What Is Forex Trading? A Beginner's Guide

Congratulations! You have just found something few forex trading beginners ever find. Here is a practical, well-detailed, step-by-step guide to understanding WHAT is forex and HOW forex trading works. 

There is quite a bit you should know before you dive in. If you want to trade forex right away, here is a quick guide.

How to Trade Forex - Quick Guide

1. Open a Forex trading account. Provide personal information, including name, address, and tax ID number, and some financial background information. You will also have to answer some questions about your finances and investment as part of “know your client” compliance.
2. Fund your Forex account. Funding is typically accomplished by bank transfer, wire transfer, debit card (after verification) and other available methods in your country. With CAPEX.com you can begin forex trading with as little as $100.
3. Research currency pairs and trade setups. Utilize technical analysis to determine your timing points and price levels for trade entry and exit. Trade size and trade management are very important to achieve the preservation of capital on losing trades and growth of capital on profitable ones.
4. Size up your first forex trade. Understand how much capital you have, as well as the specific leverage available for your chosen currency pair. Since leverage in forex trading can be up to 30:1, it is critical to understand how much capital you will have at risk on any trade.
5. Monitor and manage your position. Once the position has been established, you should have a clear understanding of your position and, through research prior to trading, have clear exit points for either taking profits or taking a loss on your trade.

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For more info about how to trade forex, you can discover everything you need to know in this forex trading for beginners comprehensive guide. 

What is Forex? 

After the accord at Bretton Woods in 1971, more currencies were allowed to float freely against one another. The values of individual currencies vary based on multiple factors, including demand and circulation and they are monitored by foreign exchange trading services. 

The amount of currency converted every day can make the price movements of some currencies extremely volatile. It is this volatility that can make forex trading so attractive: bringing about a greater chance of high profits, while also increasing the risk of great losses. 

Commercial and investment banks conduct most of the trading in the forex markets on behalf of their clients, but there are also speculative opportunities for trading one currency against another for professional and individual investors. 

How Forex Trading Works 

Forex trading, also known as foreign exchange trading, currency trading or FX trading is the simultaneous buying of one currency and selling another for the aim of earning a profit.  

Forex Trading includes all speculative trades or capitalizing on floating exchange rate between two currencies (e.g., EUR/USD) by either: 

• Buying low and selling high a currency pair anticipating that the base currency (the one on the left) will appreciate against the counter currency (the one on the right). 
• Selling high and buying low a pair anticipating that the base currency (the one on the left) will depreciate against the counter currency (the one on the right). 

In either case, the forex trader could earn an amount of money on the difference between the opening and closing price of the trade. However, if the currency pair will move in the opposite direction the trader could suffer a loss. 

Most professional and individual investors will not plan to take delivery of the currency itself; instead, they make predictions to take advantage of the exchange rate changes and/or interest rate differential between two currencies. 

Unlike stock trading, forex trading does not take place on exchanges but directly between two parties, in an over-the-counter (OTC) market. The forex market is run by a global network of banks, spread across four major forex trading centres in different time zones: London, New York, Sydney, and Tokyo. Because there is no central location, you can trade forex 24 hours a day. 

Traditionally, a lot of forex transactions have been made via banks, but with the rise of online trading, you can take a buy or sell position on the currency pairs using derivatives like CFD (Contract for Differences). 

CFD trading is leveraged, enabling you to open a position for just a fraction of the full value of the trade. By using a leverage of 1:30, every $1 you invest is worth $30, so with your $1000 margin, you can open a $30,000 deal. 

Unlike non-leveraged products, you don’t take ownership of the asset, but take a position on whether you think the market will rise or fall in value. 

Although leveraged products can magnify your profits, they can also magnify losses if the market moves against you. 

This forex price quote means you could do one of the following: 

The Benefits of Forex Trading 

There are more reasons to have forex market exposure beyond currency diversification. 
 
