Chances are you’ve already heard about Forex and Forex trading, but you’ve never really taken the time to read about it or learn how Forex traders make money. Don’t worry – this article is a crash course on Forex trading for dummies and covers everything you need to know about Forex to get started as soon as possible. We’ll cover what Forex is and who trades on it, how traders can make a profit on the market, and what you need to start trading.
What is Forex?
Let’s start with the most basic question – what is Forex?
Forex is the largest financial market in the world with an average daily turnover of around $5.3 trillion. This is $5,300 billion – in a single day! The Forex market trades the entire annual US economic output in just a few days.
Forex is the world’s marketplace for currencies. Just like stocks are traded on the stock exchange, currencies are traded on the Forex market. However, there is a subtle difference between these two asset classes: stocks are traded on centralised exchanges, while currencies are traded over-the-counter during Forex trading sessions.
There are four main Forex trading sessions during which currencies are traded – the New York session, the London session, the Sydney session, and the Tokyo session. The majority of all Forex trades are executed during the New York and London session, especially when these two sessions overlap for a few hours every day. These are also the market hours when the market is the most liquid, meaning that transaction costs will usually also be lower than when trading outside the NY-London overlap.
Currencies can’t be traded on their own, but they need to be paired with another currency to form a currency pair. The exchange rate of a currency pair reflects the price of the first currency expressed in terms of the second currency. For example, if the euro vs. US dollar pair trades at 1.30, this means that one euro buys 1.30 US dollars, or it takes 1.30 US dollars to buy one Euro.
Exchange rates in the Forex market are usually expressed with four decimal places, with the last decimal place representing a pip. A pip is the smallest increment that a currency pair can change in value. For example, if the euro vs. US dollar pair rises from 1.3000 to 1.3025, this would represent an increase of 25 pips. Forex traders use pips to report on their profits and losses and to express the movement of a currency pair – e.g. “Look, the GBP/USD has just moved 80 pips!”
Who trades on Forex?
Before the advancements of internet and technology, the Forex market was reserved for the big players. A few decades ago, the only market participants were big banks, hedge funds, multinational corporations, governments, and central banks.
Fortunately, things have changed quite a bit in the last two decades. The retail Forex industry has emerged on the back of technological advances in the IT sector to provide market access to smaller investors and traders. Forex traders can now trade on the largest financial market from the comfort of their homes, using just a computer with internet access!
It’s estimated that the retail Forex industry accounts for around 5% of the total daily turnover of the market, i.e., for around $250 billion. However, the Forex market is big enough that no single market participant can notably influence exchange rate moves, not even big banks with their multi-million orders. This levels the playground a little bit and provides fair market pricing to all participants.
Many beginners to the Forex market are asking how they can compete with such large players like big banks or hedge funds. Aren’t these big players always winning, and I’ll always be losing? The short answer is – No!
The longer answer is that the market is big enough for all market participants. Even big banks don’t possess much more information than the retail trader from the street. News is available almost instantly to anyone, and countries report their economic growth and inflation rates at times scheduled many weeks upfront. The only real difference is experience – banks employ experienced traders to trade the market and make them a profit. The good news is that experience is something that anyone can gain, provided you spend enough time on your trading platform learning about the market.
What is traded on Forex?
So far, we’ve covered what Forex stands for and who the major players in the market are. To continue our dummies guide to Forex trading, let’s dig deeper into what is traded on Forex.
You already know that Forex is the world’s marketplace for currencies. There are eight major currencies in the world: the US dollar (USD), euro (EUR), the British pound (GBP), the Swiss franc (CHF), the Canadian dollar (CAD), the Australian dollar (AUD), the New Zealand dollar (NZD), and the Japanese yen (JPY). The codes inside the brackets are the abbreviated forms of the currencies.
The currencies also have their nicknames: greenback (USD), the single currency (EUR), sterling (GBP), Swissy (CHF), Loonie (CAD), Aussie (AUD), and the Kiwi (NZD). The Japanese yen doesn’t have a widespread nickname, so we have excluded it from the list.
Beside the major currencies mentioned above, there are also dozens of other currencies which are not as heavily-traded as the major. They’re called exotic currencies, and include names such as the Turkish lira, the Argentinean peso, the Mexican peso, and the Czech krona, to name a few. Trading these currencies should be left to the more experienced traders, as they can move a lot in very short periods of time and usually involve higher transaction costs than major currencies.
