Forex Trading Guide: What Is Forex Trading and How Does It Work?

Forex Trading Guide What Is Forex Trading and How Does It Work

Forex stands for foreign exchange, but I’m not talking about students here. Instead, I want to help you learn how to take advantage of forex trading just like you would when trading stocks.

In fact, forex works a lot like the stock market. The only difference on the surface is that you’re trading currencies instead of shares.

Another difference lies in volume. On most days, trading volume exceeds $5 trillion. It’s a highly liquid investment pool, which appeals to many investors.

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But what is forex trading? And how can you take advantage of opportunities in the market?

You might know that I’m partial to penny stocks, but I’ve also researched many other types of investment vehicles. Each has its own unique set of rules, expectations, and risk levels, so I urge you to learn about them all.

Today, I’ll cover what you need to know about what is forex trading.

What is Forex Trading?

Forex trading, often abbreviated FX, is a global marketplace in which each of the world’s currencies can be traded based on their buying and selling price.

Forex Trading What is Forex Trading
By ImageFlow/Shutterstock.com

The spread — the difference between the buying and selling prices — can be infinitesimal because of the micro changes in currency prices.

If you’ve ever traveled internationally, you understand currency exchange. For instance, when you travel from the United States to Japan, you exchange your U.S. dollars for Japanese yen. Currently, $1 is equal to 109.87 yen.

Currencies on the forex market are traded in pairs. You’ll see the abbreviation for the currency you’re buying next to the abbreviation for the currency you’re selling.

Let’s say, for instance, that you’re trading the euro for the Canadian dollar. The pair would look like this: EURCAD. EUR stands for the euro and CAD stands for the Canadian dollar.

Since forex trading is a highly liquid investment opportunity, trades can happen in fractions of a second. In other cases, buyers hang on to their investments while they wait for a positive swing based on their position.

What is Forex Market?

Forex trading occurs on the foreign exchange market. Like penny stocks, the forex market is completely decentralized. Investors execute trades over-the-counter (OTC) electronically. The market remains open 24 hours a day because when the market closes in one geographic region, it opens in another.

Consequently, it’s an extremely exciting market to watch. Price quotes can change dramatically no matter the time of day, and investors can act quickly when they want to execute a trade to take advantage of a price shift.

How Does Forex Trading Work?

You’ve heard me talk about how much I dislike leverage, but leverage is how forex trading works. Because of its high liquidity, brokers allow investors huge leeway when it comes to executing trades.

For instance, if your broker sets 200:1 trading leverage, you would only have to put up $5 of your trading account money for a $4,000 trade.

Remember that leverage can prove dangerous.

While it might sound like a sweet deal when you want to take advantage of a big expected swing in the forex trading market, you could easily lose considerable funds, especially if you’re using more leverage than you have in your trading account.

Keep meticulous records on your trades so you don’t overextend yourself on any single trade (or on any ongoing trades simultaneously).

Just like in the stock market, price quotes are based on supply and demand. As one currency becomes devalued next to another, you have an opportunity to capitalize on the discrepancy.

An executed trade is called a settlement and is carried out in cash. If you’re selling a currency to someone else, you get the agreed-upon value of the currency’s value based on how much of it you agreed to buy.

How to Start Forex Trading

If you want to begin forex trading, you need an account with a broker. There are numerous brokers online who handle the forex market, but I recommend signing up for free demos with several of them to get a feel for how they operate.

Forex Trading How to Start Forex Trading
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It’s also a good idea to read tons of online reviews. Figure out what people are saying about those brokers before you make a firm decision.

You have to apply with a broker to get an account. The broker will want to know lots of information about you, from your name, address, and phone number to your employment status, net worth, and trading goals.

All of this information will tell the broker whether or not you’re a good fit. It’s also the law in many places for brokers to collect this information, so if it feels invasive, understand that it’s a normal part of the process.

Once you have an account, you can begin trading.

Learn Forex Trading

While it’s possible to jump in and begin executing trades right away, I caution you to wait. While I love trading penny stocks and other investments, I learned before I acted.

Researching forex trading and learning the basics (such as from this article) will make you a more informed trader. You’ll be less likely to lose your cool (and your shirt) to poor investment choices.

Watching the market is an important part of the process. Look for patterns throughout each trading day and pay attention to how investors respond. If you can follow a forex expert’s trades, do so.

Finding a mentor can also help you become more successful at forex trading. There’s no substitute for personalized advice.

Finally, make sure you’re only investing small amounts, especially in the beginning — and especially when using low margins with leverage. Only use 1 percent of your total investment account at a time, at least until you’re more accomplished.

Forex Trading Strategies

Lots of factors can influence forex trading — perhaps more than the stock market. That makes sense since it’s a far more liquid market with more volume.

It’s also a global marketplace in which you’re basing trades on pairs. You have to know the factors that influence the Australian dollar, for instance, as well as the Chinese renminbi, if those are the pairs you’re trading.

Believe it or not, economic climates in countries outside the ones in which you’re trading can also have an impact.

