Trading the foreign exchange market is a tried and true method for many investors. Exchange rates are always evolving as different economies grow and recede relative to each other, making it a very dynamic market. For traders looking to make this a full-time gig, that means there is always opportunity.
Forex trading works by speculating on the change in relative value of one nation’s currency versus another’s over time. A successful forex transaction looks like this:
- Exchange Currency 1 for Currency 2
- Hold Currency 2 as it appreciates relative to Currency 1
- Exchange Currency 2 back to Currency 1
The transaction itself is simple, the speculation takes some learning and a lot of practice though. Read on to find out how to start making money in the foreign exchange market.
How To Make Money Trading Forex
The fundamental formula for making money in the forex market is to identify a currency that is posed to strengthen relative to another. These two currencies make what’s known in the market as a pair. Convert the other currency into the one that’s gaining strength. Hold it for a bit, then convert it back for a profit.
The foreign exchange market has many similarities to other exchange markets like the NYSE or the Nasdaq, but it also has a couple of differences that forex traders like to capitalize on. Namely,
- 24/7 trading
- De-centralized market
Let’s briefly address these benefits before we move into the forex trading steps we promised.
The forex market opens at 5:00 PM EST Sunday and remains open until 4:00 PM EST Friday. These hours are a result of international time zones. As the world keeps on spinning, there is always an open market with a currency that is rising or falling relative to others.
This is beneficial for two reasons. The main technical reason being continuous trading. More time in the market means more time for your money to make money. The forex market is open for a total of 119 hours per week versus the NYSE’s 32 and a half hours per week.
That’s almost four times the time in the market! And you know what they say… it’s about time in the market, not timing in the market. So your money has more time to grow in the forex market, plain and simple.
Another side benefit of the 24/7 trading schedule is known by those who hold day jobs. Let’s be honest for a second, why are you reading this article? Is it to make enough of a living in the market to be able to quit your job?
For a lot of people, this is the case, and it can be tricky and extremely distracting to be monitoring trades on the stock market during your afternoon staff meeting. The forex hours allow you to work 9-5, and trade 5-9.
Another benefit of the forex market is the fact that it is decentralized. This benefit has been amplified significantly since the advent of the internet. It just means that there is no one physical marketplace where currencies are exchanged, and you as a trader are exchanging currency with banks or other dealers in real-time.
Decentralization is really what enables round-the-clock trading. So there we go, just a couple of quick forex benefits before we jump into the how-to.
Learn the Forex Fundamentals
The first thing to do is gain a fundamental understanding of the forex market. You’ll want to master the fundamental lingo and at least know what the following terms mean:
- Currency Pair
- Exchange Rate
Understanding A Currency Pair
The key principle driving the forex market is that the actual “asset” that is traded is one currency’s value relative to another. This means that a forex contract is always in a pair. The Euro vs. the US Dollar, the Canadian Dollar vs. the Japanese Yen, etc. There must be a pair, otherwise there is no relative value.
Pairs are always listed in the following format:
The above example is the Euro vs. the US Dollar.
Know What Exchange Rate Means
Continuing with the example of EUR/USD, let’s then quickly define the exchange rate. The current exchange rate for this pair is 1.1724.
This just means it costs 1.1724 Euro to buy 1 US dollar.
Defining A Pip
As you get into forex trading, you’ll hear the term pip thrown around. Pip is actually an acronym for “Percentage in Point,” or just “point” in other words. This is the smallest decimal point of an exchange rate.
Exchange rates are typically carried out to the 4th decimal point. This decimal value is a pip. So if the exchange rate above were to move up one pip, it would go from 1.1724 to 1.1725.
Some quotes carry the exchange rate out to 5 decimal places. In this case, the fifth decimal is a fractional pip. A pip is always the 4th decimal place of any forex exchange rate quote.
So those are a few of the key terms, you’ll want to know how to read them and what affects them.
Learn How to Read the Charts
If you’ve traded in other markets, you’re familiar with things like:
- Chart patterns
- Support and resistance lines
- Candlestick Patterns
If not, you can read up on those methods. The key takeaway here though is that these same patterns can be read in a forex currency pair chart.
The difference is that the chart always shows the relative value of one currency compared to another. And the nomenclature matters, too.
Lets use EUR/USD as an example again. A chart of this currency pair will have trends like any other capital market chart. Here is how to read those trends:
- Trending up means that the currency on the left (EUR) is appreciating in value, relative to the currency on the right (USD)
- Trending down means that the currency on the left (EUR) is depreciating in value, relative to the currency on the right (USD)
What’s unique about the forex market is that these trends are always relative to the other currency. So appreciation can happen just because the European economy is doing well, or it can happen if the US economy is declining while the Euro holds steady.
Know What Affects the Global Market
Become a student of geopolitics and global economics. The forex market exists because of all the moving economic parts throughout the world. There are many forces at play, all of which impact the value of one currency vs. another.
- Foreign trade policies
- Labor practices
- Political tension and war
These seemingly non-financial factors have very financial impacts when it comes to exchange rates. It would be best if you understood how they drive forex market support and resistance for a given currency pair.
Open an Account And Start Trading
There are different types of accounts for forex trading, you’ll have to choose which is best suited for you.
|Standard||High-quality brokerage service||High capital requirement|
|Mini||Low risk Low Capital Requirement||Low risk = Low reward|
|Managed||Professional guidance Hands-off investing approach||High capital requirement Broker commissions|
Your goals will dictate which account you set up. I like to invest for the long term with a hands-off approach, so my money is in a managed account.
A mini account is good for beginners because the risk of losing a ton of money is lower. This is also the same reason more seasoned forex traders like to use mini accounts to test new trade algorithms.
When you have a trading strategy that has been proven in a mini account, it may be time to upgrade to a standard account where the lots are bigger and the gain potential is higher.
Automate Your Trading
Automated trading is the best way to take advantage of the 24/7 forex market hours. I would definitely recommend practicing manual trading first, though. A professor once told me, if you are to successfully automate something, you must master it manually.
This is certainly true here. Test your algorithms manually in a mini account. Read up on technical analysis and market psychology. Understand how to identify areas of value in a forex chart and what indicators will present them.
Then, make the investment in some automated trading software. This will put your money to work for you, which is essentially what being “rich” is, right? Having your money work for you, not working for your money. The Forex market is certainly a place where that is achievable.