Forex trading, also known as foreign exchange trading or FX trading, involves buying and selling currencies in the foreign exchange market with the aim of making a profit from currency exchange rate fluctuations.

The forex market is the largest and most liquid financial market in the world, with over $6 trillion in daily trading volume. The forex market operates 24 hours a day, five days a week, enabling traders from around the globe to participate at their convenience.

Forex trading offers immense opportunities for profit, but it also carries substantial risks, particularly for inexperienced traders. Many retail traders (non-professional traders) never become profitable over time and they end up losing all the money they put at risk.

Successful forex trading requires a deep understanding of the market, careful analysis, and disciplined risk management. For beginners, it’s essential to start with a solid education, using free demo accounts to practice, and developing a clear strategies for trading and risk management. Over time, with experience and discipline, it is possible to develop the skills needed to navigate the forex market better and achieve financial goals.

cfd forex trading

Currency Pairs

Forex trading involves trading currencies in pairs, where one currency is bought, and the other is sold. To put it in other words: you will buy one currency and use another currency to pay for it.

Each currency pair consists of two currencies: the first currency is the base currency and the second currency is the quote currency.

Example: In the currency pair EUR/USD, euro is the base currency and the U.S. dollar is the quote currency.

  • If the exchange rate is EUR/USD 1.1827 is means that you will pay 1.1827 USD to purchase €1.
  • If the exchange rate were to chage from EUR/USD 1.1827 to EUR/USD 1.1828, it means that the euro has strengthened (appreciated) against the dollar.
  • If the exchange rate were to chage from EUR/USD 1.1827 to EUR/USD 1.1826, it means that the euro has fallen (depreciated) against the dollar.

Majors, Minors and Exotics

Currency pairs fall into three losely defined groups:

  • Major Pairs: These include the most traded currencies globally, such as EUR/USD, USD/JPY, and GBP/USD.
  • Minor Pairs: These do not include the U.S. dollar but involve other major currencies, such as EUR/GBP or GBP/JPY.
  • Exotic Pairs: Exotic pairs are typically traded much less than both majors and minors. If you are trading exotic pairs, you can expect comparatively low liquidity and wider spreads. You may have to search a bit before you find a suitable broker that offers the specific exotic pair you are insterested. One example of an exotic pair is the USD/TRY (U.S. dollar/Turkish lira).

Going Long and Going Short on the FX Market

  • Going long (buy): If you believe the base currency will increase in value against the quote currency, you go long (buy).
  • Going short (sell): If you expect the base currency to decline in value against the quote currency, you go short (sell).

Pips

A pip is the smallest price movement in forex trading.

Movements, spreads, profits, and losses in forex trading are calculated in pips.

For most currency pairs, a pip is 0.0001 of the quote currency. A notable exception is pairs where the Japanese yen (JPY) is the quote currency; in these a pip is 0.01.

In the 21st century, some brokers have begun displaying fractional pips, calling them “pipettes”.

Spread

The spread is the difference between the bid price (the price at which a trader can sell with their broker) and the ask price (the price at which a trader can buy with their broker) of a currency pair.

Tighter spreads are generally preferred by traders, as they reduce trading costs. For some trading strategies, paying higher commissions is worth it if it gets you tighter spreads.

Brokers typically make a lot of their money from the spread.

Lots

Forex is traded in standardized units called lots:

  • Standard lot: 100,000 units of the base currency.
  • Mini lot: 10,000 units.
  • Micro lot: 1,000 units. Most retail forex traders deal in micro or mini lots to limit exposure and manage risk better. For a small-scale hobby trader, buying a full standard lot would put way too much of their total trading capital at risk for one single trade. If you pick a broker that offers mini lots and micro lots, it will be easier for you to do proper diversification with a small bankroll.

Market Analysis

There are two main methods for analyzing the forex market: Technical Analysis and Fundamental Analysis.

  • Technical Analysis
    This involves studying price charts and using tools like moving averages, RSI (Relative Strength Index), and Bollinger Bands to predict future price movements. You will use historic price data in your attempts to notice trends and predict future price movements. Many forex trading platforms have built in support, tools and educational resources for technical analysis.
  • Fundamental Analysis
    This approach focuses on macroeconomic factors, such as interest rates, economic growth, inflation, and geopolitical events, to assess the future direction of a currency in relation to another currency.

