Understanding the Basics of Forex
As any experienced Forex trader will tell you, the question they receive most often from newcomers is, “What’s the best way to trade?” While this is certainly a valid question, and one that should be asked by anyone who’s searching for a path to success, there isn’t an easy answer.
This is because there isn’t one standard, universal process that can be applied to every Forex trader, for every situation in which they might find themselves. But why is this? Because the Forex market encompasses a wide variety of trading styles and approaches, and not every one of these could possibly apply to every circumstance.
Within the Forex, the primary trading styles are Long-Term, Medium-Term, and Short-Term, and the different approaches include Technical, Fundamental, and Mixed, which includes aspects of both Technical and Fundamental. We’ll be taking a more in-depth look at these in a moment, but first, we need to define a key term, and then discuss your two most important resources when trading on the Forex market.
What are Pips?
A pip, which stands for Percentage In Point, is the smallest price increment available within the Forex market. For example: Imagine you purchased 10,000 AUD/USD for 1.0262, and sold them at a later date for 1.0269. After the sale is complete, your profit would amount to 7 Pips, because the difference between the purchase price and the sales price is 0.0007.
Time and Money – Your Most Important Resources
It’s important to recognize that your two most valuable resources as a Forex trader are your time, and your money. In other words, you’ll need to decide how much time and money you’re willing to devote to trading currency, which will then establish the approach and style that is best suited for your specific circumstances. First, let’s discuss your availability.
Identifying Your Forex Trading Availability – in Hours
- If your goal is to become a full time Forex trader, then you must commit to being flexible. Because the Forex operates 24 hours a day, seven days a week, you’ll need to be available at all hours of the day.
- If you currently have a full time job, it’s very unlikely that you will be able to devote an additional eight hours of your day to Forex trading.
- If this is the case, you’ll need to scrutinize how much of your day you’re willing to devote to Forex trading.
Deciding on Your Initial Investment Amount – Risk Capital
- Your money (e.g. capital) is subject to risk, and can be lost. You’ll need to decide upfront how much risk capital you’re willing to invest, without it affecting your overall financial position.
- Your risk capital must be funded directly through you. In other words, do not borrow money elsewhere and then consider it risk capital.
- After determining your risk capital threshold, you will then be able to choose the trading platform that works best for you. Each individual broker (e.g. TDAmeritrade, Forex.com, etc.) may require different starting capital minimums in order to open a Forex account. For example: TDAmeritrade requires a minimum of $3,500 to start a new account, though this doesn’t mean that you will be required to apply all of this capital toward trading, which can be as little as $200.
Now, let’s dig in to some of the different Forex trading styles that we mentioned earlier…
Short-Term Trading (also Known as High Frequency Trading)
Unlike short-term trading on the stock market, where your position can be held anywhere from a couple hours to several days, short-term trading on the Forex market implies holding your position for a matter of seconds or minutes. In fact, very rarely will a short-term Forex trade pass the one-hour mark. This is because currencies entail a heavy amount of liquidity and narrow-bid offer spreads, which causes fluctuations in relatively small increments. These fluid price options provide Forex traders the ability to execute extremely short-term trading options, and who are not typically interested in which direction the market is moving.
Short-term trading is also known as In-and-Out trading, or Scalping. Whichever term you decide to use, it’s important to remember that the amount of time you hold a position is not the determining factor for a short-term trade; the number of pips you gain is what really counts.
When considering whether or not short-term Forex trading is the right style for you, keep in mind that it is not suitable for every personality type, especially those who are prone to impulsive or emotional trades. In order to effectively use short-term trading, you need to be extraordinarily self-disciplined. While most new Forex traders will immediately attempt to dive in to short-term trades, primarily because they can be very lucrative in a short amount of time, they quickly realize that other methods may be more effective.
In short, because your character will be your strong point when trading on the Forex, it’s best to utilize a style that matches your individual personality type. While it’s true that market direction isn’t a big factor with in-and-out trading, the fast pace and hectic activity requires extreme self-discipline.
When compared to short-term trading, the timeframe for medium-term trading isn’t significantly longer; usually ranging from just a few hours, up to 1-2 days. What primarily differentiates the two styles, however, is the amount of pips that the trader is looking to earn. In short-term trading, traders earn their profit from minor fluctuations in price, whereas medium-term traders are generally more interested in earning larger amounts of pips. Also, medium-term traders scrutinize which direction the market is moving, because they intend to hold their positions for longer periods of time.
Like short-term trading, medium-term trading is a popular choice for new Forex traders, though as you gain experience, you may find yourself switching between the two styles. It’s important to note that medium-term trading also requires an immense amount of self-discipline in order to be successful.
Unlike short-term, medium-term trading requires a broader market perspective, in addition to more robust analytical skills and higher levels of patience. This is because your position will be held for greater lengths of time, and you’ll need to have a firm understanding which direction your currency pair is moving, and construct your strategies accordingly.
Long-term Forex trading involves holding your position for much longer periods of time, which can last anywhere from weeks to years. While there are many individual traders who utilize the long-term trading style, it is most often implemented by large financial institutions that have the ability to move hundreds of millions of dollars. From a research perspective, long-term Forex traders are required to be as up-to-date as possible on worldwide economic and political news, including interest rate cycles, economic growth cycles, currency policies, and more.
So, Where Do I Begin?
As we mentioned at the beginning of the article, the different trading styles listed above will be more beneficial to some personality types than others, depending on factors such as emotional strength, level of discipline, and character makeup.
As you delve deeper into trading on the Forex market, you’ll likely find yourself leaning more toward one particular style over another. Throughout your journey, you’ll certainly experience good days and bad days; will make good calls and bad calls; and will revel in your successes, while overcoming your mistakes. Throughout this though, you’ll learn, firsthand, what it takes to succeed in the Forex, and with which style you’re most effective.
Here’s to your success!
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