Forex Trading: Here's What You Need to Know

Forex Trading: Here's What You Need to Know

You've probably heard of the alarming albeit the real fact that more than 90 percent of traders fail to make money in forex. Although this is indeed a gloomy statistic, enough for any sensible person to turn around and look for another means of income, it also means that making money in this multi-trillion-dollar market is a possibility. For novices who are serious about trading forex, here are fundamental things you should know:

Leverage Can Be a Double Edge Sword

Leverage, in the context of forex trading, refers to borrowing money to increase your position or trade size. The majority of brokers allow leverage of 1:500, meaning that for every $1 of the trader's own money deposited into the account, he/she can buy $500 worth of currency. That allows traders to increase their potential winnings in any given trade. Used irresponsibly, however, leverage can amplify your losses and can blow your account in a matter of a few bad trades. As a forex beginner, use leverage in moderation. To figure out how much leverage you should use per trade, consider your trade size, the minimum margin requirement for the currency pair you're trading, stop loss and target profit, market volatility, and success rate of your trading strategy.

Spot Forex Isn't the Only Way to Trade Forex

Thanks to the advent of electronic trading and the surge in online forex brokers, spot forex has become a popular trading venue for anyone looking to add currencies to their investment portfolio. However, spot forex isn't the only way to trade currencies. Forwards and futures markets are also two approaches that many financial institutions and trading firms use to take advantage of forex opportunities. Although simply knowing spot forex and how it works is enough to start making trades in the market, knowing other trading venues can help you develop more advanced trading strategies as you become more experienced, such as hedging your trades using forward or swaps market.

Forex Can Be Especially Risky and Intricate

Relative to stocks and bonds, which come as more straightforward investment vehicles, forex can involve a higher level of risk and complexity. The network of banks around the world have varying degrees of oversight and regulation, which means the currency pairs that are being transacted are not standardized. The interbank market is comprised of financial institutions buying and selling from each other around the globe. These institutions have to identify and agree upon acceptable credit and sovereign risks. For the small-time retail investor, this lack of regulation begs the question of - how do you ensure fair market pricing mechanisms on your trades? It helps to do research on your forex broker to see if they are regulated and, if so, by who. For instance, in the U.S., the NFA and CFTC regulate forex transactions.

You Can Trade Forex Without the Risk

Live forex trading training can help you experience a real trading environment without any monetary risk. Demo accounts are a popular tool offered by most brokers that let you trade with the same platform that real traders use. You can view charts, add indicators and strategies, look up real-time market quotes, and initiate dummy trades. While demo accounts do not make you real money on a winning position, it gives you a firsthand experience on what it's like to trade.

Interest Rate Spreads is a Profitable Opportunity

The "carry trade" strategy is a time-tested strategy that involves buying a currency with a high-interest rate yield using another currency with a lower interest rate yield. One of the distinguishing characteristics of forex trading versus trading in other financial markets is the interest rate yield that you either earn or pay for holding a currency pair overnight. Interest rates are decided and set by the central bank of each country, such as the Federal Reserve in the United States. To put the profitability of carrying trade into perspective, say you bought China's Yuan, which has a current interest rate of 3.85 percent, versus the U.S. dollar, which has an interest rate of 0.25 percent. You essentially earn a 3.6 percent yield just for buying and holding the currency pair. In addition, depending on the price direction of the underlying currencies, you may also profit if the Yuan increases in value relative to the dollar.

These are fundamental concepts that every forex trader should know about. Keep in mind that it is only the tip of the iceberg, and there is a myriad of more information you'll need to learn and master before you become an effective forex trader.