Like stocks, currency trading happens in the financial market. The forex market happens to be the largest financial market in the world in terms of daily transaction volume.
Unlike stocks, most of that currency transaction volume is seen in the relatively unregulated over-the-counter markets rather than on the more formal, highly-regulated stock exchanges.
What’s Currency, or Forex, Trading?
Foreign exchange (forex), or currency trading, involves the exchange of one national currency for another at a market-determined exchange rate. Since currencies only trade in pairs, they are valued relative to one another in the forex market.
Each national currency has its own unique three-letter currency code to identify it that was established under the ISO 4217 International Standard for currency codes. The most recent edition is ISO 4217:2015, and its purpose is to provide internationally-recognized codes to represent currencies.
Some of the most commonly traded national currencies, their countries of origin and ISO 4217 codes and most common nicknames used by forex traders and market commentators are shown in the table below.
How Does it Work?
Traders often perform market analysis before taking a trade. This can involve looking at the fundamentals for a currency pair, including relevant news and economic data releases, as well as checking out a chart of the exchange rate for the currency pair as it moves over time and applying technical analysis methods to see if the likely future direction of the pair can be discerned.
One of the most popular types of charts that forex traders use is known as a Japanese candlestick chart. Each time period shown on this type of chart has a body that stretches from the open to the closing exchange rate. This body is also color-coded, with one color that signifies a rise in the market and one that signifies a decline.
At the top and bottom of each candle’s body is a vertical line called a wick. The upper wick stretches from the open or the close (whichever is higher) to the period’s high point, while the lower wick goes from the open or close (whichever is lower) to the period’s low point.
To explain how trading works, let’s suppose that you’ve done some technical analysis based on a chart like the one shown above.
As a result of your research, you now think that the EUR/USD exchange rate will decline, which means that you expect the value of the euro to fall relative to the U.S. dollar. Your market view would, therefore, be bearish on the euro and bullish on the U.S. dollar.
How to Start Currency Trading
Using the example in the previous section to start trading forex, you will need to make a trade to profit from this bearish euro view. You might decide to sell 1 million euros and buy U.S. dollars at a EUR/USD exchange rate of 1.2000 as your first transaction or trade. You would end up holding $1,200,000 since that equals 1 million euros multiplied by the 1.2000 exchange rate.
Since you made that trade to take an initial position in the market, a forex trader would say that you had sold or “gone short” 1 million euros against the dollar at 1.2000. You would also simultaneously have bought or “gone long” $1,200,000 versus the euro by taking that position.
The way that you would subsequently make money on that short euro trade versus the U.S. dollar trade would be if the EUR/USD exchange rate was lower when you purchased the euros you originally sold back. Conversely, you would lose money if the exchange rate rose by the time you bought euros and sold dollars to close out the initial position.
As an example of the magnitude of gains you could make if your market view was correct, let’s say the market went down to 1.1900 and that you decided to buy the euros you had sold back at that point. Your profit would be 1.2000 minus 1.1900, or 0.0100 multiplied by 1 million euros. This yields a gain of $10,000 on that successful trade.
Another increasingly popular way to start trading is to find a successful trader with a proven track record whose transactions you can copy, usually for a fee. This is known as copy trading, and it can be a good way for people with little experience or time to devote to market analysis to get quickly involved in trading the forex market.
What You’ll Need Before You Start
Now that you have some idea about what forex trading involves, you’ll need to take some practical steps before you can actually start making currency transactions. See the step-by-step guide below.
Step 1: Learn About Forex Trading
One of the best ways to avoid the various pitfalls of trading is to be prepared. You can do this by educating yourself about the forex market and what factors move it.
You should also take time to learn about fundamental and technical analysis to develop the ability to make directional predictions about the way the market will move in the future.
This helps you improve the odds of winning on trades you take. Fortunately, most online brokers provide a range of educational materials, tools and market analysis that you can use to further your trading education. Or, you can check out some a forex trading course or forex trading book to expand your knowledge.
Step 2: Find a Suitable Online Broker
Once you feel suitably prepared and educated, shop around for an online forex broker. Ideally, a broker will be well-regulated in your local jurisdiction, keep client funds separate and have a good reputation among its past and present clients.
A broker should also offer competitive dealing spreads and access to the forex market and other any other asset classes you want to trade.
Step 3: Get an Online Trading Platform
Once you’ve found a broker, the next thing you will need to do is obtain a trading platform, or a type of software you use to execute trades. You can either get access to a platform through your broker or you can download and install the popular MetaTrader 4/5 platform from the MetaQuotes website.
This platform has the advantage of a large user community that has created numerous expert advisors (EAs) capable of trading the market automatically for you. You can also access low-cost copy trading services provided by members of its user community.
Step 4: Open a Practice Trading or Demo Account
Before you fund a trading account with real money, practice trading to get used to your broker’s trading platform. You can do this by opening a demo account funded with virtual money with your broker. Most brokers offer free demo accounts to prospective clients.
Step 5: Develop a Trading Plan
A winning trading plan and the discipline to stick to it is the key to long-term success as a forex trader, so it makes sense to devote some serious time to developing a plan you can follow with confidence.
Once you have one formulated, you can backtest it using MetaTrader 4/5 over a specified range of historical exchange rate data to see how the strategy would have performed if you had been trading it during that testing time frame.
Step 6: Gather Some Risk Capital Together
Now start thinking about where the money to fund your trading account is going to come from. Since trading is generally a speculative activity, you should never put money at risk trading forex that you need for the essentials of life like food or housing. It’s also better to avoid trading on borrowed money.
Step 7: Open and Fund a Live Account
At this point, you’ll need to gather your personal documentation together to satisfy your broker’s requirements and to prove your identity so you can open an account. You might also need to show a government-issued ID, a passport and/or proof of address like a utility bill, in addition to providing your bank account information.
You’ll also need to have your funds available in liquid form to transfer to the broker via a deposit method the broker accepts. Withdrawals generally need to be made via the same method as deposits. Different brokers have different payment and withdrawal methods.
Step 8: Analyze the Market
Now that you’re ready to trade, figure out what the market is most likely to do by analyzing it and following your trading plan. Most traders use fundamental analysis to discern the likely long-term direction of the market and technical analysis to time entry and exit levels.
Step 9: Take a Position
This final step involves actually executing a transaction based on the view you developed by analyzing the market. If you are bullish on a currency pair, you might go long, and if you’re bearish, you can go short.
Ready to Go?
Now that you know what to expect when you trade currencies, you can check out any of the best forex broker options we’ve compiled to start your trading education and open an account today.
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