An introduction to Forex: avoiding the pitfalls to make a profit

An introduction to Forex: avoiding the pitfalls to make a profit

Forex trading is an industry with a lengthy history, and has long been utilised as a way for those with the know-how to make money while simultaneously developing and diversifying their trading portfolios. However, for newcomers to the Forex trading market, it can be difficult to know where to start. This can sometimes lead to would-be traders opting not to get involved at all due to a lack of knowledge, or possibly jumping in at the deep end without doing thorough research and making a mistake they will later regret.

That’s why we at Alpari have put together this introductory guide to Forex, including a Q&A with some of our industry experts, to help you better understand the markets and avoid falling into some of the common pitfalls that beginners tend to make when diving head-first into trading.

 

An introduction to Forex trading

The Forex market, also known as the FX for short, refers to the ‘Foreign Exchange’ of global currencies. The way this works is that currencies are purchased and sold in exchange for other currencies during set Forex trading sessions, with the trader hoping to make a profit.

In some ways, this can be compared to stock traders that purchase stocks on the stock exchange to then hopefully be sold for capital gains. Where this differs, of course, is that the Forex market solely consists of global currencies.

Ideally, traders will purchase an amount of a currency when it is available at an attractive price on the market, and then later sell that currency for a different price than was originally paid, and retain the difference as profits. Note that FX trades can be profitable when prices go up or down, as long as the trader uses the appropriate strategy, this is due to two methods, long and short. While long consists of betting that prices will move higher, short bets that price will move in the opposite direction. Exchange rates are constantly changing, so a currency’s value may be very different today than it will be a few months from now.

All currencies are quoted in pairs, meaning that the value of a currency is represented in another currency. For example, if USDJPY is quoted at a price of 133, that means it costs 133 Japanese Yen to purchase 1 US dollar.

When trading in the Forex market, external factors can have knock-on effects to the value of different currencies. Recessions, inflation rates and unpredictable events - such as a global pandemic - can all alter the value of currencies around the world and ultimately impact trading.

These factors can influence the value of a currency, which can provide opportunities for traders. Extensive research into market trends and ongoing factors that could influence exchange rates is vital when it comes to Forex trading.

 

Avoiding the pitfalls

With much of the exchange process being knowledge-based, from a good understanding of global events that could be influencing the exchange rates (fundamental analysis), to a knowledge of which chart patterns from the past will soon be replicated (technical analysis), it’s also crucial for those that participate in the Forex market for the first time to have a good understanding of what not to do.

While there may be an impulse to make your first trade as quickly as possible, it’s fundamental to spend time monitoring the markets ahead of time and doing your due research into the currencies you intend to trade.

To break down the top mistakes that newcomers tend to make when starting out as a trader, our team of experts have weighed in:

What are the biggest pitfalls people can fall into when starting out in Forex investment?

What mistakes do you typically see people make?

“People often trade with no trading plan. They have no concept of how their trade size should relate to the size of their trading account. They often trade on emotion and not use stop limit orders which can help better manage their risk. They may even take on too many positions and start guessing. Not knowing when to exit a position is also often another crucial mistake.”

For beginners to trading, the importance of researching the markets and building up as much knowledge as possible cannot be emphasised enough. This can ultimately be the difference between making a bad trade that leaves you in financial trouble, or successfully utilising the markets to your advantage.

With that being said, it’s crucial to remember that there is no guarantee that investments will pay off in any market, including Forex. As with any activity in the financial markets, there are always risks involved.

 

Weighing up the risks

Forex comes with a fair amount of risk. As is the nature of any financial market, the Forex market can become volatile as currencies fluctuate in value, and what may seem like a good investment at the time could easily turn into regret in the future if the risks aren’t calculated and considered ahead of time.

Realistically, you should only ever invest what you’re willing to lose if a trade falls through and you’re not able to at the very least recoup your investment. This is especially true for beginners who are just starting out in the markets, as they are generally more likely to see their first few investments be unsuccessful.

However, that doesn’t mean newbies are doomed to fail. There are ways in which you can gauge how well currencies typically perform on the market, which in turn will inform you of how high the demand is. A good way to lose money is by investing in currencies that regularly underperform and have a low demand, as you’re likely to be stuck with them or have to sell them off at a loss.

Our experts have shared their opinions on risk-management when trading Forex:

 

What are the chances of a Forex investment being successful? How risky is it to invest in Forex?

