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Forex 101

What is Forex Trading?

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Forex is a combination of the words foreign exchange, and this is exactly what takes place in forex trading (Also known as FX Trading). This is essentially the trading of one currency for another.

We are here to teach you the terminology used, and to guide you on getting started as a forex trader.

Terminology of Forex Trading

Before you can walk the walk, it is always good to be able to talk the talk. Within forex trading, you’ll encounter a variety of terms that have significance in the market. Understanding this terminology will have a positive impact on your forex trading journey and help you to become a better trader.

Here is a basic rundown of a few terms that you are most likely to encounter along the way:

The Forex Market

The forex market is the market on which you are trading. It is completely decentralized and is where all currency exchange takes place. The exchange of one currency for another is exactly what forex trading is, and precisely what the forex market facilitates.

The volume traded daily on the forex market is more than any other trading market in the world and because of this globalized, decentralized nature, it operates 24 hours a day, 5 days a week around the world. When you get into forex trading, you will have access to the forex market through your forex broker.

Forex Broker

A forex broker is your link to the forex market, due to licensing requirements different brokers can only accept clients from specific regions. We offer a list of trusted brokers below, and recommend the best for each region.

Not all brokers you that find online are well-regulated, many of them have a poor history of fraudulent behavior, which is why performing due diligence is important. Below we include a list of brokers which you should avoid.

Currency Pairs

Currencies within the forex market are always traded in pairs. This is just the same as when you frequent a bank or currency exchange. You may see the symbols EUR/USD, or USD/JPY, and more. These are known as currency pairs and signify how much it costs to trade one currency for another.

The layout is also important, the first currency is the base currency, and the second is the quote currency. So where you see EUR/USD is 1.15 for example, this means that 1 Euro is worth $1.15, or that it costs $1.15 to buy 1 Euro at the current rate. Hundreds of currency pairs are available with forex brokers offering them in three categories, major pairs, minor pairs, and exotic pairs.

Leverage

When we talk about leverage in forex, in the most basic of terms it means the additional money that you can borrow from your broker based on the balance of your account. As forex is typically traded in $100,000 standard lots, a lot of trading on leverage takes place. Within Europe, most brokers will offer a 30:1 leverage (the maximum allowed under EU regulation). This means that if you have an account balance of $1,000, you could potentially enter trades to the value of $30,000.

The leverage available really depends on where you are trading from and in some areas, under different regulations, brokers can offer leverage of 500:1 or more.

Margin

Margin in forex trading is invariably linked to leverage also. The margin is how much of your own funds you must have in your account to open a trade, or to keep that trade open. So, if you are trading with a leverage of 50:1 and you want to enter a trade worth $100,000, then you will need a $2,000, or 2%.

Pips

Pip is something you will see a lot of in forex trading and is short for “percentage in point”. A pip is defined as the smallest movement that a foreign currency market can make based on how the rates are listed to four decimal places. The value of 1 pip then is always 1/100 of whatever market you are trading. It is an important measurement to be aware of and calculate, as things like your spread will also be calculated in pips.

Spread

When trading forex you will always see two prices, the buy, and the sell price. The spread is the difference between these prices. Given that many of the top brokers operate on a commission-free basis and with minimal fees, the marginal spread that they do apply is an area where they can make a slight amount from each trade.

The spread in forex differs from market to market and changes all the time based on a number of factors like market volatility and volume, though most of the top brokers start their spread from as low as possible.

How to Get Started in Forex Trading

Armed with all of the most common terms in the industry, you are now well placed to start your journey as a forex trader. Here we will go through a few of the most common steps to take in finding the best broker for you, and what you will need in order to set up a forex trading account.

Choosing a Regulated Broker

With forex trading being completely decentralized, that means there is no one authority overseeing the market and the operations of the many forex brokers within that market. This makes choosing the broker with the best regulations in place a very important task.

There are a number of key, very well-respected regulatory bodies around the world that forex brokers try to become regulated by. The best among these include CySEC in Europe, FCA in the UK, and ASIC in Australia. There are many more that can also point to trusted regulation, but these are some of the most sought after.