Once you do some homework, you will realize that forex is among the most rewarding asset classes for traders and investors. Even though the forex market is dominated by short-term, high-risk speculators, there are investing/trading styles suitable for both: 

1. More conservative active traders use longer-term holding periods and specific methods and instruments to reduce risk.
2. Long-term investors who know how to:  
   – Ride stable, proven, long-term forex trends.  
   – Involve in carry trade. 

Here are the 8 main advantages of the forex market that make it one of the most attractive for traders and investors worldwide. 

1. The Highest Risk/Reward Potential 

Forex market offers some of the best risk/reward opportunities of any financial market IF (big if here) you learn how to control the risk. The availability of leverage in forex trading, meaning the use of borrowed funds to control large blocks of currencies and thus magnify gains and losses, creates the unmatched profit potential for those with limited trading capital IF (again, big IF here) they learn how to control the downside risk. For example, with 30:1 leverage, a 1 percent move means 33.33 percent profit. It also means a 33.33 percent loss. 

This allows substantial profits but also substantial losses on small price movements, because: 

• For every $1 you have at risk, you control $30 
• For every $1,000, you control $30,000. 

2. The Most Flexible Hours 

One unique aspect of this international market is that there is no central marketplace for foreign exchange. Rather, currency trading is conducted electronically over the counter (OTC), which means that all transactions occur via computer networks between traders around the world, rather than on one centralized exchange.  

Forex market trade in a seamless 24-hour session, 5.5 days a week, from Sunday 5:15 P.M. EST until Friday 5:00 P.M. EST. So, those with work or family commitments can trade a fully liquid market whenever convenient.

3. The Lowest Start-up and Trading Costs 

Forex trading has among the lowest entry or start-up costs in money and time of any financial market, in terms of trading capital and training/equipment costs, as follows: Unlike most markets, you do not need many thousands of dollars to get started. That’s because, in the forex market, we can trade with leverage (borrowed funds), typically 30:1. 

In theory, you can often start with as little as $100. However, you’ll learn that the larger the account the larger the stop loss you can use to keep risk per trade at 1-3% of your trading capital. As explained in the risk and money management course, the small forex position sizes available from mini and micro-accounts allow those with limited funds to trade smaller positions, which keeps the percentage of capital risked per trade low. 

• Training and equipment costs: Forex brokers typically provide free full-featured trading platforms and data feeds, and the best Forex brokers offer extensive archives of free training materials and market analysis. With online stockbrokers, traders typically need to maintain minimum balances or minimum trading volumes to get free quality charting and trading apps from their brokers or get access to worthwhile research.  
• Free Practice Accounts: Even better, they typically provide full-featured practice or demo accounts that allow smart beginners to simulate most of the trading experience and practice with play money until they feel ready to risk their capital. 
• Low transaction costs: Most forex brokers charge no fees, commissions, or hidden charges. They earn their money on the difference, called spread, between the buy and sell price, typically a few ten-thousandths, called pips, of the price. Depending on the lot sizes traded, a typical one-pip spread to open and close a position can cost anywhere from $0.10 (micro-lot) to $10 (standard lot).  

4. The Best Liquidity 

A liquid market is one that has many buyers and sellers. The more buyers and sellers at any given moment, the more likely you are to get a fair market price when you buy or sell. The more liquid a market is, the less likely it is that a few otherwise insignificant orders or players can move prices in wild, unpredictable movements. 

Indeed, unlike in stock markets, even the biggest players will have trouble manipulating the price action in major currency pairs beyond a matter of hours. Two exceptions to that, are a few central banks and crooked forex brokers. Fortunately, dishonest brokers can be identified and avoided with some research, and central bank intervention risk is usually known or soon uncovered after the first incident, putting markets on guard. The more liquid the market, the easier it is to get in and out at the stated price or very close. 

