Foreign exchange, known as forex, is where all world currencies are traded, and is the world’s most traded market. Due to the flexibility and relatively low deposit required to open an account forex trading it has grown in popularity with traders, but it’s important to understand the benefits as well as the disadvantages before you begin. We’ll look at these in detail, as well as explaining how forex works.
Exactly how does forex work?
The method of forex trading is quite simple, but it requires understanding and commitment to succeed. Explained simply, Forex involves the exchanging of one’s country’s currency for another, with the intention of selling at a profit later on. It is also quoted in what’s called ‘currency pairs’, such as EUR/US. Forex trading is dependant on fluctuations in currency exchange rate, which is influenced by factors such as geopolitical events, inflation and industrial production. High inflation rates lower currency value, which gives the trader the opportunity to buy in. Sudden geopolitical ups usually increase the value, giving the trader the chance to sell.
It sounds like the stock market – what’s the difference?
Even though forex trading sounds like stock trading (buy when values are down, and sell when they are high) there are some key differences. The differences are between the equities market and the forex market are as follows:
- Traders can pick and trade as much currency as they can afford – there’s no minimum quantity for trade, as with stocks.
- Trades don’t need to invest a lot of money in forex at once, unlike stocks. Traders are able to get started with a little initial investment and then build up slowly.
- Traders pay only the spreads involved in the bid/ask process; forex firms usually don’t charge commissions, unlike stock exchange firms.
- Traders are in control of when and how to trade, within a 24-hour market day.
- Traders can trade on estimated currency leverages, though this has to be done carefully so as not to lose money. This cannot be done with stocks.
Advantages and disadvantages to forex trading
As already discussed, what makes forex trading so popular is the initially low deposit required (meaning that it’s more accessible to novice traders), as well as the flexibility and ease of trading. With forex, you’re able to trade around the clock and throughout the week, unlike the traditional stock market which has set opening hours. This enables traders to make the most of currency fluctuation opportunities. This makes it a good option for those who already have a full or part time job and rely on trading as more of a hobby or means to top up their income. It’s also extremely accessible, as traders are able to trade remotely from laptops or even mobile phones.
The downside to forex trading is that, like any trading market, it does carry a high degree of risk. The combination of using margins and the volatility of the foreign exchange market means that traders are vulnerable to making a substantial loss on even a relatively small price fluctuation in a currency. It’s incredibly important the individual has an in depth understanding of the currency market, recognising and keeping abreast of events that influence it, so that they’re able to make informed trades. This is sometimes not a realistic requirement with those new to trading. Without this basis of knowledge the trader is far more likely to make a loss.
Do’s and don’ts if considering trading in the Forex market
The forex market sees an average volume of 4 trillion US dollars in trade, over a 24-hour market action. This makes forex indubitably the largest financial market in the globe. Due to the simplicity of it’s trading terms forex has a reputation as being easy, but it’s important to understand that there is risk involved. It’s still easy to lose money on forex, particularly if you lack experience. To help someone new to Forex, let’s look at some do’s and don’t’s while trading in the forex market:
- Do your due diligence: in order to make informed trades it’s vital to study the foreign exchange market’s history, as well as the economic and geopolitical factors that affect currencies. Learn to constantly adapt to changing market conditions, world events and regulations.
- Start with a practice account: look for a demo account from an established broker (such as CMC Markets) so that you’re able to practice your skills without having to invest initially. This way, you’ll be able to gain understanding of how forex works, practice before trading with real money and establish whether you are actually any good. This is incredibly important to minimize your chances of making a loss.
- Get a good broker: be sure to open an account only with a registered firm that’s a member of the National Futures Association (NFA) and the U.S. Commodity Futures Trading Commission (CFTC). Only deal with a legitimate broker, researching your trader’s commissions, spreads, account funding, offerings and withdrawal policies before signing up.
- Watch your analysis chart: delete from your trading chart any such analysis technique that does not help enhance trading performance. Configure your chart with the right colors so that you can quickly interpret changing market conditions and respond accordingly.
- Start small and humble: stick with your practice account until you’re confident enough to trade live, and then set out a trading plan. Learn from mistakes made by other traders. When you finally go live, start with minimum amounts until you have gained more experience and are confident in your abilities. Set a limit on daily losses so trading for the session closes automatically when that figure is reached. Maintain a daily trading journal, including your emotional state at the time of trading, to learn from your experiences.
- Consult a tax specialist: build a relationship with a tax professional and obtain guidance on forex taxation, regulations and changing laws.
- And finally, never bet more that you can afford to lose: this is the number one rule to follow with any trade – never bet more than you can afford to lose. Forex trading can be immensely profitable and rewarding, but you can stand to lose large sums of money, particularly if you put forward more than you can afford to lose.
Hope this article will help you to know more about why many forex traders lose money.