There are many financial markets in the world, such as the stock, bond, and commodities markets, but few of them can compare to the Forex market in terms of daily turnover, trading hours, and opportunities. The Forex market is the largest financial market in the world and is open around the clock, from Monday to Friday. In this article, we’ll provide a Forex trading tutorial for new traders who are interested in joining this exciting market.
Forex tutorial: What is Forex trading?
Forex is the market of the world’s currencies. Being an over-the-counter market, there are no centralised exchanges like in the case of the stock market. Instead, currencies are traded during various Forex trading sessions that span from Sydney in Australia, to New York in the United States. Forex traders buy a currency if they anticipate that its price may rise, and short-sell a currency if they believe its price could fall, making a profit from the difference in the entry and exit price.
In order to start trading on Forex, all you need is a computer with internet access, a trading platform, and a brokerage account. The trading platform is a type of software used to analyse the market and place market orders, and can be downloaded directly from your broker’s website once you open an account. Signing up for a brokerage account doesn’t take more than a few minutes, and most brokers offer demo accounts which can be used to practice trading in a risk-free environment.
In addition to a brokerage account, you’ll also need to learn what the Forex market is and how to make trading decisions. This Forex tutorial covers all the basics you need to know if you’re a beginner to the market. So let’s start right away with the history of the Forex market.
History of the Forex market
After World War II, countries needed stable currencies to restore their infrastructure and spur economic growth. As a result, the Bretton Woods agreement established a fixed exchange rate regime among major currencies and the US dollar, which in turn was pegged to the price of gold. The US government had to devalue the US dollar a few times, before the Bretton Woods agreement came finally to an end in 1973.
As a result, major currencies began floating again and the Forex market with freely floating currencies was born. However, only large institutional players could trade on the Forex market at that time, but advancements in technology have made Forex available to smaller retail traders as well.
The daily market turnover has been on the rise ever since, and reached $3.9 trillion in 2010, up from $590 billion in 1989. Today, the Forex market trades around $5 trillion a day.
The retail Forex market, as we know it today, has started growing in the last few decades with the advancement of internet and technology. It’s estimated that retail traders account for around 5% of the $5 trillion daily turnover, which still equals a respectable $250 billion a day.
Let’s continue this Forex trading basics tutorial with the major currencies that are traded on the Forex market. Those include the US dollar (USD), euro (EUR), British pound (GBP), Swiss franc (CHF), Japanese yen (JPY), Australian dollar (AUD), New Zealand dollar (NZD) and the Canadian dollar (CAD). Besides these eight major currencies, there are two more currencies that round up the G10 currencies – the Norwegian krone (NOK) and the Swedish krone (SEK).
The US dollar is involved in around 80% of all Forex transactions, which makes it the single most traded currency on the Forex market. All currencies are quoted in pairs, which consist of the base and the counter-currency. The exchange rate always shows the price of the base currency, expressed in terms of the counter-currency. For example, if the EURUSD (euro vs. US dollar) pair trades at 1.20, this means that it takes $1.20 USD to buy 1 euro.
All currency pairs that involve the US dollar as either the base or counter-currency are called major currency pairs. They include the EURUSD, GBPUSD, and USDJPY, to name a few. Currency pairs that don’t include the US dollar, but include the remaining seven major currencies, are called cross pairs. Examples of cross pairs are GBPJPY, GBPAUD, and AUDNZD.
Finally, there is also a group of currencies that is not heavily traded on the Forex market, which means that their liquidity is low and volatility is high. Those currencies include the Turkish lira, Mexican peso, or Czech krone, for example. The high volatility of these currencies makes them unsuitable for beginners, at least until they gain enough trading experience.
All mentioned currencies have their own characteristics and personalities. The US dollar, euro, and Japanese yen are major reserve currencies held by central banks around the world, but the Japanese yen (and US dollar to some extent) are also safe-haven currencies that rise in value in times of political and economic turmoil in the world. On the other hand, currencies like the Canadian dollar, Australian dollar, New Zealand dollar, and Norwegian krone are also called commodity-linked currencies, as they heavily depend on the price of commodities such as oil and copper.
Basic Forex terminology
Let’s continue this Forex tutorial for beginners with the basic Forex terminology you need to know.
- Pips – Pips are the smallest increment that currency pairs can change in value. A pip refers to the fourth decimal place of an exchange rate, but bear in mind that some pairs that include the Japanese yen have their pips on the second decimal place. For example, if the EURUSD pair rises from 1.2050 to 1.2057, this would equal an increase of 7 pips. On the other hand, if USDJPY rises from 110.35 to 110.42, this would also equal an increase of 7 pips.
- Leverage – Since most major Forex pairs don’t move more than 1% a day, Forex traders use leverage to magnify the profits. Trading on leverage refers to borrowing money from your broker in order to open a larger position size than your initial trading account size would allow. For example, leverage of 100:1 allows you to open a position 100 times larger than your account size. But be cautious when trading on leverage, as it magnifies both your profits and losses!
- Margin – To be able to trade on leverage, you need to put a small part of your trading account aside as collateral for the leveraged trade. Don’t worry, your broker does everything automatically for you. The margin will be returned to your trading account once you close your leveraged trade or it hits its exit price. The following table shows the required margin to open a trade, based on the used leverage ratio. For example, a leverage of 100:1 requires a margin of 1%.
- Spread – The spread is the difference between the bid and ask price of a currency pair. This is usually the only transaction cost you need to pay to your broker in order to open a Forex trade. Spreads can be as low as 1 pip (or lower) on major pairs like EURUSD, but can widen in the event of lessliquid cross-pairs and exotic currencies.
- Market, stop loss and take profit orders – A market execution order is used to open a Forex trade at the current rates offered by your broker. The trade will immediately be executed and you’ll have an open position on your account. Whenever you open a new trade, you should use stop loss orders to prevent large losses if the price goes against you. A stop loss order automatically closes your position once the prespecified price is reached. Similarly, take profit orders are used to lock in your profits after a trade plays out well and hits a certain price.
Forex trading platforms and tutorials
To conclude this Forex basic tutorial, let’s see what trading platforms are all about. A trading platform is simply a program that you install on your computer which is then used to connect to your brokerage account and start trading. Nowadays, there are also web-based and mobile-based trading platforms which can be opened directly in your browser or installed on your smartphone. Check with your broker if those types of platforms are offered.
One of the most popular trading platforms among retail Forex traders is the MetaTrader platform. It offers advanced charting tools, a range of market orders and a large online community were you can ask for help whenever you need it. There are many Forex exchange tutorials that cover how to use MetaTrader to trade on the Forex market, and your broker of choice might also have some basic guidelines on its website.
It’s important that you understand all concepts outlined in this Forex trading online tutorial before opening a real account and trading real money. It’s always a wise decision to apply for a demo account with your broker first in order to get familiar with your trading platform, and prevent costly mistakes on a real account.