Trading forex is profitable, but you must know that it can be a bit complicated.
You don't simply buy and sell currency pairs here. Tons of stuff comes in between before you get your sweet return.
These can range from mastering the logic behind forex trading and managing risks to making informed decisions and strategies when speculating the exchange rate between the currency pairs.
Lesson Highlights
- The forex market is volatile. While this can present profitable opportunities, it can also subject your position to huge risks.
- When you trade forex, you speculate on the exchange rate fluctuations of the pair, position your trade, and hope the market moves in your favor.
- A common strategy when analyzing the market is to look at the technical data and the fundamentals.
- To profit from the forex market, you must employ sound trading strategies. Common and beginner-friendly strategies include leveraging, starting with small capital, and using a minimum 1:2 risk-reward ratio.
The Logic Behind Forex Trading
The volatile nature of the forex market always lurks when you trade forex. This is the reason why exchange rates change all the time.
But that's not always a bad thing. Although risky, volatility magnifies trading profits when you ride with the market movement.
Buying and selling a currency pair based on market movements gives you favorable opportunities.
If you think the base currency's value will increase, this is the best time to buy a pair. This way, you get a return when the currency pair price increases as expected.
But remember to sell the currency pair when you expect a decrease in value. This can help you avoid losing the potential profit of your position.
What Is Exchange Rate
The exchange rate applies to all currency pairs. It refers to the value of one currency relative to another when traded or exchanged.
In the previous lessons, you learned about currency pairs. That's where traders quote two currencies against one another, hoping for profitable opportunities. Simply, you simultaneously buy one currency and sell another.
Traders use different strategies to monitor and effectively trade exchange rates. Among these strategies, technical and fundamental analysis are the staples of traders.
Technical Analysis
Having the skill of technical analysis in your arsenal is useful when you want your trade to ride with the exchange rate.
When you look at the market using technical analysis, you can predict future price movements through historical price data and various trend patterns. This trading discipline applies to any trading instrument that moves with supply and demand.
Technical analysts assume that past trading activities and price patterns are advantageous if traders want their trades to ride market changes.
One common and reliable indicator is price movement support and resistance. Support indicates the price's lowest level over a specific period, while resistance represents the highest level.
When the price is nearing its resistance level, you should sell or exit your position. Technical analysts expect the value to decline, so exiting before the value decreases ensures you maximize your position's profit.
Meanwhile, buying a trade or entering a position is best when the price nears the support level. With this, you can assume that the price trend will bounce upward once it reaches the support level.
Fundamental Analysis
Unlike technical analysts, traders who use fundamental analysis focus solely on the external factors that drive market movement and its value.
That includes economic, geo/political, and social events. Technically, you're looking at global events to predict the currency's long-term value.
Fundamental analysis can be used in different ways. It's most beneficial when you want to time your trading entries and exits and identify long-term currency trends.
To put it into perspective, here's a common scenario that affects the currency pair's movement:
| Imagine you're going long on GBP/USD with a value of 1.2700 per unit |
| Say the United States economy is facing higher inflation than the United Kingdom. With this, the GBP/USD is now trading at 1.3200 per unit because the GBP strengthens against the USD. |
| You exit your trade by placing a sell order. With this trade, you incur losses of 0.0500 per unit or 500 pips overall. Essentially, you'll receive fewer USD for each unit of GBP. |
Strategies to Profit from Your Forex Trades
One common yet grave mistake you can make when trading forex is to trade rashly. That mistake can drag you and your investment down the drain.
Here are the best and most profitable forex trading strategies when starting your forex journey.
Leverage Trading
Leveraging forex trades is crucial if you want to enter a bigger position with a smaller initial investment.
If you have a leverage of 1:100 for a USD 10,000 trade value, you only need USD 100 to enter the position and control the whole USD 10,000 trade.
Through this strategy, you're subject to larger profits if you're successful with your trade.
But as enticing as it sounds, remember that leverage trading also magnifies the risk. If the market moves against your position, you'll most likely lose a significant portion or totality of your capital investment.
Start Small
The rule of thumb when you start trading is to trade a percentage or two of your investment capital. This way, you're not subjected to financial ruin if your investment experiences losses.
Remember, mitigating potential losses is an essential aspect of risk management, and effective risk management impacts your trade's profitability.
Trading in small amounts allows you to gain valuable experience and employ different trading practices without losing a big chunk of your trading capital.
This discipline also gives you emotional control. When you invest a small portion of your capital, the stakes of your trade are low. Less emotional pressure allows you to make rational trading decisions without fear and greed.
Minimum of 1:2 for Risk/Reward Ratio
Setting a realistic and positive risk-reward ratio safeguards your investment. This crucial discipline balances the risk you will take for a target profit.
The 1 risk, 2 reward ratio indicates that every time you risk USD 1, you must expect to gain USD 2 in profit.
Employing a higher than 1:2 risk–reward ratio would help you sustain your investment, especially if you just started trading forex.
Okay. You've learned different ways to make a profit in the forex market. For the next lesson, you'll learn about percentages in points (pips) and how to use them to determine trading losses and profits.
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