How to Trade Forex

Forex trading, or foreign exchange trading, involves buying and selling currencies on the global decentralized over-the-counter foreign exchange market. With daily turnovers averaging around $6 trillion, the forex market is by far the world's largest and most liquid financial market. 

This article covers essential topics ranging from understanding the basics of forex trading, setting up a trading account, developing a strategy, managing risks and selecting the right broker. By the end of this piece, you will have gained sufficient knowledge to open a demo account with an online broker so you can start to practice currency trading more confidently.

How Trading Forex Works

At its core, a forex trade involves purchasing one currency using another currency at a specific rate of exchange or exchange rate, which serves as the price in forex trades. In practice, making a forex trade involves buying or selling a currency pair (EUR/USD) where the first currency in the pair is called the base currency, while the second is known as the counter or quote currency. 

Currencies trade in pairs against each other in the global and largely unregulated forex marketplace that operates 24 hours a day from the Sydney open at 5 p.m. ET on Sunday afternoon to the New York close at 5 p.m. ET on Friday. This massive market lets forex traders buy and sell currency pairs freely at any time during its standard opening hours. 

Currency values constantly fluctuate relative to each other because of various economic and geopolitical factors, creating opportunities for traders to profit from them. Forex traders actively engage in financial market speculation, aiming to profit by taking a position in a currency pair that correctly predicts whether the base currency will appreciate or depreciate against the counter currency.

Steps to for How to Trade Forex

To start trading in the retail forex market, you can follow these simple steps.

Research and Select a Broker

Before getting into forex trading, you have to select a reliable broker. Key aspects to consider when choosing a forex broker include:

• Margin and leverage: Check how much money (collateral) you need to place trades and what leverage the broker offers. Higher leverage can boost your profits, but it also increases your losses. You can learn more about leverage and margin here.
• Regulation: Make sure the broker follows the rules of financial authorities in its country. This adds safety and credibility. Learn more about forex broker regulations here.
• Fees and costs: Look into trading costs, including spreads, commissions, and fees for deposits and withdrawals.
• Customer Support: Make sure the broker offers good support through channels like email, phone, live chat, or social media.

Set Up a Forex Trading Account

Once you've chosen a reputable forex broker, you need to register for a trading account by providing personal details and verifying your identity. Regulatory authorities often mandate stringent "Know Your Customer" protocols that require every trader to authenticate their identity.

Your chosen broker will likely offer different accounts for traders with varying levels of skill and investment amounts. Take the time to read about each account and pick the one that best fits your experience, trading style, and budget. Here are some common account types you might come across:

• Microforex accounts: These accounts typically have low initial deposit requirements, narrower lot sizes and restricted leverage ratios, making them ideal for beginners looking to gain experience with minimal risk.
• Standard forex accounts: This account type generally features average deposit minimums, standard lot sizes and moderate leverage levels, catering to intermediate and advanced traders who seek a more balanced trading environment.
• VIP forex accounts: These accounts usually come with premium services, higher deposit limits, broader trading capacities and personalized support. They generally target high-volume and well-capitalized traders requiring advanced features and dedicated attention. They often come with exclusive discounts and VIP bonuses.
• Islamic forex accounts: Since they abide by Sharia law, Islamic accounts eliminate riba (interest) on swaps and rolling positions. Such accounts thus present an ethical option for Muslim traders seeking compliance with their faith while engaging in online forex trading.

Fund Your Forex Account

Most brokers will allow you to practice trading forex with virtual money through demo accounts before investing cash. You'll want to use this opportunity to familiarize yourself with the broker’s trading platform and its various functions without risking your hard-earned capital.

After registering your live account and testing the broker’s platform, the next step is to fund your trading account with appropriate capital. To do this, you'll transfer funds using one or more of the secure payment methods approved by the broker, so make sure the broker you select offers a funding method you want to use.

