Forex Trading Guide

Where to begin?

The foreign exchange market is known as a global phenomenon allowing traders to exchange currency pairs against one another. Strengthened by its ease of access and constant activity, the FX market tends to be the largest and most liquid asset market in the world. Traders speculate on geopolitical events, deploying strategies and market knowledge to build their portfolio and maximise their investment.

1) What is Forex?

Forex is the mixing of foreign currency and exchange. Foreign exchange is the process of transferring one currency into another currency. This transfer can be conducted for a number of reasons, including for the sake of commerce or trading – or perhaps for leisurely reasons such as travel and tourism.

History of Forex

The forex market is a structure that is relatively young and recent. The most simplistic understanding of the forex market is individuals seeking to convert one currency to another in order to obtain a financial advantage. Forex itself has been around since nations around the world began minting their own respective currencies. The modern formulation took place after the accord at Bretton Woods in the year 1971, major currencies were given permission to float freely against each other. Due to the fact that the values of individual currencies change this has given rise to the need for foreign exchange services and trading.

Who is involved in Forex Trading?

Both Commercial and Investment banks conduct most of the trading in the forex markets on behalf of the clients that are involved in their institutions. However, there are further risk involved opportunities in the industry as well. Individuals can trade one currency against another for professional, experienced or even every day retail investors.

What currencies are available through Forex Trading?

Some of the most common currencies include:

• AUD (Australian Dollar)
• NZD (New Zealand Dollar)
• CHF (Swiss Franc) 
• JPY (Japanese Yen) 
• EUR (Euro)
• GBP (British Pound) 
• USD (American Dollar) 
• CAD (Canadian Dollar)

3) Forex for Hedging

Corporations that operate businesses in other foreign countries are at risk due to the fluctuations in currency values. This can affect the buying or selling of goods and services outside their local domestic market. Foreign exchange markets provide a way in which to hedge currency risks by fixing a rate at which a transaction will be completed.

To ensure this occurs, a trader can buy or sell currencies in the forward or swap markets in advance, locking in a certain exchange rate. Example: A company plans on selling Japanese made cutlery in America, the exchange rate between the Japanese yen and the American dollar (JPY/USD) is ¥1 to $1.

If the cutlery costs ¥100 to manufacture, the Japanese firm plans to sell the product at $200, competitive with other cutlery sets made in Japan. If this strategy is successful, the company will make a profit of ¥100 because the exchange rate JPY/USD is even. However, if the YEN rises in value against the US dollar and becomes 0.80, this will mean that it will cost ¥0.80 to buy $1.00.

The problem is that the company still needs to invest ¥100 to manufacture the cutlery and sell it at $200 to remain competitive. When this translates back into YEN, the profit is smaller ($200 x 0.80 = ¥160). Instead of generating a ¥100 profit, because the currency value has risen, the profit is only ¥60.

This risk could have been reduced, by shorting the USD and buying the YEN when the currencies were equal. By doing this, if the YEN was to increase in value, the profits of the trade would balance the reduced profits from the sale of the cutlery. Whereas, if the YEN had fallen in value, the more favourable exchange rate would increase the profit made on the sale of the cutlery sets, offsetting the losses in the trade.

This strategy of hedging can only be done in the currency futures market. The positive for the trader is that futures contracts are standardized and accepted by a central authority. However, it should be noted that currency futures may exhibit less liquidity than the forward markets, which are decentralized and exist within the interbank system on a global scale.

4) Forex for Speculation

The supply and demand for currencies depend on a number of factors including; interest rates, economic strength, geopolitical risk and tourism. This range of factors creates a high level of volatility on a daily basis. Opportunities to traders present themselves allowing them to profit from changes that either increase or decrease one currency’s value compared to another. A forecast that one currency will weaken is essentially the same as assuming that the other currency in the forex pair will strengthen based on the fact that currencies are traded in pairs.

Imagine a trader that is interested in the forex pair: EUR/JPY. They believe that the interest rate will rise throughout Europe in comparison to Japan. The current exchange rate between the currency pair (EUR/JPY) is 0.71 (it takes €0.71 EUR to buy ¥1.00 YEN). The trader believes that higher interest rates throughout Europe will increase the demand for EUR, and therefore the EUR/JPY exchange rate will fall because it will require fewer, stronger EUR to buy YEN.

If in this case, the trader has assumed correctly and the interest rates do rise, the exchange rate might fall to 0.50. This means to buy ¥1.00 YEN, the trader only requires €0.50. If the investor had shorted the YEN and went long on the EUR, they would have profited from the change in value.