Prices are fairer and more stable, less subject to sudden unpredictable movements. You should avoid trading in illiquid markets, except on rare occasions when trying to enter positions at bargain prices offered by those desperate to close a position. Forex market trading volumes dwarf those of equities. The latest estimates put average daily forex turnover at around $6.59 trillion per day in 2019, according to the 2019 Triennial Central Bank Survey of FX and over-the-counter (OTC) derivatives markets (Forex Turnover), of which individual retail traders alone account for about $2 trillion. That huge trading volume, going on 24 hours a day, means abundant buyers and sellers are usually present at any given time. That means you are more likely to get a fair price no matter when you buy or sell. It means that you rarely see partial fills, which are cases in which you can only buy or sell part of your intended order.  

5. Less Slippage 

Slippage is the difference between the stated price on your screen and the actual price you pay or receive. The less liquid the market, the more often slippage happens because fewer traders are present to take the other side of your trade. For example, let’s say you buy 1,000 shares at $30, and to protect yourself in case the price falls, you place a protective stop-loss order to sell the shares at $29. However, if there are no buyers at $29, then the price “gaps” lower until it hits the next buy order, so you incur a greater loss. 

Because forex markets are: 

• typically running at full speed in at least one if not two continents 24 hours a day, over five days a week 
• have no specialists controlling prices, and trade at larger volumes than equities, 

forex traders face a lower risk of slippage. Indeed, many forex market makers provide some kind of “no slippage” policy that lessens the degree of price uncertainty. 

6. Advanced Warnings of Changes in Other Markets 

Forex markets often react to changing conditions before other markets, providing valuable advanced warning of trend changes. As detailed later, certain currencies tend to move in the same direction as “risk assets” like stocks or industrial commodities, and others tend to act like “safe haven assets” like bonds. When these correlations break down, that too can often be a warning of a change in direction for other markets. 

7. No Centralised Exchange with Specialists Holding Monopoly Power to Regulate Prices 

In most stock markets, the specialist is a single entity that serves as buyer and seller of last resort and controls the spread, which is the difference between the buy and sell price for a given stock. Though in theory they are regulated and supervised to prevent they are abusing that power to manipulate prices at the expense of the trading public, specialists are experts at knowing when they can get away with a degree of this and force you to buy higher or sell lower. In forex, no single specialist regulates the prices of individual currency pairs. Rather, multiple exchanges and brokers are competing for your business. Though the lack of centralized exchanges can complicate regulation, competition and easy access to pricing information have brought competitive pricing. 

8. No Uptick Rule: Possible to Profit in a Falling Market as in a Rising One 

Just as it is easier to row with the current than against it, it’s easier to profit by trading in the direction of an established market trend. Unlike with stocks (and other financial markets), in forex, it’s as possible to trade the falling markets as is to trade the rising ones. This is a huge advantage of forex markets. During an uptrend, when prices are rising, most traders go long, meaning they buy the asset with the hope of selling it at a higher price. They are attempting to buy low and sell high, the classic way most people view investing. 

During a downtrend, when prices are falling, it’s more possible to profit by trading with that downtrend. So, the more sophisticated equities traders try to exploit that downward momentum and sell short; that is, sell borrowed shares with the hope of buying them back later at a lower price, returning the borrowed shares, and profiting on the difference—for example, sell borrowed shares for $100 per share, buy them at $80, return them to a broker, and pocket $20 per share. However, most stock exchanges are controlled and regulated by those who have an interest in keeping stock prices high with short-selling restrictions and huge costs. 

What moves the forex market? 

The forex market is made up of currencies from all over the world, which can make exchange rate predictions difficult as there are many factors that could contribute to price movements. However, like most financial markets, forex is primarily driven by the forces of supply and demand, and it is important to gain an understanding of the influences that drives price fluctuations here. 

Let’s look briefly at each fundamental factor that drives currency prices. For a more in-depth understanding visit CAPEX Academy. 

