A Simple Guide To Forex Trading
At one time or another, we’ve all been hit with a barrage of adverts, trying to get us all to learn more about that “forex” thing. But what’s it all about?
We know. That “Forex” thing gets advertised virtually everywhere, with a multitude of forex platforms for beginners on the market, promising huge returns on your money. The rush of quick profits will lure many people who are looking to find the royal road to riches.
If you’ve ever spoken to anyone about foreign currency trading you’ll most likely get a response such as “It’s too risky!”, “You’ll lose all your money!”, or “It’s a scam! My uncle tried it out and lost thousands!”.
But seriously - what is all the hype and drama surrounding forex trading about? Can it really make you rich? Is it worth investigating?
In this article, we're going to provide you with a simple guide to forex trading for beginners, breaking down the topic, and showing how you can start currency trading.
The Basics
When forex trading, there’s one main objective, and that’s to eventually make a profit. To make a return on your initial investment, you’ll want to look at buying when the market is trending upwards, and selling when the market is trending downwards. This means that no matter the direction of the market, you’ll always have an opportunity to profit from market fluctuations.
First Off: What Actually Is Forex?
“Forex” is an abbreviation of the term ‘Foreign Exchange”, and refers to the act of exchanging one currency for another, with the chief aim of making a profit.
For example, you see there has been a flurry of news which is making a hugely positive impact on the US economy, so you decide to take full advantage of this by purchasing some US dollars using the British Pound, expecting an increase in the value of the dollar vs. the pound. You buy $1000 with £700, wait for the dollar's value to increase, then sell when you see the dollar value rise. When you finally decide to exchange your dollar back to GBP, your £700 is now (hypothetically) worth £800 - a £100 profit. Nice!
The above example is obviously just hypothetical but gives you a simplified picture of how the forex trading world really works.
It's important to remember that although it may be an easy way to make a quick profit, it's also just as easy to make a huge loss. Luckily, there are simple rules you can practice to ensure you safeguard your funds from catastrophic losses and helping you to make tidy profits on a regular basis.
When Do I Buy & Sell?
There’s a huge list of factors you’ll need to consider before deciding whether you’ll be buying, selling, or placing a trade at all.
One of the keys to trading is to buy low and sell high. To do this you’ll need to be able to analyse a combination of technical and fundamental indicators, using them in conjunction to form a proper trading plan.
Luckily, we’re going to break down a few of the main factors you need to be aware of before placing your first trade.
Platforms To Use
There's a myriad of forex platforms for beginners. For those of you looking to gain a feel for how the currency trading markets move, we highly recommend starting out by practising on a demo account.
Demo trading accounts are widely available - ones that we like include Trading 212 and eToro. Both of these platforms will provide you with the essential trading tools to get you started on your way to becoming a successful trader, without running the risk of losing any real money.
Investing.com is a great resource that keeps you up to date with the latest market news and provides you with a list of important economic events that you’ll need to take note of before placing your trades.
Let’s Get (Slightly) Technical
You may have seen a few clips on the TV of these typical high-speed trading bankers who are running on 150 cups of coffee and an obscene amount of cortisol, looking at 20 different screens and a load of squiggly lines and graphs. That's how the pros do their work, however, in the beginning, you don't necessarily need to have a complex set up to grasp the basics of trading, and to learn what all of those squiggly lines actually mean.
In this section we’re going to give you a brief insight into a few technical indicators, describing what they mean, and how you can utilise them to help you make profitable trades.
MACD
The MACD is arguably one of the most popular technical indicators in the world of stock and foreign currency trading. MACD stands for ‘Moving Average Convergence Divergence’.
This technical indicator helps you to assess the mood of the current market. The red and green bars are known as the MACD Histogram. The green bars indicate the market is going in a positive direction, and red bars mean that upward momentum is slowing, and is starting to move downwards.
(source: Trading212 - Image: MACD Indicator)
Likewise, the two (blue and yellow) lines shown in the example describe the current market sentiment. If the lines are rising upwards, then the market is positive, and when facing downwards, it shows the market is in a negative state. A key thing to remember when assessing the MACD lines is that the most prominent signals are given when the lines converge closer toward one another and eventually cross, showing there may be a potential reversal in market action.
The MACD is a great way to see which direction the market is going in. So remember, if the lines are facing upward, and the histogram is showing a green bar, the market will likely show positive momentum. If the lines are facing downward, and the histogram is showing a red bar, the positive momentum may have been worn out, and the market is likely going to move down.
As we're keeping this post for beginners, this is a fairly basic description of how the MACD works. There are many ways you can utilise this indicator to inform your trading decisions, so as you gain more confidence in the topic of trading, we highly recommend you do some further research on the MACD to ensure you're getting the most out of it.
RSI
The RSI, known as the Relative Strength Index, is an oscillator which depicts whether a market is currently is ‘Overbought’ or ‘Oversold’.
When the red line is in Overbought territory, (shown by the top horizontal line), this means the market is extremely positive and is trading above value, however, this optimism may soon run out of steam - it’s time to sell. Likewise with Oversold (bottom horizontal line), which means the market is currently trading below value and may mean the market is ready to rise - time to buy.
(source: Trading212 - Image: RSI Indicator)
The RSI is a pretty easy technical indicator to use as it clearly states whether the market is likely to start trending up or down. When the indicator reaches above or below the Overbought and Oversold threshold, this is the perfect time to start looking for trading opportunities.
