"Forex" is a shorthand way of referring to the foreign currency exchange. It's the market where currencies from different countries are traded. [1] X Research source Investors trade in forex for the same reason that they trade in any other market: because they believe that the value of certain currencies will go up or down over time. Remember, currencies are commodities just like anything else. On some days, they'll go up in value. On other days, they'll go down in value. You can use forex to take advantage of the fluctuation in foreign currency prices to make money.
Steps
Part 1
Part 1 of 3:
Learning Basic Forex Principles
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Know how currencies are traded in the forex market. The forex market is a global exchange of currencies and currency-backed financial instruments (contracts to buy or sell currencies at a later date). Participants include everyone from the largest banks and financial institutions to individual investors. Currencies are traded directly for other currencies in the market. As a result, currencies are priced in terms of other currencies, like Euros per US Dollar or Japanese Yen per British Pound Sterling. By effectively seeking price differences and expected increases or decreases in value, participants can earn (sometimes large) returns on investment by trading currencies. [2] X Research source
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Understand currency price quotes. In the forex market, prices are quoted in terms of other currencies. This is because there is no measure of value that is not another currency. However, the US Dollar is used as a base currency for determining the values of other currencies.
- For example, the price of the Euro (EUR) is quoted as (price quote number) USD/EUR.
- Currency quotes are listed to four decimal places.
- Currency quotes are simple to understand once you know how. For example, the Yen to US would be quoted as 0.0087 JPY/USD. You should understand this as "you need to spend 0.0087 US Dollars to buy one Japanese Yen."
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Learn about arbitrage. Arbitrage, put simply, is the exploitation of price differences between markets. Traders can purchase a financial instrument in one market with the hope of selling it for more in another. [3] X Research source Within the forex market, arbitrage is used to profit from differences in the quoted prices of currencies. However, these differences do not occur between two currencies alone, so the trader must use "triangular arbitrage," which incorporates three different trades, to profit from differences in prices.
- For example, imagine that you notice the following quoted prices: 20.00 USD/MXN, 0.2000 MXN/BRL, and 0.1500 BRL/USD (between the US Dollar, Mexican Peso, and Brazilian Real). You wonder if there is an arbitrage opportunity here so you start with a theoretical value of $10,000. With your $10,000, you could buy 200,00 Pesos (10,000*20.00 USD/MXN). Then, with your 200,000 pesos, you could buy 80,000 Reals (200,000*0.2000 MXN/BRL). Finally, with your 80,000 Reals, you could buy $12,000 Dollars (80,000*0.1500 BRL/USD). By making these trades, you've gained a $2,000 profit ($12,000 -$10,000).
- In reality, arbitrage trades offer very little, if any, profit and price differences are corrected almost immediately. Lightning-fast trading systems and large investments are used to overcome these obstacles.
- Trades in the forex are made in terms of lots. A standard lot is 100,000 units of a currency, a mini-lot in 10,000 units, and a micro-lot is 1,000 units. [4] X Research source
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Understand leveraged trades. Traders, even very good ones, are often only left with a few points of arbitrage differences or trading gains. To counter these lows return percentages, the traders must make trades with large amounts of money. To increase the money available to them, traders often use leverage, which is essentially trading with borrowed money. Compared to other securities types, trades made in the forex markets can be made with incredibly large amounts of leverage, with typical trading systems allowing for 100:1 margin requirements. [5] X Research source
- The 100:1 requirement means that you only need to actually deposit 1/100th of what you are investing in the currency. The deposit is known as the margin and protects you against future currency-trading losses. [6] X Research source
- Trades using leverage magnify both potential gains and potential losses, so be careful when making these types of trades.
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Part 2
Part 2 of 3:
Finding the Right Forex Broker
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Ensure the broker is compliant with prevailing regulations. The broker should be a member of the National Futures Association (NFA) and be registered with the U. S. Commodity Futures Trading Commission (CFTC) as a Futures Commission Merchant and Retail Foreign Exchange Dealer. [7] X Research source Usually, you can determine if the broker is in compliance by visiting the "About Us" section of its website. That's where the company will disclose if it's a member of the NFA and registered with the CFTC.
- The NFA establishes rules that preserve the integrity of the currency exchange market.
- The mission of the CFTC is to "protect market users and the public from fraud, manipulation and abusive practices related to the sale of commodity and financial futures and options, and to foster open, competitive and financially-sound futures and option markets."
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Ensure that the forex pairs you want to trade are offered. It may be the case that you're looking to trade a specific pair of currencies (for example, U.S. dollars for Swiss francs). Be absolutely certain that the brokerage you're considering offers that pair.
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Check the reviews. If you think you've found a great brokerage, search online for reviews of the brokerage and see if other people have had a good experience. If you find that the vast majority of reviewers are complaining about the brokerage, move on.
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Look at the trading platform. Make sure that the trading platform is designed in such a way that you find it easy to use. Usually, brokerage sites will offer screen shots of their trading platforms online. You might also find some YouTube videos showing people actually using the trading platform. Be sure that it's the kind of platform you can work with.
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Pay attention to the commissions. You're going to have to pay money every time you make a trade. Be sure that the commission you're paying is competitive.Advertisement
Part 3
Part 3 of 3:
Trading in Forex Successfully
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Use a practice account. As with everything else in life, you get better at forex trading with practice. Fortunately, almost all of the major trading platforms offer a so-called practice platform that you can use to trade currency without spending any of your hard-earned money. Take advantage of that platform so that you don't burn cash while you're on a learning curve.
- When you make mistakes during your practice trading sessions (and you will), it's important that you learn from those mistakes so that you avoid making them again in the future. Practice trading won't do you any good if you're not benefiting from the experience.