Leverage

Leverage allows traders to control a larger position than their initial capital. For example, with 1:100 leverage, you can control a $100,000 position with just $1,000 from your trading account. The broker will lend you the rest of the money.

While leverage amplifies profits, it also amplifies losses. Before using leverage, it is very important to research exactly how it works, and put a proper risk management strategy in place.

In several parts of the world, including the European Union, the United Kingdom, and Australia, the financial authorities have limited how much leverage brokers are permitted to give to retail traders (non-professional traders). Some authorities also require brokers to provide non-professional traders with Negative Account Balance Protection, which means that they can not lose more than the money they have in their trading account – they can not end up owing the broker money. If your account has Negative Account Balance Protection, it is important that you learn about how it works and adjust your trading- and risk management strategies accordingly, because this type of protection comes with strings attached and the broker has a duty to automatically close one or more of your open positions in certain situations.

How to Trade Forex: A Step-by-Step Guide

  1. Education and Research

Start by learning more about forex trading. Use several different sources and be critical of any source that makes forex trading sound like a low-risk, low-effort endevour.

  1. Trading Strategies and Risk Management

Develop a basic strategy for how you will start forex trading. Preferably stick to just one pair in the beginning, to avoid spreading yourself too thin. Also develop a risk management strategy.

You will adjust both strategies over time, and as you become more skilled and experienced, you can utilize more complex strategies.

For beginners, it’s often best to start with a major pair like EUR/USD or USD/JPY because majors tend to have tighter spreads and are more liquid (reducing the risk of slippage).

  1. Demo Account

Open one or more free demo accounts with brokers. They will come filled with play-money and they will benefit you in several ways.

  • Use a demo account to see if you like a specific broker and trading platform. If you don´t, it is best to find out before you have made any first deposit of real money.
  • Use a demo account to test your strategies against real fx market data.
  • When you have picked a broker and platform, use a demo account to really learn how the platform works and how to carry out your trading strategy. That way, you can reduce the risk of costly beginner mistakes when you switch over to using real money.
  1. Open a Real-Money Account with a Broker

To start trading forex, you need to open a real-money account with a forex broker. Brokers offer platforms for trading and provide access to the currency markets.

When choosing a broker, you should take many factors into consideration. Here are a few examples:

  • Is the broker authorized to be active in your country? Is it authorized and licensed by reputable financial authority known for its strong trader protection?
  • Do you like the platform? Is it suitable for your strategy?
  • Is the currency pair you want to start with available? What does the rest of the selection look like? (You may want to branch out later.)
  • What are the spreads and commissions? What would it cost to use your specific trading strategy with this broker? Are there other fees, e.g deposit fees, withdrawal fees, and platform fees?
  • Does this broker accept any method for deposits and withdrawals that you are willing to use, and that would not be too expensive to utilize?
  • Are you willing and able to meet the first deposit size requirement? There are many brokers available online where you don´t have to make a big first deposit if you don´t want to, e.g. brokers where you can get started with a small $10 deposit.
  • How and when is customer service available? Is it available when you are most likely to be trading? If you want phone support, will you be required to make an expensive phone call to a call centre on the other side of globe?
  • Support for Technical Analysis, if you plan to use this.

When you have selected a forex broker, you will sign-up for a real-money account. You will need to go through a Know-Your-Customer (KYC) process, since the broker must comply with routines to prevent money laundering and terror financing. You will need to verify your identity, e.g. by uploading a photo of your pass port or national ID-card. You will need to verify your address using a utility bill or similar.

  1. Make Your First Deposit

Make your first deposit to fund your account. Examples of common transaction methods are bank transfers, credit/debit cards, and e-wallets.

First deposit requirements will vary by broker and account type.

6. Place Your Trade

After analyzing the market, decide whether to go long (buy) or short (sell) based on your predictions. Set stop-loss and take-profit orders to manage your risk and lock in profits.

Stick to your trading plan and avoid emotional trading. You will most likely adjust your plans for trading and risk management over time, but adjustments should be made when your positions are closed and your mind is at ease. Do not suddenly change plans because something exciting is happening on the market.

Advantages of Forex Trading

Here are a few points that help explain why forex trading is so popular.