Regulatory oversight of your broker from one of these bodies is a very positive sign that you can trust them completely. These regulators also put in place a number of things to help protect you as a trader, including maximum leverage amounts, negative balance protections, and more. Therefore, if you are a new trader and entering the industry for the first time, we would highly recommend choosing a well-regulated forex broker.

Consider all of the Trading Conditions

Every forex broker will of course have their own trading conditions. Some of these will be bound by the regulatory body that your broker is under. Within CySEC regulation for example, trading leverage offered by the broker can’t be more than 30:1. Other conditions though are left very much to the discretion of the individual broker.

This means that you should take a close look at things like minimum deposits, spreads charged by the broker on the different account types, commission charged, and all other fees that can increase your cost of trading such as deposit/withdraw fees and any fee for inactive traders or holding your positions open for a period of time.

With that said, you can also keep in mind that some of the top forex brokers strive to offer the best deals and often have loyalty programs and rebates for more active traders. Some with have welcome bonuses and other kinds of incentives though this again will depend on the rules of the local regulator.

Try a Demo Forex Trading Account First

One of the best ways to get started and completely risk-free, is to select a forex broker who offers a good quality demo account. These demo accounts from the top brokers are often unlimited in the sense that you can keep them open for as long as you like, and allow you to trade with virtual currency, but in an environment that completely replicates that of a real trading account.

This is a really great way for you to get to know exactly what a broker has to offer, and also learn more about the trading platforms and how to trade forex in general. It is a crucial step that we highly recommend, particularly if you are trading forex for the first time.

Choose Your Account Type & Trading Platform

Almost all of the top forex brokers will have a number of account types that you can choose from when opening your account. The trading conditions may vary on these types of accounts, and the minimum deposit usually also changes.

Typically, the higher the minimum deposit is on an account type, the better the trading conditions tend to be in terms of spread, fees, and any bonuses available.

You may also have the chance to choose your trading platform with most major brokers offering the top trading platforms from Metatrader of MT4, and MT5, as well as cTrader. Some brokers will also have their own proprietary trading platforms that you can trade through which can be very user-friendly for new traders too.

Account Funding

The last step in opening an account with any forex broker is to make your deposit. Again, the top forex brokers usually make a range of deposit options available to traders. These can include bank wire transfers, credit and debit cards, or eWallet methods like PayPal and Neteller that are commonly found.

The majority of these funding methods the broker’s usually try to offer without any fee. This can make sure you receive the best possible value for your money when making a deposit. On this point though, you should also check with your own bank about their fee policy particularly if you are making a wire transfer.

Trusted Forex Brokers

Forex.com – United States & Canada

– Regulated by NFA, CFTC, FCA, FSA, IIROC & CIMA
– Member of the National Futures Association (NFA# 0339826)
– Forex trading involves significant risk of loss and is not suitable for all investors.

City Index – UK

– Authorized & Regulated by the FCA (# 113942)
– City Index is a trading name of GAIN Capital UK Limited.
– Head and Registered Office: Park House, 16 Finsbury Circus, London, EC2M 7EB.
– GAIN Capital UK Ltd is a company registered in England and Wales, number: 1761813. Authorised and Regulated by the Financial Conduct Authority.  VAT number: 524837435
– 74% of clients lose money. Capital at risk.

City Index – Australia

– ASIC Regulated.
– City Index is a trading name of GAIN Capital Australia Pty Ltd. GAIN Capital Australia Pty Ltd, 100 Harris street, Pyrmont, NSW 2009 (ACN 141 774 727, AFSL 345646) is the CFD issuer and  products are traded off exchange.
– All trading involves risk and losses can exceed deposits.

City Index – Singapore

Regulated by the Monetary Authority of Singapore (MAS)

– City Index is a trading name of GAIN Capital Singapore Pte Ltd.
– GAIN Capital Singapore Pte Ltd 168 Robinson Road, Capital Tower #20-01, Singapore 068912. Tel: 6826 9988. Fax: 6826 9968.
– Company Registration # 200400922K.
– All trading involves risk and losses can exceed deposits.

