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The global foreign exchange market (forex) is the largest financial market in the world. While it’s a highly liquid marketplace that enables traders to trade currency pairs round the clock, it can be confusing to new participants.
Read on to find out more about how to trade forex.
Trading CFDs and forex on leverage is high-risk and you could lose more than your initial investment. It may not be suitable for every investor. Refer to the provider’s PDS and consider the risks before trading.
Foreign exchange trading (also known as forex, FX or currency trading) refers to exchanging currency with the goal of making a profit on the exchange rate between two currencies.
The forex market is large and complex and involves many different players, both institutional and individual. When talking about forex trading for individual traders, most people are referring to a set of instruments that are traded on the retail forex market, and which allow people to profit from currency movements without actually owning or holding foreign currency at any stage of the transaction.
The forex market is known for being:
Forex trades always involve two currencies. The two currencies involved in the transaction are known as currency pairs. Some examples of currency pairs are set out below:
The first currency in the currency pair is the base currency. The second currency is the quote currency, and indicates how much of that currency is required to buy one unit of the base currency. In a forex transaction, the investor is understood to be exchanging one currency for the other.
Rather than physically exchanging the two, however, traders lodge a ‘buy’ or ‘sell’ order with a broker. Forex brokers are basically intermediaries who facilitate trade by standing ready to accept either buy or sell orders on a range of currency pairs.
If the trader lodges a ‘buy’ order, they’re understood to be buying the base currency and simultaneously selling an equivalent amount of the quote currency. If they’re lodging a ‘sell’ order, they’re understood to be selling the base currency and buying an equivalent amount of the quote currency.
Once the exchange rate moves, the trader ends the trade (or ‘closes out their position’) by entering into an opposite transaction to the one they initially lodged. So if they initially lodged a ‘buy’ order for the currency pair, they’ll now lodge a ‘sell’ order, which reconciles the arrangement with the broker and ends the trade.
To learn more about currency pairs, visit our guide to the most widely traded currency pairs.
Spreads start from 0.0 on major currency pairs and you get some of the lowest forex trading fees in Australia.
Disclaimer: Trading CFDs and forex on leverage is high-risk and losses could exceed your deposits.
The main way that you can realise a profit from forex trading is when the value of one currency changes relative to the other.
Say you lodge a ‘buy’ order (or in other words, purchase a quantity of the base currency while selling an equivalent amount of the quote currency). In that scenario, you stand to gain if the value of the base currency increases relative to the quote currency.
Once you ‘close out your position’ (or in other words, sell the base currency while buying an equivalent amount of the quote currency), you get more of the quote currency back than you initially sold, because the exchange value of the base currency has gone up. You stand to profit off that difference.
Another key attraction of forex trading for many is the fact it enables short-selling, which means you can profit when the exchange rate of a currency decreases. In this scenario, if you had an inkling that the value of the base currency was about to fall (relative to the quote currency), you would lodge a ‘sell’ order, which would simultaneously result in you ‘buying’ a quantity of the quote currency.
Once the value of the base currency falls, you’d then place an order to ‘buy’ it back. Because the exchange rate has fallen, you can now buy it for less of the quote currency than you initially bought. Once again, you pocket the difference.
Movements in currency values tend to be quite small. Usually, a large initial investment is required to realise any gains from forex investments. Today, however, everyone can stand to make reasonable returns thanks to the widespread use of leverage, also known as buying on margin. This involves opening a margin account where they contribute a fraction of the total amount of the trade, and the broker contributes the rest.
Margin trading means that significant profits can be realised from relatively low upfront investments. Equally, leveraged agreements between investor and broker mean any losses are magnified too.
You’re feeling good about the odds so you decide you want to use leverage to magnify your potential earnings and get another $2,500 from your broker. Now you can invest $5,000 in total.
After deciding to trade in the forex market, you need to open a margin account with an initial deposit. The size of the initial deposit depends on the amount of leverage that’s been agreed with the broker, often expressed as a ratio. For example, the leverage ratio may be 50:1 or 100:1 or 200:1.
The leverage ratio indicates the percentage you must have available as cash in the account. For an account with a 100:1 leverage ratio, you need to have a cash deposit of 1% of the total invested amount. Most trades are done on 100,000 units of currency, so if you want to trade $100,000, you would need to have a $1,000 deposit.
Michael has AUD$1500 to invest in the forex market. He decides to trade the currency pair EUR/AUD which is currently trading at 1.25*. This means that one Euro buys 1.25 Australian Dollars. Michael does some research and believes the Euro will rise even more, relative to the Australian dollar.
