Understanding Forex trading for beginners
Evidently, there’s no need for you to be a true daily trader to make the most of the foreign exchange market. Each time you exchange your funds into a foreign currency when traveling overseas, for example, you’re directly involved in the foreign exchange. The foreign exchange market is a quiet giant in the financial world, making its rivals dwarfs in many regards.
Notwithstanding this market’s enormous size, the key principle is simple, when it comes to trading currencies. For understanding Forex trading for beginners, you should continue reading this basic Forex trading guide. Let’s have a look at the key concepts of this business.
Unlike the stock market, with a huge abundance of equities to choose from, in the foreign exchange market, you only require following eight basic economies and then determining which is going to provide the best overvalued or undervalued opportunities. These 8 countries form the cornerstone of the Forex market:
- The USA
- The EU
- Great Britain
- New Zealand
These economies boast the largest and certainly most sophisticated financial markets around the globe. By simply focusing on these eight majors, we are able to get the most relevant information for effective currency trading. You should realize this fundamental thing before we shift to other points including how to understand Forex trading charts and basic Forex trading strategies. Every day economic reports from these majors are published for all market participants, helping traders to estimate the economic health of every key country of this giant mechanism.
Return and yield
Understanding Forex trading suggests that you realize a simple fact that it’s yield, which drives return in the foreign exchange market.
When trading in the foreign exchange spot market (the exact place where trading occurs instantly or in other words on the spot), investors sell or buy two underlying currencies. In this financial market, all currencies are included in pairs for convenient quoting. For instance, with 1.2200 in the currency pair ERU/USD, you’re expected to shell out $1.22 to buy one euro.
In every transaction in the Forex market, you’re purchasing one currency, while selling another at the same time. In fact, traders simply use the proceeds from the currency sold by them to buy another currency.
Moreover, every currency in the financial world is firmly attached to an interest rate. This crucial parameter is set by the major financial institution of the country, the currency of which traders buy or sell in the foreign exchange market. If you decide to make your first steps in the foreign exchange market with Fxmcapital, you will be given an opportunity to undergo substantial training and acquire a number of crucial skills, including understanding Forex trading signals, understanding forex trading graphs, and basic forex trading rules.
As a Forex trader, you’re bound to pay the interest on the asset you’ve already sold, although you also have the right to earn interest on the asset you’ve just purchased. Let’s consider the currency pair NZD/JPY. For example, the major bank of New Zealand has set an 8% interest rate, while Japan’s interest rate accounts for 0.5%. Interest rates are calculated in basis points in the foreign exchange market. A basis point amounts to 1/100th of 1%. Therefore, New Zealand’s interest rate can be expressed in 800 basis points, while Japan’s 0.5% will stand for 50 basis points. When opening a long position in this currency pair, you will grasp 8% in annualized interest, although you will require paying 0.5% for a net return of about 7.5%, which stands for 750 basis points.
The foreign exchange market also provides enormous leverage. A great number of Forex brokers offer a standard 100:1 leverage. It enables the trader to manage $10,000 worth of assets having only $100 at hand. On the other hand, being a double-edged sword, leverage can do a lot with your trading capital. It can bring you huge revenue, but at the same time it can potentially eat up all of your trading deposit if you neglect to place stop loss orders.
You require using leverage wisely, but even if you opt for 10:1 leverage, then a 7.5% profit on the currency pair NZD/JPY suggests a 75% return for you on an annual basis. When holding a 100,000 unit position in the given pair utilizing $5,000 worth of equity, your daily income would amount to $9.40. In this case, you will get up to $94 dollars in 10 days, while you can count on $940 for three months, while the whole year will bring you $3,760. That’s not so bad considering that the same amount of money would only bring you $250 if you tried to save them in a bank with an annual rate of 5%. However, to say the truth, the bank can ensure this amount absolutely risk-free.
The use of leverage is capable of exacerbating any kind of market movements. With great ease, it can generate huge losses or profits. As we told above, the use of stop-loss orders is the only way to prevent losing everything. By the way, nearly all Forex brokers provide a so-called margin watcher. This sophisticated software tool keeps an eye open on your trading position 24/7 and automatically closes it as soon as the broker’s margin requirements are surpassed. In this case, your trading account will never have a negative balance. If you want to progress in your understanding trading in Forex, you’re welcome to study training materials on the official website of Fxmcapital. Here you can also learn 3 basic forex trading strategies for beginners.
Currency values never stand still. Their dynamic nature has made it possible to utilize one of the most popular trading strategies – the carry trade. Carry investors can do more than just earning the interest rate differential within the currency pair. They’re interested in positions expected to increase in value. There have been many opportunities for huge gains in the past. We’d like to illustrate several historical examples.
