If you’ve traveled abroad, chances are you visited a cambio or bureau de change to buy local currency with the currency you brought with you from home. That was a basic type of foreign exchange or forex transaction that simply involves exchanging one national currency for another.
As old as money itself, the foreign exchange market enables foreign trade that in turn boosts prosperity for a country or region. While trading forex is essential for international businesses, it is also a potentially lucrative market to speculate in. Read on to learn the basics of forex trading, including why, how and where to get started.
The foreign exchange or forex market is a global, decentralized and largely unregulated market for currency trading. It operates through a network of financial institutions generally situated in major money centers around the world.
This allows the forex market to operate on a 24-hour basis from 5pm ET on Sunday when the Australian forex market opens the trading week up to 5pm ET on Friday when the U.S. forex market closes the week down.
Currencies do not trade at a price or absolute value in the forex market but instead trade relative to other currencies at various rates of exchange. This means currencies trade in pairs, like the U.S. dollar vs. the Canadian dollar, for example. This pair is abbreviated USD/CAD when using the three letter International Organization for Standardization (ISO) codes associated with each national currency.
The modern foreign exchange market that features floating exchange rates formed during the 1970s after the breakdown of the Bretton Woods fixed exchange rate system and its associated gold standard. Due to rising globalization, the forex market quickly became the largest financial market, with average daily trading volumes reaching $6.6 trillion in April 2019, according to the Bank for International Settlements.
The rise of the IT sector through the 1990s saw the arrival of the retail forex market that trades via online forex brokers. Software development also allowed for better charting services, faster feeds and execution times, mobile trading, and lower overall costs. Some estimates show that retail traders now account for 5.5% of the daily forex market trading volume or around $363 billion.
How to Make Money on Forex
While trading forex is relatively simple, making money consistently when doing so takes practice, discipline and an understanding of the currency market. Important things to consider while trading forex include:
- Trade moderately volatile currency pairs. It is hard to make money on a forex trade if the exchange rate doesn’t move. Looks for pairs that move frequently so you can capture part of that movement, but avoid pairs that move excessively since that might create too much risk. You can use the Average True Range (ATR) indicator that shows the average volatility over a set number of periods (usually 14) to assess how volatile a currency pair is.
- Set realistic profit expectations. You only realize profits (or losses) once you have exited a trade, so don’t start spending any unrealized gains. Also, your profit expectations have to be realistic, especially since most retail forex traders lose money. Situations where you capture twice the average daily range are unlikely to happen. While your trading profit target might depend on your technical analysis, your actual results will probably not be more than 25%-30% of the ATR.
- Use a stop-loss level. Trading without a stop-loss is like playing with matches at a gas station. Too many things can go wrong. Even before you enter a trade, you should have a general idea of where to get out or place a stop-loss order just in case you are wrong. This is usually based on how much you can afford to lose or technical factors like support and resistance levels. You can also use 10% of the ATR reading as a rule of thumb to set your stop loss level.
- Trade what you see, not what you think. It might sound counterintuitive, but avoid anticipating exchange rate movements. At any time, the exchange rate might do 1 of 3 things: go up, stay put or go down. Every time a candle closes on a chart, it is new information telling a story on what the exchange rate might do next. Interpreting this information correctly and acting upon it when it happens (not before or too long after) is one of the cornerstones of profitable trading.
- Develop and test your own ideas. Losses are inevitable when trading, and understanding them is essential for your learning process. Keeping a trading journal with your rationale for taking each trade and an analysis of why it did or did not work out helps provide useful feedback when learning how to trade. Make sure to test a new trading strategy over historical data and then using a virtual money account before starting to trade it in a live account.
- Do not abuse the leverage. Leverage is a double-edged sword. It can make you money, but it can also wipe out months of profitable trading in seconds. Leverage doesn’t change the odds; it instead amplifies them. While some offshore brokers allow leverage ratios as high as 1,000:1, U.S. regulators insist that brokers only allow U.S. clients to use leverage ratios of 50:1.
- Keep track of the fundamentals. Just like earnings announcements on the stock market, the forex market has its economic calendar. Major re-occurring news includes central bank benchmark interest rate decisions, employment data, inflation reports and gross domestic product (GDP) numbers. Following this data for any of the currencies you plan on trading will help you avoid market shocks and understand the bigger economic picture.
