Forex trading for beginners is really no different than any other trading instrument in that you must start with an understanding about your chosen market. There are some basics that if you don’t understand, you are already behind the eight ball before you even open a Forex trading account.
The first understanding you must have is that unlike stocks or many futures markets, you are actually trading two currency pairs when you open a trade. This is why you will see quotes such as:
The first currency is the main currency and to properly read the above, it means $1 British Pound will get you $1.67 in USD. To further simplify this you can simple write it out: $1 GBP = $1.67 worth of USD. If you were to buy the GBP, you are selling the USD. The rate tells you the amount of the quote currency that must be sold to buy 1 unit of the base currency.
Understanding this is vital for beginning Forex traders.
There are many currency pairs available to Forex traders but Forex trading for beginners should really focus on four major pairs. These are the pairs that have more participation and no retail trader (you) should have a problem with liquidity in these markets:
- EURUSD: Euro vs. USD
- GBPUSD: British Pound vs. USD
- USDCHF: USD vs. Swiss Franc
- USDJPY: USD vs. Japanese Yen
What are contract sizes?
You have probably heard the term “lot sizes’ in terms of Forex trading. This is the term used to describe the size of the contract you are trading. They are broken down in four types depending on how much capital you have and risk.
- Standard lots – $100000
- Mini lots – $10000
- Micro lots – $1000
- Micro-mini lots (not offered by all brokers)
Whatever size you trade depends on how much capital and leverage you have to use. Before touching on that, beginning traders must understand how to make money with Forex trading.
Pips, not points
Price changes in Forex are calculated in pips unlike other markets with trade in ticks and points. The smallest price movement in Forex is one pip. Using the GBPUSD, if price is at 1.6700 and moves to 1.6701, that “1” is a one pip increase in price. The amount of money you gain or lose depends on the contract size.
Using the EURUSD and trading one standard lot, each pip equals $10. If you make 20 pips, you gross $200. If you lose 20 pips, your loss is $200 plus spread.
Many beginners entering the Forex market are drawn by the no commission ads they see. While there is no commission in the general sense, there is a cost involved and that cost is called spread. Spread is simply the difference between the bid and the ask price. It varies depending on the currency but you should understand that Forex trading, in size, can be more costly than trading the currency futures.
If you are trading the EURUSD with one standard lot and the spread is 2 pips for retail traders, you are paying $20 just to take the trade! Compare that to the 6E Euro Futures contract and you may be $5 for the trade. Futures are off limits for some due to their capital requirements but it is food for thought down the road for beginning Forex traders.
Forex trading and margin
Leverage is a big draw to Forex trading and can aid you in controlling much more in terms of contract size compared to your actual capital in your account.
Let’s say your trading account as a balance of $5000. If you use leverage of 1:50, this means for each dollar in your account, you can control $50. Your entire account could control $250000 but this in no way means you should ever trade that amount.
You can make more money by using too much leverage but at the same time, an adverse move could wipe out your entire account. I personally would never consider basing my trading decisions on the full leveraged amount.
Be a risk manager
Beginning Forex traders should consider that there main goal is not to make money, but it is to manage risk. This starts with knowing how much in dollar terms you will risk per trade.
Due to the different sizes of contracts available to those that trade Forex, most trades, regardless of the pip risk, can be brought into an acceptable risk in dollar amounts.
Here is an example on how you can decide on the types of lots you will trade. You must use your own judgment on dollar risk and discuss this with the appropriate professionals.
Account size: $5000
Risk in pips: 40
Percentage of account you risk per trade: 1%
Calculation of dollar amount: 5000 x .01 = $50 risk
Calculation of dollar per pip: $50 / 40 pips = $1.25/pip
In the example above, each pip can be worth $1.25. This would allow you to trade, rounding down, 1 mini lot will equal $1/pip.
Using these numbers, if this trade hits your stop, you have only lost 1% of your account which is not difficult to recover with a winning trade.
What type are you?
Forex trading, for beginners and even advanced traders, comes with a big decision in knowing what type of trader you will be.
- Day trader – Taking positions during the day to exit before the end of session
- Scalper – Quick in and out of the market taking 5-10 pips
- Swing trader – Attempt to take advantage of the natural ebb and flow of the markets. Usually hold positions for a few days
I think most new traders to Forex should focus on swing trading. Day trading is fine however since the currency markets trade 24 hours per day, many get into the habit of trading the slow periods.
For day traders, you would want to trade during the high volume times which is usually the European session and the U.S./European overlap session. Other times can find you stuck in a trade that is going no place.
The traders I know find scalping the Forex market a novice mistake and I agree. On a cost basis alone considering spread costs, it can be quite expensive for multiple trades over the course of a day. You will also find widening bid/ask spreads which increase your costs as well as trading “noise” with short price moves.
A big downside of the two methods above is the required short decision making times. Both styles can be extremely hectic and can challenge even the most skilled trader.
Swing trading can be done in a more relaxed way and on higher time frame charts. The chart below shows you an example of what many would consider swing trades.
The green line shows that the overall trend (direction) of this market is up which means for greater probability of a winning trade, you want to buy.
The red lines show the corrections against the trend and your goal is to get into the up move when it resumes as seen by the dark arrows.
If trading using a four hour chart, you only have to check the charts briefly a few times per day to find an opportunity.
While the risk in pip is generally larger than a day trade, the profit potential can be immense.
The free version of Trend Jumper actually comes with a trade plan using the daily chart of the EURUSD. You can download it here and get a hands-on education about swing trading.
Starting your trading journey
This post gives you some insight into the basics every trader should know about currency trading. Forex trading for beginners is simple but is truly not easy to do. Arming yourself with a solid trading education like that offered by Premier Trader University and a focus on risk should put many of you on the right road.