AUD/USD demonstrated an upbeat yield spread of about 2.5% between 2003 and the end of 2004. You might find it small enough, but 1:10 leverage could extend it to 25%. For that period, the Australian dollar managed to inch up from 56 cents to up to 80 cents versus the evergreen buck that demonstrated a 42% appreciation in the pair. You would have grasped such an impressive profit if you were in that trade. It would have ended up in enormous capital profits in the underlying investment of yours. Just imagine how much various hedge funds earned in that trade, and they did.
Another bright example of the carry trade was observed in the currency pair USD/JPY. In the period of January – December of 2005, the greenback managed to jump from 102 to 121.40 per yen before concluding at 117.80. It’s the same as a 19% jump. It turned out to be more attractive compared to the return of just 2.9% offered by the S&P 500 in 2005. Moreover, simultaneously the interest rate spread between the Japanese yen and the evergreen buck averaged nearly 3.25%. Without leverage, one could have grasped 22.25% over the course of 2005. With 1:10 leverage, traders could have earned a mind-blowing 220% profit. Understanding Forex trading charts can make it a reality for you. Just carefully study the training materials provided by Fxmcapital.
Carry trade success
Perhaps, you think that for a successful carry trade strategy, just pairing up the chosen asset with the highest interest rate versus something with the lowest rate would be enough, but it’s not so. You need to realize that the direction of the spread is more crucial than the absolute spread itself. For successful carry trading, you require being long enough in a currency with an interest rate, which is currently in the process of expanding versus an asset with a contracting or stationary interest rate. Apparently, this dynamic can come true if the main financial institution of the country you’re long in considers lifting interest rates or if the major bank of the state you’re actually short in considers lowering its interest rates.
In that USD/JPY example above, from 2005 to 2006 the Fed was quite aggressively lifting interest rates from 2.25% to 4.25% that stands for a 200-basis point leap. On the other hand at that time, in Japan, the BOJ had been keeping its interest rate intact – it remained at 0%. As follows from this, the actual spread between Japanese and US interest rates rallied from 2.25% to 4.25%. That’s a typical example of an extending interest rate spread.
Keep in mind that currency appreciation can drastically spur the value of your carry trade revenue, but on the other hand, depreciation can eat up all of your carry trade profits.
Being aware of where interest rates are headed is crucial in this business. It requires a proper understanding of the country’s economics. In general, countries performing well and with firm surge rates and soaring inflation are more likely to have their interest rates lifted for the purpose of taming inflation and controlling surge. On the contrary, countries with stagnating economies will most probably reduce their interest rates.
News in Forex trading
Various macroeconomic events and news have a powerful impact on currency prices in the foreign exchange market. It’s essential for you to closely watch the crucial news. Even if you base your trading decisions solely on technical analysis, while neglecting news, nevertheless, it’s highly recommended to at least be aware of when major events are scheduled. This approach will enable you to make rational decisions in the foreign exchange market.
Well, before, during and also after a news publication you have a few choices. Fxmcapital offers the following tips on how to treat news in the foreign exchange market:
- Stay away from opening new positions ahead of crucial news events.
- If the price is near your take profit, you’d better have your trading position closed ahead of high impact news. Gambling with your gains is what you shouldn’t do.
- When being in a trade, you should have your stop loss tightened. The matter is that in times of high volatility your stop-loss orders mightn’t be executed at the actual price level. So, you’d better close your trading positions before a crucial news event.
- You require waiting 30-60 minutes after its publication before you enter a fresh trade. Post-news price volatility can be extremely unpredictable and erratic. Wait for some time until the dust settles and then make your decision.
Another crucial nuance is which news one should take into account. Fxmcapital has a good new calendar, enabling you to learn the most crucial daily news.
Fxmcapital marks the news item depending on their impact-level and shows which asset is most impacted. That’s a list of the top-notch market movers in the foreign exchange market:
- Major bank meetings (BOJ, Fed, BoE, RBA, ECB, SNB);
- Consumer Price Index (CPI) – it gauges inflation;
- Unemployment data, in particular, the US NFP;
- Interest rate decisions – for currencies they’re the key long-term drivers.
It’s what traders call their life. If you don’t have enough margin, you won’t be able to open a trading position. Moreover, with an open trading position moving against you, a margin call can show up – a bitter situation when a trader doesn’t have enough funds to support his trading position.
As you might have already understood, a margin can be defined as the amount of funds required to open a leveraged trading position in the Forex market. For instance, if a broker offers 1:50 leverage and a trader is eager to open a $100,000 position, he has to ensure up to $2,000 of margin. If the trader’s position moves against its forecast to the very point where his account equity gets less than his margin ($2000), the trader will have a margin call. In other words, the broker will ask for more margin to hold the trader’s position.
Due to the widespread availability of electronic trading networks today, Forex trading is currently more accessible than ever before. Fxmcapital will help you to make the most of this largest financial market around the globe.