FOREX 101 – How Foreign Exchange Currency Market Trading Works

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You may know about stock markets but how about the foreign exchange market (FOREX)? If you’ve never heard of it, you should because it’s substantially larger than any single stock market. The New York Stock Exchange (NYSE), for example, handles $153 billion a day in volume, but the foreign exchange market has a daily volume of $4 trillion, or about 25 times as much as the NYSE! This market is huge.

What is it?

Let’s assume that you took a fist full of dollars on an overseas trip to Japan. You can’t pay in dollars so you exchange your dollars for Yen. At that specific time, one of your dollars got you 82.53 Japanese Yen. Later, that day you exchanged more of your dollars and the rate was 82.56 Yen. This means that while you were out shopping in Japan, the value of your dollar rose and you just profited from your foreign exchange trade. Although that .03 Yen may not seem like much, if you’re exchanging a lot of dollars, it can add up fast. Also you don’t need to go overseas to trade foreign currencies, you can do it all online from the comfort of your home – just like the stock market.

If you know how to make money in the stock market, your half way there to understanding the foreign exchange market. The goal is to buy low and sell high. Again, just like the stock market the FOREX market has second by second fluctuations that are controlled by a variety of factors including trader sentiment, interest rates, economic and geopolitical news, interest rate, central bank policies, time of day, the weather, and just about any other variable possible.

Because FOREX trading is done in an international market, the number of variables is even larger than country specific stock exchanges who are more levered to domestic issues. That’s not to say that stock markets don’t respond heavily to world events, but the 24×7 nature of FOREX markets makes the stock markets look slow.

Basic Strategy

All FOREX trades are done by trading pairs. That is, if a trader is trading a currency pair, they are simultaneously buying the Euro and selling the U.S. Dollar. All currencies have a three letter code. The United States dollar is USD while the Euro is EUR, the Brittish Pound is GBP, the Canadian Dollar is CAD, and the Japanese Yen is JPY. All good FOREX trading sites can provide the code if you know the country.

The most commonly traded currency pairs are EUR/USD, the GBP/USD, the USD/ CAD, the USD/JPY, the CHF/USD (CHF is the Swiss franc), and AUD/USD which is the Australian dollar. Although there are many others, these pairs produce the largest amount of trading volume on the foreign exchange market and given the stability of the underlying countries are probably the best trading option for non-professional investors.

Order Types

If you have ever traded stocks, you already know about the various order types available to the FOREX trader. Market orders are used to purchase a currency pair at the current market value. Limit orders allow the trader to set their maximum purchase price or minimum sell price. Stop orders trigger a sell order if a currency pair reaches or goes below the stop price.

In addition, there are numerous advanced order types depending on the FOREX broker you use. Traders use various order types to remove all emotion from the buy and sell process, protecting themselves both on the up and downside.

In Depth Trading Strategies

Again, if you’re comfortable with stock trading strategies, you will have a much easier time learning FOREX trading strategies. Momentum trading, swing trading, strategies based on news events, and purely technical trading are all common strategies used. But, these are for more advanced traders and unless you have a lot of free time, I suggest you stick to simple buy and sell strategies using the most common currencies.

Virtual Accounts – Learn For Free

It is highly advisable that if you are new to FOREX trading, then begin trading using a virtual money account. This type of account allows for trading of virtual currency in order to test strategies and get familiar with the FOREX trading platform of the applicable broker. Once you show a track record of making money in the virtual FOREX market, you can start using real money. Popular FOREX trading sites like Zecco offer free accounts with $50,000 of virtual money, that I recommend new traders start with.

Caution

Like equity markets, it is estimated that only 25%-30% of all FOREX traders actually make money on a consistent basis; and there are reasons for this. First, no investment should be used to make fast, easy money (FOREX trading is not gambling!). If you’re trying to make money without advanced knowledge, you will most likely lose.

The secret to doing well in the FOREX or any market is education. It will take time gain enough knowledge and experience to make money so make sure you trade virtual funds for a long time until you know what you are doing. If you’re serious about making money in the FOREX market, see it as a long term strategy or as one part of your overall investing approach. But the goods news is that if you invest the time to learn, you can make some big money quickly.

eToro

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