May 20, 2021 | Adaline Fritz
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The foreign exchange, referred to as forex or FX, is a prime addition to any investor’s portfolio, as its volatile nature allows for the potential to make healthy profits. Trading takes places using currency pairs, and is affected by fundamental factors, such as interest rates, trade and geopolitical events.
According to the CFD trading platform Plus500, it is the world’s largest financial market, with a huge average daily trading volume of $5 trillion. It is also the most liquid market in the world, which makes it highly attractive to investors.
Like with any investment, forex trading comes with its risks, so in this article will guide you through what it takes to successfully trade on the forex market.
Understand the forex market
Before making any decisions about your position in the forex market, you should fully understand how it works, and what factors can impact its movement. Forex instruments themselves, can mainly be traded on the over-the-counter market, through future contracts, or via contracts for difference (CFDs).
Forex trading consists of purchasing one currency against the other, known as the base and quote currency, which together form a currency pair. These currencies can reflect the economies that they represent, as well as the relationship between the two nations. Therefore, understanding the various technical, political and economic events that have a significant effect on each of the currencies, is highly recommended in order to be successful.
Learn how to read currency pairs
One of the first steps you should take when forex trading, is to understand how to read the currency pairs involved. As previously mentioned, the base is the first currency in the pair, as it is the asset in which you would buy in. The quote is consequently the second currency in the pair, and reflects the rate at which you are exchanging. The quote currency is the currency you are selling in. If the base currency strengthens against the quote, then you would expect a profit. In the event of the opposite, then you are likely to incur a loss.
It’s advised that to have the best opportunity at success, you should start trading in your own nation’s currency against the major currency of the US dollar (USD). USD is regarded as the world’s base currency, and you are likely to know and understand the fluctuations of your own country’s valuation, therefore with this strategy you are setting yourself up for a better chance at success. You should firstly open with small trades, to ease yourself into trading, and from there you can carefully observe how the market is performing over time and increase your capital accordingly.
Develop your forex trading strategy
A successful forex trader will have a trading strategy that suits their style and investment profile therefore, you should research the trading tools and techniques available to you before you begin trading.
There are two main types of analysis used in a forex trading strategy, which are fundamental and technical. As the market is affected by events happening around the world, fundamental analysis is vital when investing in forex. It involves the examination of factors that can impact the economy, and as a result the value of the relevant currency. Fundamental traders would use an economic calendar, for example, to analyse the market reaction to certain important events and act accordingly.
The forex market has plenty of historical data, so lends itself well to technical analysis. This involves evaluating the charts and graphs representing the data from the market, to identify potential trends and patterns. From here, technical traders can predict the likely direction of the price of currency pairs, and reactively enter or exit the market.
Once you have a strategy in place, you should trial its implementations on a demo account, to ensure the success of your techniques. That way when you come to trading on the forex market with real money, you can feel confident and secure in your strategy.
Depending on the forex broker or trading platform that you decide to use, you should have different risk management tools available to use that can help maximise your profits and minimise your losses.
These can include a ‘Close at Profit’ limit, which closes the trade when a certain level of profit, or a ‘Close at Loss’ limit which limits the risk to a certain value. This will help you to sensibly manage and maintain your capital when forex trading, as you should never trade more than you can afford to lose.