WHAT IS FOREX TRADING?

Forex is the foreign exchange market (also known as the currency exchange market or just FX). If you have ever visited a foreign country and needed to trade some of your currency for their currency – you have already participated in a Forex transaction.  Traders do not actually “handle” the foreign currencies that they buy/sell, but are speculating on the currency exchange rates between two countries.  Since exchange rates change constantly, there is always an opportunity to profit from these exchanges.  Forex markets trade about $5 trillion (USD) per day, making Forex the largest and most liquid financial market in the world.  By comparison, all the world’s stock exchange markets combined turn over around $50 billion USD per day; in other words, the Forex market trades about 98 times more volume than the stock exchanges daily!

When and where do you trade Forex?

This international market has no (physical) central marketplace for foreign exchange.  Trades are made almost instantaneously online from just the push of a button.  You can basically trade from anywhere.  On vacation in Hawaii?  No problem!  As long as you have an internet connection, you can trade from your laptop, tablet, or even smart phone.

 The trading day has three main sessions: Asia, London, and New York.  These run in a continuous loop, with some overlap – because of the different time zones around the world, there are always markets available to trade via the internet 24 hours a day, Monday through Friday.  So, you really can set your own schedule (though there are certain times that most traders feel are most important to pay attention to, such as NY close). 

Who can Trade Forex?

Although the major players are large financial institutions and corporations, since the advent of the internet – literally anyone can learn to trade Forex and participate in the electronic OTC (over-the-counter) market via a Forex broker.  It doesn’t matter where you’re from, what language you speak, whether you hold any degrees, have internship experience, or special training – no one is checking on your credentials in this field.  The only thing that matters is results.   Since it’s your money you’re risking, you answer to yourself.  Individuals, who trade for themselves and not for an employer, are called “retail traders”.  Retail traders make up about 5% of the entire Forex market.

Four Markets to Trade Forex

The largest market by far is the “spot market”, and when people refer to Forex trading, they are usually referring to the spot market.  The spot market is where currencies are bought and sold for the current price (“on the spot”).  This market has the greatest liquidity (meaning a readily available supply of buyers and sellers), which is important because the greater the liquidity the more easily the market can move (and we need that volatility in order to make money in the market).

The “futures market” (sometimes called “forwards”) is where currencies are not actually traded, but instead they deal in contracts to buy or sell at a specific price on a specific future date.  Futures markets’ contracts can offer protection against risk when trading currencies.  Typically, corporations use these markets to hedge against future exchange rate fluctuations, but there are some speculators that take part in these markets as well.  These markets take place in well-regulated and monitored exchanges, so they are relatively safe – but cannot be traded 24-hours a day.

The “options market” deals with financial instruments called “options” that allow a trader to have the option to buy or sell an asset at a specific price on the expiration date of the option.  Options are traded through a central exchange just like futures, so they cannot be traded 24-hours per day.  One downside to Forex options trading is that it has less liquidity than the futures or spot markets.

The last market is the “Exchange-Traded Funds market” (or ETFs).  ETFs allow traders to diversify with different assets, so they could have a combination of currencies and stocks in one ETF.  ETFs are created by financial institutions, and since they contain stocks, they are subject to commissions and transaction costs.  ETFs are traded through exchanges and are not open for trading 24-hours a day.

Advantages of Forex Trading

We’ve already mentioned the fact that the Forex market is open 24-hours a day, Monday through Friday – this is a huge advantage because there are just far more opportunities to trade than a market which is open only during normal business hours.  We also discussed the high liquidity of the Forex market, which means that there is constant change in the price of currencies.  As we pointed out – we need this movement in price in order to create opportunities for us traders to profit.

Another advantage is that unlike most markets, it’s fairly easy to get started in Forex trading.  You don’t have to go to a special school to learn to be a trader or work for a big bank, and you don’t need much money to get started.  There are even free demo accounts offered by brokers, so you can learn how to use the trading platform and get the hang of things before risking your cash.  The internet is flooded with information and videos on “how to trade Forex”, and there are many online communities that a new trader can participate in to learn the ropes as well.  

Forex brokers offer low transaction costs when compared to other exchange markets (in the form of the bid/ask spread).  There are also no fixed lot sizes in the forex market, so you can determine the amount of risk you are willing to take on your trades.  Also, because brokers offer leverage (a.k.a. gearing), a small deposit can still give the trader the ability to make nice profits and at the same time keep your risk to a minimum (leverage does increase risk however, more on that later).

In my opinion, the best advantage of all is that you can work from home, while on the road, on vacation, wherever!  Successful retail Forex traders work for themselves, and don’t have a boss to answer to, can wear whatever they want, look however they want, etc.  Forex trading doesn’t have to take up all of your time either; you can spend as little as 30 minutes a day analyzing the charts and managing your trades.  For many people, Forex is the dream job, that could provide the dream lifestyle and the time to enjoy it. 

Risks of Forex Trading

Like any form of trading, Forex is not without risk.  Forex trading actually carries more risk due to the trader’s ability to leverage capital; leverage magnifies profits, but it also magnifies losses.  For example, let’s say you had a 50:1 leverage ratio, this means that it is possible to enter into a trade for up to 50 dollars for every dollar in your account.  So, while risking $1000, you could potentially earn $50,000.  However, you also run the risk of losing funds based on a $50,000 trade, so if you aren’t careful, you can quickly wipe out your account causing a margin closeout. Lastly, make sure that you are dealing only with a reputable broker who is in good standing with the recognized regulators for their country.  Fraud used to be a serious problem in Forex trading, but most countries now have regulators that supervise the trading market and brokers; just remember that not all countries’ governments and regulators are free of corruption themselves, so brokers from these areas are riskier.

 

The fact is that majority of traders lose money in the Forex market because they rush in and begin trade before they really understand the markets.  Some traders fail because they approach trading like gambling. The thrill of Forex can be addictive, and certain traders seem to be unable to stop themselves from overtrading and over extending their risk.  Also, be cautious of paying for things like “magical indicators”, “signal services”, and expensive “guaranteed to win” trading systems; there are many scams and worthless “helpers” available on the internet. 

Conclusion

Like any skill, it takes time to learn what works with Forex.  It’s not a get-rich-quick scheme.  Successful trading requires to you to not only “figure it out”, but also to have mental discipline, a strong psychological fortitude, and proper money management with a positive risk/reward system in place.