD, they would have made a profit.

Forex Trade Examples

Here are two trading examples, both with the AUDUSD pair, where one is a long trade, and the other is a short trade.

How to Calculate Profits

A trade profit is calculated as the change in price, multiplied by the closing price, multiplied by the size of the trade (in units)

Long Trade Example

A trader buys one standard lot (100,000 of the base currency) of AUDUSD, and opens a long trade at 0.7858 with the expectation that the value of the pair will increase.  After some time, the value of AUDUSD increases as expected to 0.7879 so the trader closes the position.

Since the trader predicted the market correctly and sold at a higher price, the trade is closed with a profit of 210 AUD.

Short Trade Example

If we thought the value of the AUDUSD was going to weaken, the trader could open a short position on the trade.  If we were to open the short position on the same trade, entering at 0.7858, and the value of AUDUSD drops to 0.7818 then the profit would be 400 AUD.

Note:  If you are going short, and the profit in your calculation is a negative number, that is a positive result on your account.  Read more on how to calculate your profit and loss.

Quotes and Spreads

Forex brokers make money by offering different prices for buying and selling a currency pair or a commission on the volume traded.  The difference between rates is known as the spread, and it is different for every currency pair.  Spreads are measured in pips which is the smallest change in value a currency can make.

Example spread: AUD/USD is 4 pips

While some brokers or account types have fixed spreads, some brokers will also have variable spreads which change based on the liquidity available.  More on Forex quotes here.

Forex Trading For Beginners

Forex trading beginners should start with a demo account.  A demo account is a play-money account with real market data where novice traders can practice.

Start by reading basic tips, learning some of the terms used in trading that we discuss in our education section and studying examples of trades.

How can I trade Forex successfully?

To be successful, you will need to learn the basics of trading, invest time into doing analysis and stay up-to-date with international news events.  You will also need to cultivate your self-discipline.  Trading successfully is difficult, and it requires focus and a strategy.

There are three main strategies for analysis in trading:

  1. Trading the fundamentals – trade based on analysis of news events that affect markets. An excellent example of this would be trading the Non-Farm Payroll Report from the USA or trading the COT Report.
  2. Trading the technical charts – trading by following charts and trading the patterns.  If you are going to be a technical trader, you should understand trends and momentum in the market, as well as pivot points where the market makes a sudden turn.
  3. Trading the market sentiment – Trading by watching what the traders and banks are doing, and following them or going against them.

How much money can I make from Forex trading?

Some traders make money trading Forex, but 70-90% of retail traders lose money.  How much you can make trading Forex depends on the amount you are trading with, the amount of time you spend trading and your appetite for risk.  Should you break even trading Forex, you are doing a lot better than most other traders.

How to get started

To get started, a trader needs to pick a broker and open a demo account. A lot of learning can be done without having an account, but once the charts are in front of you and it becomes hands-on, then learning will accelerate.

Compare Forex Brokers

Broker Min. Deposit Min. Spread
AvaTrade $100 0.7 Visit Website Read review
XM Global $5 1 Visit Website Read review
FxPro $100 0.6 Visit Website Read review
easyMarkets $100 1.8 Visit Website Read review
eToro $200 2 Visit Website Read review
IC Markets $200 0.1 Visit Website Read review

How much money do I need to start trading Forex?

Some Forex brokers will let you start trading with as little as 5 AUD in your account.  A deposit of at least 250 AUD is recommended, because your account needs to be able to cover any temporary losses on your account, which may not be possible with a smaller balance.  If you don’t have the funds to protect the loss, the broker will close your trade early in a margin call.

How do I start Forex trading?

To start trading, you need to sign up with the Forex broker of your choice.  When picking a broker you will need to look at the minimum deposit expected, the leverage available to traders, the minimum spread, and the regulation.  Together, these will help you determine the right broker for you.

When you visit a broker from our website, you will go to the account sign up page.  After completing your details, the broker may call to introduce themselves and see if they can answer any questions for you.  They will also use this opportunity to explain a process called KYC or “Know Your Customer” that is a requirement for broker working with clients to protect them and you from money laundering activities.

To complete your KYC requirements, you need to provide copies of a national identity document and also a utility bill or proof of residence.  As soon as these documents are completed, you will be able to make your first deposit and start trading.

The Risk in Forex Trading

Trading Forex CFDs comes with significant risk, and if you are concerned about losing any the money that you are depositing, then don’t trade Forex.  Forex trading is not a get rich quick scheme and requires dedication and study.

As a trader, you will need to develop a trading plan, understand risk management, and have a goal with what you want to achieve.  Don’t start depositing money until you are sure you want to give this a good shot.

Every trader loses trades that they were sure they would win, so expect the unexpected and have a plan for when your trades fail.

Trading Forex and CFDs is not suitable for all investors and comes with a high risk of losing money rapidly due to leverage. 75-90% of retail investors lose money trading these products. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.