“Firstly, at least 70% of traders are known to lose money when trading forex. Provided you have done lots of homework, understand the market environment and have a strategy which you have tested, you might then tip the odds in your favour. Investing time in building your own knowledge, whilst making the effort to hone your trading skills, can also help improve your chances at success in FX markets.

Ultimately, understanding and applying the principles would set a solid foundation for a trader. But always remember that trading is a long-term journey and not a “get rich quick” scheme. Traders often have to make a net profit over a series of trades, rather than getting lucky in one fell swoop, to be successful.”

 

Are there ways to predict how successful an investment will be ahead of time?

“If you use technical analysis, then there are several indicators which determine if an asset is overbought or oversold. That doesn’t mean you have a guaranteed winner, but it may in part help you to determine whether your trade according to that measure is very expensive or very cheap. We would always advise using more than one indicator for trade entry and exit.

Fundamental analysis often offers a numerical value of the asset that an investor can aim for, based on factors such as macroeconomic data. If market conditions allow the asset’s fundamentals to shine through, that could help realise potential gains in that investment.”

As with all factors of Forex trading, knowing your markets and educating yourself is key. There are also ways to trial your investment strategies before making large monetary investments that could leave you in a financial deficit, such as the use of demo accounts.

These allow you to try out trading strategies and test their effectiveness while also functioning as a way to build your knowledge and understanding of how these trades work. This is a great opportunity to really test your risk-management skills without losing out on real money.

 

Knowing your currencies

In order to trade Forex, you first need to purchase currencies to be traded. There are a seemingly endless number of currency pairs available for trade on the exchange at any moment, so it can be overwhelming for beginners to know which currencies are a sensible investment. Alpari trades in just 46 selected currency pairs on our platform, significantly simplifying the process.

To determine which currencies could pay off, traders often look to those that are most actively traded.

Currently, the most actively traded currencies are:

• USD - US dollar
• EUR - Euro
• JPY - Japanese yen
• GBP - British pound
• AUD - Australian dollar
• CAD - Canadian dollar

Exchange rates fluctuate daily, but there are some currencies that tend to be more stable than others. In general, developed countries typically have stable currencies that can make for more secure trades – although it’s never guaranteed.

Alongside choosing a currency pairing to trade in, it’s also important to weigh up whether the current price is likely to lead to a profit, whether in a long or short trade.

Alpari’s expert team shares their advice when selecting a currency pair to trade:

 

Which currencies typically perform the best/are the most stable?

“Generally, the currencies of developed economies are seen to be more stable as compared to emerging market currencies. Different currencies are prone to move on various factors which can be specifically related to that country’s economy. For example, some G10 currencies like the US dollar, Japanese yen, and Swiss franc are traditionally known as safe haven currencies and are bought in times of market stress. Others like the aussie and kiwi do well when economic growth is strong and commodities are in demand.”

 

Is there such a thing as investments that are ‘too expensive’? Are people better off steering away from Forex trades over a certain amount?

‘Expensive’ is a relative term. Nothing is too expensive if someone else will pay more for it! On the flip side, an asset may be deemed ‘too expensive’ if its price is far removed from existing demand. Your analysis and homework should help you figure out if the asset is too expensive, or too cheap. Fundamental analysis might support an asset’s valuation while technical analysis could indicate if the asset’s price is overbought or oversold, in a trend or perhaps about to reverse.”

 

When starting out, should you focus on building a portfolio of multiple smaller trades or invest heavily in a currency that is relatively stable and performs well?

When it comes to trading Forex, the aim of playing the ‘long’ game is always to pay less than someone else is willing to pay (buy low, sell high), in order to turn a profit on your investment – while ‘shorts’ are the opposite. Overall, a diversified range of currency trades is recommended.

 

Final thoughts

The Foreign Exchange market can be intimidating to beginners, and certainly shouldn’t be taken lightly. However, for those that are willing to put in the work to research and understand the ways the market works, Forex can potentially provide a money-making opportunity within an ever-changing and exciting market landscape.

If you’re thinking about getting started in Forex trading but don’t know where to begin, Alpari has a dedicated educational section specifically to help those that are just Getting Started, which can provide you with useful information and insight to get you on your way into trading. We also provide a range of educational courses – which are a requirement for trading with us at Alpari.

For those looking to test out their strategies in a safe environment, we also provide demo accounts that allow users to improve their style and technical knowledge prior to jumping into real-money trading.