Understanding Forex Trading As A Whole
Welcome to the first chapter in this guide on Forex Trading For Beginners! In this guide, we will go right back to the very basics in forex trading itself in What Is Forex Trading? Step 1: Understanding Trading As A Whole!
If you’re a beginner, this is the perfect place to be and by the end of this guide, you will understand how the concept of forex trading works.
And more specifically, how people can profit from making trades and why it can sometimes be more complicated than you might think.
It is vital to understand what forex trading is before you jump into the world of forex because if you don’t understand how people can make a profit (or a loss!) from a trade, then it will be impossible for you to earn from forex trading.
Forex trading requires a lot of learning from traders. It is not something you can simply just do. Just like a surgeon, you need to be taught first. In forex trading, ignorance certainly is not bliss!
By the end of this guide, you will be fluent in the basics of forex trading, the history of forex trading, understand why people trade forex, how to measure value and understand what it takes to become successful.
Let’s get stuck in!
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Back To Basics: What Do We Mean When We Say ‘Trade’?
Here’s a quick definition by the Cambridge Dictionary:
“[T]he activity of buying and selling, or exchanging, goods and/or services between people or countries”
It’s a pretty simple concept; you give something to someone, and they give you something back in exchange. That, in a nutshell, is what a trade is.
A trade is not always about trading goods for other goods (e.g. a banana for an apple - though that is a super simple example), it can also be a service for other services (e.g. a haircut for fixing a sink - though perhaps such an arrangement isn’t too common!) or services for goods or vice versa.
It’s an exchange between two people or entities that both sides should agree on. It’s debatable though if it still counts as a trade if one side is forced into the arrangement.
But here’s where things start to get more complicated; in order to make it as a ‘profitable’ trader, you are always looking to profit from the deal.
In other words, you want the more valuable possession in order to sell it on for a profit. Or at least, what you perceive to be more valuable (more on measuring value below under ‘How do you measure value?’).
You can then sell it at a higher price than what you paid, and that is where your profit comes from. Or, if you end up selling it for less than it is worth, this is clearly a loss.
Some traders may also view selling a procession at the same price as they purchased it as a loss or even selling it a very small return can also be seen as a loss. This largely depends on time.
If you waited a very long time to sell something, and it only gives you a very small profit, you may view that time as wasted as you could have used it trading something more profitable.
‘Time is money’ after all, and time you’re wasting on something that’s not profitable can be very frustrating and make it harder to continue trading.
However, if a short-term trade gives you a small but quick profit, this is not so problematic, in fact, it may even be good if you can repeat this trade, over and over again. This will then be very profitable (this is called ‘compounding’, more on that in a bit).
Breaking even (when you sell something at the same price you paid for) might also not be so bad if you are concerned that the item’s price will further depreciate.
In that case, you are preventing further losses. There’s no need to hold on to a useless asset. Unfortunately, some items will never recover in value.
Any trader should have experience and knowledge about what they are trading and should always keep away from the unknown.
In most cases, the unknown tends to lead to losses as you have no idea what its potential value would be.
The History Of Trading
Humans have been trading for thousands of years and it is widely believed that trading has helped advance human civilisation. In fact, the history of trading started way before the use of currency.
Indeed, trade helped us survive and reach the pinnacle of existence that we have reached today. When you really think about it, so many trades are happening right now, probably not even that far from where you’re sitting.
Human civilisation needs trade to not only keep moving forward but to keep existing. If all trade ceased now, how many things in your life would stop working?
In ancient times, different tribes trading goods promoted peace between them as neither would want to harm the arrangement - that is if both were profiting from the arrangement.
Ideas and technology between different groups could also be shared and when different groups of people were no longer seeing each other as enemies, fighting over the same resources, they could focus on development rather than defending or attacking another.
Trade is a more effective way for groups of people to get what they want, instead of starting a war and taking it for themselves.
If you trade long term with another nation, for example, you will get more out of the arrangement than if you just attack them and take what they have in one go.
War will end up destroying the possibility of trading with them or receiving more from them as they will be unable to produce anything.
If war does break out, traders (or perhaps in this case merchants) can have a lot to lose.... but that’s not always the case (if they’re in the arms trade, for example, it would be great news).
The Silk Road is often regarded as the first-ever international trade route. It stretched a great distance from China to Europe.
The Indus Valley is also cited as a part of the world that relied heavily on trade, which brought peace to neighbouring societies. And there are of course many more examples of this throughout the world.
As technology advanced, our ways of trading with each other became more complex and we were able to reach more markets and trade with them.
