Forex trading is highly appealing for someone new to investing or trading. But forex trading requires in-depth knowledge of market movements to make it a profitable affair.
In this article, we have covered all the basics that would help you make a foundation for forex trading and you can proceed further to understand the complexities of trading with currencies.
We have divided this article into two parts –
- Important terms to know
- How to trade forex (in 5 easy steps)
Without any further ado, let’s start reading about how to do forex trading.
Terms to Know Before Starting Forex Trading
#1. Currency pair
A combination of two currencies in which you trade. You’ll buy one currency by paying in another currency. For example, EUR/USD is a currency pair in which EUR (euro) is the buying currency (or base currency) and USD is the paying currency (or quoting currency).
The top 5 global currency pairs are
#2. CFD (Contract for Difference)
A contract for difference (CFD) is an instrument called a derivative that allows traders to trade on listed asset’s price movements without actually owning the asset.
If a trader analyzes that the price of a forex pair will increase in near future, he will buy CFDs for that currency set without buying the physical currency and vice versa.
#3. Ask & bid price
Ask price is the lowest price on which you are willing to buy a currency.
Whereas, the bid price is the price on which you are willing to sell your currency.
The difference between the Ask price and the Bid price is the spread. Most forex brokers do not charge a commission, they earn through spreads. The spread size is impacted by many factors such as trade size, currency demand, and market volatility.
#5. Lot size
A lot is a standard size in which currencies are traded. There are 3 common lot sizes:
- Standard lot size – consists of 100,000 units of the currency
- Mini lot size – consists of 10,000 units,
- Micro lot size – contains 1,000 units of the currency.
Some brokers also offer nano lot sizes worth 100 units of the currency.
A lot size has a considerable effect on a trade’s profits or losses. The bigger the lot size may lead to either higher profits or bigger losses and vice versa. That’s why beginners are advised to start with Micro lot size.
#6. Pip (Percentage in Points or Price Interest in Point)
A pip is the minimum price move within a currency pair quoted in four decimal points. One pip is equal to 0.0001. One hundred pips are equivalent to 1 cent, and 10,000 pips are equal to 1 USD.
The pip value can also vary depending on the standard lot size offered by your broker. In a standard lot of $100,000, each pip has a value of $10.
Trader’s profit and loss in each trade are calculated by Pip. Brokers also charge their commission, in the form of spreads, through pips.
For example, let’s calculate the EUR/USD trade’s profit or loss through pip.
|Currency Pair||Exchange Rate at |
Closing of Trade
|Pip Change||Trade Amount|
Number of USD per pip – 100,000 x 0.0001 = 10
Value Per Pip – 10 ÷ 1.1325 = 8.83 EUR per pip
Trade Profit / (Loss) – 52 pips x 8.83 = 459.16 EUR profit.
#7. Margin & Leverage
Margin is the money put down upfront in the trading account for currency trade. Broker lends trader the extra money (in a fixed ratio to trader’s margin money) to perform bigger trades. This extra money provided is called Leverage.
Leverage is given in ratios like 1:40, 1:100, or 1:500.
For example, in a 1:500 ratio, you’ll get a 500x amount to trade on your deposited margin money. That means if you deposit $1000 in your forex account, you can trade up to $500,000. Margin money increases the chances of higher profits as well as losses.
Leverage allows the trader to participate with more money in the market even if he doesn’t have it at that time. Whereas, margin money assures the broker that the trader will be able to pay the leveraged money even if he loses the trade.
Also read – Best trading app in India
How to Trade Forex (5 Easy Steps) in 2022
#1. Learn How Forex Markets Work
Similar to the stock market, forex price movement is based on the demand and supply of buyers and sellers.
Apart from that, there are other bigger forces also play important role in this market that influence the demand for particular currencies. The macro forces could be interest rates, central bank policy, the pace of economic growth of a currency’s native country, and the political circumstances in that country.
Remember, the forex market is operational 24 hours for five days a week, that’s the reason forex markets react immediately to any news that may or may not affect the stock market later on.
