Currency trading’s somewhat glamorous image leads many to incorrectly assume that the foreign exchange market is closed to all but the rich and daring. In reality, though, it only takes a few hundred dollars to access this highly liquid $1.9 trillion market. Success as a currency trader does take dedication to studying the market, but there’s no shortage of material to help beginning currency traders get off to a profitable start. Learn the basics of how traders earn from this market and decide for yourself if currency trading is right for you.
If you think of foreign currency trading as an expensive hobby reserved for millionaires with nerves of steel, you’re in for a pleasant surprise. Naturally, there are risks involved in currency trading, but there are also reliable ways to manage those risks. As for investment capital, although not too long ago currency trading did require a large investment, these days it’s possible to start trading with as little as $250.
How the Foreign Exchange Market Works
Currency trading is done on the foreign exchange market, also called the "forex" or "FX" market. On this market, the currency of one country can be exchanged for that of another. This enables, for example, the government of England to sell products to the US and receive British pounds in exchange for US dollars. The four most-commonly traded currency pairs are US dollar/Japanese yen, US dollar/Swiss franc, British pound/US dollar and Euro/US dollar. While most trading is done by governments, export and import companies, brokers who work with foreign assets, and financial institutions, the market’s daily trading volume of some $1.9 trillion dollars offers plenty of room for private investors, too. Private investors in the forex market profit by judging whether the exchange rate between two currencies will increase or decrease and then buying or selling accordingly. Foreign exchange price quotes include a "bid" (buy) and "ask" (sell) price. The difference between the bid and ask is called the "spread" and is where the trader’s profit or loss lies. For trading purposes, currency prices are usually quoted to four decimal places with the last decimal place being known as a "pip" or "point." It's this last decimal place that traders watch.
Is Currency Trading Right for You?
Currency trading may be an excellent opportunity for many, but isn't for everyone. Success in the forex market takes not only special knowledge and skills, but certain personality traits, as well. One of the most essential traits for a good currency trader is self-discipline. The most reliable way to success is to find a trading system that suits your needs and stay firmly with that system. Unfortunately, fear or greed leads some people to start basing their trades on emotions and hunches, rather than on their chosen system. This kind of nervous trading may be responsible for more losses than market conditions ever could be. To profit consistently, a trader must be patient enough to wait for the right moment to buy or sell, yet decisive enough to act immediately when that moment comes. This decisiveness is part of the self-confidence that comes from thorough knowledge. For a trader who's fascinated by the market and loves studying it, spending time acquiring trading skills isn't hard. However, someone who’s bored with the whole process might be better off either finding another market to invest in or putting their money in a managed fund and letting someone else to the work.
What You Need to Get Started
To get started trading on the foreign exchange market, there are really only three basic things you’ll need: investment capital, access to the market, and trading skills.
Investment Capital
When it comes to investment capital, what’s true in other markets applies to the forex market, as well. Don’t invest money you can’t afford to lose. That said, it's not at all difficult to save up enough capital to get started trading. Most brokers offer two types of accounts: standard and mini. While opening a standard account usually takes an investment of at least $2,000, there are mini accounts that can be opened with as little as $250. Of course, there are differences between these two types of accounts. Specifically, mini accounts usually offer more leverage, which is necessary to profit from a small investment, and they carry more risk.
Access to the Market
These days, almost all currency trading is done over the Internet. A software program known as a "trading platform" is used to execute the trades from the trader’s PC. Numerous trading platforms have been developed, so there’s something available to fit any trader's individual needs and level of skill.
Knowledge and a Trading System
Despite what some late-night infomercials proclaim, currency trading isn’t an easy road to riches. If you aren’t willing to invest time in learning how the foreign exchange market works, you may as well take your money to a casino. Even for those experienced in trading on equities and other markets, it takes some additional learning to invest profitably in the forex market. Forunately, though, the foreign exchange market has been the subject of analysis for hundreds of years and a number of proven systems have already been developed to help traders along. Rather than re-inventing the wheel, new-comers to the forex market often do better by choosing a proven system that fits with their personal financial situation and goals.
Trading software may be either Web-based or client-side. With a Web-based trading platform, the trader logs into an account on the broker's Web site and performs all actions connected with the trade on that site. In contrast, a client-side trading platform is a software program that must be downloaded and installed on the trader’s PC. This software connects with the broker's server to complete the trades.
