Why Trade Forex?

With huge daily trading volumes, forex trading is as popular as ever. The forex market is a highly liquid, global market and offers traders many advantages.

24 Hour Market. The Forex market is worldwide so you can trade when you choose, whenever the markets are open – 24 hours a day, five days a week.

Global Access. Anyone across the world can participate in the FX market which includes all world currencies.

High Liquidity. Liquidity is the ability of an asset to be converted into cash quickly and being able to move large amounts of money into and out of foreign currency with minimal price movement.

Low Transaction Costs. These are usually included in the price with Forex and are known as spreads. The spread is the difference between the buying and selling price.

Leverage. With forex trading, you can trade the market using leverage which is the opportunity to trade more money than what you have in your account.
For example, if you trade with 100:1 leverage, you could trade $100 on the market for every $1 that is in your account. This, in essence, means you would be able to control a trade of $100,000 with just $1,000 of your own capital.

Profit Potential. The Forex market has no restrictions regarding directional trading which means you can profit from both falling and rising currency pairs.

How Does Forex Trading Work?

Forex trading works by buying one currency and selling another at the same time. If the currency you buy increases in value against the currency you have sold, the position can be closed for a profit. Otherwise, you will make a loss. For example, take EUR/USD (Euro vs US dollar). A trader will seek to profit from the fluctuations in the exchange rate between these currencies. If they think that EUR will strengthen against the USD and buy EUR, they are also selling USD on the expectation that the exchange price will go up in value.

If their expectations are correct, the trader stands to make a profit. However, if proven wrong and EUR depreciates relative to USD, this will leave the trader with a loss.

Forex Basics

Newcomers to forex trading can find some of the new phrases and concepts a little tricky to master in the beginning. It is therefore important to be aware of at least some of the most basic ones before setting out to trade on a real account.

Lots

The size or volume of a trade is usually calculated in lots. It is a trading term used to describe the size of a trading position with reference to a standard of 100,000 units of the base currency in a forex trade.

Points, Pips & Ticks

Points, pips and ticks are terms used to describe changes in asset prices. Here is a further explanation:

Points
A point is the smallest price increment change that can occur on the left side of the decimal point. The fifth decimal place of most currencies and the third decimal place of the Japanese yen is called a point. Points give traders a more accurate indication of price movements and are a commonly used term amongst traders to refer to price changes in their chosen market.

Pips

A pip is is a very small measure of change in a currency pair in the forex market. Each pip is worth roughly one unit of the currency in which an account is denominated and is usually the fourth decimal place of the quote currency in a pair. Pips help traders calculate profit or loss in relation to the number of pips that a currency rises or falls, compared with the price at which it was bought or sold.

Ticks

As explained, a pip is the smallest increment by which a currency can change in value whereas a tick is the increment by which it actually occurs. A tick may be anywhere on the right side of the decimal point. How many ticks are in a point is determined by how many ticks it takes to increase the price on the left side of the decimal by one.

Spread

The spread is the difference between the buy and sell prices quoted for a forex pair and is traditionally denoted in pips.
Leverage

Leverage enables traders to enter into trades that exceeds the value of their initial investment and is expressed as a ratio.

Margin

Margin is the percentage of a trader’s account balance that is required to secure a position. The more leverage a trader uses, the less account balance is required as margin. Forex trading offers high leverage so that for an initial margin requirement a trader can accumulate and control a large amount of money.

Risk Management

Risk management can make all the difference when it comes to making a success of forex trading. Without the appropriate risk management in place, a trader can deploy the very best trading system but still go on to fail. Hence, once real money and emotions come in, risk management is very important.

Risk management involves the implementation of several strategies to control your trading risk. It can be done in various ways such as limiting your trade lot size, ​knowing exactly when to take losses or by diversifying your risk by trading markets which are non-correlated i.e. those not impacted by the same events.

Stop-Losses

An effective form of risk management is controlling your losses i.e. knowing when to cut your losses on a trade. Stop-losses are one of the most important aspects of risk management and are designed to reduce losses and protect the trader’s account from full exposure to the markets. A stop-loss closes the trade at a price defined by the trader, usually when the trade is in a losing situation. Using a physical stop-loss helps traders clearly define the amount of risk or loss they are willing to tolerate. Stop-losses can also be moved while a trade is open to lock-in profits.

More experienced traders are also known to use mental stop-losses, a price level at which the trader decides he would rather get out of an open position. At this point, the trader will manually execute the trade. This type of stop-loss is best used by more experienced traders as less experienced traders could put their full account balance at risk.

Use Correct Lot Sizes

There is no exact science when it comes to using the correct lot size, but in the beginning, smaller is better. Every trader will have their own tolerance level for risk and the best advice is to be as conservative as you can. It is important to understand the risk of using larger lots with a small account balance and that keeping a smaller lot size will allow you to stay flexible and manage your trades with logic rather than emotions. Generally speaking, traders do not risk more than 5% – 10% of their total account equity on each trade. The whole concept of risk management is to stay in trading long enough to recover any losses.

Reward/Risk Ratio

The reward/risk ratio is an important concept in risk management as it will help determine a trader’s success or failure in trading. When a trader first sets out, losing trades will frequently outnumber winning trades according to a trader’s ability and strategy used, so to survive in Forex trading it is vital that a healthy reward/risk ratio is maintained.

As a basic example, if a trader places a trade and decides to risk $500 and take profits of $500, this is a reward/risk ratio of 1:1. However, if you take into account that there may be more losing than winning trades, a reward/risk ratio of 1:1 will deplete your account very quickly. Working to a strategy of every second trade being successful i.e. a reward/risk ratio of 2:1 will keep your account balance growing thus 2:1 as a minimum is recommended. Higher reward/risk ratios tend to result in fewer wins but the profits will usually compensate for this.

Risk management is thus all about keeping your risk under control. The more control you exercise, the more flexible you can be when the need arises. By limiting your risk, you ensure as much as possible that you can continue trading when things do not go according to plan. Overall, using effective risk management make all the difference towards becoming a successful forex trader.

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