5) Forex Trading Risks

Leverage

When trading with forex, the concept of leverage asks from a trader a minor investment. This investment allows the trader to gain access to trading more substantially with foreign currencies. Leverage is the employment of borrowed capital funds, to allow for a trader to expand its asset base and generate greater returns on capital. Forex traders are able to accumulate a lot more leverage than they normally would in the stock market. For this reason, leverage in the Forex world is known as a double-edged sword.

Transaction Risks

This type of risk is associated with the various differentials in time from the commencement of a contract to when it ultimately settles. Trading of FX is continuous, and can, therefore, catch the differences in constantly involving exchange rates. On this understanding, currencies may be traded at different prices at varying times during the hours of trade. If the gap in time is quite large between entering into a contract and subsequently settling it – the transaction risk rises. Time differences allow the exchange rates to fluctuate, causing for sometimes onerous, transaction costs.

Volatility Risk

Volatility risk describes the degree of fluctuations within the markets and should certainly be included in a trader’s thought process. Traders should constantly track market trends, analysing and varying their investments accordingly.

Volatility, when gone unnoticed, can certainly affect profits and exacerbate losses, however, it can be employed as a positive tool. Without at least a certain degree of volatility, it would be nearly impossible for a trader to benefit in their trading activities. It’s usually during high impact news events that volatility can spike and become inordinately high. It is especially during these times that volatility can adversely affect a trader’s position.

Unregulated Forex Brokers

Dealing with unregulated forex brokers overseas is the final risk warning which is why comparing the FX brokers shown on this site is recommended. This may be the highest risk warning of the above factors so it’s strongly recommended to check regulation prior to signing up and trading underlying assets. You should also read their financial services guide.

6) How does Forex Trading work?

Ultimately, the various roads of trading forex all lead to the same destination. The purchasing of one currency and the selling of another. Majority of forex transactions are made via a forex broker, however, with the rise of online trading, a trader can take advantage of forex price movements using a derivative like CFD trading.

A CFD is a leveraged product, enabling a trader to open a specific position for a fraction of the true value of a particular trade. Different to non-leveraged products, a trader does not accept ownership of the particular asset, however, will maintain a position in regards to whether the market will rise or fall.

How to Become a Forex Trader?

Taking the first steps in the Forex area including finding a regulated Forex broker who offers competitive trading conditions that suit your particular strategy. This broker should come equipt with a trading fx platform that exhibits powerful technology and excellent customer service. When a trader chooses a broker, it is integral that the broker offers strong features including quick execution of trades and negative balance protection.

To open an account with a Forex Broker, traders do not need a large amount of capital, this is based on the notion that a trader can trade on margin. On average, the minimum deposit in a Forex account is $200, this will enable the trader to begin setting up their initial trades. It is recommended that the initial deployment of funds should be approximately $1000 – $2000.

Although this recommendation will sound a bit out of the reach first-time traders, this will at least create a sizeable buffer in the case of losses. The strategy should not be to use the entire amount, rather utilizing it as a cushion so that you’re not forced out of a trade. This is a situation that is common amongst traders with smaller balances. Also, you may wish to complete a forex course before commencing trades.

7) A Forex Trading Example

Assume a trader believes that the value of the AUD will appreciate or rise against the value of the YEN. An alternative way of thinking about this situation is that the YEN will devalue in relation to the AUD.

They buy the AUD/YEN at 1.1500 and purchase $6,000 worth of currency. Later that day the price increased to 1.1550. The trader is up $30 (6000 * 0.0050). If the price dropped to 1.1430, the trader would be losing $42 (6000 * 0.0070).

Due to the fact that currency markets are on the go twenty-four hours a day, experienced traders may choose to hold their position in a currency pair overnight. Their chosen broker will allow for the rolling over of their position, with the individual ultimately receiving either a debit or a credit, determined by the interest rate differential between the AUD and YEN. If the interest rate of the AUD is higher, post roll over the trader will receive a credit, however, if the opposite was to be true, and the interest rate of the YEN is higher, the trader would receive a debit.

The concept of rollover can determine the outcome of many trading decisions. This is specifically true when traders have the intention to hold positions for the long term. The other point of strong consideration is the varying differences in interest rates. If there are large variances, this can result in significant credits or debits on a daily basis. If chartered incorrectly, this can erode the generation of profits or even worse, increase losses on a specific trade.

As mentioned above, a Forex example would be incomplete without consideration of major forex risk, leverage. Most brokers provide leverage. Many brokers in Australia,  provide leverage with the range varying from 30:1 up to 500:1. In this example, let us imply that the trader used the leverage of 50:1. If using 50:1 leverage, although the value of their trade will be worth $5,000, this is not the amount of money they will be required to invest. They will only need a substantially more minute amount of $100. As long as the trader has $100 and 50:1 leverage they will be able to trade with $5,000 worth of currency.