Consider the fact that each country trades goods and services with many others. When trading deals fall through, tariffs rise, or other changes in the market take place, the forex market gets affected.

That’s why I’m going to focus on fundamental analysis as well as technical indicators. They’re both equally important in forex trading.

Let’s look at some of the key factors you need to understand to become good at forex trading.

Fundamental Analysis & Fundamentals Trading Strategies

Fundamentals or fundamental analysis refers to indicators based on economic shifts.

In the stock market, you use fundamental analysis to evaluate a company’s profit margins, P&Ls, debt, liquidity, and other information. The same goes for forex trading.

The difference is that you’re evaluating an entire country — two countries, actually — as well as the global marketplace.

Wars and conflict, for instance, can have an impact on forex trading. Military costs can add up quickly when a country needs to defend its borders or engage in combat on foreign soil. Those costs influence the foreign exchange rates.

You can also look at factors like the country’s unemployment rate. When the unemployment rate increases, the currency value tends to decrease. Citizens are depending more on social services to get by, and there’s less activity in the business sector.

There’s something called sentiment analysis, which refers to how you feel about a given position in the marketplace. For instance, you might think that the Australian dollar is about to lose value, while everyone else seems to take a bearish outlook.

It’s your job to determine whether your sentiment analysis has roots in facts and data. If it doesn’t, you’re trading based on emotion, so you need to step away.

Spend time looking at fundamental analysis to figure out why your sentiment analysis differs from everyone else’s.

Technical Analysis & Technical Indicators

You’ve heard the phrase “history repeats itself,” right? It’s often true.

If you’ve taken a three-mile run every morning for 30 days, you’ll likely continue that pattern over the subsequent 30 days.

You can also see this trend in politics. We expect name-calling, ad hominem attacks, factual errors, and posturing during political elections, and politicians never let us down. The cycle repeats every four years during the presidential elections.

This is the foundation upon which technical analysis rests. It’s actually a lot more complicated, but the basic takeaway is that technical traders believe that historical trends will repeat themselves in the future.

Consequently, they base their trading decisions — in whole or in part — on reading charts.

Forex Trading Technical Analysis Technical Indicators

It isn’t that technical traders ignore fundamentals. On the contrary, they take the position that the fundamentals are reflected in historical graphs.

For instance, if the U.S. dollar has increased in value every time the unemployment rate dips below a certain percentage over the last 10 years, a technical trader might use that indicator to buy U.S. currency to take advantage of the bounce.

By looking at the charts and comparing them, they can find patterns on which to base future forex trades.

You would think, based on these facts, that five forex traders could look at the same set of charts and reach the same conclusions. That’s actually not what happens.

Every trader bases his or her trades on specific indicators and patterns. You’ll develop your own system of evaluating charts, and it might be completely different from mine.

There’s nothing wrong with that as long as your system doesn’t put you in successive losing positions. In that case, you need to reevaluate.

Currency Pairs

The entire forex trading system is built on currency pairs. The base currency goes first and the quote currency goes second.

For instance, the most popular currency pair in the world is the euro and the U.S. dollar. In this case, the currency pair would look like one of these:

  1. EURUSD
  2. EUR/USD

Either way, the euro is the base currency and the U.S. dollar is the quote currency.

Major Pairs

Major pairs are the most commonly traded pairs on the forex market exchange. They consist of EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF, NZD/USD and USD/CAD. These pairs are responsible for about 85 percent of market activity.

They’re also the most liquid trades because of their high volume. If you plan to trade on these currency pairs, you have to pay careful attention to technical and fundamental analysis.

Cross-Currency Pairs

A cross-country pair is simply a currency pair that doesn’t involve the U.S. dollar. In other words, there’s no need to exchange the currency into U.S. dollars to compete the transaction.

Exotic Currency Pairs

As the name implies, exotic currency pairs refer to rare pairs that are rarely traded on the FX exchange. Exotics can change over time as pairs fall into and out of favor based on economic conditions and other factors.

Forex Trading Exotic Currency Pairs
By Pixabay

For instance, EUR/TRY is considered an exotic. It’s the euro as the base and the Turkish lira as the quote.

Many exotics include the U.S. dollar, such as USD/DKK (the Danish krone as the quote currency) and USD/THB (with the Thailand baht as the quote).

When it comes to exotic currency pairs, you’ll want to pay attention to macroeconomic factors. For instance, what does supply and demand look like? How are the countries faring in terms of international relations?

Political instability can give you a false understanding of where an exotic currency pair might go. Be careful with these kinds of trades, and if you start to lose, get out quickly.

Key Forex Terminology

I’m a big believer that you can’t learn to trade in any market without first understanding the terminology. Jargon floats around the forex market like flies, and if you can’t keep up with the conversions or literature, you’ll get lost fast.

We’ve already talked about the different types of currency pairs, so I won’t go over those again. You’re also familiar with forex trading and how it works. There are two key terms, however, that you need to know backward and forward before you jump into trades.

Long Position vs Short Position

Remember the currency pairs I talked about earlier? This is where they come into play.

For the sake of our example, let’s look at a trade on EUR/USD.

