Among the numerous areas for investing, the foreign exchange market is one of the most active and promising. Forex trading has become one of the best options for diverse investment opportunities; therefore, knowing some basics is crucial.

The basics can be confusing, but this guide will help you understand them so you can make the right choices.

What is forex trading?

So, what is forex trading and how does it work? Forex, commonly known as foreign exchange trading, consists of buying and selling currencies. While stock trading happens through exchanges, forex trading is an over-the-counter market where transactions are done directly between buyers and sellers, mostly through electronic networks.

The forex market is the biggest market in the world, with a daily turnover of more than $6 trillion. This large trade volume ensures high liquidity, making buying and selling currencies very easy.

An introduction to forex trading

Currency pairs

It should be noted that in forex trading, currencies are bought and sold in pairs. A pair always contains a base currency and a quote currency. The base currency is the first currency that makes up the pair; the quote currency is the second. For instance, the EUR/USD quote is EUR versus USD, where the base currency is EUR while USD is the quote currency.

Understanding spreads

The spread is the difference between the bid price, also known as the buy price, and the asking or selling price of a particular currency pair. This spread is the cost of trading, and brokers generate their income from it. A close spread means the market is more liquid and the trading costs are low, whereas a wider spread means high costs.

Leverage

Leverage is one of the most important tools enabling a trader to control large amounts of the financial market with limited capital. For example, using 1:10 leverage, you can manage a $10 000 position with only $1 000 of your capital. The subject of leverage is that although it is used to increase gains, it also leads to the possibility of greater losses. Leverage should be used carefully, and the risks of such use should be known.

Pips

A pip is a unit that measures the change in a currency pair’s exchange rate and equals one one-hundredth of one cent. Thus, for most currency pairs, a pip stands for 0.0001. For example, if the EUR/USD pair shifts from 1.2000 to 1. Pips are used to determine the price change and profit or loss.

Why diversified investment in forex trading is desirable

Reducing risk: Diversification ensures that money is invested in different types of assets to minimise risks. It is thus important to have forex trading as one of the assets in your portfolio to act as a diversifier when other assets are performing poorly. Currency markets are not affected by stock and bond markets as often as other markets and can be used for risk diversification.

High liquidity: Because of this, it is easy to get in and out of positions in the forex market, and this is the same even for large trades. This high liquidity means that spreads will be narrower and transaction costs will be low, and therefore, it can be useful for diversification.

Picking gains in both rising and falling markets

Slightly different from ordinary stock exchanges, where you buy assets with the expectation that they will increase in value, forex trading lets you earn from increasing and decreasing prices. It enables you to place orders to buy (long) or sell (short) the chosen asset, depending on the market situation.

Accessibility and convenience: Forex trading is open to every individual investor through numerous online trading platforms. Some brokers provide simple-to-navigate platforms, learning material, and dummy accounts for new traders. The forex market is an around-the-clock market that is open for business five days a week, meaning that you can trade at any time of the day or night according to your schedule.

Learning the basics of trading forex

Choosing a broker: Choosing the right broker is one of the first and most important decisions a trader must make. Stick to brokers regulated by the world’s leading financial bodies, such as the UK’s Financial Conduct Authority or the US’s Commodity Futures Trading Commission. Regulation helps to protect investors because it means that the broker follows a set of rules laid down by the regulatory body.

Developing a trading plan: Having a proper plan is crucial for any trader in the forex market, and this is a proven fact. The plan should entail the objectives you wish to achieve in your trading, your level of risk, and how you will make and exit trades. You should try to adhere to your plan and not make decisions based on emotions.

Technical and fundamental analysis

Successful trading in the foreign exchange market involves using technical and fundamental analysis.

Technical analysis: This entails examining price graphs and employing tools like indicators to look for trends and signals of when to enter or exit the market. Some examples are Moving Averages, the Relative Strength Index (RSI), and Fibonacci Retracements.

Fundamental Analysis: This approach uses economic factors, political events, and investors’ attitudes to predict currency fluctuations. These factors include interest rates, inflation rates, employment rates, and political events.

Risk management

Risk is another name for uncertainty and has to be effectively controlled in the forex trading arena.

Here are some strategies to help protect your capital:

• Set stop-loss orders: A stop loss is a tool that closes a trade when the asset’s price reaches a certain level to minimise losses.
• Use proper position sizing: You should decide on the right position size based on your account size and risk-taking ability. Do not put all your eggs in one basket when placing your trade.
• Diversify your trades: It is not recommended to invest all your money in a particular currency pair. This means that you should not invest all your money in one pair to minimise the risk.

Continuous learning and adaptation

The forex market is volatile and ever-changing, which makes it a very interesting market to trade in. Keeping abreast of the changes in the market environment, fine-tuning your strategies, and drawing lessons from the past are all important for the longer term. Some of the many services brokers provide to keep you informed are educational materials, webinars, and tutorials.

Brought to you by HF Markets.

Moneyweb does not endorse any product or service being advertised in sponsored articles on our platform.