How to Trade Forex

The foreign exchange market, also known as the forex (FX) or currency market, is the largest and most liquid market in the world. It represents the exchange of one nation’s currency for another, and is used for everything from travelers exchanging currencies to global financing. With over $7.5 trillion  in currencies traded daily, the FX market impacts consumers in a global market, affecting the price of imported and exported goods. To put this in perspective, the five-day Average Daily Trading Volume (ADTV) for US stock and options traded daily is less than $300 billion. While the forex market is huge, 75% of FX trading is conducted in the seven major currency pairs, six of which include the U.S. dollar (USD), with participants including governments, large international banks, regional banks, corporations, and individuals.

Foreign exchange trading continues 24 hours a day, with only the trading centers changing throughout the day. We’ll look at how the forex market works and what you need to know to trade in the financial world’s biggest and busiest arena. 

How to Trade Forex

Trading foreign exchange markets involves buying or selling one currency in exchange for another. The goal of trading is to profit from the changes in exchange rates between the two currencies. To trade forex, you will need to open a trading account with a broker that provides access to the FX market. After opening an account, you will need to deposit funds to use for trading. 

Once you have funds in your account, you can start trading by placing buy or sell orders for currency pairs. These orders can be placed through the broker’s trading platform, which provides access to real-time pricing information and charts. To be successful in trading forex, you will need to develop a trading strategy that takes into account factors such as market conditions, news events, and chart analysis. Trades are sized in lots, with the standard lot representing 100,000 of the base currency (first of the pair). If you put a buy order in for USD/CAD, for example, you are betting on the U.S. dollar appreciating against the Canadian dollar, and this is considered a long position. If you put in a sell order for USD/CAD, you are betting on the Canadian dollar appreciating against the U.S. dollar, and it is a short position. 

Foreign exchange traders typically utilize technical analysis for their trading, and many also use fundamental analysis to gauge the relative strength of global economies. It is also important to manage your risk by using stop-loss orders and proper position sizing. Before placing a trade, you want to know your entry level as well as your exit points for taking profits or minimizing losses. Trading forex can be challenging, but with the right knowledge and discipline, it can be a rewarding and profitable experience.

Steps Required to Trade Forex 

Getting started trading forex is relatively straightforward. While there are some differences in opening a traditional stock trading account vs. a FX brokerage account, the overall steps are largely the same. 

Step 1: Research and select a broker.  The first step is to find out which brokers will offer you a foreign exchange trading account. If your existing broker supports FX trading and you have an approved margin agreement, you can skip ahead and begin trading. If not, you’ll want to look at FX brokers and compare them in terms of platform capabilities, regulatory compliance, fees, margin rates, and customer support. Investopedia does a regular roundup of forex-focused brokers to consider, and there are also large, traditional brokers worth considering. Once you’ve identified a broker that fits your needs, opening a forex trading account is a fast and easy process.

Step 2: Open a forex trading account. To open an account, you need to provide personal information, including name, address, and tax ID number, and some financial background information. You will also have to answer some questions about your finances and investment goals as part of “know your client” compliance.

When you open a FX trading account, it will include the execution of a margin agreement, because currency trading includes leverage. An options agreement will be required to trade currency options, which can be accomplished through either over-the-counter (OTC) options offered by some of the forex brokers or exchange-traded options on currency futures. 

Step 3: Verify your identity. Your broker will confirm your identity through your passport, license, or national ID. A copy of a utility bill or bank statement will also assist with verifying your address. The broker requests the financial and tax information to comply with U.S. government laws and Commodity Futures Trading Commission (CFTC) rules. 

Once your account and margin agreements have been approved, you need to fund the account to start trading. It should be noted, however, that some of the leading online forex companies do not offer accounts to U.S. customers.

Step 4: Fund your forex account. Once your account has been approved, you need to fund it in order to begin trading. Some forex platforms allow you to begin trading with as little as $100, which at the 2% margin (or 50:1 leverage) available for some markets, allows for a position of $5,000. Funding is typically accomplished by ACH bank transfer, wire transfer, debit card (after verification), or check. 

Step 5: Research currencies and identify trading opportunities. Once the account is open and funded, forex traders typically choose the currency pairs they want to trade, then utilize technical analysis to determine their timing points and price levels for trade entry and exit. Like all markets, but especially leveraged markets like foreign exchange, trade size and trade management are very important to achieve the preservation of capital on losing trades and growth of capital on profitable ones. 

The overall financial condition of a country, including interest rates, plays into the value of a nation’s currency, so there is a place for fundamental analysis in currency trading. News and fundamental data releases can also have a large impact on currency values. Beyond fundamental considerations, however, technical analysis is a critical part of currency trading because of the often fast moving currency markets. Many traders focus exclusively on technical analysis to capitalize on the price action of the forex market, using common technical techniques such as trend lines, channels, breakouts, patterns, and support and resistance levels to identify trading opportunities in the foreign exchange markets.

Step 6: Size up your first forex trade. Before making their first FX trade, every trader needs to understand how much capital they have, as well as the specific leverage available to them for their chosen currency pair. Since leverage in forex trading can be as high as 50:1, it is critical to understand how much capital you will have at risk on any trade. The 1% rule for how much capital to risk on an individual trade is a good rule of thumb for new forex traders. This means you should only risk 1% or your total account value on a particular trade. Other traders may choose to use a 2% or even 5% rule for the amount of capital they will allocate to any particular trade. 

The amount you are willing to risk along with how far you are willing to let the market move against your position before taking a loss sets the parameters of the trade. You should also set a take profit point if you intend to systemize your trading, but with the downside risk contained, you always have the option of letting winning positions run. Once the trade parameters have been determined, you are ready to enter the order through your broker’s trading platform.

Step 7: Monitor and manage your position. Once the position has been established, the trader should have a clear understanding of their position and, through their research prior to trading, have clear exit points for either taking profits or taking a loss on their trade. Many traders will use a one-cancels-the-other (OCO) so that they will automatically take their profit or loss should either of these levels be reached, and cancel the remaining order. 

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