How to Trade Forex: FX Trading Steps
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Originally Posted On: https://www.fpmarkets.com/education/forex-trading/how-to-trade-forex/
With high liquidity and non-stop trading hours, it’s unsurprising that the forex (short for foreign exchange) market is the world’s most traded financial market with a daily global trading volume of (US dollar) $6.6 trillion. Currency prices are constantly fluctuating in value against each other and the forex market offers great opportunities to profit from these price movements. Read on to discover how to trade forex and the steps you need to take to capitalise on these opportunities.
Learn How the Forex Market Works
The Basic Concept
Forex trading involves simultaneously buying and selling two currencies. For example, if you are buying the GBP/USD, it means you’re buying GBP by selling USD and if you’re selling the pair, you’re buying USD by selling GBP.
In the foreign exchange market, forex pairs are divided into three main groups – majors, minors, and exotics. The majors are the most traded pairs and each pair includes the USD and one of the other seven major currencies (EUR, GBP, JPY, CHF, CAD, AUD, and NZD). The minors include any two of the other major currencies apart from the USD. Exotic pairs are those that include a major and an exotic currency, for example, EUR/TRY or USD/THB.
The main difference between the groups is their liquidity, with the majors being the most liquid and the exotics the least.
How Forex Traders Make Profits
The objective of forex trading is to buy a currency cheap and sell it later at a higher price. For example, if the EUR/USD is trading at 1.1250 and you believe that the exchange rate will rise, you would buy the EUR/USD pair at the current rate. If after a few hours the rate reaches 1.1315, you make a profit of 65 pips.
Forex Traders also use a technique called ‘short-selling’ to profit when prices fall, so there are opportunities to make profits whether the market is rising or falling.
Note: A pip (point in percentage) is the smallest amount by which a currency quote can change. It’s usually $0.0001 for USD-related currency pairs but for other currencies like JPY it’s denoted as $0.001.
How the Currency Market is Analysed
Technical analysis involves analysing price charts based on the assumption that history tends to repeat itself and price patterns that have worked in the past will likely work in the future. Due to this characteristic, technical analysis can provide exact entry and exit points for a trade.
Fundamental analysis involves measuring the fair value of a country’s currency by looking at the country’s unemployment and inflation rates, interest rates, economic growth, and other macroeconomic data that can impact the supply and demand of the currency.
Fundamental analysis is usually longer-term compared to technical analysis and staying on top of market news is important as many market movements are influenced by things like economic news and political events.
Other traders also use sentiment analysis which is based on how investors feel about a particular market. Applying technical and fundamental analysis is key, but having an additional feel for the market consensus may improve trading decisions.
Choose a Broker and Open an Account
Choosing the right broker to trade forex online will allow you to devote time to analysing the market and developing your forex trading strategy instead of worrying about getting scammed. A good broker can also increase your chances of being successful in the competitive forex trading landscape.
Search for a broker who:
- Is regulated so that your money is protected
- Has good customer service, especially after you open an account. You can find out by evaluating other experienced traders’ reviews or through your experience with a demo account.
- Has a good trading platform. For example, MetaTrader 4 (MT4) is one of the best forex trading platforms in the world.
- Has resources to support your trading. For instance, FP Markets offers extensive educational resources which discuss the fundamentals of trading and help you become a successful trader.
After making your broker selection, you can open a currency trading account. It’s important to start with a Demo Account to learn the dynamics of the forex market and how to trade currencies before risking real capital and to make the most of your initial investment.
Build a Trading Plan
Discipline is one of the common traits all successful traders have and a trading plan will help you maintain this discipline. A plan should help you trade consistently, manage your emotions, and focus on your trading objectives. It can also help you improve your trading forex trading strategy.
Your trading plan creation process should include:
- Setting trading goals so that you have realistic expectations of returns.
- Assessing your capital at hand and determining how much you will start trading with.
- Deciding how you will analyse the markets.
- Determining the currency pairs you will trade.
- Determining your risk profile. Are you a conservative, moderate, or aggressive trader? Understanding your risk profile will help you create a strategy that will help you succeed.
- Creating an overall forex trading strategy.
The Trading Strategy
There’s no fixed way to trade and what matters is having a strategy that will help you to trade successfully in different situations. Focus on creating a strategy that aligns with your risk profile and applies trading techniques and tools that will help you succeed.
Your strategy should also include risk and money management rules that will help you cut your losses and make sizable gains that offset those losses. Some important rules to have include:
- How much to risk per trade. Most traders generally risk a maximum of 1% to 2% of their capital on a single trade.
- A risk/reward ratio. As a general rule, most traders use a 1:2 ratio.
- Setting stop-losses to limit losses when the market makes an unfavourable move.
- Using take-profit orders to capitalise on favourable market moves without worrying about manually executing the trades.