Opening your Forex Broker Account

The final step in the process of getting involved in forex trading is to open your forex broker account. This means you will have selected your broker, and perhaps even tried their demo account, and you are now ready to open your own live trading account and start trading for real.

If that is the case, then the process is quite simple, though there are a few steps you should follow.

Prepare Your Documents

The process of opening a forex trading account can be pretty fast, though there are a couple of documents that you should be sure to have prepared to make the process as easy as possible. All major forex brokers will ask for the following:

  • Proof of identification ( Your passport or driver’s license would be best for this)
  • Proof of residence (A utility bill or bank statement within 3 months should be fine here)

With these documents, you typically upload them online through one of the broker’s trusted, secure services and they are verified within a few hours. Once you have completed verification, you will be completely free to trade on your new account.

Brokers to Avoid

These brokers should be avoided at all cost

53option.com

Crown Forex

Cyber Market Group

Fixed Star Investments Inc

Forex Macro

FXCM

FXReturns

Titan Trade

TorOption

Trade24

Final Thoughts

Forex trading from an outside perspective may appear to be a complex, even daunting sector to start trading in. The reality is that, with some of the basic knowledge provided, and the help and educational infrastructure of a top forex broker, you can easily become involved.

Once you have made the first steps in forex trading, you can also be open to much of the great potential that a market with trillions of dollars in daily trading volume can bring. We also have a number of other trading articles that can really help you learn and grow on the next steps of your journey as a forex trader.

Forex Risk Disclaimer

“There is a very high degree of risk involved in trading securities. With respect to margin-based foreign exchange trading, off-exchange derivatives, and cryptocurrencies, there is considerable exposure to risk, including but not limited to, leverage, creditworthiness, limited regulatory protection and market volatility that may substantially affect the price, or liquidity of a currency or related instrument. It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable, or that they will not result in losses.”

Affiliate Disclaimer

Some of the links in this website either through images, text, audio or video are affiliate links. This means if you click on the link and purchase the item, the owner of this website will receive an affiliate commission.

To learn more visit our affiliate disclosure page.

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Anthony is a financial journalist and business advisor with several years’ experience writing for some of the most well-known sites in the Forex world. A keen trader turned industry writer, he is currently based in Shanghai with a finger on the pulse of Asia’s biggest markets.

Forex 101

What is Algorithmic Trading in Forex?

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Trading in the forex market has been steadily evolving over decades since it first began. This has particularly been evident in recent years with the continuing emergence of new trading strategies and methods. These have generally advanced trading to become both more convenient, and more efficient.

One such method which has experienced a sharp growth in popularity of late, is algorithmic trading. Here we will examine what exactly algorithmic trading in forex is, the methods available, and how it could be an effective tool in your trading arsenal moving forward.

Algorithmic Trading Basics

Algorithmic trading at its core, is trading based on a computer program. This computer program follows a preset collection of instructions, an algorithm, to perform a number of functions for you as a forex trader. Typically, within forex trading, this algorithm would be set to execute trades at certain points, or to follow a defined trading strategy in a certain way based on market changes. To this end then, algorithmic trading, also known as algo-trading, can do exactly that. It can automate trading based on a strategy which you desire to implement. This strategy is then made into an algorithm and put to work on your behalf.

As technology continues to advance, not only are an increasing number of traders turning to algorithmic trading methods as a means of trading, but the algorithms themselves, are becoming more and more advanced.

In the current market, there are an endless number of options available in this market space. These range from forex robot trading which you can purchase and implement directly, to community based automated trading strategies which you can take and implement yourself through many trading platforms if your forex broker allows algorithmic trading.

Different Types of Algorithmic Trading

Broadly speaking, we can break algorithmic trading into four different types based on the desired results. We will then define this further into the most common strategies used by trader who engage in algorithmic trading.