He opens a margin account with a forex broker offering a 1:100 leverage ratio. Leverage is the loan the broker provides you to trade forex. A leverage of 1:100 means Michael can borrow up to 100 times the amount of his initial deposit of AUD$1500. This also increases his profit potential up to 100 times. At the exchange rate of 1.25, Michael exchanges all of his AUD$150,000 and purchases EUR€120,000.
Michael is correct in his assumption. The Euro strengthens against the Australian dollar. It’s now trading at 1.26. He now exchanges his EUR€120,000 back into AUD, except now it’s worth AUD$151,200. As a result, Michael now has AUD$2200 in his trading account after returning the loan ($149,000) to the broker. Taking into account his initial deposit of $1500, this is a profit of $700.
All forex trades involve simultaneously buying one type of currency and selling another. These are known as currency pairs. Think of each currency pair as a different individual product which is bought and sold. The first currency listed is known as the base currency, while the second is the quote currency.
Example: AUD/USD = 0.73
When you buy a currency pair, you are buying the base currency and implicitly selling the quote currency. The opposite applies when selling a currency pair, where you are selling the base currency and implicitly buying the quote currency.
Example: AUD/USD = 0.73
The bid is the buying price. It refers to how much of the quote currency you need to buy one of the base currency. The ask is the selling price, and it refers to how much of the base currency you will need to sell to get one of the quote currency.
Example: AUD/USD = 0.73
There are as many currency pairs as there are currencies and just because you’re in Australia doesn’t mean you have to trade Australian currencies. You might buy a currency pair of euros and Japanese yen (EUR/JPY = 129.49). But remember, the key to actually making money with forex trading is to have an understanding of how currency values are likely to change.
If you aren’t following shifts in both the euro and the Japanese yen, then that particular trade may not be a good idea.
The highly-leveraged nature of currency trading means that any profits realised from the trade can be magnified. Equally, so can the losses. If the currency you’ve invested in goes down in value instead of up, the potential losses you stand to make are amplified. Most investors put in place mitigation strategies to contain any losses. These measures include limiting the amount of capital that they invest in any one trade, plus issuing stop and limit orders.
Once you’ve decided to trade forex, the next step is to consider how you’ll go about executing the trades. One consideration is whether to use a broker to execute trades on your behalf, or an online discount forex broker.
In deciding to use a broker to execute trades, make sure you consider the following:
When comparing online forex trading platforms, there are a couple of key considerations to keep in mind:
Compare Australian forex brokers below to find one that meets your trading level and needs.
Trading CFDs and forex on leverage is high-risk and you could lose more than your initial investment. It may not be suitable for every investor. Refer to the provider’s PDS and consider the risks before trading.
Forex presents some distinct advantages over other asset classes, such as:
See our guide to online trading and investing for a rundown of other products available for trade.
Deciding your forex trading strategy: Short-term versus long-term forex trading
As with other forms of trading, there are various strategies available to forex investors when they trade. Short-term strategies involve buying and selling currencies over shorter timeframes. A few different approaches are common within this strategy.
With a long-term forex trading strategy, investors are banking on a gradual upward trend in the value of one currency against another. They therefore hold their currency pair over a long period of time and ignore any intraday or intra-week volatility. This has the advantage of necessitating fewer transactions. A level of patience is required to enable the trader to weather daily fluctuations in the value of their currency holdings.
The key to making smart trades is to understand the market. With forex, that means understanding the international currency market and foreign exchange rates. It’s important to keep up with the news and keep an eye out for factors that may affect currency values, like strong economic growth, natural disasters or political strife.
Want to learn more about how to make smart trades? Read up on some strategies that may help.
| Currency pair | The two currencies involved in a forex transaction. When you trade forex, you are understood to be exchanging one currency for another. |
| Base currency | The first currency quoted in a currency pair. |
| Quote currency | The second currency in a currency pair. The quote currency is always shown in the amount required to buy one unit of the base currency. |
| Pip | A “point in percentage”, or a fraction of a single unit of currency. It’s usually 0.0001 of a single unit, though this varies from currency to currency. |
| Bid | The amount the forex market is prepared to pay for your currency pair. If you purchased a particular currency pair, this would be the price to be mindful of. |
| Ask | The amount at which the forex market is ready to sell a particular currency pair. |
| Spread | The difference between the bid and the ask price of a particular currency. |
| Stop order | A price point you can set, which needs to be exceeded before any trades are executed. Essentially, it’s a directive you can issue, to start buying or selling a particular currency pair once it reaches a certain price. |
| Limit order | An order that sets the maximum or minimum price at which you are prepared to buy or sell a particular currency pair. |
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