The earliest trading societies would have been restricted by geographical issues, such as mountain ranges, deserts, seas and the weather.
But as the obstacles were overcome by new ways to transport goods - ships, planes, trucks, trains - new markets were reached, trade increased, more products arrived on our shelves as well as new ways of thinking.
Way before trade reached the distant shores across the world, we developed money and value was given to things like precious metals, rocks and jewels.
We no longer just traded things we needed to survive but possessions that we thought (and sometimes correctly) would enrich our lives.
These other possessions with their high value could also be traded, but with such valuable items, it was hard to say how much they are worth as their value is very subjective.
And along the way we started trading currencies against other currencies in what is called ‘foreign exchange’, or as we commonly refer to it as forex.
Today, there are a plethora of different types of ways people can trade and instruments to trade with: commodities, forex, cryptocurrencies, stocks/shares, equities, ETFs (exchange-traded funds), bonds… the list goes on!
Typically, traders will stick to one method of trading, each one requiring a good degree of knowledge about them.
Why Do People Trade Forex?
To make a profit is the short answer to that question. But before we dig into the longer answer, we should clarify that there is a difference between being a consumer and trader.
Trading between traders is different from an exchange between a trader and a consumer.
For example, when you buy your groceries, while you are technically making a trade in a sense, they are the ones who profit.
Your motive here is not to make money from them, your motive is to pay for your groceries!
Buying Low And Selling High: The Basic Concept
In every trade, you have a buyer and seller, both with different motivations. The buyer wants to get the item at the lowest possible price, while the seller wants to sell at the highest possible price.
The person selling might believe that the value of their possession is as high as it will go. They may have purchased it at a much lower price. You, on the other hand, might believe that it will go up in value.
Some traders may take what they have bought to another place where it is more valuable for a quick profit. In such instances, you are taking advantage of supply and demand.
You take something that has a low demand, where the value is therefore low, and sell it where the demand is higher, and people are more willing to pay more for it.
Traders Put Different Values Behind Different Things
Of course, though, the value of every item to every person is not always predictable.
For some people, there is sentimental value attached to certain items, which will increase their value to them. They may pay more to you to get hold of them or want a higher price when selling to you.
Further to that, there are also some individuals who just want to get rid of things, they don’t care what the price is, they just want to get rid of it, perhaps it has bad memories attached to it.
Timing is important as we mentioned earlier. Certain events can drag up the price of certain things.
For example, war, economic crises, natural disasters, they can all increase or decrease the price of certain things.
As a forex trader, you should seek to take advantage of these moments. Of course, though, these events can be very difficult to predict.
Sometimes these events will only be a small increase in price, but these small increases over time can make you a handsome profit.
In forex trading, there are many different approaches, but perhaps the wisest is to take your time.
Is Investing The Same As Trading?
No, Investing is not the same a trading. It should be made crystal clear that ‘trading’ and ‘investing’ are quite different activities. Though the goal remains the same; to make a profit in the end. They require a very different mindset.
What separates the two is time. Traders deal with the short to mid-term, while investors deal with the long-term.
A forex trader may make numerous trades in a day or week or month. Investors may invest in something and wait for years or decades before selling.
Investors typically stick to what is often referred to as the ‘buy and hold’ method, which is where they buy at any price, whether it be low or high (to them it doesn’t matter) and wait a long period of time before selling off.
If you buy stocks, for example, and wait ten years for the price to increase before selling, you’re an investor, not a trader. Remember, a forex trader deals with more short-term exchanges.
Because of this difference in approach, forex traders are under a lot more pressure than investors and are a lot more involved in making a profit for themselves.
Investors, on the other hand, can usually relax and not put too much thought into their investment after investing, at least until it is time to collect their profit.
Another interesting thing to note is that investing usually requires a lot more capital than forex trading. An investor may pump thousands of dollars into a project or company.
Because of this, investing is not typically something everyone can do, while trading forex can be done with a relatively small amount of capital, which means it is easier for everyone.
If you’re reading this guide and thinking about getting into investing, the rest of the series on forex trading might not be useful as although there are some similarities between investing and forex trading, the differences will become more apparent later.
Is Forex Trading Ethical?
Forex trading has gotten a bad name in some circles mostly because there are people out there who think it’s just about making money for themselves at the expense of others.
Of course, there is an element of self-centredness involved in forex trading, but perhaps it is only more obvious because traders deal directly with money.
When you really think about it, aren’t most business endeavours about enriching ourselves?
