Can Forex Trading Make you Money?
Trading forex has become one the most attractive investment opportunities of the 21st century. The reason is the many advantages the forex market holds over all other financial markets combined as well as the high return on investment potential compared to a savings or a fixed term deposit account at your local bank. Online trading does have some pain points, but the savvy forex trader can use the available tools to set up a solid risk management strategy that safeguards his investment and guarantee consistent positive returns.
Forex Trading 101
In an attempt to get everyone on the same page, it’s best that we start with the basics. The forex market or foreign exchange market is a decentralized financial market which is just a fancy way of saying that it's not running or controlled by a single institution. Much like the internet itself – it’s made up of multiple nodes that connect to one another with the purpose of facilitating the trading of the hundreds of financial instruments available.
To make things clearer, the participants in forex trading can be split into four different categories.
- Major banks
- Big companies like Apple and Microsoft
- Governments and Central Banks
- Retail traders
Even though we established that the forex market is mainly decentralized, the big banks like JPMorgan and Barclays, that comprise the interbank, are actually the ones that control market pricing due to the huge volume of forex trading they make on a daily basis.
When you are trading forex, you are actually buying a currency and selling another at the same time. This is why forex orders are quoted in pairs e.g. EUR/USD = 1.4796 with the first currency (EUR) known as the Base currency while the other (USD) is called the Quote. Of course, this all happens over the counter with a forex broker facilitating your trade and the important distinction here is that you don’t actually buy/sell or own any physical money at any point during this transaction.
Moreover, your trading platform will probably show each forex pair with a BID and ASK price, where the BID being the price the owners of the currency are willing to sell and ASK being the price everyone else is willing to buy. Each currency pair you are willing to buy or sell as a forex trader is quoted at a price which is determined by the exchange rate of the two underlying currencies. The difference between the BID and ASK price is called the SPREAD and that is the cost incurred for trading forex.
Trading Forex Pairs
There are multiple financial instruments available in the market and online forex brokers are very competitive in continuously updating and expanding their offering. Signing up for an account at a brokerage will give you access to currencies, spot metals, commodities, indices, stocks and even cryptocurrencies.
However, currency pairs make up most of the trading volume across the market and especially the ones which are paired with the USD which we call the Majors. The reason why the USD is so popular is that of how strong the US economy is, it’s superiority in terms of political and military power and the fact that the USD is the world’s reserve currency.
If you, as a forex trader, are looking to speculate on the EUR/USD for example – and you believe the EUR currency will rise against the USD, you obviously should be buying EUR and selling USD. So, you open a long position by buying the EUR/USD pair at the currently available ASK price. If your speculation pays off and the value of the Euro rises against the US Dollar you will stand to profit according to how many Pips the price of the Euro went up. Since currency pairs are quoted in rates with usually up to 4 decimal points, it’s easier to measure any changes in price starting at the 4th decimal which has been coined the Pip or percentage in point.
Recalling our previous example where we bought the EUR/USD, let’s consider that the ASK price was at 1.4796 at the time we opened the position. If the value of the EUR indeed went up to 1.4854, you would have made 58 Pips in profit (1.4854 – 1.4796 = 58).
Following this simple example across the various other financial instruments and it becomes obvious why online trading is so popular. Indeed, there are many opportunities presented in the forex trading markets, but in order to be able to take advantage of these opportunities, you first need to find a reliable forex broker. This is of utmost importance to all traders. It’s the most crucial step for every forex trader to find a regulated forex broker because it’s the only way to safeguard your funds from any malicious activity.
Online Trading on Demo
Trading forex with a demo account or paper trading as it’s commonly known should be your bread and butter when starting out. If you are not consistently breaking even or turning profit while trading with a demo account for at least a few months – you should never dive into trading live with real money. Some would even tell you, and they would be right, that even if you are consistently making winning calls on a demo account and you’ve already doubled your virtual USD 50,000 deposit, you shouldn’t expect the same results on live. It’s not because that your broker offers different spreads on live vs demo or that they are making things easier for demo traders. What makes live forex trading so different than demo trading is psychology.
A forex trader’s psychology is what makes him tick. It’s what can turn an eventual winning trade into a premature stop-loss hitting waste of money. The string of losses only serves to more righteous indignation and the cognitive dissonance leads to further losing streaks and the inevitable blown account.
Trading forex needs discipline most of all. The name of the game is capital preservation. If you are trading with the notion “I’m going to turn this $100 to $100,000 in a month” you are destined to fail. Great expectations are never your friend and knowing when to fold is a skill you need to pick up along the way. If you keep adding on a losing trade, you will eventually blow your account. If you should take anything away from this is that learning to follow the trend is your best bet to survive as a forex trader. If you try to beat the market, you will promptly be receiving a hard life lesson.
The market is a cruel mistress and sometimes if you open a position, you could stand to lose more than the money you invested in it. If your risk management isn’t thorough enough, not even a tight stop-loss limit can save you from the high volatility unleashed during sudden market-moving news.
Admittedly, the timing has never been better to start learning about the financial markets and success can definitely be found via online trading as long as you can afford to spend enough time educating yourself, find a reputable and regulated forex broker and apply a strict risk management strategy to protect your invested capital.
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