Forex Basics

Forex stands for Foreign Exchange. A Forex trader simply trades currency by buying or selling of one currency over another. They do so buy placing orders on currency pairs. A currency pair consists of two currencies. For example, the EUR/USD pair consists of the Euro and the US Dollar. In this case, the Euro is the base currency. This means when you place an order to buy the pair EUR/USD, this means that you are buying the Euro with the US Dollar. When you buy, you are betting that the Euro will go up. When you sell, you bet that the Euro will go down.

The next step to trading Forex is choosing a broker. If you are an inexperienced trader, you will want a broker with a low minimum deposit and a good spread. Hopefully, you can find a broker that will offer a fixed 1 pip spread. Let’s talk a bit more on the broker. Brokers process your trade. Each broker may or may not have their own trading platform. However, all brokers will use MetaTrader 4 or MetaTrader 5. MT4 and MT5 are standardized trading platforms. They offer a wide range of technical analysis tools such as line entrancement, channels, and more. The most important thing to consider when choosing a broker is looking for a low deposit and a small spread. These are the things to keep in mind when choosing a broker:

1. For those that are new to Forex trading, a low deposit is very important. Why? A lower deposit amount is usually safer as less money is at risk. Many discount brokers allow a deposit amount of only $1. This means that beginner traders can start trading with only $1. If the dollar is lost, it isn’t that big of a problem as it is only a buck. However, if a broker required a minimum deposit of $500, you potential loss if $500, which is not very pleasant in case that $500 is lost while trading.

2. Leverage is the next thing to consider. Leverage increases your buying power. Brokers usually offer a 1:1, 100:1,500:1,1000:1, and 10000:1 leverage. A 100:1 leverage means that you can control $100 for every dollar you have in your account. Assuming that you have $5 in your account, you can trade with $500 rather than just $5 if you have no leverage. Keep in mind that bigger doesn’t mean better. Since the concept of leverage is borrowing money from your broker and repaying them back, a bigger leverage means more to pay back. This posses as a greater risk for inexperienced traders as the chances of losing the borrowed money are much higher. A good leverage amount is around 100:1 to 200:1 for beginner traders.

3. The final thing to keep in mind when choosing a broker is spread. Before we talk about the spread, we need to go over some background information. Currency prices are quoted in two prices. The first price is the bid price. This is the amount others are willing to pay. The second price is the ask price, which means the price traders are willing to sell. Let’s use the classic example of cars. Let’s say you want to sell your car because you need some extra cash. You place an ad in the local newspaper and your ask price is $5000. This is the price you are willing to sell your car at. Those who wish to buy the car may not wish to pay that much so they give you a new offer. Let’s say a person offers $4800 for the car. This person is placing a bid of $4800. In conclusion, the best price (lowest price) a seller offers is the ask price and the best price (highest price) a buyer offers is the bid price. Anything in between the bid price and the ask price is known as the bid ask spread. In Forex trading, the bid ask spread is the amount between the bid price and the ask price. This is usually a fixed rate, but may change depending on the broker. The bid ask spread is a way for Forex brokers to charge commission. Unlike stock trading, you do not pay commission every time you place a trade. In order for the broker to profit from your trade, they implement a bid ask spread. This isn’t very clear for many people, so let’s clear it up. Let’s say that you want to buy 1 lot of EUR/USD at $1.3708. The price you have paid is the ask price. Let’s say that the broker has a 3 pip spread. If you were to purchase EUR/USD at 1.3708 (ask price) and then immediately closed the position. The price you get is the bid price because you are selling to the highest bidder. With the implementation of the three pip spread, you will receive $1.3705 for your lot. By placing this trade and immediately closing it, you lost $0.0003. This may not seem like a lot, but make sure you keep in mind that your losses are actually magnified due to leverage. It is very important to find a broker that offers a reasonable spread.

After selecting your broker, you will have to decide which platform you wish to use. You could use the standardized MetaTrader platform. However, beginner traders usually struggle a bit with MetaTrader as the software requires a lot of knowledge to navigate. Many brokers offer a web trading platform, which is usually simpler to use. The web trading platform offers many advantages such as no software download and installation required, user friendly, and the ability to view open positions.

After selecting your broker, making a small deposit, you are now ready to trade. Forex trading has many benefits. However, the biggest benefit is low commission and low capital. It is possible to trade with just $1. Traders won’t earn much with a $1 deposit, but it is great for getting experience.