Forex, or foreign exchange, is a network of buyers and sellers, who transfer currency between each other at an agreed price. It is popular for its greater chance of high profits due to the high volatility of the price of currencies, which also brings higher risks.
What is Forex?
The foreign exchange market is where currencies are traded. Currencies are important to most people around the world, whether they realize it or not, because currencies need to be exchanged in order to conduct foreign trade and business.
There are 3 types of Forex market:
Spot forex market: the physical exchange of a currency pair, which takes place at the exact point the trade is settled – ie ‘on the spot’ – or within a short period of time
Forward forex market: a contract is agreed to buy or sell a set amount of a currency at a specified price, to be settled at a set date in the future or within a range of future dates
Future forex market: a contract is agreed to buy or sell a set amount of a given currency at a set price and date in the future. Unlike forwards, a futures contract is legally binding
The forex market is run by a global network of banks, spread across four major forex trading centres in different time zones: London, New York, Sydney and Tokyo. Because there is no central location, you can trade forex 24 hours a day.
Currencies are traded as pairs, and the movement of currency pairs measure the value of one currency against another. For instance, the EURUSD currency pair measures the value of the Euro against the US dollar. When the value of the pair increases, this means the value of the Euro has increased against the value of the US dollar. When the value of the pair decreases, this means the value of the US dollar has increased (or the value of the Euro has fallen).
By trading Forex and CFDs, traders can make a profit off of these currency movements.
How to trade Forex?
Trading Forex is not as difficult as people think, but it takes time and efforts to become a successful trader from a beginner. The following steps are essential for you to trade Forex:
Step 1 Choose a currency pair
Decide which currency pair you wish to trade. With so many currency pairs to choose from, picking a right trading opportunity is essential. OCL’s technical and fundamental research tools can help you spot currency trading opportunities to suit your trading style. We recommend that you take your time to understand the amount of price volatility associated with the currency pair to help manage your risk.
Step 2 Decide on the type of FX trade
Once you have picked a market, you need to know the current price it is trading at. All forex is quoted in terms of one currency versus another. Each currency pair has a ‘base’ currency and a ‘quote’ currency. The base currency is the currency on the left of the currency pair and the quote currency is on the right. Simply to say, when trading foreign currencies, you would:
1. BUY a currency pair if you believe that the base currency will strengthen against the quote currency, or the quote currency will weaken against the base currency. Your profits will rise in line with every increase in the exchange price. For every point the exchange price falls below your open level, you will incur a net loss.
2. SELL a currency pair if you believed that the base currency will weaken in value against the quote currency, or the quote currency will strengthen against the base currency. Your profits will rise in line with each point the exchange price falls. For every point the exchange price rises above your open level, you will incur a net loss.
Step 3 Decide to buy or sell
The first price is the sell price (known as the bid) and the second price is the buy price (also known as the offer). The difference between the buy price and the sell price is known as the spread, and is basically the cost of the trade.
Step 4 Adding orders
An order is an instruction to automatically trade at a point in the future when prices reach a specific level predetermined by you. You can utilise stop and limit orders to help ensure that you lock in any profits and minimise your risk when your respective profit or loss risk targets are reached. Given the volatility in FX markets, using and understanding risk management tools such as stop-loss orders is essential.
Step 5 Monitor and close your trade
Once open, your trade’s profit and loss will now fluctuate with each move in the market price. You can track market prices, see your unrealised profit/loss update in real-time, attach orders to open positions and add new trades or close existing trades from your computer or app on your smartphone and tablet.
Step 6 Closing your trade
When you are ready to close your trade, you simply need to do the opposite of the opening trade. Supposing you bought 3 currency pairs to open, you would sell 3 currency pairs to close. By closing the trade, your net open profit and loss will be realised and immediately reflected in your account cash balance.
Why Trade Forex?
Forex trading is attractive because of its following benefits:
24 Hour trading, 5 days a week
No commissions or hidden costs
Flexible and no limitations
Leverage helps you earn more with less money
Unmatched high liquidity
A wide range of tradable markets
Risks and money management
Forex trading brings an opportunity of high margin, but it also comes along with high risk. Here are 5 important
Forex risk management tips to help you manage your investment and reduce your risk.