Looking at the overview when it comes to algo-trading, we can define four general strategies, or functions, that can be performed within algorithmic trading.

Statistical Algo-Trading – This type of algorithmic trading searches through historical market data in order to identify trends and opportunities based on the data it finds, versus the current market data and trends.

Algorithmic Trade Execution – This type of strategy is used to increase the speed and efficiency of trading, typically by executing trades as quickly as possible. This type of high-frequency trading is used to great effect by scalpers within the forex trading sector.

Algorithmic HedgingThe purpose of this type of algorithmic trading is to balance your exposure to certain areas of the market, under specific conditions. This type of strategy is typically engaged by many in hedging their portfolios, or in many automated portfolio rebalancing services which have become very popular.

How to Use Algorithmic Trading

If we take the strategies above as general functions which algorithmic trading can perform, then this enables you to implement a number of different solutions or times when you may want to use algorithmic trading. Some of the following may be made possible when you engage the strategies mentioned above.

Price Action/ Trend Following – This is one of the primary purposes for which algorithmic trading is used. It is also one of the most simple. Using the algorithm, both the previous market trend, and the current market trend can be compared and used to identify profitable trading opportunities.

Arbitrage – Particularly in forex trading, algorithms can be used to identify opportunities in various markets to exploit price differences. To employ this strategy, you will typically need to have two or more forex broker accounts. You could then potentially exploit price differentials between the two by employing algorithmic trading.

Forex ScalpingForex scalping is the act of moving in and out of trading positions very quickly throughout the day. In doing this, scalpers aim to profit from very small market movements at any given time. These may represent tiny profits to some traders, but using algorithmic trading, it is possible to engage in thousands of these trades per day at a much faster rate that you would if trading manually.

Benefits of Algo-Trading in Forex

With a basic grounding in what algorithmic trading is, and how it functions, you may wonder what benefits it can ultimately bring to you as a trader. Here are a few of the major benefits associated with algorithmic trading in forex.

Better Trade Prices – Since algorithmic trading is preset to execute trades at certain levels, this is done almost automatically, or at least at a much faster pace than you could possible achieve through manual trading. This typically means that you have a much higher possibility of executing trades at your best desired price.

Time Saving – If you have employed an algorithmic trading strategy, then you can just set it up, and leave it to work. You do not need to be there to monitor it. This means you save yourself an untold amount of time behind the screen and executing trades.

No Emotion – Algorithmic trading is completely systematic. It is essentially a computer program which will follow the data, precisely as you instruct. This leave no room for either human error, or emotional decision making, both of which can often be costly if you are trading in any market.

Final Thoughts

When it comes to algorithmic trading, where previously you may need to have had advanced computer programming knowledge to implement some of the strategies, now that is simply not the case. Though it would be helpful, you really can get started with algorithmic trading very easily through using codes from other members of the community, or trying out some other dedicated forex robot services which can make the whole thing very easy.

Ultimately, if you want to take a more hands-off approach to forex trading which will definitely save you time, and has the potential to increase your returns, then algorithmic trading is something well worth considering.

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Forex 101

What is Interest Rate Parity?

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As you become more and more involved in the forex market, you will realize that there are a wide number of factors which can influence the exchange rates at any one time. This can include an array of both internal, and external factors. One of the biggest factors in determining currency exchange rates, is the interest rate of a country. The two are interwoven and looking at the difference between the interest rates of two countries, can even help you plot the future course of the exchange rate. This is according to the theory of interest rate parity which we will explain and examine in further detail here.

What is Interest Rate Parity?

At the most basic of levels, what interest rate parity means is that you should not be in a situation where you can benefit more from exchanging money in one country and investing it in another, than you would from earning that money and investing it in your own country and then converting the profits to the other currency.

Before looking at an example to illustrate this point, it is important to note that the forward exchange rate is integral to the theory of interest rate parity, so let’s quickly recap the difference between the spot rate, and the forward rate, in forex trading.

Spot Rate: This is the current exchange rate for a currency if you are trading right now on the forex market. As a regular forex trader, this is the rate you will almost always see posted by your broker.