When choosing a trading platform, it's important to consider exactly which type of foreign exchange markets the platform covers (spot and exotic currencies, for example), how simple or complex the system is, and how quickly the system can execute a trade. Most online trading platforms offer a system in which the user must go through several Web pages, fill out a form with trade information, and then wait while this trade information is sent through the broker's ordering system. The problem with this is that, in foreign exchange trading, seconds matter. You don't want a program that’s going to make you wait several minutes while it sends your trade request, possibly losing your profit in the process. A better option is an interactive system in which the trader can watch a live market on the screen and perform trades in real time with one click of the mouse.
Before using any trading platform to trade real money, you can open a free demo account that will allow you to trade in real market conditions with "virtual money." When choosing a demo account, be aware that many of these accounts start you off with $2,000 to $10,000. That’s fine if you actually intend to invest that much. If you’re planning to open a mini account, though, get a demo account that gives you an amount similar to the amount you really plan to invest, even if that's only a few hundred dollars. This way you won't get used to advantages that you won’t actually have when you begin trading with real money.
A Word About Leverage
Leverage is the ability to trade with borrowed money and is commonly used in currency trading. Although leverage increases the potential profits, it also increases the potential for loss. For example, if trading one lot (100,000 units) of currency only requires $1000 as a deposit, then theoretically a trader with $5000 in his account would be able to trade 5 lots of that currency. Just because it's possible, though, doesn’t mean doing it is sound trading practice. Rather than looking at this trade as $1000, it's far more sensible to treat it as the $100,000 that is actually being moved. Improper use of leverage will force you into making trades at less than preferable rates. To avoid this situation, try not to use more than 10% of your account at any one time.
Actually performing a trade with software might be simple, but the process of determining how much of which currency to trade and when to trade it can easily become a full-time job. In order to make accurate judgements, traders must understand the essentials of both technical and fundamental market analysis.
Technical Analysis
Most small-time investors use technical analysis to guide their trading decisions. This type of analysis is concerned with how prices move, rather than why prices move, and operates on the idea that prices move in predictable, repeating trends. Technical analysis is used to identify patterns of market behavior that are expected to produce certain results. These patterns are charted on bar charts and candlestick charts.
Fundamental analysis
Fundamental analysis tracks the economic and political environment in a country in attempt to predict how that country’s currency will move. Fundamental analysis is used primarily for long-term investments. While fundamental analysis may provide an excellent perspective on possible future trends, it can be extremely time-consuming and often produces contradictory results.
Forex Systems
There is a multitude of systems that can be used to make trading decisions on the foreign exchange market. However, there is no such thing as a system that never makes a loss and no one system is right for every trader.
Although each trader must take his or her personal needs and skills into account when choosing a system, there are some basic things to look for. One of the most important aspects of a profitable trading system is that it must not require any readjustment. Having to repeatedly adjust the system to keep up with changes in the market only increases the likelihood of causing an error in the system. A good system can be used exactly the way it is to bring long-term success independent of the market direction. A system that has been designed for long-term success will be able to show consistently good results over at least a five-year period.
Hypothetical or simulated performance results are the most common way of evaluating a system, but these results should be based on real world—not hypothetical—data. The downdraw of a system should be considered in order to assess the volatility, and thus the risk, involved in the system. Downdraw is the amount of decline in an account's value from the highest value to the lowest value.
Brokers and Managed Accounts
Unless you’ve got a million or so to invest, you’ll be trading through a broker. Before you settle on one brokerage firm, though, do some solid research to find a firm that not only provides high-quality services, but that provides the type of services you personally need. Not every broker is a good fit for every investor. When choosing a broker, consider what account types and leverage options are offered, the spread you’ll be allowed to trade at, what trading platform and research tools are offered, and the level of customer support. The foreign exchange market operates around the clock, so your brokerage firm should have live customer service available twenty-four hours a day.
If you’re interested in investing in the forex market, but lack the time or expertise to trade for yourself, a managed account is another option. With this type of account, you give permission to a fund manager or trading agent to make trades on your behalf. When choosing a managed account, look for a fund manager who can personalize his or her trading strategy to meet your needs. Also, consider the fund manager’s risk management strategy and be sure you’re clear on the fees involved.
Where to Go from Here
If you think you have the temperament necessary to succeed in this market, there are hundreds of books and Web sites available to help you develop your knowledge of trading systems and market analysis. Taking an online course in foreign exchange trading is another way to get started. Once you have an understanding of how to profit from the forex market, contact a broker to open a free demo account so you can try your skills in real market conditions.
External Links:
Oanda - Currency trading tutorials and tools offered by one of the top currency trading sites.
Forex.com - Offers a thorough, yet easy-to-read introduction to forex trading from basic to advanced.
Forex Factory - Provides active and diverse forums for currency traders along with market news