Learn to manage your investment in Forex
The Foreign Exchange market is a very volatile and unpredictable market, so it’s better to trade “conservative amounts” from your disposable income. It might sound obvious, but the first rule in currency trading, or any other kind of trading for that matter, is to only risk the money you can afford to lose. Many traders, especially beginners, skip this rule because they assume that it “won’t happen to them”. Similar to gambling at a casino, you wouldn’t take all the money you have to the casino to bet on black. It’s the same with trading – don’t take unnecessary risks by using money you need to live.
Make a Forex trading plan
Have a Forex trading plan and stick to it in all situations. A trading plan will help keep your emotions in check and will also prevent you from over-trading. With a plan, your entry and exit strategies are clearly defined - and you know when to take your gains or cut your losses without becoming fearful or greedy. This brings discipline into your trading, which is essential for successful Forex risk management. To properly manage your Forex risk, you need a trading plan that outlines:
When you will open a trade
When you will close it
Your minimum reward-to-risk ratio
The percentage of your account you are willing to risk per trade
It stands to reason that the success or failure of any trading system will be determined by its performance in the long term. So be wary of apportioning too much importance to the success or failure of your current trade. Do not bend or ignore the rules of your system to make your current trade work.
Make good use of risk management tools and techniques
Control your risk with a stop loss
A stop loss is a tool to protect your trades from unexpected shifts in the market. Simply, it is a predefined price at which your trade will automatically close. So if you open a trade in the hope that an asset will increase in value, and it decreases, when the asset hits your stop loss price, the trade will close and it will prevent further losses. (Just note that stop losses aren't a guarantee - there can be cases where there are gaps in prices when an asset won't hit the stop loss, meaning the trade doesn't close.)
There are different types of stops in Forex. How you place your stop loss will depend on your personality and experience. Common types of stops include:
Chart stop (technical analysis)
Limit your use of leverage
Leverage, in a nutshell, offers you the opportunity to magnify profits made from your trading account, but it also increases the potential for risk. Your level of exposure to risk is therefore higher with a higher leverage. If you are a beginner, avoid high leverage. Consider only using leverage when you have a clear understanding of the potential losses. If you do, you will not suffer major losses to your portfolio - and you can avoid being on the wrong side of the market.
Use take profits to secure profits
Once you have clear expectations, one way to secure your profits is by using a take profit. This is a similar tool to a stop loss, but with the opposite purpose - while a stop-loss is designed to automatically close trades to prevent further losses, a take profit is designed to automatically close trades when they hit a certain profit level.
You would set your take profit at your target profit level (let's say, 40 pips), and your stop loss would be half that distance from the opening price of your trade (in this case, 20 pips).
Diversify your Forex portfolio
A classic risk management rule is not to put all your eggs in one basket, and Forex is no exception. By having a diverse range of investments, you protect yourself in cases where one market might drop - the drop will be compensated for by other markets that are experiencing stronger performance.
With this in mind, you can manage your Forex risk by ensuring that Forex is a portion of your portfolio, but not all of it. Another way you can expand is to exchange more than one money pair.
Prepare for the worst
No one can predict the Forex market, but we do have plenty of evidence from the past of how the markets react in certain situations. What has happened before may not be repeated, but it does show what is possible. Therefore, it's important to look at the history of the currency pair you are trading. Think about what action you would need to take to protect yourself if a bad scenario were to happen again.
Learn to master your emotion
Forex traders need to have the ability to control their emotions. If you cannot control your emotions, you won't be able to reach a position where you can achieve the profits you want from trading.
When a trader realises their mistake, they need to leave the market, taking the smallest loss possible. Waiting too long may cause the trader to end up losing substantial capital. Once out, traders need to be patient and re-enter the market when a genuine opportunity presents itself. Or traders who are emotional following a loss might make larger trades trying to recoup their losses, but increase their risk as a result. The opposite can happen when a trader has a winning streak - they might get cocky and stop following proper Forex risk management strategies.
Ultimately, don't become stressed in the trading process. The best Forex risk management strategies rely on traders avoiding stress, and instead of being comfortable with the amount of capital invested.
Olikriet Capital is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Olikriet Capital or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
Olikriet Capital does not endorse or offer an opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and Olikriet Capital shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.