But there are also deeper questions about the ethics of trading, specifically in regards to when forex trading has a negative impact on society.
It is an ethical question that not many forex traders know how to answer; do you trade against something that’s important to the economy? Is it right to profit off the back of a crisis?
It might make you money, but are you harming people? Many forex traders will say that it’s not their problem, others may disagree.
It’s up to you to decide what you think on the issue and come to your own conclusions.
In the past, there have been financial crises that have been caused by bad trading practices and people have lost everything because of this, which hasn’t helped the image of trading at all.
Thankfully though, there are regulations in place in most parts of the world to prevent bad trading practices, though they can differ from country to country, of course.
Largely, regulations are put in place to prevent dangerous greed and from damaging the economy, which will have a negative effect on a country’s citizens.
They are also designed to protect traders as well in cases where their money might be lost due to circumstances beyond their control.
Is Forex Trading The Same As Gambling?
No, forex trading is not the same as gambling. Something super important that should be made crystal clear to anyone thinking about getting into trading is that it is nothing like gambling!
Many beginners - or people who know little about forex trading - can make this misconception, and it’s not too hard to see why; both involve risking money for more money.
But the hard truth is that in gambling there is absolutely no skill involved. Anyone can gamble, it’s a game of chance. Of course, there will be gamblers who disagree with this viewpoint.
The thing is that with gambling, the game is always rigged against you, “The house always wins” as the old saying goes.
Gambling games are designed to eventually take everything from you, no matter if you win a few times along the way
(it motivates you to gamble more if you win a bit).
When it comes to forex trading, luck plays little to no impact on your success.
Of course, there will be times where being at the right place at the right time will pay off, but forex traders cannot count on that if they want to be successful.
The key difference is that you can access data about the market you are trading and make predictions that can help you decide the best possible trades to make.
With gambling, you don’t have this benefit. You really have no idea what number the roulette wheel will land on or if the other player has all the aces.
It’s All About Probability
Probability is about examining the chances of things happening. In every scenario, there are a number of different outcomes. But not all of them have an equal chance of happening.
There is no right or wrong, win or lose; in reality, we are dealing with numbers that move up and down and we have to predict what number will come next as best as possible if we want to make a profit.
You need to bet on the number that’s most likely to appear, which you can only do if you examine all the possibilities based on past data.
Still, though, you will never be completely right. Even if you aim for the most likely scenario, there is always a chance it might not happen, and you will make a loss.
But that isn’t something traders should be afraid of. Losses are a natural part of trading and it is important to accept them, learn from them and move on.
Though history repeats itself, the market is always unique at every moment. The randomness of the market should never be underestimated.
But remember, that element of randomness does not make forex trading the same as gambling!
Anything can happen in either the world of gambling or forex trading, but at least with forex trading, you can have a much better idea of what are the likely outcomes.
Can Forex Trading Become Gambling?
Yes, trading forex without a plan can become gambling! Now that we’ve cleared the air about the difference between forex trading and gambling, we have a bit of bad news; when you trade without any kind of plan, you are effectively gambling your money away!
You can’t just start trading forex, or anything in that case, without knowing anything about it.
If you just buy something randomly without knowing anything about its potential value, and just hope that its value will increase, that is basically gambling.
But that’s just the beginning, you also should know about an important phrase called ‘chasing losses’.
Chasing losses is a gambling term but it also exists in forex trading as well. It is where a forex trader (or a gambler) makes a loss and continues to trade in an attempt to make back what they lost.
Typically, this involves the trader making larger and larger traders to cover each loss, and as you can imagine, this only makes things worse and worse.
How Do You Measure Value?
Working out the value of something is a very subjective activity. The value you assign to something can be very different in the eyes of others.
Research is the key to making these predictions, but again your research can be different from other forex traders.
You might put more weight behind some facts and less behind others and they may do the same in a different way.
But in the end, the more you know the better as you will be able to see a much bigger picture, which will always improve your chances of making a successful trade.
An interesting thing to point out is that markets tend to move in cycles.
These cycles can appear in the short term, like a week or two or a month, or if you look even further back, you can see them taking place in decades.
These cycles have four stages:
1. Ranging low (accumulation).
This is where the market is at a low point and is ranging (not going up or down much).
2. Uptrend (break out).
This stage is characterised by higher highs and higher lows (the market is largely on the rise).
3. Ranging high (distribution stage).
This is where the market is a high point and is ranging (similar to the ranging low, it isn’t going up or down much, but is still at a high point).
4. Downtrend (declining stage).
This stage is characterised by lower highs and lower lows (the market is generally going down).
