In a single line, the foreign exchange/forex/FX market is a global marketplace for exchanging national currencies.
It is the largest market in the world and the reason is the worldwide reach of trade, commerce, and finance.
Currencies trade against each other as exchange rate pairs. For example, EUR/USD is a currency pair for trading the euro against the U.S. dollar.
Index of Content
What is Forex Trading?
Forex trading is the exchange of currencies to profit from fluctuations in the exchange rate. To open a trade, a trader must choose a currency pair and the direction in which he expects the exchange rate to move. As the exchange rate between the two currencies changes, the trader can close the trade for profit or loss.
Currency pairs are an expression of the value of one currency in terms of another currency. For example, if USD/BRL is at 1/4, we are saying that 1 US dollar is equal to 4 reais.
In Forex trading, common currency pairs include GBP/USD, AUD/USD and EUR/USD. If you buy GBP/USD you are effectively buying the GBP and selling the dollar at the same time. When you close your position, you are selling the pound sterling you bought and buying back the dollar.
If the pound sterling strengthens against the dollar over this period, you will make a profit — as you can now pick up more dollars than you originally sold. ↑
How do you trade Forex?
To start trading, a participant will have access to a market where currency pairs can be bought and sold. A Regulated Forex Broker is the only way to access this market, and depending on how the broker is set up, the broker will either hold the market (market maker) or offer a direct connection to the international market (direct market access).
In any case, the participant will need to create a trading account with a broker and set up a trading platform to get started.
Forex trading is usually performed through a product called Contract for Difference (CFD) with your broker. This is a contract between you and your broker to pay any difference in the price of two currencies between the opening and closing of your transaction.
This is very useful as it means that neither you nor your broker need to be in possession of any currency. ↑
What is the difference between
trading Forex and trading stocks?
When we think about investing, we often hear about stock trading in the stock market and mistakenly include Forex trading in the same group. Forex trading is a form of CFD trading and differs from investing in stocks in several ways.
Currencies are traded in pairs, while stocks are physical and bought with cash. Trading currency pairs means that as you buy one pair, you are selling the other at the same time. In this simultaneous buying and selling of currencies, it is the relative value between the two currencies of the pair that generates the profit.
The Forex market is a decentralized over-the-counter exchange, where all transactions and participants are confidential — unlike the stock market, which are centralized and public records of buyers and sellers are maintained.
An attractive element of currency trading is the low cost of entry. In order to make substantial profits, stock brokers use large amounts of capital, which is obviously not an option for investors with limited income. Here is my top picks stock broker in 2022.
Forex trading is not an investment. Any transaction on the Forex or CFD market does not give the trader partial ownership of the asset being traded. In this case, the trader is speculating on the future value of the assets involved in the trade. Thus, calling it an investment would be incorrect, as participants in this market are only speculating on the value of assets.
Currency pairs are leveraged products. Leverage allows the trader to make much larger trades than their account balance allows by borrowing additional funds through the broker. Leverage means that all profits are magnified, as are any losses.
Traders are responsible for losses of the total amount traded — as such, using high amounts of leverage can lead to significant losses. ↑
What is leverage?
Forex CFD trading is usually leveraged. This means that the trader only contributes a small amount of the trade value and borrows the rest from a liquidity provider (usually large financial institutions or banks that work with their broker).
This has two effects: first, the cost of entry to the Forex market remains low; second, all profits are magnified, but so are losses. Traders are responsible for losses of the total trade amount. ↑
How do beginners learn Forex trading?
Beginners are advised to learn to trade using a Demo Account before depositing money into a real account. We have a full guide of practical advice to get you started and more tips on how to make your first trade.
It will take some time and persistence to learn how to trade CFDs successfully as traders need to study the various components and strategies to make trading more successful. ↑
How to choose the best Forex strategy?
There are many Forex trading strategies and you won't be successful using just one. The best trading plan will involve multiple strategies, all working together.
At the most basic level, Forex trading strategy will be based on fundamental analysis (analyzing broader economic trends and geopolitical events — for example, Brexit and its effect on GBP/USD or the release of US non-farm payrolls and its effect on EUR/USD) or technical analysis (analyzing historical price action on charts).
Technical analysis in particular is a broad field and there are many strategies that rely on it in various ways. Here are the most used trading indicators you have to know.
Other factors to consider when planning a Forex strategy are the time of day (and how it affects volatility), order types (such as a breakout stop loss — possibly the most valuable part of any strategy), and trading software/bots. automated trading (which can track movements in the market that you might miss).
Before trading you have to know how to use them and build a trading plan together. ↑
How much do I need to start trading Forex?
Trading accounts can be opened for as little as 5 USD, but the recommended deposit is between 200 USD and 500 USD. A minimum deposit of 200 USD is recommended because your account balance will determine how much leverage you can use.
And if this balance is too small, it will be impossible to trade with leverage or your trades will be closed due to an account with insufficient balance to cover losses. ↑
What are the risks of Forex trading?
Trading Forex and CFDs carries significant risk which includes losing all of the money in your trading account in a short period of time. 75-90% of investors lose money trading these products. You should consider whether you understand how CFDs work and whether you can afford the high risk of losing your money. The main risks of trading are:
Risk 1: The Forex market is often extremely volatile. After all, it is because of this volatility that we can profit from transactions. However, the market can move very quickly, and that can mean that a deal can go against you in a short period of time. If you are trading, you must stay active and keep an eye on your trades at all times.
Risk 2: The Forex market is not something you can predict. There are too many factors and players in this market for it to be entirely predictable. Traders need to set a win-loss goal where you account for some losses and use some strategy to minimize them.
Risk 3: Trading CFDs requires the use of leverage. Leverage is a tool used in trading to amplify your profits, but it also amplifies your losses, which are automatically deducted from your trading account. Your account balance can be totally wiped out with a single bad transaction.
Risk 4: In some cases, interest may be charged on your trades. For example, interest may be charged when you keep trades open overnight and a tom-next adjustment is applied, and this may mean that your broker will withdraw funds from your account to pay this fee. ↑
What is the best time to trade Forex?
The biggest profits from Forex markets are made during periods when the market is most volatile. So it makes sense for traders to stay active during these periods. The most volatile periods are when the big markets (Sydney, Tokyo, London and New York) are open.
Hence, investors should create a trading plan that takes these times into account and plan trading sessions when Forex markets are open. ↑
Do Forex Investors Pay Taxes?
Forex earnings are not tax-exempt income, and all profits are taxable even if your brokerage and capital are overseas.
Traders are expected to report their profits like any other income, either as an individual or as a company. ↑
Is Forex trading right for me?
By now you should know that it is high risk, that you need to find a reputable broker you are comfortable with, and set the amount you want to put into your brokerage account. To trade Forex you must commit to learning, and so you must be ready to:
- Compare the best brokers to find one that suits you.
- Read educational resources and learn everything you can.
- Understand how the Forex market and CFD trading work.
- Learn the software and tools that will power your trading.
- Be prepared to lose any money you put into an account.
- Do not deposit money that you cannot afford to lose.