The Forex market offers many lucrative trading opportunities on a regular basis, but many Forex traders still struggle to find a way to be consistently profitable. Emotions and inexperience, combined with inappropriate risk and trade management, are often the main obstacles that new Forex traders face. In addition, beginners usually don’t have a complete and well-rounded trading plan, don’t stick to their trading strategy, and often overtrade and chase the market for potential trade setups.
In this article, we’ll address the main problems that prevent traders from making money on Forex, and provide easy-to-follow solutions for them.
How to make money trading currencies on Forex?
Before we explain how to make money trading Forex, let’s start with the basics. Forex is the marketplace of the world’s currencies and the largest financial market by daily turnover. Currencies are always quoted in pairs, which consist of the base currency and the counter-currency. The price of the base currency, expressed in terms of the counter-currency, is called the exchange rate.
Just like in any other market, Forex traders make money by buying a currency cheap and selling it later at a higher price. When trading CFDs, there is also a way to profit from falling prices on the market – called short-selling. The core principle is more or less the same, the Forex trader profits from the difference in the entry and exit price of a currency. For example, if the GBPUSD pair currently trades at 1.30, and a trader believes that the exchange rate will rise, he or she would buy the British pound at $1.30 and sell it later at a higher price. Similarly, if the trader believes the price will fall, he or she would short-sell the British pound at $1.30 and close the position later for profit at a lower price.
There are also other ways to make money on Forex. It involves the buying of currencies that offer a higher rollover interest rate, by borrowing currencies that carry lower interest rates. This technique is often called “carry trade”, and besides the interest gains, you can also profit from the rising price of the higher-yielding currency since higher interest rates increase the demand for those currencies.
Volatility creates trading opportunities
When talking about how to make money on Forex, we have to mention volatility as well. Many traders who are new to the market don’t pay attention to the volatility of the currency pair that they’re trading. The truth is, Forex traders live on volatility, as volatility is what creates profitable trading opportunities.
In trading, volatility refers to the extent of a price movement in a period of time. If a currency pair makes large movements during a shorter period of time, that pair would be more volatile than a pair that makes only small movements or doesn’t move at all. To profit from less volatile pairs, Forex traders have to increase their leverage to magnify those small price changes.
To explain how to make money through Forex volatility, let’s see what determines the volatility of a currency pair. Basically, if there are many buyers and sellers at any given price point who increase the liquidity, the volatility will usually be lower. Major currency pairs that include the US dollar will therefore exhibit lower volatility than cross pairs and exotic currencies. That’s why you shouldn’t focus only on major pairs like EURUSD or GBPUSD to find trading opportunities, but regularly follow other pairs, such as GBPJPY, which have a higher volatility and hence higher profit potential.
Develop a trading plan
All successful Forex traders have a well-rounded and effective trading plan to trade the market. If you ask any successful trader about how to make money on Forex online, having a good trading plan will probably be among their first answers.
As it name suggests, a trading plan is a plan, preferably in a written format, that outlines how a trader analyses the market for trade setups, when to enter and exit a trade, how much money to risk per trade, etc. It should include everything important for your trading, such as your trading strategy and risk management. Having a trading plan prevents you from opening trades based on emotions or from chasing the market, as it provides a complete framework with strict rules to trade Forex.
If you don’t have a trading plan yet, you should start to develop one as early as today. In its most basic form, a trading plan should include how to analyse the market and the entry and exit triggers for a trade.
Don’t chase and overtrade the market
Another prerequisite of making money through Forex trading is to prevent chasing and overtrading the market. When beginners make a few winning trades in a row, they start to feel increasingly confident in their ability to find good trade setups and start to chase the market for trading opportunities. This ultimately leads to poor trading decisions and large losses, sometimes even wiping out the previous profits or the entire trading account. Don’t chase the market for trade setups. You need to be patient and let the setups come to you. There’s a saying that markets don’t owe you anything, and you can’t create a good trade setup if it just doesn’t exist.
Chasing and overtrading the market are closely linked. Similar to a trader who chases the market for trade setups, a trader who is overtrading the market opens too many trades in a short period of time in hopes of making large profits. Unfortunately, this emotional trading usually results in large losses and blown accounts in the end.
In addition, emotions such as fear and greed are a major obstacle in making money on Forex. Fear leads to cutting the profits too short, i.e. closing profitable positions too early and not letting the setup perform. On the other hand, greed leads to chasing and overtrading the market, as well as letting losers run in fear to close a losing position. Ask any successful trader how to earn money on Forex, and one of the answers will be cutting losers short and letting profits run – not the other way around.
Respect risk management: Here’s how to make gains trading Forex
Even the most successful traders have losing trades from time to time, and without proper risk management those losing trades could easily wipe out all earlier profits. If you’re wondering how to make money on Forex, then start by learning more about risk management.
Risk management involves a number of concepts that help you manage the risks when times get tough and your trades turn against you. Some of the most important concepts include the risk-per-trade and reward-to-risk ratio.
Risk-per-trade refers to the amount of your trading account that you’re risking on a single trade. If your trading account size is $10,000 and you’re risking $2,000 on a single trade, then your risk-per-trade, expressed in percentage terms, would equal to 20%. If you have 5 losing trades in a row, you would lose your entire trading account this way. That’s why taking a risk-per-trade of 20% is way too much risk. The golden rule is not to risk more than 1% or 2% per any single trade – this way you’ll still be able to make money, but can also withstand the negative consequences of a losing streak. Bear in mind that you need to make 100% of profits to return to break-even, after you lose 50% of your trading capital.
The reward-to-risk ratio is the ratio of your potential profits and potential losses of a trade. If you open a trade and risk $100 to make $100, your reward-to-risk ratio would be equal to 1. A reward-to-risk ratio of at least one has shown to generate the best trading results in the long run, so bear this in mind if you’re asking yourself how to make money on Forex.
Keep a trading journal
Finally, you should keep a trading journal of all your entries and trades and make regular retrospectives of your journal entries. A trading journal should at least include the traded instrument, the entry price, and stop loss and take profit levels, the reasons why the trade is opened, and its results.
Trading journals are a great way to understand how to earn money trading Forex, as they can be used to learn from your previous mistakes and to fine-tune your trading strategy. Trading journals should be an integral part of your overall trading plan.
Final words: How to use Forex to make money
In this article, we covered some important points on how to earn trading Forex. Forex traders make money by buying a currency cheap and selling it later at a higher price, by short-selling a currency if they believe the price will fall, or by buying a higher-yielding currency and borrowing a lower-yielding one. Since this still doesn’t explain how to earn on Forex by making a good trading decision, you need to learn how to take advantage of volatile currency pairs, develop a complete trading plan, respect risk management, and avoid chasing and overtrading the market.
In addition, you can check out online trading forums and ask successful traders how to make money trading Forex. There’s a huge online community and many traders would be more than willing to help you out. Forex trading doesn’t have to be a complicated undertaking – all you need to do is to gain experience and learn as much as you can.