Nowhere is the old adage “you have to spend money to make money” more true — or at least more literal — than forex trading. Trading on the foreign exchange means converting your money into and out of foreign currencies in an effort to time the changes in exchange rates to turn a profit.
Forex is one of the more complex and arcane areas of the investing world, so it’s most likely not a good option for anyone who doesn’t really enjoy things like economics, monetary policy and mathematics. It’s typically only people with an ability to analyze and a penchant for numbers who can make money trading forex consistently.
Here’s a step-by-step look at how you can get started trading forex so you can get a better sense of what this type of investing entails.
1. Be Absolutely Sure This Is for You
Before you make the transition from asking “what is forex trading” to “how to trade forex,” you should be certain this is something you want to undertake.
You can always try forex trading on a small scale to see if you like it, but generally speaking, it is not for the faint of heart. One of the first things beginners learn about how to trade forex is that it’s very difficult and involved, combining complicated mathematical formulas with knowledge of the economic and political climates of the currencies you’re trading.
If you’re just looking for another way to invest your nest egg, the odds are good that forex trading is not for you. If you still want to learn forex trading, however, be prepared for a major commitment on your part.
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2. Find the Best Broker for You
Before you can learn how to trade currency, the next step in forex trading basics is to find a broker that suits your needs.
“In the U.S., many online brokerages such as TD Ameritrade or Interactive Brokers offer forex trading along with standard stock and futures trading,” said Michael Golembesky, lead forex trader at ElliotWaveTrader. “There are also some standalone forex brokerages such as OANDA and Forex.com, which typically have smaller minimum deposit requirements than the standard online brokerages.”
According to Golembesky, the key factor when choosing a forex brokerage is to ensure it is in good standing with the regulating agency in the trader’s country of origin. In the U.S., this is the Commodity Futures Trading Commission and the National Futures Association.
“Traders should also compare the spreads and commission rates, deposit requirements and minimum tradeable lot size to see which platform will work best for them,” Golembesky said.
You should also examine the tools available on each platform to see which interface or options you like best. Make sure you’re asking about the broker’s policies and rates on margin trading, as that can be an essential part of forex trading.
3. Decide on a Currency to Trade
There’s no rule saying that you can’t try to trade a variety of different currencies, but an intimate familiarity with both the economic status of the country involved and the trading patterns of that particular legal tender are essential to success, meaning that focusing on just one currency is advisable. If you speak a second language or have a particular familiarity with a different culture or country, you can use that knowledge to help guide your decisions.
4. Develop a Strategy for How to Trade Forex
“As with trading or investing in any speculative market, trading forex can certainly be profitable,” Golembesky said. “However, like any endeavor, one must first take the time to learn a method which can be applied systematically.”
There are a number of forex trading strategies that can produce positive results, but most tend to fall into one of two categories: fundamental and technical analysis.
Fundamental analysis involves looking at political and economic factors that might affect the value of a certain currency. Technical analysis is rooted in using patterns in past price movements to anticipate future ones. Any successful strategy should incorporate both elements, but depending on the trader, one or the other might end up being a greater point of emphasis.
One other key concept to understand in developing a strategy is leverage. The movements in value for currencies tend to be incremental, meaning turning a large profit requires putting large sums of capital behind any given trade. Forex traders typically create additional weight for each trade by buying on margin. Buying on margin means borrowing money to make investments. If you’re going to borrow on margin, make sure you’re familiar with your broker’s margin rates and policies.
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5. Manage Your Risks Carefully
One of the key things to remember in forex trading is that you want to keep each individual trade relatively small in relation to your total bankroll. Even the best traders are going to be wrong much of the time, so if you’re going to trade forex for a living, you have to give yourself the room to make mistakes without wiping out your resources.
“By far the most important factor in becoming successful at trading forex is proper risk management,” Golembesky said. “One must not ever risk too much capital on any one particular trade or series of trades. Due to the high leverage that can be used in forex markets, it’s important for new traders to avoid the temptation to risk too much capital on any one particular trade or set of trades.”
Using leverage can be risky. Although using borrowed money to speculate can mean bigger profits when you succeed, it also means bigger losses when you fail. A bad trade can result in owing money well beyond what you risk initially, so be sure to keep your trading within the levels that you can afford.
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