Forex is a global electronic market for trading international currencies and currency derivatives. It doesn’t have a central physical location, but the forex market is the world’s largest and most liquid market in terms of trading volume, with billions of dollars changing hands every day through transactions with banks, brokers, and other financial institutions. Forex traders make their profit from market price movements between foreign currencies. Trading in the forex market can be very profitable, but it can also come with significant risks. Here is an overview of the pros and cons of forex trading.
What Is Forex?
Foreign exchange (often called forex or FX) is the exchange of one currency for another. For example, the US dollar can be exchanged in the forex market for the euro and vice versa.
The market determines the value of most currencies, also known as the exchange rate. Exchanging currencies can be as simple as changing one currency for another at a local bank, or it can be complex exchanges in currency trading in the forex market.
The foreign exchange market is open 24 hours a day, five days a week, excluding public holidays. The forex market is open on many public holidays when the stock exchanges are closed, although the trading volume might be lower.
Different Types of Trade Strategies
A forex trading strategy is a series of analyses that a forex day trader uses to determine whether to buy or sell a currency pair. Below are the four main types of forex trading strategies and how they work:
Scalping is the shortest form of trading. Scalp traders only hold open positions for a few seconds or minutes. These short-lived trades target small daily price movements. The goal is to make many quick trades with lower profits but to accumulate profits throughout the day due to the volume of trades executed in each trading session.
This trading style requires tight spreads and liquid markets. As a result, scalpers often trade only major currency pairs such as GBP/USD, USD/JPY, and EUR/USD (because of high trading volume and liquidity).
- Day Trading
Day traders enter and exit positions on the same day, which eliminates the risk of large movements overnight. Ultimately, they close their positions with a profit or a loss.
Transactions are usually completed in a matter of minutes or hours and therefore require sufficient time to analyze the markets and monitor positions regularly throughout the day. Like scalp traders, day traders often rely on small profits to build profit.
Day traders pay close attention to fundamental and technical analysis and use technical indicators such as moving average convergence divergence (MACD), Relative Strength Index, and stochastic oscillator to identify market trends and conditions.
- Swing Trading
Swing traders typically hold positions for a few days, but sometimes for a few weeks. Traders don’t have to follow charts and trades all day to capture short-term market movements because positions are held for a period of time.
This makes it a style of trading that is popular for those who have other commitments and want to trade in their spare time. Nevertheless, it is necessary to spend several hours a day analyzing the markets.
- Position Trading
Position traders focus on long-term price movements and look for the maximum potential profit that can be made from large price changes. As a result, transactions often span weeks, months, or even years. Position traders tend to use weekly and monthly price charts to analyze and assess the markets using a combination of technical indicators and fundamental analysis to identify available entry and exit levels.
Since position traders do not have to deal with price fluctuations or minor withdrawals, their positions do not need to be monitored as minutely as other trading strategies, but can be monitored occasionally to follow the main trend.
Risks of Forex Trading and How To Minimize Them
- Lose More Than the Money in Your Account
Contracts for differences (CFDs) are leveraged, so you only have to bet a fraction of the value of your trade to open them; you can lose or win a lot more than your first deposit.
You can reduce risk and secure profits by setting an automatic stop or limit to set the level at which you want to close your trade.
- Unexpectedly Closing Your Positions Causes You To Lose Money
To keep your trades open you need a certain amount of money in your account. This is called margin and your position may be closed if your balance does not meet the stated margin requirements. To avoid this, keep an eye on your current balances, which are visible on your platform or app, and add more money as needed.
- Sudden or Greater Than Expected Losses (or Gains)
Markets can change rapidly or move very quickly and unexpectedly in response to announcements, events, or trading behavior. Besides setting up stops, you can also be notified of important movements by setting a price or distance alert, giving you the option to act or not.
How to Avoid Losing Money In Forex
- Do Your Homework
Learning forex is an essential part of a trader’s success. While most trading knowledge comes from experience and live trading, a trader should learn everything they can about the forex markets, which includes the geopolitical and economic factors that affect the preferred currencies of a trader.
- Find a Reputable Broker
The foreign exchange industry is much less supervised than other markets, so it is possible to do business with less than a reputable forex broker. Investors should do research on each broker’s account offerings, including their leverage amounts, commissions, spreads, account first deposit and funding, and withdrawal policies to learn more about the broker.
- Use a Practice Account
Almost all trading platforms have a practice account, also known as a simulated or demo account, which allows traders to make hypothetical trades without a credit account. Perhaps the most important benefit of a demo account is that it allows the trader to become familiar with order entry techniques.
- Keep Your Charts Clean
When a forex trader opens an account, it can be tempting to take advantage of all the technical analysis tools on the trading platform. While most of these indicators work very well in the forex markets, for them to be effective it is important to remember to minimize analytical techniques.
For example, using multiples of the same type of indicators, such as two volatility indicators or two oscillators, becomes unnecessary and even provides opposite signals. You want to avoid that.
- Protect Your Trading Account
While the focus is on making money in forex trading, it is important to learn how to avoid losing money. Good money management skills are an essential part of the process. Many experienced traders agree that you can take a position at any cost and still make money. It all depends on how you fare.
- Start Small When You Go Live
Starting small allows a trader to assess their trading plan and emotions and to practice executing correct order entries without risking their entire trading account. Real trading cannot be simulated by enormous practice trading, which is why it is so important to start small when going live.
- Use Adequate Leverage
Forex trading is unique in the amount of leverage available to its participants. One of the reasons forex attracts active traders is the possibility of potentially huge profits with a very small investment. Leverages offer the potential for growth, but leverage can increase losses just as easily.
For traders, especially those with a limited amount of money, a small amount of day trading or swing trading is easier in the foreign exchange market than in other markets. For those with longer-term horizons and larger funds, position trading can be profitable.
Along with a focus on understanding the macroeconomic fundamentals that determine currency values, the experience of technical analysis can help new forex traders become more profitable.
We’ve covered the definitions of forex, entry and exit strategies, and most importantly, tips on choosing a broker, which are the basic things you need to start a forex trade. Ready to start trading? Let’s help you get started NOW!
Eddy Alexandre | Author
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The author is a Cybersecurity Engineer with 27 years of experience in engineering and over 13 years as a professional trader. The author is a seasoned actor actively trading various financial instruments and markets, and a financial advisor helping families to build wealth.