Forward Rate: This is the rate that a bank or other party to the agreement agrees to pay for a currency at a certain time in the future. This is the rate you will also see if you are trading in forex futures.

Interest Rate Parity Example

The forward rate is important when we are talking about the theory of interest rate parity. As a very simplified example, you should not benefit from exchanging US Dollars to Euros and then investing it in Europe, and exchanging it back to Dollars, more than you would from investing the money in the US and then exchanging the resulting profits to Euro.

Detailing the example further, presuming that the spot rate is €0.75 for every dollar, you will receive €7,500 for a $10,000 exchange. Also presuming the interest rate In Europe is 3%, your return after 1 year would be €7,720.

Now, if you were to keep this money invested in the US at a higher interest rate, then exchange your return to Euro at the end of one year, you would be availing of the forward rate. This would, according to the theory of interest rate parity, net you the same result of €7,720 when the formula is applied.

In essence, what the theory, and example should demonstrate is that the interest rate difference between two countries, should also match the difference between the spot and forward currency exchange rate.

Covered or Uncovered Interest Rate Parity

When we talk about interest rate parity, we can actually divide it into two different types. These are covered interest parity, and uncovered interest parity. In the most simple of terms, covered interest parity is said to exist when there is a forward contract in place which has locked in the forward interest rate. This should leave no room for any difference at all between what is contracted, and what actually happens.

Uncovered interest rate parity is exactly the opposite in that there are typically no contracts in place here to lock in the forward interest rate. The parity in this case is simply based on the expected spot rate in the future. With this, there may be room for error and possibly a slight difference between the result of the formula, and the actual outcome. With that said though, forecasts on spots rates in the future tend to be quite accurate.

Why is Interest Rate Parity Important?

There are a couple of key reasons why interest rate parity is important. The first of these is to stop actions like arbitrage happening on a large scale. Now, this kind of thing does certainly still occur, but the scope for it to happen is greatly tightened. This is the simultaneous purchase and sale of currency or assets in two different markets or areas, exploiting a short-term difference.

More broadly speaking, it prevents not only retail, but also more powerful traders from exploiting gaps in the market which would leave them with a guaranteed, no-risk return. In the bigger picture, what this would do is actually remove the integrity from the forex market and others in entire countries or regions. A by-product of this would be that as traders moved to exploit these gaps, there would be huge and volatile swings in the market. Interest rate parity provides for a degree of assurance that this will not happen, and thus a stability that traders can rely on.

There are still some situations in which the theory of interest rate parity can be challenged. These include in certain arbitrage situations particularly as technology and algorithmic forex trading continue to advance, and the carry trade has long posed a challenge to the formula of interest rate parity, though this can be mitigated depending on if it is covered, or uncovered.

Final Thoughts

The concept and formula behind interest rate parity can be one which many in forex trading, even those with more experience, find to be complex. This is true at least at face value. With a pragmatic approach though, it becomes clear that the core of the concept is relatively simple, and it can even help you to accurately forecast future currency rates if correctly applied. If you are getting involved in more complex trading situations, particularly involving multiple currencies, and regions, having the formula, and a clear understanding of the concept of interest rate parity becomes essential to reaching your forex trading goals.

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Forex 101

What are Carry Trades in Forex?

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As you continue increasing your knowledge about forex trading and the market in general, more and more new concepts and ideas will pop up. This includes a growing range of trading technique and strategies. One such trading strategy which has been around for a very long time in the industry, is the carry trade. Here we will take a closer look at exactly what a carry is in forex, and provide all the information you need to decide if carry trading is a good strategy for you as you move forward on your trading journey.

Basics of How a Carry Trade Works

In its most simple form, a carry trade in forex, is borrowing one currency, and using it to buy another. For example, you may borrow (sell) $100,000 Australian Dollars, and use those funds to purchase the same amount of JPY. Placing a carry trade is one of the most popular trading strategies in the entire sector, and used by many traders to benefit from the position of currencies around the world.