1. Overall Risk Appetite 

The most influential fundamental factor that determines the fate of a currency pair in a given period is overall risk appetite, otherwise known as market sentiment or, in plain English, whether markets are feeling optimistic or pessimistic. If they’re feeling optimistic, be it over a period of hours, weeks, or longer, risk assets tend to rise and safe haven or safety assets tend to fall, and vice versa. 

These major currencies are classified as one of two kinds: risk and safety or safe-haven currencies. For now, just know that in general: 

In other words, the AUD is the currency that tends to rise the most when markets feel optimistic and want risk assets, and the JPY tends to fall the most. In times of fear, when risk assets are selling off, the opposite occurs. 

These labels refer solely to how these currencies behave relative to other assets. These categories do NOT refer to the safety of these currencies as a store of value. For example, the JPY generally behaves as the ultimate safety currency, however, few would dispute that the CAD is a better long-term store of value given Canada’s better fiscal health. While the above general ranking works over a given period of weeks or months, it rarely applies perfectly on a daily basis. For example, even if markets are feeling very optimistic, and classic risk barometers like the S&P 500 are trending higher, currency specific news events can cause lower-ranked risk currencies to outperform the AUD and NZD. 

They are not guaranteed to maintain their value and statute during periods of market volatility. Furthermore, what constitutes a safe haven may change over time.  

Here are the obvious questions: 

1. What creates this overall market sentiment?
2. How do traders and investors gauge it? What do they watch to determine whether markets favor risk or safety assets at a given moment or planned holding period? 

The purported causes of market optimism or pessimism are debated and discussed daily in the financial media. Over time, you’ll develop your own preferred sources of news and will form your own opinions or at least a core group of analysts you trust. Sometimes the causes of the market’s mood are clear, other times they aren’t. However, the actual mood of the market is typically quite clear, even when its underlying cause is not. Look at the charts of the following risk appetite barometers, note the price action and trend, and you’ll have a picture of whether markets are optimistic (showing risk appetite) or pessimistic (showing risk aversion). 

Risk Appetite Barometers 

There are many, of varying degrees of effectiveness and sophistication. Here we’ll provide just a few that are quite easy to use and find. They usually provide a reliable picture of whether markets are feeling optimistic or pessimistic. That information in turn can tell you a lot about how almost any asset class should be performing in a given period. 

1. The S&P 500 Index (S&P 500) and other stock indices
2. Major sovereign bond prices or Credit Default Swap (CDS) spreads
3. Indexes of the major currencies, like the US Dollar Index
4. Growth-related commodity prices like copper and oil
5. Gold and silver for gauging confidence in the most widely held forms of cash, the USD and EUR 

EurUsd forecast and price predictions

2. Short-Term Interest Rates 

After overall market sentiment, the single most influential driver of currency prices is central bank benchmark interest rates and any data that change expectations about the direction, timing, or size of increases or decreases in these benchmark short-term rates. Indeed, one could argue that most of the other fundamental drivers of currency prices that follow below are influential only to the extent that they influence interest rate expectations or the rates themselves. They are influential because rising yields allow traders to capitalize in two ways: 

• “Carry Trade” profiting from interest rate differences between currencies. 
• Capital appreciation (much of that driven by carry-trade). 

What Drives Short-Term Interest Rates? 

Why do central banks change short-term interest rates? They lower them to stimulate growth, and they raise them to keep inflation low. Their benchmark overnight lending rate is typically an attempt to strike a balance between these two needs. Economic conditions determine which need takes priority. In bad times, promoting growth is usually the main concern hence lower rates. In good times, cooling inflation is the priority, hence higher rates. It’s common to see nations with stronger economies have stronger currencies because their central banks will be raising rates, both to minimize inflation threats and to buy themselves more room to lower rates (which encourages growth) when their economies weaken. 

From a trading perspective, forex movements are more influenced by changes in market expectations about the direction or pace of rate change than actual rate changes themselves (which are usually anticipated and already priced in when they actually do occur). 