This is highly useful to know because, in some market situations, it is simply not possible to sell at a higher price.
Or, if the market is ranging, you’ll have a clearer idea of what the potential highs and lows are, helping you set realistic goals.
You should always trade with the direction the market is taking. Buying when the price is low and selling when the price is high will not work if the market keeps going down in value, for example.
In ranging markets, you need to be able to spot the highest and lowest possible points, and not let your expectations exceed them.
A good forex trader should be able to succeed in any market situation, but they must take these cycles into account. You may have heard of the saying “The trend is your friend”.
How Do You Become Successful As A Forex Trader?
That’s the billion-dollar question everyone is trying to figure out! Could you tell us the answer?!
Joking aside, there are quite a lot of different ways traders become successful. In a sense, you already know it; buy something undervalued, hold it and then sell it at a higher value.
Let’s take a look at a very simple example
Frank buys 200 bottles of whisky of a new brand he really likes and believes will go up in value at a price of £30 per bottle (that’s a total of £6,000).
He’s done the research and seen that similar new brands of whisky can increase in value up to £5 per bottle and also decided that a great time to sell his stock would be around Christmas as people are more likely to buy expensive whiskies then.
After waiting six months, Christmas comes around and just like Frank’s analysis showed, the price of the whisky did indeed increase.
Not exactly to his ideal price of £35 per bottle, but to £34.50 per bottle.
But Frank is still satisfied as he still makes a nice profit of £4.50 on each bottle of whisky, which is fantastic.
Today most trading professionals do not trade goods in the way that Frank did in the example. Of course, you can still trade in this way, but it requires a lot more effort.
Now let’s look at a forex-related example. And this time Frank is a forex trader and Frank likes to trade the US dollar (USD) against the British pound (GBP).
Frank has done his research and is pretty sure that in a couple of days the USD is going to surge in value against the GBP due to poor management of UK-EU relations.
So, Frank makes a trade. He buys 1,000 of USD against GBP at a price of £0.78. That’s £780.
A couple of days later, Franks research pays off and the price of GBP does indeed sink in relation to the USD and now the price of USD against the GBP is £0.87, and he decides to sell.
That means for every dollar, Frank has made £0.09, which is pretty good! And, selling at that price, Frank makes a total profit of £90 for that trade.
This would be called a swing trade because the trade took place over the course of a few days. If the trade took place in one day, it would be day trading.
And while £90 might not seem like a lot of money (of course, that depends on what you consider a lot of money!), if Frank does many trades like this, it will amount to a lot.
We’ll dig a lot deeper into trading forex news later on in this series Forex Trading For Beginners, so sit tight and keep reading! (We’ve got it all covered!)
The Rise Of Retail Forex Trading
Many financial traders now trade online via a broker. These individual traders (commonly referred to as ‘retail traders’) who trade for themselves are referred to as retail traders.
Some forex traders trade on the behalf of banks, funds and other financial institutions and may receive a percentage from their successful trades. However, retail traders get the whole pie, not just a percentage.
For many, retail forex trading is very appealing; you can work from home, at your own hours, no boss to answer to and you get to make your own decisions.
And of course, there are plenty of people who have done just that - quit their jobs, went into full-time forex trading and made their fortunes.
Retail forex trading really took off in the early 2000s when the Internet made it possible.
You no longer needed to phone up your broker to put in a trade, you now could just do it all online via an online trading platform.
But there is another side to that coin.
As appealing as retail trading may seem, retail traders need to be highly motivated people who can impose strict rules on themselves and stick to them.
Forex trading is a profession, not a hobby. There are of course people who will think you don’t really work because to work for yourself, but that is far from true.
The rise of retail trading has led many forex traders to work from home as independent traders.
What Is Forex Trading Psychology?
Forex trading psychology is a really large topic that really started to bloom in recent decades.
Its primary purpose is to explore how a forex trader’s mental state affects how they perform as a trader.
If, for example, you lose many trades in a row, that affects your expectations. You start to expect that it will happen again and may not change your style.
Can lead to ‘analysis paralysis’, where you become too afraid to enter the market, or you may even just quit altogether.
Likewise, a lot of winning can also be dangerous, you might start to think you’re untouchable, that every move you make is golden.
Some forex traders say when you keep winning that’s when you’re at your most dangerous as you may get reckless.
Trading psychology teaches us to analyse what we are doing as a forex trader and to notice how it affects us.
This can sometimes mean spotting small things such as our heartbeat and other sensations which can often be ignored but are greatly important.