So, what is the benefit in borrowing one currency and using it to buy another? This comes from the difference in interest rates between the two currencies. Let’s look again at our example in more detail.

Presuming the interest rate on the Australian Dollar was 4%, and the interest rate on the JPY was 0.1%, a carry trade would be where you buy the AUD/JPY market, as here, what you are effectively doing is selling (borrowing) Japanese Yen, to purchase Australian Dollars. In the most simple of ways, you will now have placed a carry trade. Here you will earn 4% interest on the Australian Dollars you are holding, while paying 0.1% interest on the Japanese Yen you have borrowed. This should leave you in a profitable position if the rate does not change, and is known as a positive carry trade at +3.9%.

Why is Carry Trading Popular?

From an outside perspective, even looking at our hypothetical example where there is quite a gap between the interest rates, you may wonder why placing carry trades is so popular when the potential profit may seem quite small. There are two main elements at play in the forex market though which make this a very attractive type of trading strategy.

Currency Pairs: The fact that currencies are traded in pairs make a carry trade very accessible, and convenient for all traders. The difference in interest rates has never been so easy to take advantage of as it is in forex trading, where you can directly trade low and high interest currencies in pairs.

Leverage: The availability of extensive leverage in forex makes it the ideal place to carry trade. Many forex brokers can make leverage of up to 500:1 available on certain currency pairs. This basically means that even a relatively small deposit of $1,000 can open up huge buying power of $100,000 at 100:1 leverage, or more. Dealing with such large numbers, even low percentage profits are very meaningful.

Popular Forex Pairs to Carry Trade

Given the fundamentals of how a carry trade works, borrowing a low interest currency, to buy a high interest currency, then this is precisely what traders are on the lookout for in the forex market when it comes to placing a carry trade. There are a couple of currencies in particular that are most popular in this regard.

As a selling currency, the Japanese Yen is always a very popular choice. This is thanks to the historically very low cost of borrowing in Japan. The country has not had an interest rate of above 0.5% in more than 20-years. Another popular choice as a selling currency may be the Swiss Franc (CHF).

On the buying side, popular choices include both the Australian, and New Zealand Dollar as countries which typically hold slightly higher interest rates, yet are recognized as quite stable currencies.

Benefits of a Carry Trade

A carry trade in forex can be an excellent long-term investment strategy. You will have the potential to benefit from a carry trade even if the rates do not change at all thanks to the difference in interest rates. This makes it perfect for an investor who intends to hold the position for a long time.

Added to that, if the rate does change in your favor, then you can potentially have a sizable profit when added to the interest rate difference, and factoring in the leverage used. The fact that many brokers nowadays also cater for trading with very competitive fees and low spreads also plays to your advantage if placing a carry trade, and is something that many look out for.

Risks Involved in a Carry Trade

With every form of trading, there is always a certain element of risk. With a carry trade, though it is seen as a low-risk strategy, there are still a couple of things to be mindful of.

The market can still move against you. A change in the market can certainly negate any benefits you have gained from the positive interest rate difference. Particularly if you decide to trade in minor, or exotic currency pairs which are less common, you should note that these markets can be highly volatile, and subject to change in a very swift fashion. Some examples include trading with the MXN (Mexican Peso), or NGN (Nigerian Naira). Both may appear attractive for a carry trade, but can be subject to intense volatility. This risk can be amplified even further if you are trading with a lot of leverage.

You should also remember that, just because there may be a positive rate difference at the moment, the monetary policy in every country is subject to change at different times. The perfect example of this would be right now, in the midst of the coronavirus pandemic, many nations have moved to cut interest rates. This has the possibility to really change the dynamics of your carry trade.

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Trading Risk Disclaimer: There is a very high degree of risk involved in trading securities. Trading in any type of financial product including forex, CFDs, stocks, and cryptocurrencies involves a high level of risk.

This risk is  higher with Cryptocurrencies due to markets being decentralized and non-regulated. You should be aware that you may lose a significant portion of your portfolio.

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