Discover how you can generate wealth and build for your financial future by trading forex.
Forex is a common abbreviation for foreign exchange, and forex trading refers to investors trading in the foreign exchange market. The primary objective of forex trading is to make a profit by exchanging one currency for another at an agreed price, for example exchanging Australian Dollars for US Dollars. Forex is the world’s most traded market but it does carry some risk. With this in mind, forex trading is much better suited to experienced investors than new traders.
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How does forex trading work?
Forex traders have one main aim: profiting from the change in value of one currency against another. They do this by basing their investment decisions on which way they think forex prices will fluctuate in the future.
For example, if the Australian Dollar is expected to go down in value in relation to the US Dollar, a forex trader would sell their Australian Dollars and buy US Dollars. If the US Dollar then increases in value, the trader then possesses greater purchasing power to buy more Australian dollars than they initially had, resulting in a profit.
On the global forex market, all currencies are quoted in pairs - that is, in terms of their value versus another currency. For example, AUD/USD, GBP/EUR and USD/GBP are just a few common currency pairs.
Trading foreign exchange is quite simple and there are a range of trading platforms to choose from. To place a trade, all you have to do is select whether you want to buy or sell a particular currency pair and the amount of your transaction.
What are the benefits of forex trading?
Forex trading has many advantages for the right investor, starting with the fact that forex markets are highly accessible with many open 24 hours a day. Unlike the Australian Stock Exchange, for example, which only offers normal trading between 10am and 4pm on business days, the global forex market runs around the clock (but not on weekends). This means foreign exchange prices are constantly going up and down and there are plenty of investment opportunities for traders.
In addition, because forex is a leveraged product, investors can trade on the market for a smaller initial outlay. In order to place a trade, you only need to spend a small percentage of the full value of your position, which means there is a much higher potential for profit from a small initial outlay than in some other forms of trading. Unfortunately, this also means there is a greater risk of suffering a loss.
Case Study: Graham Trades USD/EUR
Graham is a veteran investor buying and selling currency pairs. Believing that the US Dollar will likely increase in value against the Euro, Graham decides to purchase $100,000 worth of US Dollars at €0.90. He buys a forex contract worth €90,000. Because his forex trading platform allows him to place trades at a margin of 1%, this investment costs Graham $1,000 to place.
Graham’s prediction is correct and the US Dollar rises to €0.925, resulting in a profit of around AUD$3,500 for Graham, less any transaction fees.
What forex trading platforms are available?
There are several forex trading services that available to Australian investors. These include:
- Forex Capital Markets
- CMC Markets Australia
- FOREX.com AU
- IG Australia
- City Index
- FP Markets
Before deciding on the right trading platform for you, make sure to compare the fees and benefits of several providers.
What’s the cost involved in forex trading?
Just like with any other form of investment, you need to make yourself fully aware of the fees and charges that apply before you begin trading forex. To start with, compare the margin you will be required to meet in order to make a trade with a range of providers. This could be 0.5%, 1% or some other figure, and this will affect the amount of money you will have to spend to buy or sell forex. For example, if your account has a margin of 1%, a trade worth $100,000 will require you to spend $1,000.
In addition, most providers will charge a commission for every trade you make. These fees are generally be quite low, such as a few cents per thousand dollars. However, some providers will not charge any commissions on your trades. Other fees may apply to credit and debit card payments.
Finally, you will also need to consider the spread, which is the difference between the buy and sell prices for each currency pair and is effectively what a broking platform will charge you to make a trade. Look for a trading platform that offers tight spreads to minimise the cost involved.
What do I need to open a forex trading account?
Most forex trading platforms will typically allow you to apply for an account within minutes online. While the application process varies between providers, you will usually have to fill out an online application and then await a response from the provider to learn whether or not your application has been approved.
You will usually have to supply:
- Your name
- Your date of birth
- Your contact details
- Your address
- Your country of residence
- Proof of ID, for example a driver’s licence or passport
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What are some common forex trading strategies?
Just like with any other form of investment, there are several strategies you can consider when trading forex ranging from the basic right through to quite complex approaches. One strategy traders can use is to perform technical analysis or fundamental analysis to try and accurately predict the future performance of currency pairs.
