One of the investing trends that has been gaining traction in recent years is forex trading. The idea of trading currencies is attractive, since it provides an interesting (and potentially lucrative) alternative to other types of investing.
However, as Warren Buffett famously pointed out, you want to make sure that you understand what you’re investing in. And, since forex trading isn’t true investing (at least not in the sense that you actually “buy” something and own a piece of it), it’s important to know what is going on, and how you can get started without losing more money than you can afford to.
Do You Understand How Currency Trading Works?
Before you trade anything, no matter how conventional, you should know how it works. This is especially true for “exotic” assets like currencies. Before you begin trading currencies, learn how it works. Don’t start using your forex account until you have an idea of how the whole process is executed, and what factors influence currency trading.
Forex is an interesting market. It can be exciting for some traders. The FX market is highly liquid, carries a volume of trillions of dollars a day, and is quite volatile. On top of that, the ability to obtain high leverage can mean the potential for huge gains. However, it’s not as simple as it might appear at first. Successful trading involves understanding the right times to enter and exit positions, as well as being aware that the large amounts of leverage can also mean that your losses are magnified.
Before you begin trading forex, do your research. Know what items influence currency movements, understand how quotes/prices are set and know how to use the trading platform in question. Most brokers/dealers have their own trading platforms, and you need to be thoroughly familiar with the way it works if you want to avoid making serious mistakes that can lead to huge losses.
4 Considerations for the Beginning Forex Trader
1. Do You Have the Money?
One of the most important rules of investing is to never invest money that you can’t afford to lose. The same thing is true of forex trading. While forex trading offers you the chance to make a lot of money, you also have to be aware of the potential for loss. If you are just starting out, it can make sense to open a “mini account” with a reputable broker. You can usually start with as little as $2,500, and as long as you are careful, that should be enough to get you started and making a little extra money. As you learn the ropes of the foreign exchange market, and improve, you can always invest more. But it’s better to start trading forex with a smaller amount of money on the line.
2. Which Forex Broker Should You Use?
It’s important to choose a reputable forex broker. There are some shady operators in the space, and they have given forex trading and binary options trading a bad name. However, there are plenty of reputable forex brokers as well. Take the time to read forex brokers reviews to get an idea of which broker might work best for you, and which are reputable.
Look for features that make sense for someone just starting out, including a demo account and the ability to start with a small amount of money. You should also pay attention to average spreads, so you can get an idea of how the forex broker operates, and how much you are really likely to make.
3. Have You Practiced Trading?
While forex trading isn’t that difficult, the truth is that it does take a little getting used to. The way you trade forex is different from using an online broker to invest in stocks. Plus, you want to test out any online trading platform before you use it. The fact of the matter is that every trading platform is a little different, and understanding that platform can make a big difference down the road.
Most reputable forex brokers offer demo accounts. This allows you to get the hang of forex trading before you actually risk any of your own money. As a beginning forex trader, this makes a lot of sense. Get a feel for how forex trading works, and how the specific platform works, and you’ll stand a better chance of success.
4. Do You Know When to Quit?
When you start making some money with forex trading, it’s easy to get caught up in the excitement. However, with forex trading, understanding when to exit a trade is just as important as knowing when to enter. While it might be tempting to run your profits, seeing how much you can get in the end, it actually makes more sense — especially for the beginner — to take profits when they are made.
When starting out, take your profits as they come. This gives you a feel for the process, and prevents losses from stacking up. As you become increasingly proficient, and as you become adept at placing stop loss orders and using other tools, you can attempt to run your profits a little bit. But it’s always essential to know when a trade is played out and it’s time to quit (hopefully taking your profits with you).
Forex trading can be an interesting and rewarding way to make money. However, you really do need to know what you’re doing, and it helps to be a little cautious when you are just starting out.
Ready? Time to Open a Practice Forex Account
The good news is that many forex dealers will allow you to open a free practice or demo trading account before you get started. You can begin with anywhere between $10,000 and $100,000 in virtual money to practice different strategies and learn how the platform works.
A practice forex account is a good idea, since it can provide you with hands on practice before you risk any of your own money. However, you should remember that, no matter how good the practice account is, you will still need to learn some of your trading the hard way, through experience (and possible losses).
Consider Trading More Conventional Currency Products
You don’t have to just stick with the spot/OTC forex market, though. If you want to add currencies to your portfolio, but don’t think you have the risk tolerance to engage in OTC trading, consider currency derivatives.
These are financial instruments that are based on underlying currency movements. Forex futures contracts, currency options contracts, and currency ETFs can all bring you exposure to forex, without the need to try and make OTC trading work for you. Plus, these exchange products are often better regulated than the spot forex market, and you can see more consistent and transparent pricing.
However, you should still know what you’re doing before you invest. You need to have an idea of how the currency market works, and have a solid understanding of the factors that influence the outcome of the market.
No matter you’re trading, a little knowledge can go a long way toward helping you make better investing decisions.