Forex trading touches our lives on a regular basis yet few of us seem to realise it. At the heart of it is a need by someone (often you) to buy a different currency to have some cash when you go abroad on holiday. That need creates an opportunity for someone to trade this into an attempt to make money from currency movements.
The Forex market is the largest in the world. It is dominated by three major financial centres: New York, London and Tokyo. It’s a market which is rarely ever closed, being open 24 hours on weekdays and only closing over part of the weekend. Due to the time differences, Forex is traded throughout the day, starting with Tokyo, before moving on to London and finally finishing up in New York.
These are the major currencies:
All have their names shortened into 3 letter words which you see above in brackets.
Currency trading is not for the faint hearted. Its fast. Forex markets can react incredibly quickly to economic news. At the heart of Forex trading are currency pairs. When you are buying one foreign currency you are selling another. For example, you might sell GBP and buy USD because you believe Sterling will weaken and the dollar will strengthen. One key point, although there are more than one dollar currencies in the world, there is only one ‘Dollar’, i.e. the US one.
Currency trading is known as a zero-sum game. Unlike shares, where a profit warning can leave your asset down 80%, in currency trading you, you are betting against something else. A 1% move down in one currency is matched by a 1% gain in the opposing currency.
A key area which affects currency prices is interest rates set by central banks such as the New York Federal Reserve. The price of a currency is heavily influenced by what you can earn from it. If the USD can earn you 3% in interest and the GBP 0.5%, holding USD is more appealing. As more people agree with you, the USD will gain in value, allowing you to profit from capital growth as well as from interest.
Some of the key areas to ensure success in Forex trading is to develop a profitable trading strategy by developing your own Forex trading plan. This will imbue you with the discipline required to avoid taking unnecessary, emotionally driven risks. This also feeds well into risk management. Most new retail Forex traders approach Forex trading looking to take a risk whereas they should be looking to limit their risk!
Risk management encourages you to take a risk as long as you mitigate the downside. A key strategy is using the risk reward ratio, where your trade is weighted to produce at least twice the profit than the risk taken. This requires using stop losses which you will soon learn to see as your best friend!
It is best to be master of one trade rather average at many. The same applies to Forex trading. Learning one price action pattern will allow to develop your skills as well as controlling your emotions. An example of a trading strategy is the ‘pin bar’.
This Forex trading strategy tells us that a certain price or technical level has been sharply rejected. This gives us some pointers as to what is going to happen next. Also pin bars are used in range-bound and trending markets, on any time frame and with any instrument.
The biggest rookie Forex trading mistake is to be over-confident. Some aspiring Forex traders who start trading enjoy immediate success. This leads them into taking bigger risks. Worse, many will turn to leverage, leading them to lose not only their initial capital but more besides. It is a painful experience best avoided. Rookie currency traders should realise that there is a great deal to learn first before they can trade profitably. This involves being prepared to study and learn from their mistakes. Just walking away from your computer after you have lost money won’t help you in the long run. Swallowing your pride and analysing how you lost your money will ensure you are less likely to repeat that mistake again.
The hardest area to master and the one that few give any real thought when they first start to trade Forex is psychology. This is because it, requires us to do what is hardest and look ourselves in the mirror and admit that we may be at fault. As a trader you have to be made of ice. Your decisions should be taken because they follow a plan. do not trade on the spur of the moment. Do not let your (good or bad) mood influence your trading decisions. If you have the ability to ‘know yourself’ i.e. your tendencies as a trader you can mitigate your negative traits and encourage your positive ones. ‘Know thyself’ was valid centuries ago, it is certainly valid today.
Forex trading can provide great opportunities for an aspiring retail Forex trader. The lower risk compared to equities means mistakes are less costly. The opportunities to trade Forex successfully using the major currencies will ensure a tighter spread and therefore lower cost. The attraction of being able to trade in the evenings after work ensure you earn a second income whilst you sleep!