Understand Fundamental Concepts

Before you start trading forex, it makes sense to master some of the key terminology commonly used in the market. Here are a few of the essential forex terms you will need to know:

• Pip: Represents the smallest unit of change in a currency pair's value. A pip is equivalent to 0.0001 for the major and minor currency pairs, other than USD/JPY where a pip equals 0.01.
• Lot: A standard minimum quantity of base currency units per trade. A standard lot is usually 100,000 base currency units, while a mini lot is 10,000 units and a micro lot is 1,000 units. Different lot sizes exist to accommodate individual trader preferences and account funding amounts.
• Leverage: Leverage is money borrowed from a broker to increase your trading power. It’s shown as a ratio (e.g., 500:1), meaning you can control 500 times your deposit amount. Your deposit, called margin, acts as collateral for your trades. In the U.S. leverage is limited to 50:1, set by The Commodity Futures Trading Commissions (CFTC).
• Bid: The exchange rate that buyers are willing to pay for a specific currency pair.
• Ask or offer: The exchange rate at which sellers are prepared to dispose of a particular currency pair.
• Market order: A trade direction given to a broker to instantaneously execute a forex trade in a specified amount at prevailing exchange rates.
• Limit orders: A limit order is a trade instruction you give to a broker to buy or sell at a better price than the current market rate. The trade only happens if the market reaches your chosen price and stays there long enough for the full order to be completed.
• Stop-loss orders: A stop-loss order tells your broker to automatically close a trade if the price drops to a certain level. This helps limit losses by stopping the trade before the market moves further against you.
• Take-profit orders: A take-profit order tells your broker to automatically close a trade when the price reaches your target level, which is better than the current market price. This helps you secure profits and avoid the risk of the market reversing.

Developing a Trading Strategy

Before you start trading with real money, make sure to come up with a trading plan with clear entry, exit, risk and money management rules tailored to your individual goals, risk tolerance and preferred timeframes. 

It generally helps to incorporate technical analysis (chart patterns, indicators, trend lines, etc.) and fundamental analysis (economic data releases, geopolitical events, etc.) into your trading plan to maximize your decision-making accuracy. Adapt your trading strategy depending on evolving market conditions and volatility fluctuations.

When creating a forex trading strategy, it's typically helpful to consider relevant timeframes and prevailing market conditions to optimize your overall profitability. Remember that certain trading strategies tend to suit different trader personality types, timeframes and situational contexts better than others. Some of the more popular forex trading strategy types are discussed further below.

• Scalping: This is a trading strategy where traders make very quick trades to capture small price changes multiple times during a session. Scalpers open and close positions rapidly, often using high leverage and special strategies like the martingale system. Because forex markets move fast, many scalpers use automated trading bots to react instantly.
• Day trading: This strategy involves making multiple trades within the same day, aiming to profit from short-term price movements. Traders open and close all positions within a single trading session, avoiding overnight risk. Day traders rely heavily on real-time charts, monitoring minute-level tickers and news feeds to pinpoint fleeting momentum shifts and capture quick profits. Popular tactics embrace breakout strategies, pullback plays and mean reversion techniques.
• News trading: Centers around reacting quickly to sudden news announcements, reports or unexpected events, often involving a rapid interpretation of breaking headlines and geopolitical developments to generate profits by accurately predicting resulting exchange rate impacts and trading short-term volatility spikes.
• Swing trading: Focuses on exploiting medium-term market fluctuations occurring over several days or weeks. Swing traders tend to use a blend of technical and fundamental analyses to detect emerging trends and reversals, as well as indicators like moving averages, candlestick patterns, momentum oscillators and market sentiment surveys.
• Trend (or position) trading: This involves holding trades for months or even years, focusing on long-term market trends driven by economic factors. Traders use tools like market cycles, Elliot wave theory, and structural trends to identify major turning points and profit from big price movements.

Choosing a Currency Pair to Trade

When trading forex, the first step is choosing which currency pair to trade. A currency pair consists of two currencies, where the first is called the base currency and the second is the quote currency. For example, in GBP/USD, GBP (British Pound) is the base currency, and USD (US Dollar) is the quote currency. This means you are trading how many U.S. dollars are needed to buy one British pound.

There are many currency pairs to choose from—over 80 in total.  Major pairs like EUR/USD, GBP/USD, and USD/JPY are the most commonly traded ones, which involve strong, stable economies. There are also exotic pairs, such as HUF/EUR, which include currencies from smaller or developing markets.