Making a profit of $30 off one trade whilst knowing that the trader only needs $100 (this can be even less if more leverage is deployed) accurately displays both the power and the downside of leverage. However, if a trader does not acknowledge the risks involved when it comes to leverage, the capital in their account will dwindle quickly.

8) Reviews of Top Brokers

While most individuals understand that forex trading strategies are critical when navigating markets they often overlook the importance of an FX broker. Brokers offer different functionality, latency and charting that are critical to trading on margin and the overall trading experience. The forex broker selected will set the trading platform options available, financial market and features.

Selecting a Broker

Before selecting your preferred forex broker, make sure that your choice is regulated within your country. Here are our top picks of Forex Brokers to consider in your research:

Pepperstone – 9.5/10 

Pepperstone is a Melbourne based ECN forex broker allowing trading directly with liquidity pools. Their main features include:

• The use of either the MetaTrader 4 (MT4) or cTrader forex platform
• Industry-leading leverage of 500:1
• Fast execution speed with the use of Equinix servers in New York and London.
• Award-winning (Investment Trends) customer service
• Buy and sell cryptocurrencies, Index CFDs, futures and commodities

Pepperstone offers the most popular forex trading platforms, low spreads and commissions, high leverage and execution speeds are why they are recommended for intermediate to expert forex traders. You can compare Pepperstone to other ASIC regulated firms on the Australian forex broker comparison table.

View Pepperstone Review >>Visit Pepperstone >>

AxiTrader – 8.5/10                                                                         

AxiTrader Pty Ltd is similar to Pepperstone offering ECN forex trading in a fast foreign exchange environment.

Their key strengths are:

• The offering of the most popular forex trading platform – Next-Gen
• Added NextGen platform features including autochartist
• Fast execution speeds thanks to Equinix data centres
• Automation trading using Expert Advisors (EAs) and DupliTrade
• Leverage of 400:1 on currency pairs (30:1 in Europe)

AxiTrader only offers MetaTrader 4 which can be limiting for some traders but if this is your preferred forex trading platform this may be the right forex broker for you. Their enhanced trading features including EAs are ideal for traders looking for tools to assist their trading. Compare AxiTrader to other FCA regulated firms on the forex broker UK table.

View AxiTrader Review >>Visit Axitrader >>

Go Markets – 7.5/10 

GO Markets is a Sydney based forex broker with a tiered service approaching.

The brokers’ core features are:

• The offering of MetaTrader 4 Genesis with enhanced features and charting
• Low spreads and fees depend on the deposit made within the account
• Extra financial services including buy and selling of binary options
• 300:1 leverage available
• VPS option to speed up the forex trading environment

GO Markets is an excellent option but only for those that opt for their new GO Markets PLUS account. This account has the lowest fees with raw spreads and Australia Dollar $3.00 per side commission. The issue though is that regularly the minimum deposit is $10,000 making this broker only suitable for high volume currency traders. If you’re a high-frequency trader, then you should consider this forex broker.

View Go Markest Review >>Visit GO Markets >>

easyMarkets – 5/10                  

easyMarkets are a Cyprus based forex broker with a Sydney offer and locally regulated for Australian forex trading.

Their main strengths are:

• Deal Cancellation allowing forex trades to be cancelled within 60 minutes
• Risk management safeguards including guaranteed stops and negative balance protection as standard
• Fixed spreads and no commissions providing transparent trading costs
• 300+ markets including the option to buy and sell cryptocurrencies
• 400:1 leverage when trading foreign exchange

easyMarkets offering of transparent trading fees combined with unique risk management tools makes them the ideal forex broker to beginner forex traders of those with a low-risk profile. They focus on those new to trading but are not the best in the category as you can view on the forex broker beginner page.

View easyMarkets Review >>Visit easyMarkets>>

Plus500 – 4.5/10                           

Plus500 is a public listed company that has an office in Sydney.

The forex broker offers to trade with:

• 300:1 leverage
• Their own forex trading platform
• CFD Trading Platform
• No commission trading with variable spreads
• Share trading of the ASX 200 and other financial services
• Risk Management tools including guaranteed stops

Plus500’s key strength is their offering of financial products outside of CFD trading such as shares. Their CFD trading platform is very unique to the other Australian Forex brokers which are both their strength and weakness if you want to change brokers at a later stage. They do though have very high fees. If the brokerage is important to you then view the low fee forex broker comparison page.

View Plus500 Review >>Visit Plus500 >>

*Your capital is at risk ‘76.4% of retail CFD accounts lose money’

Overall, find the broker that is right for your needs and is regulated in your region. Other popular brokers including Markets.com, FXTM, TD Ameritrade, and ThinkMarkets.