Another common strategy is known as the day trading strategy, and it is based on the simple premise that you do not hold any forex positions overnight. Because the longer you hold open a position the greater risk of you suffering a loss, traders can close all the positions they hold before the end of the trading day and therefore minimise risk.
A third common strategy is support and resistance levels. This involves researching the past fluctuations of a currency and using them to predict future price movements. The previous upper limit of a price is its resistance limit and the previous lower limit is its support limit. This can help traders make an educated guess as to when a currency’s value may rise or fall.
What are some of the risks associated with forex trading?
Before you start trading forex you should make sure that you are well aware of all the risks involved with this sort of trading. These include:
- Even though you only have to pay a small percentage of the value of your trade upfront, you are still responsible for the entire amount.
- Foreign exchange rates are volatile and can quickly move against you, causing you to lose a significant amount of money.
- As markets are open 24 hours a day, you may need to devote plenty of time to tracking any open positions.
- Predicting currency markets is quite difficult as they can be affected by a wide range of factors.
- Even stop loss orders which are designed to minimise your losses can only offer limited protection against the risks involved.
Frequently asked questions about forex trading
How can I tell if forex trading is for me?
Once you’ve familiarised yourself with all the risks involved in trading forex, you may want to consider opening a demo account with a forex trading platform. This will help you see if you have what it takes to successfully trade forex.
What is a pip?
A pip (point in percentage) is generally the smallest movement an exchange rate can make. In most cases this refers to the 4th decimal place of a currency e.g 1.445, but in some trading platforms with fractional pips, this can be the 5th decimal point e.g 14456. In some currency pairs, the pip can refer to the 2nd decimal place e.g 89.84.
What are the most commonly traded currencies?
The most commonly traded currencies include the US Dollar, the Great British Pound, the Euro, the Japanese Yen, the Swiss Franc, the Canadian Dollar and the Australian Dollar.
When can I trade on the forex market?
Due to international time differences, the forex market is open 24 hours a day, six days a week.
A forex trading platform is offering a free trade - should I sign up?
Ensure that you read the fine print of any promotional offer closely and also check out the features and fees that the platform offers.
I’ve never invested before but I’d like to start - is forex a good option?
Trading forex is quite complex and features a large number of risks, so ensure that you do some research before trading forex.
What is an intraday position?
This is a trade that is opened and closed during the same trading day.
What is an overnight position?
This is a forex trade that is still open at the end of normal trading hours (5pm AEST).
What is a stop loss order?
This is a conditional order that is designed to minimise your risk when trading. It allows you to arrange for a position to be automatically liquidated if it reaches a certain predetermined price.
Does the global forex market have a central location or exchange?
No. Forex trading is conducted between a global network of banks, institutions and individuals around the world.
What factors can affect the foreign exchange rates?
The value of currencies can be affected by everything from supply and demand to economic conditions, political conditions, interest rates, inflation and consumer confidence.
What else should I be aware of when trading forex?
Many first-time traders are unaware that forex trading places them at risk of losing more than their initial investment. However, this can and often does occur.
Forex trading glossary
- Ask price. This is the lowest price at which a trader can buy a currency.
- At best. This is an instruction given to a broker to purchase or sell a currency at the best rate currently available in the market.
- Base currency. This is the first currency listed in a currency pair. It shows the value of one currency when measured against another, for example AUD/USD.
- Bear market. A bear market situation is when prices sharply decline.
- Bid price. This is the price at which an investor can sell a currency.
- Bull market. This is a market where prices are rising.
- Forex. An abbreviation of foreign exchange.
- Hedging. This involves opening a new position in opposition to an already open position in order to protect against exchange rate fluctuations.
- Leverage. Leverage refers to a trader’s ability to control a large amount of money in the foreign exchange markets after only having to invest a small percentage of the overall value of a trade.
- Margin. The amount you are required to spend to open a trade.
- Margin call. This is a warning message when your trading account does not hold sufficient funds to maintain all the positions you have open.
- Spread. The difference between the bid price and the ask price.