When you trade forex, you are predicting whether one currency will go up or down compared to the other. This is often done using CFDs (Contracts for Difference), which allow you to trade without actually owning the currency. CFDs use leverage, meaning you can open a much larger trade with only a small amount of money (called margin). However, this also means that your potential losses can be much larger than your initial deposit, so managing risk is important.

Before choosing a currency pair, it's a good idea to research how the two currencies move in relation to each other. This uses fundamental analysis (looking at economic events, interest rates, and political news) and technical analysis (studying price charts and patterns). This research will help you make better trading decisions.

Deciding Whether to Buy or Sell

After selecting a currency pair, you must decide whether to buy or sell it. Your decision should be based on whether you think the base currency will strengthen or weaken against the quote currency.

• If you believe the base currency will increase in value compared to the quote currency, you should buy the pair.
• If you think the base currency will decrease in value, you should sell the pair.

For example, let's say GBP/USD is trading at 1.28000. This means 1 British pound is worth $1.28. If you think the British pound will become stronger and rise in value, you would buy GBP/USD. But if you believe the pound will weaken, you would sell GBP/USD.

Setting Stops and Limits to Manage Risk

The forex market moves fast, and prices can change quickly. This is why risk management is crucial. Stops and limits are tools that help you control your risk and lock in profits automatically.

• Normal stop-loss: This closes your trade if the market moves against you to limit losses. However, in fast-moving markets, it might not always close at the exact price you set (this is called slippage).
• Guaranteed stop-loss: This ensures that your trade is closed at exactly the price you set, even if the market moves very fast. You pay a small extra fee for this protection.
• Trailing stop: This moves with the market when prices go in your favor but locks in profits by closing your trade if the market turns against you.
• Limit order: This automatically closes your trade when the price reaches a profitable level that you set in advance.

Practice and Implement Your Strategy

Once you have developed a trading strategy that works well for you, remember to take the time to hone your skills and test your strategy in real time by trading in a demo account before operating in a live trading environment. When you have gained confidence in your strategy and ability to implement it, you can start trading live and gradually increase exposure size as your confidence builds and proficiency improves. 

Before you place large financial bets, remember to determine the appropriate position size for each trade considering your account funding, overall portfolio composition and desired risk parameters.

Place, Monitor and Manage Your Trades

After you start a trade, keep an eye on it regularly. This helps you see how it's doing and make changes if the market moves against you.

Many traders use stop-loss and take-profit orders to protect their money and reduce losses if the market moves against them. It's also important to check your past trades, track your results, and adjust your strategy based on what works, your risk comfort level, and good judgment.

What You'll Need to Open a Forex Trading Account

The documentation required to open a forex trading account can differ depending on where you live, your chosen broker’s legal jurisdiction and whether you want to open a personal or corporate account. 

Most forex brokers require the following personal documentation before you can open and fund a live trading account as an individual: 

• Proof of identity, such as a national ID, driver’s license or passport
• Proof of address like a utility bill or a bank statement
• Bank account details for deposits and withdrawals
• Your tax identification number (TIN)

Types of Forex Markets

You can trade forex in various ways, so be sure to select the most suitable forex market type for your trading goals:

• Spot forex market: The spot forex market is the most popular and works fast. When you make a trade, it's usually completed within 1-2 business days. The exchange rate of a spot forex contract reflects current market conditions. 
• Futures forex market: Futures forex markets let traders use leverage and trade set contract sizes with fixed expiration dates. These markets offer only a few standardized forex contracts but provide a secure system to reduce the risk of one party not paying the other.
• Forward forex market: Forward forex contracts are mainly used by businesses to protect themselves from currency price changes. These are private agreements with banks, allowing companies to set custom trade sizes and choose a future date for the exchange, rather than following the standard spot market timeline.

Featured Offering

FOREX.com offers U.S. traders cash rebates, competitive spreads starting from 0.8 pips and access to more than 80 currency pairs. Traders can utilize platforms like MetaTrader 4/5 and TradingView, benefiting from real-time trade data and market insights. With leverage up to 50:1, the platform also provides robust educational resources, including webinars, tutorials, and strategy tools to support all levels of traders.

Frequently Asked Questions