- Avoid trading high-impact news. High impact news can result in market volatility that can make or break a trade. Even if your research is correct, the market can still overreact. It can also initially go in the “wrong” direction before reversing as participants take profits. The only thing worse than just being wrong is being right too early and getting stopped out before the market moves in your favor.
- Find a trading style that suits you. There are many ways to trade that range from making scalping trades that last just seconds to trend trades that can remain open for months. There is no one-size-fits-all approach, so you will typically have to research what style fits your personality the best to get optimal results from trading.
Why Trade Currencies?
- Easy to understand: Exchanging currencies is as old as money itself. You are simply buying one and selling another because you believe the exchange rate will rise or fall.
- Highly liquid: The forex market is the largest financial market in the world, with an average daily trading volume of $6.6 trillion in April 2019. Because of its high liquidity, this market can absorb substantial trades without significant movement, which is an advantage over a relatively illiquid asset class like penny stocks. If you develop a good trading strategy that can achieve consistent profits, you can replicate your results on a larger scale.
- Cheaper to trade: The forex market is one of the more affordable markets to trade. Such high liquidity means dealing spreads are tighter, and trades are usually commission free. This cost reduction adds up over time, especially if you are an active trader or plan on increasing your transaction size.
- Available 24 hrs a day: The forex market stays open from Sunday until Friday afternoon. During this time, there is always an open trading session somewhere in the world. This is an advantage over stock markets that trade in a series of shorter daily sessions.
Benzinga’s Best Forex Trading Platforms
The first step toward successful forex trading is finding a good broker. Check out Benzinga’s recommended brokers in the comparison table below, and open a demo account to test their trading platforms.
- Best ForInvestors interested in 0% commission or eco conscious trading
CedarFX is not regulated by any major financial agency. The brokerage is owned by Cedar LLC and based in St. Vincent and the Grenadines.
- Best ForForex Execution
- Best ForForex Investing
- Best ForNon US Forex Trading
One Market to Rule them All
Often overlooked by retail traders, the massive forex market has become very accessible to just about anyone. All you need to start trading currencies is a relatively modern Internet-connected device and a modest deposit to use as margin.
Once you achieve consistent profitability trading forex, even while operating in a small trading account, your strategy can scale up to produce even more profits in a much larger trading account. Yet, this sounds easier in theory than it is in practice. The forex market requires patience, planning and discipline. You will have to resist the temptation of entering a trade for the sake of simply being in the market.
While the forex market is typically slower-paced than some other asset classes, like stocks or commodities, currency trading is not without perils. Violent movements (like the Swiss franc shock in January 2015) do happen, and you must remain vigilant when trading currencies. Using a regulated broker is the first step in the right direction, but ultimately, success in forex trading comes down to knowledge, discipline and dedication.
Frequently Asked Questions
Forex trading is generally legal, but laws regarding retail forex trading can differ among various jurisdictions and regulatory environments. Also, online brokers that deal with retail traders generally need to have proper licenses for each country they operate in. U.S. retail forex trading regulations are relatively strict and include limiting maximum leverage to 50:1 for major or 20:1 for minor currency pairs and eliminating “hedging” (i.e. no simultaneous buying and selling). U.S. regulators also require online forex brokers to hold a $20 million deposit as reserves in qualifying institutions.
Forex refers to foreign exchange, which is an exchange of one currency into another. It is the largest financial market in the world and a requirement for foreign trade. The forex market operates through a decentralized network of financial institutions. Accessing this network allows companies and individuals to exchange currencies for both practical and speculative purposes. While a company may need to buy foreign currency in exchange for its domestic currency to pay a foreign supplier, an individual retail trader might buy a currency pair to speculate on short term movement in its exchange rate.
The forex market operates via a global banking network around the clock from 5pm on Sunday until 5pm on Friday Eastern Time. While some companies buy or sell currencies through their banks, individual speculators are more likely to operate through online brokers.
Related content: What Makes the Forex Market Move?
Get a Forex Pro on Your Side
FOREX.com, registered with the Commodity Futures Trading Commission (CFTC), lets you trade a wide range of forex markets plus spot metals with low pricing and fast, quality execution on every trade.
You can also tap into:
- EUR/USD as low as 0.2 with fixed $5 commissions per 100,000
- Powerful, purpose-built currency trading platforms
- Monthly cash rebates of up to $9 per million dollars traded with FOREX.com’s Active Trader Program
Learn more about FOREX.com’s low pricing and how you can get started trading with FOREX.com.