How interest rates affect the markets

3. Macroeconomic data and indicators 

Economic indicators influence currency prices because they’re barometers of the following: 

1. The health of the underlying economy: That means increased demand for that economy’s currency from exports and foreign investment in local hard assets like businesses and real estate.
2. The direction of interest rates and central bank policy: As noted earlier, faster growth makes inflation more likely, and thus further rate increases more likely because:
3. Central banks use rate increases to reduce inflation risk
4. They like to raise rates in times of growth to allow room to lower rates when their economies start slowing and need a boost. 

Which fundamental data are most important? Here are some guidelines: 

1. Quarterly Gross Domestic Product (GDP): Typically, there is an advanced or preliminary reading about four weeks after the quarter ends, and a final one about three months after the quarter ends. The preliminary reading is what carries the most influence because the final reading rarely deviates from it.
2. Monthly jobs report: Again, the more important the economy, the more important the report. Jobs (see Non-Farm Payroll or NFP) take on even greater significance in economies like the United States or the United Kingdom, where consumer spending is a more important component of GDP than manufacturing or exports.
3. Monthly retail sales: Same as above.
4. Inflation data: Typically, monthly CPI and PPI.
5. Purchasing Managers Index (PMI) for both manufacturing and service sectors: The key point is that a reading over 50 suggests expansion, and under 50 suggests contraction. They provide a measure of the health of the manufacturing and service sectors, respectively.
6. Housing data: This includes a range of monthly reports like housing starts, new home sales, existing home sales, new building permits, etc. Considered an indicator of what stage the economy is within the current business cycle. It is also a sign of the health of the banking sector and consumer lending, consumer spending, and jobs, given the significant impact housing has for these sectors. 

Why Economic indicators matter for traders 

4. Geopolitics 

Though all financial markets can be influenced by major geopolitical events like news of political instability in key countries or military actions, few are as sensitive as the FX because of its extremely international nature. Of course, certain currencies and their related pairs will be especially sensitive to related local developments. As stock prices reflect market sentiment about companies, so do currencies for countries. Thus, they are responsive to geopolitical changes insofar as these affect expectations for interest rates, growth, trade and capital flows, and so on for the underlying economies. 

Because the professional traders who manage the big money in forex focus first on risk management (take the hint, so should you), the first rule of trading based on geopolitical unrest is that markets tend to sell first and ask questions later. In other words, markets are prone to volatility in times of serious unrest. Remember, whenever professionals fear any threat to their capital, they quickly retreat into cash, especially safe-haven currencies, until the political risk fades. 

In sum, a general rule of thumb in all kinds of financial markets including FX is that politics usually trumps economics. In other words, very good or bad geopolitical data tend to outweigh economic data. 

5. Capital and Trade Flows 

Another key factor in analyzing the demand for a given currency is whether the underlying economy is more dependent on trade flow or capital flow. In other words, is the economy based more on exports or on attracting foreign investment? Trade flow refers to a country’s income from trade, i.e., exports. Capital flow refers to how much investment it draws from abroad. Export-oriented economies depend more on trade flows, and countries more focused on financial industries are more dependent on capital flows. 

The export-oriented economies, whose currency strength depends on their trade flows include: 

1. Canada: oil, gas
2. Australia: industrial and precious metals
3. New Zealand: agricultural products, particularly dairy product
4. China, Japan, and Germany: finished high-value-added manufactured goods, heavy industry 

6. Government and Central Bank Special Interventions in Times of Crisis 

One of the most enduring lessons of the “Great Recession” that began in the summer of 2007 is that in desperate times governments will take desperate measures that by definition are unique and thus unpredictable. 

After the subprime crisis in the United States morphed into a global banking crisis with the fall of Lehman Brothers and global markets appeared to be at the brink of the abyss in early 2009, intensive government intervention produced a rally in risk assets that lasted until late 2009, with the start of the EU sovereign debt and banking crisis. 

