Trading the forex markets is challenging. The markets gyrate consistently, trying the patience of even the most seasoned traders. Intra-day swings can generate losses that, in many cases, scare the novice trader out of a position. However, there are several things you can do as a trader to help mitigate risk while learning more about how the forex markets work. Here are five forex tips for beginner forex traders.
Learn About Forex Pairs and Forex Trading
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The securities that are traded in the forex markets are forex pairs. Instead of one asset, such as the S&P 500 index, you are trading the value of one currency relative to another. The exchange rate represents the value of a currency pair.
Two key exchange rates are prevalent in forex trading. The first is called the spot rate. The spot rate is the rate you will trade when you deliver the currency you sold to a counterpart two business days following the transaction date. If you want to deliver your pledged money for a period beyond two business days, you would need to transact in the forward market. The difference between the spot and forward rates is that the forward rate adds or subtracts forward points. Forward points are basis points added or removed from the spot rate to incorporate the interest rate cost of carrying.
What are the Major Currency Pairs?
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The forex market is a worldwide market. People from around the globe need to exchange local currency for another currency for several reasons. If you are going on a vacation in a different country, you might need to exchange your local money for the currency of your holiday destination. A treasurer for a company might have assets in another cash that they need to exchange for local currency for accounting purposes.
When you trade in the forex markets, you want to ensure that you trade a liquid currency pair. Liquidity means that you can enter and exit and not pay away the farm to do so. The liquidity of a currency pair can be evaluated by looking at the bid-offer spread. The bid-offer spread is the difference between the buying and selling prices.
The most liquid currency pairs are the major currency pairs. These currency pairs usually have the tightest bid-offer spread. The major currency pairs consist of the US dollar, Euro, British Pound, Swiss Franc, Japanese Yen, Canadian Dollar, and Australian Dollar. For one of these currencies to be considered a major currency pair, the counter currency needs to be the U.S. dollar. About 85% of the global currency trading volume is through the major currency pairs. The benefit of trading these currencies is the liquidity nearly around the clock.
Educate Yourself on Strategies
After you have had a chance to evaluate the types of currency pairs that are actively traded, you want to educate yourself on different trading strategies. Most of the analysis done in the forex market is either fundamental or technical analysis. Fundamental analysis studies the macro events that can impact the future direction of a currency pair, which could include evaluating the interest rates in a specific currency or the trade flows that happen each month. Many forex traders will track the economic releases in many major currency economies. Additionally, jobs and inflation data, along with economic GDP, are economic variables that can move a currency pair.
Another type of popular analysis is technical analysis. Technical analysis studies past price movements to attempt to predict future price movements. Technical analysis consists of evaluating support and resistance levels and learning about repetitive price patterns. You might also want to know about trend-following strategies and momentum. Traders will also employ oscillators such as the relative strength index (RSI), which can help them decide when a currency pair is overbought or oversold.
Practice Using Different Instruments
Once you have learned about the different types of analysis used to generate a trading strategy, you might want to practice trading using a demonstration account. To find an environment where you can practice trading, you need to find a reputable broker that provides access to a demonstration account. Some brokers will provide access to their forex trading through contracts for differences (CFDs), while others might use futures contracts, ETFs, or over-the-counter currency transactions. You want to find a mechanism that is easy for you to understand and practical to your trading strategy.
The benefits of practicing your trading strategy in a demonstration environment are enormous. Not only can you decide if the platform is right for you, but you can also see if your strategy will work in real-time. In many instances, your strategy might work in theory, but could become difficult to manage when you start to practice.
Learn About Margin
Before you place your first trade, you should understand margin and leverage. Leverage is using capital from your broker to enhance the size of your trading position. To accomplish this, you will need to open a margin account. The collateral that you would use is the securities you are trading. Your broker only will care that the equity in your account is large enough to cover your losses. Remember, leverage cuts both ways. You can make a lot and also lose a lot. What is important to understand is your broker will not cover your losses. If the equity in your account drops below a specific predefined level, your broker will ask you to add money. This process is called a margin call. If you don’t quickly add additional capital, your broker will have the right to liquidate your positions.
Summary
The upshot is that there is plenty to learn before you start trading. You want to learn about currency pairs and which ones are the most liquid. It’s helpful to design a trading strategy and then practice using the strategy in a demonstration environment before you risk real capital. You also want to become familiar with margin and leverage to understand the ramifications of using these tools before you begin trading.