Since most forex trading concentrates on speculation or hedging, traders have to be quick in decision-making that may cause sharp fluctuations in currencies.
So understanding of forex market, keeping updated about the global news that may fluctuate currency prices is crucial for making a profit out of it.
#2. Open a Trading Account
To start forex trading, you need a trading account with any Indian broker like Zerodha to start trading in INR pairs.
But if you want to trade in global pairs other than INR (SEBI doesn’t permit that), then you can go with an international forex broker like Interactive Brokers or OctaFX.
You have to pay commission to forex brokers in the form of spreads between the buying and selling prices (calculated with pips). We’ll discuss spreads and pips in the “Terms to know” section.
Some forex brokers also charge commissions along with spreads, so duly check the broker pricing details before opening the account.
If you are a beginner, you can go with a basic account with low capital requirements and negative balance protection so that you can get time to learn forex trading without wasting huge money.
Once the trading account is set up, the next step is to learn about the currency pairs that you are gonna trade.
#3. Understand the Price Quote
If you analyze a currency pair, there are two prices shown.
Let’s understand the above quote (GBP/USD) exchange rate in detail.
- The left side represents the base currency (the G.B. Pound)
- The right side represents the quote currency (the U.S. Dollar)
- The exchange rate means how much of the quote currency you require to buy 1 unit of the base currency. So, the base currency is always depicted as 1 unit, whereas the quote currency keeps on changing based on the current market.
- If the GBP/USD exchange rate is 1.32, that means 1 GBP will buy 1.32 USD (or, you’ll have to spend 1.32 USD to buy 1 GBP).
- An increase in the exchange rate means the base currency has risen with respect to the quote currency (because 1 GBP will buy more U.S. dollars). On the other hand, if the exchange rate decreases, that means the base currency value has fallen.
#4. Choose Your Position
Whenever you place any trade, you open a position, so understanding about choosing a position is highly crucial.
A position is the amount of a particular trading entity like a commodity or currency owned by a person trading in that entity.
In forex trading, since you are not owning anything physically, a position is a binding commitment to buy or sell a given number of currencies for any given price.
Forex trades have two types of positions – long and short.
A long trade position is when you buy a currency in expectation of the currency price will increase in the future and you’ll earn profit by selling at a higher price.
A short trade is the opposite of long trade in which, you bet on the decrease in currency’s future price.
#5. Follow a Trading Strategy
Since you have now understood how forex trades happen, your strategies will also be based on the above ones.
Let’s discuss the top 4 trading strategies based on the duration and number of trades.
1. Scalp trade
Scalp trade or scalping is trading based on small price movements. You hold a position (Buy or Sell) for a few seconds or minutes to earn small profits.
You earn profit in terms of the number of pips a price moved.
2. Day trade
If you hold a position (or multiple) for short-time-interval but liquidate within the same day, that’s considered a Day Trade.
The time span of a day trade can start from a few minutes or it could be multiple hours but the position is closed on the same day.
You need strong technical analysis skills and an understanding of reading important technical indicators like Bollinger bands, RSI for profitable trading.
The only difference between scalping and day trading is, scalping is done rapidly for a very short time interval but day trading you close position within the same day either after a few minutes or multiple hours.
3. Swing trade
When you hold the trading position for more than one day (or even weeks), you are doing swing trading.
Swing trading doesn’t require keeping your eyes fixed on the trading platform throughout the day because they have a longer timeline.
Swing trading is useful during major economic events such as government announcements. You just need to gauge economic and political developments across the globe that can impact your traded currency’s price movement.
4. Position trade
In a position trade, you hold the position for a longer duration that could be a couple of months or even years.
Similar to value investing in stocks, position trade in forex needs deep fundamental analysis expertise because you can position a currency for so long only if you have evaluated it would be profitable in the future.
Now you have got a basic understanding of forex trading. But remember since forex trading involves market volatility and high leverage. It’s wise to start with small to avoid big losses.
If you have any questions regarding forex trading, do let me know in the comments.