It's also worth mentioning that all currency pairs that include the US dollar and one of the remaining seven major currencies (as either the first or the second currency in the currency pair) are called “major” pairs. On the other hand, pairs that don't include the US dollar, but include two of the remaining seven major currencies are called “cross” pairs. You might often hear about major pairs and cross pairs on Forex trading forums, and that’s why we mentioned them in our dummies guide to Forex.
How do Forex traders make a profit?
It’s time for the most interesting question – how do Forex traders make a profit? Just like stock traders, Forex traders try to buy a currency cheap and sell it later at a higher price. However, there’s also a way to profit when prices fall through a technique called “short selling”. We won’t get too technical in our Forex guide for dummies, we will explain short-selling in one of our next articles.
Let’s say the euro vs. US dollar is currently trading at 1.3050. If a trader believes that the exchange rate will rise in the future, they would look to buy the EUR/USD pair at the current rate of 1.3050. If after a few hours or days the exchange rate reaches 1.3250, our trader would have made a profit of 200 pips!
The only difference in calculating pips comes with pairs that involve the Japanese yen. In these pairs, one pip is usually the second decimal of the exchange rate. For example, if a trader buys the USD/JPY pair at 110.50 and the price rises to 112.00, our trader would have made a profit of 150 pips in that trade.
How the market is analysed? Forex explained for dummies
Before entering a trade, traders need to analyse the market to determine whether they’ll go long (buy) or short (sell). The market is analysed according to two major analytical disciplines: technical analysis and fundamental analysis. Without proper market analysis, trading would resemble gambling.
Technical analysis involves the analysis of price charts and is based on the assumption that history tends to repeat itself. In other words, a certain price pattern that worked great in the past should work equally good in the future. While technical analysis is not a perfect science, it has a proven track record and there are many Forex traders out there that trade solely based on technical analysis. Unlike fundamental analysis, technical analysis provides exact entry and exit points for a trade.
Let’s see now how to fundamentally analyze the currency markets for dummies. Fundamental analysis involves the measurement of the fair value of a currency. To do so, fundamental analysts measure the economic growth of a country, its inflation rates, unemployment rates, and other macro data which might have an impact on the supply and demand forces on a currency. Fundamental analysis is usually longer term based compared to technical analysis, as it takes a certain period of time for the fundamental forces to change exchange rates and create a trend.
What do you need to start trading?
It’s pretty easy to start trading on Forex. All you need is a computer with internet access, a trading platform installed on your computer, and a brokerage account. Let’s go through each of these elements.
You can basically use any modern computer or laptop that has internet access. Naturally, faster computers are better because you’ll likely have many tabs open in your web browser when performing market analysis, so make sure that your computer doesn’t slow down too much in that case.
A trading platform is provided by your broker after you open a brokerage account. A trading platform simply acts as a bridge between your computer and the market, and is used to analyse the price charts of currency pairs, to enter, manage, and close trades, and to perform a whole range of other tasks depending on the platform’s features. One of the most popular trading platforms is the MetaTrader platform, so make sure that your broker offers that platform as it also involves great online support from millions of traders worldwide. There are two versions of MetaTrader – MetaTrader 4 and MetaTrader 5. While the latter one is the newer version of the program, both versions are quite similar and don’t make a real difference for beginners on the market.
Finally, you’ll need a brokerage account opened with one of the online Forex brokers. After you fill out the registration form and fund your account, you’ll be able to trade on Forex. This usually doesn’t take more than 1-2 business days.
Final words – how to trade Forex for dummies
In our guide on Forex currency trading for dummies, we explained the most important aspects of Forex trading to give you a jump-start on the market. Just like stock trading, Forex trading requires a lot of experience accumulated through trial and error to learn what works and what doesn’t in currency trading.
Currencies are traded in pairs and the exchange rate reflects the price of the first currency (base currency) expressed in terms of the second currency (counter-currency). If you think that the exchange rate will rise, you should buy the pair; and if you think the exchange rate will fall, you should sell the pair.
To determine whether an exchange rate will rise or fall, Forex traders mostly rely on two analytical disciplines – technical analysis and fundamental analysis. Technical analysis is based on price chart analysis and provides exact entry and exit points, while fundamental analysis is vaguer and involves the measurement of a currency’s fair price. It’s usually easier to learn technical analysis for beginners, as fundamentals include certain economic theories to be fully understood.
Finally, if you think that you’re ready to start trading on the market, you’ll need a brokerage account and a computer with internet access. Your broker will also provide you with a trading platform to analyse the market and place trades. Most Forex brokers also offer mobile trading apps which can be downloaded to your smartphone and provide market access anytime, no matter where you are. With some experience, you can become a profitable Forex trader. Welcome to the world of Forex trading!