When you take a long position on EUR/USD, you’re betting that the base currency (EUR) will go up in price in comparison to the USD. In other words, you’re going long on EUR.

It’s also called a buying position because you eventually want to sell your EUR for a profit because of the expected rise in value.

But what if it’s the other way around? If you take a short position on EUR/USD, you’re betting that the euro will decrease in value compared to the U.S. dollar.

Forex trading is unique because you are, in effect, always going long because of those currency pairs.

In other words, even though you’re taking a short position in the last example, you’re actually going long on USD. It’s different from the stock market, which typically revolves around the shares rather than the money used to buy or sell them.

You don’t often hear of a stock trader who’s going short say, “I’m going long on the USD,” even though that’s the case because he or she is using U.S. dollars to buy or sell shares.

Forex Trading Charts

I mentioned charts before, but I want to give them a little more attention. If you’re going to get started with forex trading, you need to know how to read charts, even if you’re planning to focus on fundamental analysis.

The most common charts you’ll find are candlestick, bar, and line charts. Each offers benefits and drawbacks depending on how you like to visualize market patterns. I’m partial to candlestick charts because they make the most sense to me.

You might prefer bar or line charts, so don’t just blindly follow my preferences.

Let’s look at each type of chart individually to understand what they tell you.

Candlestick Chart

A candlestick chart looks something like this.

As you can see, each bar looks like a candlestick.

From the candlestick chart, you can glean four pieces of information about a currency’s behavior: opening price, highest price, lowest price, and closing price.

The wide section of the chart indicates the span between opening and close. A black body indicates that the closing price was lower than the opening price. A white body indicates the exact opposite.

The wicks (also called shadows) show you highs and lows for a day’s trades. You can make inferences based on the difference between the opening closing prices (the length of the wicks).

Bar Chart

A bar chart is similar to a candlestick chart, but not quite as data-intensive. A typical bar chart looks like this:

The top of the bar indicates the high price while the bottom indicates the low price. In between, you have the opening and closing prices represented by connected horizontal lines to the left and right respectively.

Line Chart

The line chart is probably the one you’re most familiar with. It’s also the simplest, but it doesn’t provide as much insight as candlestick charts.

Many beginning forex traders start with line charts. They’re extremely easy to read, which makes them ideal for learning technical analysis.

As you progress, you can check out other bar types to figure out if they make more sense.

It’s also the easiest chart to overlay with other charts. You can see differences in weekly behaviors going back months or even years to understand historical performance.

Foreign Exchange Risk and Benefits

Every investment comes with inherent risk. Don’t let anyone tell you different.

If you’ve followed my career for any length of time, you know I’m opposed to high-risk plays. I want to keep my money safe and grow it when the timing seems right.

Forex Trading Foreign Exchange Risk and Benefits
© 2018 Millionaire Media, LLC

I encourage you to follow the same philosophy with Forex trading.

While high volume and liquidity make forex trading incredibly lucrative for the savvy investor, it also brings along additional risk. The market can move so fast that you lose thousands of dollars without realizing a change occurred in the market.

Remember, you’re investing along with hedge funds and big financial institutions that use high-tech software to make rapid-fire decisions. If you’re not careful, you can lose big to them.

Is Forex Trading Worth It?

Forex trading is worth it if it brings you joy and makes you money. That’s it.

I recommend trying it for a short period, such as six months. Make short-term trades to get a feel for the market, and limit your investments to 1 percent of your trading account.

Resist the urge to use tremendous amounts of leverage. You can get yourself in trouble that way. Remain conservative in every play you make.

How To Become a Forex Trader Expert

If you want to become an expert in the forex market, you’ll have to devote significant time to education. The more you learn about the market and its intricacies, the smarter your plays will become.

I’m not talking about a weekend immersed in books. I’m talking about months or even years of hard-core studying to prepare yourself. Otherwise, you’re setting yourself up to fail.

Who is Tim Sykes and What Is the Trading Challenge?

I’m Tim Sykes, one of the most well-known traders in the world. My reputation is built on the fact that I turned just over $12,000 into several million dollars primarily by trading penny stocks.

Forex Trading How To Become a Forex Trader Expert
© 2018 Millionaire Media, LLC

You can say that pennystocking is my bread and butter.

However, I’m also known as a teacher. I created the popular Trading Challenge, which allows people like you to learn from me and my most successful students. Many of my students have generated five, six, and even seven-figure profits by following what I teach.**

It doesn’t happen overnight, but it’s rewarding and fruitful.

The challenge involves learning everything you can from my extensive collection of written and video assets. You’ll also join an active community of traders just like you who share their trades, encourage one another, and learn from each other.

Conclusion

Forex trading is one of the most popular investment choices in the world. It’s also extremely lucrative if you play it right.

Of course, it comes with risk, but that’s true of any investment.

Learn the key forex terminology, study trading charts, and understand the risks and benefits. If you’re interested in becoming a better trader regardless of the investment vehicle, consider applying for the Trading Challenge. I’m always looking for my next success story, and that person could be you.

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