What You Need to Know Before Your First Forex Trade
While it can be very exciting to participate in the forex market given its dominance, there’s a steep learning curve to trading currencies. However, you can turn a profit when armed with the right information.
Foreign exchange (forex) accounts for the world’s largest financial market. In fact, it was valued at $6.6 trillion (£5.3 trillion) last year, with London reigning as the largest forex market with a 43% share.
Here are some things that you need to know before making your very first trade:
Learn the basics
Forex, or the world of finance in general, can be very intimidating for the average person. The first step to breaking that barrier is to learn the fundamental aspects as well as common forex trading terms. Here are a few key terms that should be in your vocabulary:
• Currency pairs – Forex is always traded in a pair of currencies, which represents the value of one against another. For example, GBP and USD is represented by GBP/USD or vice versa.
• Base – The first currency in a pair. For example, GBP in a GBP/USD pairing.
• Quote – The second currency in a pair. For example, USD in a GBP/USD pairing.
• Exchange rate – The amount of quote currency needed to buy 1 unit of the base currency. For example, GBP/USD = 1.2252.
• Bid – The price at which you’re willing to buy the currency pair.
• Ask – The price at which you’re willing to sell the currency pair.
• Pip – The smallest price changes given an exchange rate.
• Spread – The difference in pips between the Bid/Ask prices.
• Leverage – A trader’s borrowed capital from a broker’s credit. This allows traders to fund their trade without having to pay the full value upfront.
Understand the factors that affect forex
Knowing the right words is only the first step. You’ll need to have a working understanding of what moves currencies in the first place. This allows you to make an educated trade and minimise the risk of incurring any losses. These are some of the most important factors that increase trading risk:
• Interest rate – Rising interest rates generally correspond to a stronger exchange rate, while falling interest rates can result in a depreciation in currency value.
• Country – Take note of the country’s economic stability, especially for developing or third world nations.
• Counterparty – It refers to the broker or trading platform used which come with their own risks.
• Leverage – The more leverage you acquire could potentially lead to a bigger loss.
• Transaction – Communication or confirmation errors that can lead to a loss. For instance, significant time difference between markets leave plenty of room for market fluctuations, which can impact the trade made.
• Politics and Economy – Both have significant impacts on a country’s performance in the forex market. For example, the expected 25% downfall in the economy of the UK during Q2 will likely lead to a weaker performance of the GBP against other currencies.
• Liquidity – The high liquidity of the forex market means the demand and supply can vary wildly, which can affect market prices.
Choose a reliable forex broker and trading platform
To start trading, you need to find a reliable broker and the right trading platform. A broker is an individual or a firm that facilitates your trade. You buy or sell through a broker, who also gives you the leverage needed. When choosing a broker, find out whether they are regulated by The Financial Conduct Authority. See if they also offer a trial period so you can sample their services before committing to a certain brokerage firm.
A trading platform, on the other hand, is the software that allows you to access and trade in the forex market. Most offer demo accounts, which enable you to experiment and practice trading under real market conditions. Understand that trading forex is not without risk. However, knowing basic information, such as industry terms, allow every kind of trader to make more favourable decisions.