Moving Averages
Moving Averages are used to give an accurate average of price action over a specific time period. The blue line in this example is giving us the average price over the last 13 days, whereas the yellow line is showing the average price over 26 days.
Moving Averages
Moving Averages are used to give an accurate average of price action over a specific time period. The blue line in this example is giving us the average price over the last 13 days, whereas the yellow line is showing the average price over 26 days.
(source: Trading212 - Image: Chart with 13-day and 26-day moving average)
This technical indicator is used by professional traders to assess the current market's average value and can be utilised as a guideline for when to buy - notice how the price bars seem to rest and rebound off the moving average lines. When the price is way above the moving average, avoiding placing your trade until the price has moved back down towards the line.
Although technical indicators are great, it's important that you don't use too many at once, otherwise, you'll end up looking for patterns that don't exist, clouding your judgement and leading you down the path of bad decision making. It's much better to stick a few indicators that you know and trust and use them in combination to help you make well-informed trades.
Know Your Fundamentals
Knowing your fundamentals is a huge part of trading, especially when trading foreign currencies. To be able to make the most informed trading decisions, it's crucial you keep up to date with the latest news announcements that can affect the value of each currency.
For example, there are many data announcements made every day by each country which gives an indication of how well their economy is performing. Data such as ‘monthly retail sales' will show the growth or decline in consumer spending, which will have a direct impact on a country's economy, thus impacting the value of their currency.
There are many tools available, such as investing.com’s Economic Calendar, which gives you a detailed list of all the upcoming economic events happening around the world, and the currencies that will likely be impacted by the events.
Take note of these upcoming announcements and watch closely to see the outcome. If the news is better than expected, it will likely have a positive impact on the associated currency, meaning it may be a good time to play a ‘buy'. If the announcement is bad news, then it may be time to look at placing a sell trade or taking profits on an already open trade.
Before You Begin: What You MUST Do
Planning Your Trades
Although there are many aspects to forex trading, there’s a certain set of rules you MUST follow before placing a trade. This means you’ll have to write out a specific plan, detailing exactly why you’re placing a trade, so you can be sure of your decision.
In your pre-trade plan, you should write down what patterns your technical indicators are showing - is the RSI in ‘oversold’ territory? Has the MACD Histogram switched from red to green? Is the price above, below, or in-line with the moving average?
Next, you'll want to detail any upcoming economic events and the results of any important data announcements that will influence your trades. After this is complete, these next steps are the most CRUCIAL to follow if you're going to be successful in the world of forex trading.
Although there are many aspects to forex trading, there’s a certain set of rules you MUST follow before placing a trade. This means you’ll have to write out a specific plan, detailing exactly why you’re placing a trade, so you can be sure of your decision.
In your pre-trade plan, you should write down what patterns your technical indicators are showing - is the RSI in ‘oversold’ territory? Has the MACD Histogram switched from red to green? Is the price above, below, or in-line with the moving average?
Next, you'll want to detail any upcoming economic events and the results of any important data announcements that will influence your trades. After this is complete, these next steps are the most CRUCIAL to follow if you're going to be successful in the world of forex trading.
Placing A Stop Loss
Risk management comes at the head of the list of the most important skills for any trader, especially if you’re just starting out.
First off, make sure you write down how much you’re willing to lose per trade - we recommend that you aim to lose no more than 1-2% of your trading capital per trade. So if you're starting with a trading balance of $1000, your maximum loss per trade should be no more than $10-$20.
Next, you’ll want to set your stop loss. REMEMBER TO ALWAYS SET A STOP LOSS! A stop loss is a function that ensures you're automatically pulled out of a trade if it's not going your way, safeguarding you from taking huge losses - it's basically your trading safety harness. No matter what or when you're trading, ALWAYS, I repeat, ALWAYS SET A STOP LOSS.
Profit Targets
Knowing when to take profits is also a key skill you’ll need to practice when trading forex. As the saying goes, “Man’s biggest downfall is greed”, so remember if you’re looking to be a successful forex trader, you must always set a logical profit target that you’re happy with, and try not to let greed get the better of you.
When starting out, we recommend you follow the 2:1 rule, meaning for every $1 you're willing to lose, you'll want to make at least $2 profit. If you place a trade with your stop loss set to $20, then you should be aiming to clinch a $40 profit from your trade. As you become a more confident, consistently profitable trader, then you may want to expand this ratio to 3:1 or even 4:1.
Conclusion
Forex trading can be a tricky skill to master, however, practice makes perfect! So make sure you start preparing yourself by utilising the free demo trading accounts available and continue to carry out further research enabling you to become a successful trader!
Remember, this article is not intended as financial advice, so make sure that you fully understand all the risks associated with forex trading before using your own money to trade.
We hope this brief guide on forex trading has helped give you an insight into how you can begin trading foreign currencies. As with any challenge, if you want to be successful, remain dedicated, persistent, and always continue to do your research in order to ensure you achieve your goal of becoming a successful forex trader.
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Lewis is a U.K. Based writer, with a huge passion for music, travel, health, fitness, finance, and self-development. He truly believes that the pen is mightier than the sword and wants to utilize his passion for writing to help empower people with information that could help them greatly improve their lives and the world around them.