To spot what is affecting us and how to control them, forex traders should keep a trading journal where they record every trade they make.
We can look at what kinds of trades make us feel uncomfortable? What did we do wrong and what did we do right?
In the end, it is all about controlling our emotions to prevent poor decision-making when trading forex. To learn to step away when it gets too much for you.
A well-known phrase in the forex trading community is sometimes the best trade is no trade. Sometimes forex traders just need to stop what they are doing and take a break.
Some trading psychologists believe that many of our trading faults come back to our childhood, specifically how we dealt with rejection and failure often follows us into adult life and affects trades.
Sometimes trading psychology can also be related to setting goals that are too hard to fulfil.
Some forex traders even try to get revenge on the market. They get angry because they keep making losses and try to make even bigger trades to make back everything they lost.
This is quite similar to ‘chasing losses’ mentioned above and is never a good idea and never works!
Forex trading is really all about self-improvement. Financially, mentally, and intellectually. Only by understanding yourself as a trader can you improve.
How Much Money Do You Need To Start Trading?
That’s a super tough question with no specific answer. It depends on a lot of variables.
First and foremost, it depends on what you plan on trading. There’s a big difference between trading forex and stocks for example.
Forex trading requires a lot less money to get started, you can trade in smaller amounts and broker fees tend to be lower, both of which can be a significant advantage.
Further to this, it also depends on the type of trading. Regular traders may be able to succeed with many small trades over a long period of time. For such traders, starting out with little capital is not a problem.
While some traders may want to make more long-term trades, which typically require a lot more capital in order to really make a profit.
Whatever you plan on doing, you should have enough money to cover the deposit to create an account. This should not be money you need to live off.
This should be money you are willing to risk. If you risk money you need, we’re back to the section on gambling again!
Many forex brokers these days require you to deposit a minimum of at least 100 of your chosen currency. But that is simply to open an account and will likely not get you very far.
In order to be liquid enough to make trades, it is usually advised that you have a fair bit more than that to trade properly.
Trying to grow such a small trading account will also be very stressful because you really can lose a large amount of it in a couple of trades.
And if you are a beginner, the likeliness of that happening is even higher.
Things get even more complicated when you consider forex traders who live off their earnings.
Such forex traders don’t just need to think about how much of their money they can risk trading, they also have to think about how much money they need to live as well.
For such traders, it is advised to have at least six months of savings just to live off. And after those six months pass, withdraw from your trading account all you need to continue for another six months.
For real financial security and to be prepared for any situation, you may want to consider having up to a year’s worth of savings.
Of course, though, this is entirely subjective, what you may see as a lot of money, others might scoff at.
Whatever approach you take to trading full-time, you need to have a backup plan and some money to full back on.
Unfortunately, forex traders with more money to hand will always have the advantage over those that don’t.
For forex traders with less money to fall back on, they need to be more meticulous about how they use their money, both personally and as a trader.
However, over time, no matter how much money forex traders start out with, if they are successful, they can compound their returns.
A benefit of making many small but profitable trades means that forex traders are able to compound their returns faster.
This means they will be able to make bigger trades sooner, which theoretically can mean making bigger gains sooner.
However, if forex traders only make large trades over a long period of time, their returns are more fixed, and it takes longer for them to compound their earnings and reach the next level.
Another important thing to highlight is that losing trades happen and forex traders need to accept this. Forex traders need to be able to accept that any trade you make can result in a loss.
Trader’s projections on the asset’s price can always be wrong, or they can simply be unlucky and price tanks because of a surprise issue related to it that you could not have predicted.
That’s why forex traders need to be careful and never trade more than you are willing to lose. That rule is golden.
If you remember anything from this guide, make it these key points.
1. A trade is where two parties agree to make an exchange for goods or services.
They both believe the other possession is more valuable or at least will increase in value, which will allow them to make a profit in the near future. In forex trading, traders need to believe a currency will be worth more against another.
2. Trading has been going on for thousands of years.
Trade helped human civilisation advance to where it is today and helped create peace between different nations. Now forex trading is one of the biggest markets in the world.
3. In short, a trader aims to buy low and sell high.
As easy as that may sound, it can get a lot more complicated. A trader has to believe that something will increase in price. Forex traders need to research the market.
4. Forex trading is very different from gambling! With forex trading, you can look at past price patterns and determine a good point to sell a currency. Gambling is purely about chance.
Well done! You’ve finished the first chapter of this guide. You’re now ready to move onto the next chapter of this forex trading guide for beginners and the topic is, the history of forex trading.