Online Forex Trading
I. What is Online Forex Trading?
Forex stands for foreign exchange. Forex refers to buying, selling and exchanging currencies on the Foreign Exchange market. Foreign exchange plays a vital role in regulating international trade and global commerce.
For instance, least developed countries can trade its products (oil, gold, coffee, and more) in exchange for currency from a state with a stronger economy. On the other hand, a country with a high exchange rate attracts more foreign investors.
Forex market enables the exchange of currency (conversion from one currency to another) for foreign trade; it is also a place where traders speculate on currency fluctuations, and it is currently the most extensive financial marketplace in the world.
Not long ago, most people used Foreign exchange services only when preparing for travel. Perhaps they wanted to visit France for vacation or on a work trip. France's currency being Euros, they needed to exchange their dollars for euro. They would then go to the bank or to a Foreign exchange broker to realize that transaction at the current exchange rate.
Online Forex Trading example
For example, let say that 1USD=0.8956EUR. If you wanted to change a 1000USD into euro, you would get 890EUR.
From the example above, USD and EUR are called currencies (USD as the base currency, EUR as a quote currency), and the 0.8956 is the exchange rate.
An Exchange rate is how much money you need to exchange one currency for another (you need 0.89EUR to buy one US dollar). These rates change all the time which is why people started speculating on those fluctuations to make more money.
High-interest rates, inflation rates, geopolitical instabilities, slow economy are the major causes of fluctuations in the Forex market.
We will use the same example to explain how fluctuations on the Forex market can play in your favor.
At the end of your trip to France, you managed to save 850£, and now you decide to go to the bank and exchange them for dollars. By chance, the value of the EUR has increased and now the exchange rate USD/EUR is 0.80. In this case, you will get 1062$ and make a profit of 62$.
Therefore, foreign exchange is a type of investment trading. You can easily speculate whether a currency will increase in value against the other.
Currency appreciation vs. currency depreciation
For example, you may have a strong intuition that the EUR will rise in value against the US dollar in the future. You then decide to buy Euros and the moment the Euros goes up, you exchange it back for US dollars, thus making a profit. The moment a currency increases in value, it is called currency appreciation, and when it decreases in value, it is called currency depreciation.
II. How does online forex trading work?
Central banks and other financial institutions, corporations, Forex brokers and investors were the major Forex market constituents.
Luckily, traders and investors can now exchange currency on the internet; all you need is a computer and good internet connection, and you can start Forex trading from anywhere around the world, 24 hours, five days a week except holidays.
On the contrary to other types of investments (stocks, commodities, bonds and so on), online forex trading doesn't require much money to start trading on the market. Online forex, however, represents a higher risk rate compared to trading stocks or other financial assets.
Therefore, new traders need to learn basic notions, analyze the market and write a trading plan before creating a trading account. If you aspire to start trading in the Forex market, it is essential that you cover all basic notions of currency exchange.
There are seven most-traded currencies: USD, EUR, JPY, GBP, AUD, CAD, and NZD.
types of currency pairing
Currencies are paired to be traded, and it exists three types of currency pairing:
1. Major pairs. Major pairs are essentially other currencies paired against the USD (EUR/USD, JPY/USD).
2. Minors and Crosses pairs. These are pairs that do not include USD (EUR/GBP, AUD/NZD).
3. Exotic pairs. Exotic pairs are currencies from developing countries paired against major currencies (USD/MXN, EUR/NOK). Note that exotic pairs present a higher risk compared to the other two pairings which are considered stable. They are less liquid; hence they contain wider spreads. Moreover, exotic pairs are susceptible to sudden change due to inflations or political instability.
When trading forex, there is a bid and ask price. A bid price is a price at which you are willing to buy a currency, while an ask price is a price you are ready to sell a currency. A spread is a difference between the two rates. A spread determines the liquidity of the paired currencies. In result, the lower the spread, the more liquid the pair is. For instance, the bid price of EUR/GBP is 1.1221, and the ask price is 1.1223; the spread will be equal to 0.0002(2 is called a pip).
Margin Forex Trading vs. Contract for Difference (CFD)
You can start trading either by using Margin forex or by Contract for difference (CFD).
Margin Forex. Also referred to as spot forex, margin forex is the process of buying a currency hoping that it will increase value and sell it back to make a profit. In this process, you own the asset.
A contract for Difference: CFDs don't require you to buy the asset; they are more of an arrangement that allows you to speculate whether a currency will increase value or not. They profit on the currencies' fluctuations. These arrangements settle through cash payments.
III. How To - Online Forex Trading
Learning basic notions of online Forex trading was the first step. The next steps will be:
Step 1. Choose your online trading style
Determining which type of online trading you want to use (Spot forex or CFDs). It is an essential step as it will help you write your trading plan. In business, it is always better to have a business plan and sticking to it. In the case where you do not know which one to choose, ask your broker or do online research, there are many tutorials and free lessons for beginners.
Step 2. Choose your currency pairs
There are over 150 active currencies; thus its good to keep in mind that some of them are less liquid than others, also many brokers prefer to deal with only major and cross pairs.
Step 3. Decide on a short or long position
These technical terms referring to whether you want to buy or sell. For instance, to go short on a currency is the act of selling it in the hope that it decreases in value. To go long on a currency is the act of buying a currency hoping that its value will increase.
In all cases, you will profit every point the exchange price falls and lose money every point the exchange price rises and vice-versa.
Step 4. Choose a type of trading order
The kind of order you choose will help determine how you plan to enter and exit a trade.
1. Market order
Entering the trade with a market order means placing an order to buy or sell at the best available or current market price. Once you spot a trading opportunity that could play in your favor, immediately click on buy/sell button on your screen and you will enter the trade.
2. Limit entry
A limit entry order allows the trader to specify his entry price. You can either choose to buy below the market price or sell above the market price.
You can set a buy order, and the minute the current price equals or goes below your specified amount, the broker will execute it.
Similarly, you can set a sell order, and your order will be placed on the market the moment the current price equals or goes above your specified price.
However, if the specified price never reaches the market place your order will not exist.
Stop-entry can be a buy or sell stop entry.
A buy stop is a specified price used to buy above the market place. For example, if you believe that a specific currency will continue to increase, you can set a price, and once the market hits that price, you will instantly enter the market.
A sell stop is also a specified price used to sell below the market place. When you believe that a specific currency will continuously lose its value, you set a price below the current price and get entered into the market whenever the market hits your price.
The benefits of limit and stop entries lies in the fact that you don't have to spend your time monitoring the price changes on your computer to place an order.
Stop loss entry: A stop loss entry primary goal is to limit losses when the trade moves against you.
Step 5. Choose a broker
Forex trading market is the most unregulated market of all, therefore be extra careful when deciding which broker you want to entrust your money with.
Firstly, go with a more reputable broker (check his statistics and verify whether he is a member of a regulatory body such as NFA or CFTC).
Secondly, search for a broker with the lowest spreads.
Lastly, look for an easy-to-use and visually attractive platform.
Step 6. Set up your online trading account
Now there are two types of forex trading account; leverage and margin account.
Margin account vs. Leverage account
Margin account: Margin is how much money you deposit in your account to start trading.
Leverage account: If you are starting with forex trading and only have enough money to open a position, you can use your margin to leverage your trade. With this type of account, the trader will borrow you the rest of the money you need to place an order.
For example, with only 100$ in your account, your broker can borrow you 10.000$ to trade in the market.
Leverage enables traders to make massive profits in a short time if a trade moves in your favor.
However, always keep in mind that the higher the leverage, the higher the risk to lose all your investments.
Recommendation: What is Online Stocks Trading?