  • High Liquidity: The forex market is the most liquid financial market in the world, allowing you to buy and sell currencies quickly without price slippage. (The exact liquidity will vary, however, depending on which currency pair you are trading in.)
  • Low Transaction Costs: Forex brokers typically charge lower fees compared to other markets, particularly when trading major currency pairs.
  • 24-Hour Trading: Unlike other markets, the forex market is open 24 hours a day, five days a week, making it flexible for traders around the world. Many retail traders (hobby traders) like that they can trade outside standard office hours.
  • Profit in Both Rising and Falling Markets: Forex trading allows you to go long or short, meaning you can profit whether the currency is appreciating or depreciating. Unlike the stock market, you never have to resort to risky short-selling using borrowed stocks on the forex market.
  • Leverage: Forex brokers offer high leverage, allowing traders to control large positions with a small amount of capital. (In some parts of the world, however, the financial authorities have capped how much leverage can be offered to non-professional traders.)

Risks of Forex Trading

Here are a few examples of risks that it is important for a forex trader to be aware of.

  • Market Volatility: Currency prices can fluctuate rapidly, particularly during times of economic uncertainty or political events. Volatility can lead to unexpected losses.
  • Complexity: The forex market is influenced by numerous factors, including geopolitical events, interest rate changes, and economic reports, making it difficult to predict price movements consistently. Even skilled traders will have many experiences of how the market suddenly goes against them. Do not risk money you can not afford to lose.
  • Counter Party Risk: You are at risk of losing your money if your broker fails to uphold their end of the deal, e.g. due to insolvency.
  • Psychological Pressure: Forex trading requires discipline and the ability to handle market swings without making emotional decisions. Emotional trading often leads to losses. The risk of emotional trading will increase in certain situations, e.g. when you are tired, ill, effected by alchol/drugs/medicines, or when there are other heavy stuff going on in your life that keeps you distracted. There is also an increased risk after a scathing loss, as you may feel tempted to take on extra risks in an effort to compensate for the loss.
  • Leverage Risk: While leverage will magnify profits, it will also magnify losses. Trading with leverage without proper risk management can lead to significant financial loss. Make sure you understand exactly how leverage works before you use it. If your account has Negative Account Balance Protection, you also need to undestand how that works.
  • Scams: Unfortunately, there are a lot of scammers who are using the popularity of forex trading to lure in victims. There are dishonest brokers, dishonest singal service providers, and more. Using brokers that are regulated by a financial authority with strict trader protection meassurments in place will reduce, but not eliminate, the risk of being scammed by the broker. As for other services related to forex trading, e.g. signal services, the risk is even higher and any user should be very careful before parting with money or personal information. Many traders have lost significant amounts of money using poor quality signal services or by letting someone else take control of their account.

How to Manage Risk in Forex Trading

Risk management is crucial in forex trading. Here are a few examples of points that can be included in your risk management strategy.

  • Set Stop-Loss Orders: A stop-loss order automatically closes your position if the market moves against you by a certain amount, helping limit potential losses.
  • Set Take-Profit Orders: A take-profit order automatically closes your position when you are at a certain, predetermined, level of profit. This can help protect you from keeping positions open for too long. When the market goes our way, it is easy to become too greedy and refuse to close the position until it is too late. That is a situation where it is great to have a take-profit order in place.
  • Limit Leverage: Use leverage wisely. While high leverage can increase profits, it can also lead to significant losses. Start with lower leverage and increase it gradually as you gain more experience. Do not use any leverage without first learning about how it works.
  • Limit Exposure: Don’t put all your capital into one trade. Have a limit in place for how much of your total bankroll that can be risked on an individual trade. Also have a limit for how much of your total bankroll that can be in open positions at the same time. If a sudden news event turns the forex market into chaos, you don´t want to be sitting with most of your bankroll in open positions even if you have diversified by putting the money into different trades.
  • Stick to Your Trading Plan: Establish a well-thought-out trading plan that includes your goals, entry and exit points, and risk tolerance. Avoid making impulsive decisions based on market swings. You will adjust your trading plan over time, but adjustments should be made with a level head – not when you are in the midst of hectic trading.
  • Risk Only What You Can Afford to Lose: Never risk more than you can afford to lose on any single trade or in the market as a whole. Proper capital management is essential for long-term success.