Foreign Exchange: An Intro
At its simplest, foreign exchange (or Forex, combining the ‘for’ from ‘foreign’ and ‘ex’ from ‘exchange’) is the act of turning the currency of one country into the currency of another. Every time a consumer goes to a bureau de change, a foreign exchange transaction occurs. An exchange rate measures the change in value when money moves from one currency to another. Depending on which country has the more valuable currency, this transaction could either save the consumer cash or cost them more. That value, meanwhile, is determined by a variety of factors. While in some places, the value of the local currency is decided by an authority of some sort (such as a national government), the capitalist economies of the world generally leave their currencies to fluctuate in value based on the traditional laws of supply and demand.
As a result, everything from how many tourists visit a nation, to the demand for the products and services of the nation’s businesses, can end up influencing the final cost. However, there’s another side to Forex as well, and that’s the way in which it can be traded by speculators. Rather than buying a particular foreign currency to pay for goods and services in a specific location, Forex speculators buy a currency as an investment, in the hope that its value will rise and they can sell it on for a significant profit.
HOW IT’S DONE: TRADING FOREX
Unlike many asset classes, you can’t trade a foreign currency as a single unit. Instead, you invest in a currency pair and stipulate what outcome you think will happen. Say you are investing in the Japanese yen/Australian dollar Forex pair – if you’re hoping for the yen to surge ahead against the dollar, you will use the dollar to purchase the yen and then sell the yen back if it makes a profit. Also, you should note that there are two distinct ways in which you can trade Forex, and the option you go for will likely depend on your chosen Forex trading strategies.
The first way to do it is to buy the foreign currency itself and then sell it on at a (hopefully) higher price further down the line. The second way to do it is to buy a derivative of the currency (such as a CFD, or contract for difference) and trade that instead. Under this system, you won’t actually own the underlying asset, but you’ll be able to trade in a way that resembles ownership of a currency on the actual market, and you’ll be subject to the same market movements as someone who owns the currency outright. If you do it the latter way, you can boost any gains (or, indeed, losses) you might make because CFD trading tends to be done on a margin basis, in order to harness the power of leverage.
TACTICS: THE BEST CHANCE OF SUCCESS
When it comes to trading Forex, taking a tactical approach is the only real way to be in with a chance of financial success. Some people misunderstand the world of foreign exchange trading and assume that it’s just a game of chance. While it’s certainly possible that you may have occasional success here and there without a solid trading strategy in place, it’s almost certain that there won’t be any long-term gains. That’s the first reason why implementing a strategy is something that successful Forex traders do.
If you’re looking for a way to test out these strategies before you go ahead with them on the open market, though, it’s possible to do that. This is one of several advantages associated with CFD Forex trading rather than actual asset-based Forex purchases. CFD brokers have virtual cash options that allow you to see how your strategies would actually work on the open market – without having to stake any cash yourself. Once you’re happy with your virtual performance, you can make the shift over to the real cash investment side of the platform and apply your new-found knowledge.
STICK TO FOREX TACTICS
Researching a list of trading strategies is a good place to start when it comes to the Forex world, but it’s not a foolproof way to ensure that your Forex strategy is going to be a good one. That’s because strategy in the trading world is an umbrella covering many different asset classes and modes of investment, and the type of strategy that works well for one instrument isn’t necessarily going to work for others. Forex, in particular, is a unique market in many ways, and this means that the strategies you select should be highly tailored to the market.
When choosing a Forex strategy for beginners, you’ll need to ensure that it takes into account the fact that the market is exceptionally dynamic because of high trading volumes, for example, while it should also consider the fact that pairs can change in value at different times because they are geographically removed from each other.
You should also make sure that the Forex strategy you pick is compatible with backtesting. That’s not always something you can rely on when just looking at general trading strategies, so you should be careful. Some strategies that are designed for cryptocurrency trading, for example, don’t take into account the role of backtesting because cryptocurrency is so new and there’s not as much data for it available. If you were to apply a strategy like that to Forex trading, you’d potentially be missing an essential tactical element.
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Get Your Priorities Right
Whether you want to try scalping or trend trading, there are plenty of different Forex trading strategies available. Although it may seem difficult at first (especially to a new trader), selecting from these many strategies is something that needs to be done in a detached and scientific way. Choosing a tactic based on how impressive it sounds on paper or how easy it is to implement, for example, is missing the point. The strategies you choose need to be designed around your needs as a Forex trader. You need to identify what your strategic priorities are and then work outwards from there.
At the most basic level, you’ll need to think about time allocation. Scalping, for example, requires making profits on the back of small price movements, so you may need to invest a lot of time in monitoring the market for that sort of behaviour if you choose this strategy. Given the international nature of the Forex market, you may also have to trade at times that don’t match your working hours. If you’re trading the British pound and Australian dollar pair, for example, then that’s two very different time zones, and economies, to be thinking about. But there are other personal priorities that need to form part of your strategic Forex decision making – the size of your deposit may open up extra strategic avenues if it’s unusually large, for example.