It’s important to always refine your strategy as you test the market and make trading decisions. Refining your strategy is especially important after you’ve gotten a feel for the market with a demo account and once you’ve determined your risk profile.
Making Your Plan Work for You
After creating your strategy and integrating it with the rest of your plan, it’s vital to always stick to the plan. Sticking to the plan even when the market moves against you is what separates disciplined, successful traders from unsuccessful traders who ignore the plan and trade on a whim.
Starting trading over 10,000 products today
When you understand how the forex market works and you have a robust
trading plan and strategy, you can start trading.
Decide if You’re Going to Buy or Sell
(take a short position or long position)
Once you’ve determined the currency pair you want to trade, you need to know the current price the pair is trading at. All forex is quoted in terms of one currency against another, with each currency pair having a base currency and a quote currency.
The currency that comes first is the base currency and the second is the quote currency.
When trading currencies, you:
Buy a currency pair when you believe that the base currency will strengthen against the quote currency, i.e. the price of the base currency will go up or the quote currency will weaken against the base currency i.e. the price of the quote currency will go down.
Your profits will increase in line with every increase in the exchange rate and you will incur a loss for every point the exchange rate falls below your open level.
Sell a currency pair when you believe that the base currency will weaken against the quote currency or the quote currency will strengthen against the base currency.
Your profits will increase for every point the exchange rate falls and you will incur a loss for every point the exchange rate rises above your open level.
Example: Buying a Pair
Let’s say that the signals in the market are indicating that the EUR will go up against USD. You open one mini lot (10,000 units of EUR/USD), buying with the EUR and then you wait for the exchange rate to increase.
If the EUR/USD is trading at 1.1280, you will have just bought €10,000 which is worth US$11,280. If your prediction is correct and you close the position at 1.1360, you will earn US$80.
Note: Every trade has a cost known as the spread. The spread is the difference between the buy price (ask price) and sell price (bid price) and is counted in pips. In other words, it is the cost of trading. For example, if the EUR/USD buy price is 1.1280 and the sell price is 1.1275, the spread is 5 pips.
The spread charged for a trade is the spread multiplied by the size of the position. For instance, using the example above and the 5 pips spread, your trade would cost $5 (each pip in a mini lot is worth $1).
Add Your Orders
An order is an instruction to automatically trade at a point in the future when prices reach a specific level predetermined by you. A stop-loss order closes out a trade at a price worse than the current market level to minimise losses and a take-profit order closes out a trade at a price that’s better than the current market level to help lock in profits once a price target is reached.
Using stop-losses and take-profit orders is not compulsory but given the volatility of the forex market, understanding and using risk management tools such as these two orders is important.
Example: Stop-loss and Take-profit Orders
If you enter a trade to buy EUR/USD at 1.1280 and place a stop-loss order at 1.1268, you’re limiting your risk on the trade to 12 pips. Once the trade is showing a moderate profit, you can adjust the stop-loss to a position where it protects part of your profits in the trade.
Continuing with the example, assume that after you buy EUR/USD at 1.1280, the price subsequently increases to 1.1324. At this point, you can place a take-profit order at 1.1313, thereby protecting 75% of your existing profit if the market takes a downturn.
Monitor Your Trade
After entering your trade and adding orders, you can track market prices in real-time and attach orders to open positions (like the take-profit order in the previous example). You can also see how much you’ve made when your position closes.
Opening and closing trades is relatively straightforward, however, you need to avoid common pitfalls to ensure that you make sizable profits and minimise losses.
Common Mistakes to Avoid
When Trading Forex
One of the reasons why forex trading is so popular is the leverage offered by forex brokers. You can control large positions with little money and leverage 30:1 is now common in forex. Very large amounts of leverage can wipe away your capital instantly and so it’s important to understand and appreciate the risks and rewards of leverage before using it.
Overtrading refers to when a trader sees opportunities to make money with trading when there really aren’t any opportunities. There are two common types of overtrading:
- Trading with excessive volume. This is usually the result of excessive leverage and the temptation to maximise profitability in one go.
- Trading too frequently. Trading too often puts you at risk of losing more money than you can make. Success comes from making the correct trades not from making lots of trades.
Not Practising with a Demo Account
Heading straight to the live market puts your capital at risk because trading is a skill that requires practice even for seasoned traders. It’s prudent to practice with a free demo account until you have a sound strategy and you’re ready to transition to live trading.
Not Continuing Your Education
The forex market is constantly changing, with no formula or rules to guarantee success. You need to educate yourself regularly to be able to understand the dynamics of this market.
When approached correctly, forex trading works and can be a profitable and rewarding venture. Nonetheless, you need to be willing to put in the work. Learning about forex trading is not very hard but finding winning strategies takes a lot of practice, discipline and patience. Avoiding common trading mistakes and focusing on learning and refining your strategy continuously will help you become a successful trader.