Online trading for beginners
In order to understand how online trading in the forex market is performed, you first need to learn about currency pairs and their respective exchange rates. This is because traders mainly aim to profit through movements in the exchange rates of these currency pairs.
A forex quote consists of two currencies which is what we call a forex pair. The first currency is called the base currency which serves as our point of reference and the other currency is the quote or counter currency of the pair. Therefore, if you see the EUR/USD pair quoted as EUR/USD = 1.3600 – this means that for every EUR (base currency) you own, you can exchange it to 1.3600 USD (quote currency).
As you may have already noticed, currency exchange rates aren’t static. They move up and down every second and sometimes, depending on the market sentiment, they can change dramatically even if only for a short time. Luckily for forex traders, however, big movements translate to higher profit potential – assuming you predicted the move correctly and traded in the right direction.
Buy or sell
One of the many benefits of online trading is that you can choose the direction you want to trade. This means that regardless if the price of the euro is going up or down, you can buy or sell respectively and still take advantage of movements in its exchange rate. Remember though, you aren’t only buying or selling the euro – trading takes place in pairs – since you are effectively buying one currency and simultaneously selling the other.
Liquidity and trading volume
The most favorable currencies to trade are the ones that offer the highest liquidity. Simply put, highly liquid pairs are considered the forex ones that are traded the most and therefore there are multiple buyers and sellers in the market to execute orders virtually instantaneously. This is extremely important, because the market is so volatile that the exchange rates could change before your order is filled which means you will either get the second-best available price – which may not be as favorable.
The most liquid pairs in forex are referred to as the majors. These include the EUR/USD, JPY/USD and GBP/USD among others. All currencies in the major pairs are traded against the dollar which is the world’s most valuable and therefore most coveted currency.
Then you have the minor pairs and exotics which don’t enjoy the same trading volume as the majors and are generally more volatile due to the lack of market participation. Volatility isn’t a bad thing per se, as online trading opportunities grow exponentially during a volatile market climate but so does the risk exposure.
Leverage and margin
Another concept you need to come to terms with when trading online is leverage and margin requirements. Since forex is also a leveraged asset class, you can trade on margin. This means that you don’t need to cover the entire amount of a trade, but only a small amount of the total position depending on the margin requirement set by your forex broker. The margin requirement serves as insurance in case your trade doesn’t prove successful.
Leverage is typically expressed in ratios and depending on your broker you may have access to a leverage ratio of 1:500 which effectively increases your buying power many times over. A deposit of $1,000, for example, can be used to cover positions worth $500,000 and thereby magnifying the expected return exponentially.
High leverage is incredibly useful for traders because it opens up opportunities even for small positions. However, it also increases risk since your margin will run out much quicker and if the market is volatile enough, your position could be closed before there is a chance for the exchange rates to settle on a correct price.
What are the drivers behind exchange rates in forex
Since forex pairs and their exchange rates are just a reflection of their underlying economies, forex traders tend to focus on financial data that may provide insight into how these countries’ economies are faring.
Key exchange rate drivers you need to watch out for are:
- The country’s economic health
- Political stability or turmoil in the region
- Monetary policies by central banks
- Unemployment reports
Scalping as a trading strategy
Through the years, forex traders have developed a number of trading strategies and some of their philosophies has been proven to work consistently.
Traders who prefer short-term trading and quick profits tend to prefer the scalping approach for example. This trading strategy involves opening multiple short-lived trades throughout the day which are then closed as soon as they generate even a small amount of profit. The goal is to accumulate as many profitable trades as possible to offset the small amount of profits realized.
Admittedly, this trading strategy may be somewhat risky and stressful for beginners, but it’s one of the most popular ones due to its efficiency. Multiple consecutive losses can be devastating for small account holders but with proper risk management methods, scalping can be extremely effective in achieving consistent results.