MANAGE YOUR RISK
One vital aspect of trading, common across all strategies and all asset classes, is consideration of risk. Trading is an inherently risky activity, and that’s as true for Forex as it is for other financial instruments. On most Forex trading platforms, though, there are plenty of risk management tools available to help you. Order execution tools such as stop losses, for example, are there to allow you to close off a trade when it reaches a certain level of profit or loss, so you can trade in confidence, knowing that you have your best-case and worst-case scenarios covered – something that many with a low-risk appetite are keen to see.
There are a whole host of other order execution tools that can also help you manage risk, and it’s wise to investigate them and assess them to see if they will fit into your preferred risk management strategy. There’s no obligation to use risk management tools, of course, and you can choose whether or not to do so, based on factors relevant to you. The key thing is ensuring that you’ve considered them and thought about whether or not they will fit into your strategy and help you to achieve your own trading goals. Whether the answer is yes or no, assessing risk management tools and strategies is essential.
Model Your Trades by Backtesting
Nothing is guaranteed in the Forex world. There are, however, some ways you can improve your chances of making a profit, and it’s essential to consider incorporating these into your Forex trading strategies to make the most prudent choices. Backtesting is one of these methods. Put simply, it’s the practice of applying a proposed Forex trading strategy to a collection of past data points from the same market and discovering to what extent they would have been profitable.
- Backtesting is the practice of running proposed strategies over previous data
- Past performance is not always a good predictor of future market moves
- But backtesting does allow for pattern and trigger identification
This isn’t a foolproof method. If trading were that easy, of course, then everyone would backtest until they found the right strategy and then make profits from day one of trading. While past performance is never a sure-fire way of working out how an asset might perform in the future, backtesting is an excellent way to identify what makes the market for a Forex pair move and change. For example, backtesting can identify patterns and triggers that shift the market one way or another, and you can then use this information to make informed and strategic trading choices.
CONSIDER USING AUTOMATED TRADING SOFTWARE
Given the developments that have emerged in Forex technology in recent years, it’s common for some traders to use what’s known as automated trading software as part of their trading strategies. This software is designed to automate as many Forex trading tasks as possible without actually causing you to lose control over your trading decisions. You can set parameters that dictate the conditions in which your trades should be opened and closed, for example, and then these will be automatically executed once the circumstances you have specified arise. The main attraction of this kind of automation is that it allows you to continue to trade even if you’re not in a position to be at your computer or device.
As with all Forex trading tools, it’s vital to ensure that you don’t let the software replace your Forex trading strategies. If you choose to use these tools, you need to ensure that they are serving the right purposes for your Forex trading strategy. Any trading strategy that requires constant assessment of small market movements, for example, may not be well suited to automated software. As with any tool, you should make sure that you use it only if it suits your stated trading goals.
Top 3 Forex Broker Comparison
Copy trading is one of the latest developments in the online trading world. It offers trading opportunities to Forex traders who maybe aren’t confident enough, knowledgeable enough, or simply don’t have the time to make strategic decisions of their own. The trades placed by a copy trader are linked to your trading strategies and therefore outcomes. If the portfolio of the trader being copied performs well, for example, you’ll also profit – but if it doesn’t, you’ll incur the same losses as them.
- Copy trading is possible for Forex
- It saves time and prevents the need for trading decisions
- It’s important to choose a trader who matches your goals
- The platform you choose should allow for customised searches
One of the significant copy trading websites is eToro, but there are many to choose from, and it’s worth spending as much time as you can looking for the right platform before you begin trading. Remember that whichever site you choose should match your strategic priorities. If you’d like to follow a high-risk strategy to maximise the chances of returns, for example, it’s important to choose a site that allows you to sort potential traders by risk appetite.
Why Tactical Forex Trading Makes Sense
Forex trading is something that many people do for a variety of reasons. Whether it’s ensuring that you have enough cash in your pocket for a foreign holiday or enabling your business to take on new contracts, there are many reasons why you might invest in foreign currency. But it can also be done as a speculative investment, and that’s where strategic Forex trading comes into play. By taking a tactical approach to your Forex investment, you can design a system that’s repeatable and re-usable over time. Incorporating your preferences, such as your attitude to risk, into the strategy will increase the chances that your investment will play out in the way you want it to.
Similarly, you’ll need to make important decisions about whether or not you’ll incorporate tools like automated trading, copy trading and more into your tactical plan, and it’s a good idea to also think about using backtesting tools that measure your current proposed strategies against historical data. No matter what sort of strategy you eventually come up with, it’s wise to always put your own goals front and centre. By working out your preferred risk level, your ballpark deposit amount and more, you can then work outwards to find tactics that suit your circumstances. By carrying out a Forex broker comparison to find the best Forex broker available, you can ensure that the platform you eventually use has the functionalities and features required to execute your new trading strategies.