In the fall of 2010, when risk asset markets might again be in trouble, the U.S. Federal Reserve Bank (Fed) came to the rescue with a new stimulus plan, called Quantitative Easing. Risk asset markets perceived this would provide at least a temporary boost for risk assets. 

How to trade the FOMC meeting

The most basic forms of forex trades are a long trade and a short trade. In a long trade, the trader is betting that the currency price will increase in the future, and they can profit from it. A short trade consists of a bet that the currency pair’s price will decrease in the future. Traders can also use trading strategies based on technical analysis, such as Japanese candlesticks, chart patterns, Fibonacci retracement, and moving averages, to fine-tune their approach to trading. 

Depending on the duration, timeframes, and frequency, forex trades can be categorized into four further types:

Scalp trading  A scalp trade consists of positions held for seconds or minutes at most, and the profit amounts are restricted in terms of the number of pips. Such trades are supposed to be cumulative, meaning that small profits made in each individual trade add up to a tidy amount at the end of a day or time period. They rely on the predictability of price swings and cannot handle much volatility. Therefore, traders tend to restrict such trades to the most liquid pairs and at the busiest times of trading during the day.  Scalping	Day trading Day trades are short-term trades in which positions are held and liquidated on the same day. The duration of a day trade can be hours or minutes. Day traders require technical analysis skills and knowledge of important technical trading indicators to maximize their profit gains. Just like scalp trades, day trades rely on incremental gains throughout the day for trading.  Day Trading	Swing trading  In a swing trade, the trader holds the position for a period longer than a day; i.e., they may hold the position for days or weeks. Swing trades can be useful during major announcements by governments or times of economic tumult. Since they have a longer timeline, swing trades do not require constant monitoring of the markets throughout the day. In addition to technical analysis, swing traders should be able to gauge economic and political developments and their impact on currency movement.  Swing Trading
Trade trading Trend traders tend to use technical analysis tools, such as moving averages (MA), trend lines, and momentum indicators, to determine trends in the market. They will look for patterns in price movements and analyze charts to establish areas of support and resistance. Once a trend has been recognized, trend traders tend to enter a trade in the direction of that trend and the goal is to ride the trend for as long as possible and to exit it when it shows weekness.	Position trading  In a position trade, the trader holds the currency for a long period of time, lasting for as long as months or even years. This type of trade requires more fundamental analysis skills because it provides a reasoned basis for the trade.  Position traders are those who will hold a trade for the entirety of the prevailing trend, ignoring day-to-day fluctuations	Carry Trade  The purpose of a carry trade is to profit from the difference in interest rates or the “interest rate differential” between two separate foreign currencies in a pair. Basically, you should profit from a higher interest on the currency that you have bought. Most traders will enter a carry position with the hope that the interest rate differential will be flat or increase. However, any drop in the price of the currency you are holding via leverage could outweigh your interest gains.

Practice Forex Strategies

Your loss is ([€10,000 x 1.12892] – [€10,000 x 1.13672]) = –$78. 

Sources:

1. Foreign exchange turnover in April 2019 – https://www.bis.org/statistics/rpfx19_fx.htm
2. Foreign Exchange Rates – https://www.federalreserve.gov/releases/h10/current/
3. The FED’s Foray into Forex – https://www.richmondfed.org/publications/research/econ_focus/2017/q2/federal_reserve
4. Trading in foreign exchange (forex) – https://www.esma.europa.eu/system/files_force/library/2015/11/2011-412_1.pdf?download=1
5. Patterns of Foreign Exchange Interventions – https://www.imf.org/en/Publications/WP/Issues/2020/05/29/Patterns-of-Foreign-Exchange-Intervention-under-Inflation-Targeting-49252
6. Foreign Exchange: A Practical Guide to the FX Markets (a review) – https://www.cfainstitute.org/en/research/financial-analysts-journal/2007/foreign-exchange

FAQs about Forex Trading