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Start small. When you've completed your practice trading and have determined that you're ready for the real world, it's a good idea to start small. If you risk a significant amount of money on your first trade, you might find that fear of loss kicks in and your emotions take over. You might forget what you've learned in your practice trading and react impulsively. That's why it's best to invest small amounts at first and then increase the size of your positions over time.
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Keep a journal. Record your successful and unsuccessful trades in a journal that you can review later. That way, you'll remember the lessons of the past.
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Look for and take advantage of arbitrage opportunities. Arbitrage opportunities pop up and disappear many times every day so it's up to you as a trader to locate them and make your move. Looking for these opportunities manually is almost impossible; by the time you've calculated whether or not arbitrage exists, the moment is over. Luckily, many online trading platforms and other websites offer arbitrage calculators that can help you locate opportunities quickly enough to take advantage of them. Search online to find these tools. [8] X Research source
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Become an economist. If you want to be a successful forex trader, you're going to need an understanding of basic economics. That's because macroeconomic conditions within a country will affect the value of that country's currency. Pay particular attention to economic indicators like the unemployment rate, inflation rate, gross domestic product, and the money supply. [9] X Research source Even more important: pay attention to the trend in those indicators so you get an idea of where they're headed.
- If a country is about to enter an inflationary period, for example, then that means that the value of its currency is about to go down. [10] X Research source You wouldn't want to buy that currency.
- Pay attention to countries with an economy that's sector-driven. For example, Canada's dollar tends to move in tandem with crude oil. If there's a rally in crude oil prices, it's likely that the Canadian dollar will also appreciate in value. So, if you think that oil will increase in value in the short-term, it might be a good idea to buy the Canadian dollar.
- Follow a country's trade surplus or deficit. [11] X Research source If a country is running a healthy trade surplus, that means that buyers of its products will have to convert their currency into the nation's currency first. That's going to spur demand for the currency and cause it to appreciate in value. If you think a country's trade outlook is going to improve, it might be a good idea to buy that country's currency.
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Remember the "all other things being equal" mantra. There are a number of principles of sound forex trading mentioned in the previous step. However, the economic conditions that are described there don't exist in a bubble. You have to look at the complete economic picture before purchasing a country's currency.
- For example, a country could run a healthy trade surplus, which might cause its currency to appreciate. At the same time, that country could be a sector-driven nation with a currency that's tied to oil. If oil is dropping at the same time that its trade outlook is improving, its currency might not appreciate in value.
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Learn to read charts like a pro. Technical analysis is another way that you can make money in forex. If you examine the historical chart for a specific currency, you might notice certain patterns in that chart. Some of those patterns can offer predictions about where the currency is going.
- The head and shoulders pattern is an indication that the currency is about to break out of its price range. [12] X Research source That's a technical indicator used by many forex traders.
- The triangle pattern is an indication that the high-low range of a currency is tightening. [13] X Research source It's also a signal that the currency could break out, depending on the overall direction of the triangle.
- An engulfing pattern is noticeable on candlestick charts. That's when the range of one candle completely engulfs the range of the previous candle. In that case, the currency is likely to move in the direction of the engulfing candle. It's an excellent trading signal used by many forex investors.
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Warnings
- Forex trading, like any form of trading, carries a certain amount of risk. There is always the risk that a sudden shift in market expectations could cause a trade to go bad, losing you money in the process.Thanks
- Trading with leverage just increases these risks by magnifying your potential losses. This may result in your losing more money than you initially invested. In this case, you would be responsible for making up this loss with your own money.Thanks
- You should never trade with money that you need, like retirement funds. Instead, only trade foreign currencies with money that you can afford to lose.Thanks
- Trading in the forex market is also risky for inexperienced traders who are unable to keep pace with rapidly-changing market prices. What seems like a good trade in one moment may be a losing one in the next. [14] X Research sourceThanks
- With Forex trading, you are also exposed to the risk of variable currency rate exchange. For example, if the exchange rate drops by 20% and your stock goes up by 20%, the profit would be canceled out.Thanks
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References
- ↑ http://www.investopedia.com/university/forexmarket/forex1.asp
- ↑ http://www.investopedia.com/articles/trading/03/091703.asp
- ↑ http://www.investopedia.com/terms/a/arbitrage.asp
- ↑ http://www.investopedia.com/terms/s/standard-lot.asp
- ↑ http://www.investopedia.com/articles/trading/03/091703.asp
- ↑ http://www.investopedia.com/articles/trading/03/091703.asp
- ↑ http://www.investopedia.com/articles/forex/11/how-to-choose-a-forex-broker.asp
- ↑ http://www.investopedia.com/ask/answers/forex/forex-arbritrage.asp
- ↑ https://en.wikipedia.org/wiki/Economic_indicator
- ↑ http://www.investopedia.com/terms/i/inflation.asp
- ↑ http://www.investopedia.com/terms/t/trade-surplus.asp
- ↑ https://www.investopedia.com/terms/h/head-shoulders.asp
- ↑ http://www.investopedia.com/articles/technical/03/091003.asp
- ↑ https://www.wsj.com/articles/SB10001424052702304665904576384111852016334
About this article
Article Summary
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To make money in Forex, look online to find a broker with good reviews who’s registered with the U.S. Commodities Futures Trading Commission. Then, use a practice account to learn how to trade without risking any money. Look at historical charts and try to find patterns that might predict currency movements. Also, keep a journal of your trades to learn what works and what doesn’t. When you’re ready to trade for real, start with a small amount of money to minimize your risk. You can increase your positions as you gain confidence and experience. To learn from our Certified Financial Coach reviewer how to use arbitrage and leveraged trades to maximize your returns, read on!
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