New traders wanting to invest in foreign currencies have never before had so much information readily available, but the world of forex trading can still seem a little daunting when you first start. There are a few important terms and concepts that you need to understand if you are brand-new to the market.
CFD trading refers to a contract for difference trading, a form of leveraged trading that has become a popular option with traders in the UK, Australia and some other countries (CFD trading is not legal in the US). With CFDs, you are trading on price movement without ever actually owning the underlying asset. CFD trading takes place in a broad range of markets but is particularly popular in the forex market. Most new UK forex traders will want to consider the possibility of trading CFDs when they begin.
Trading using leverage involves borrowing some of the money needed to invest in a financial instrument. Forex brokers set a maximum level of leverage, which is often very generous and usually significantly more than is available for other instruments. As a trader, you decide the amount of leverage that you will use in your trading activities. There is no need or obligation to use the maximum leverage offered by your broker, and for new forex traders, this is rarely a good idea.
Using maximum leverage is tempting, as it gives you a lot of capital to play with. If a forex broker is offering leverage of 50:1, then a trader can trade with up to 50 times the amount that he or she actually has to deposit as capital. If the trader goes with that 50:1 leverage, then a deposit of just £500 will give him or her up to £25,000 to buy currency with.
While this potentially gives a trader the option to win big, it also makes it possible to lose big. Most new forex traders lose more money than they make, and experts agree that trading with maximum leverage or just too much leverage is one of the reasons. Wise traders purposely reduce their leverage to a much lower level. It is important to remember that as a trader, you decide what your leverage is. You may even find that when you open an account with a new broker, your leverage is set to maximum as a default. It is important to check and reduce it to a sensible level.
In forex trading. there are three different lot sizes. A standard lot consists of 100,000 units of base currency, which is the first currency in any forex pair. A mini lot is 10,000 units of base currency, and a micro lot is just 1,000 units. Beginning forex traders can start with a micro account, which may involve investing as little as £100.
Price changes on the currency markets are measured in pips. This can be quite confusing for beginners, but a pip is the smallest price change that a given exchange rate can make. Since most major currency pairs price to four decimal places, the smallest change is that of the last decimal point. It may not surprise you to learn, however, that this concept is not that straightforward. The Japanese yen quotes to the second decimal point, for example.
To complicate things further, there is also such a thing as a fixed pip value, which sometimes applies when trading the US dollar (USD). This happens much of the time. as the USD is the most heavily traded currency in the world. If you are trading forex pairs and the USD is second. then the fixed pip rate applies. This means that each movement of one pip in a standard lot represents a change of ten units of currency, or $10. In a mini lot, one pip represents a change of one unit of currency, or $1, and in a micro lot, each one-pip move represents a price change of just 0.10 of a unit (only $0.10). It is highly advisable that new forex traders spend some time familiarising themselves with what pip moves mean, given their base currency and the currencies that they are trading.
Understanding currency pairs is obviously an important area of knowledge for new forex traders to focus on. Most new traders will start with major forex pairs, which include the USD as one-half of the currency pair. Commonly traded pairs include USD/GBP, USD/EUR and USD/JPY (Japanese yen). It can also be advisable to start trading with minor pairs that do not include the USD, especially if you live in a region that does not use it as the main currency. Commonly traded minor forex pairs include GBP/EUR, GBP/JPY and EUR/AUD.
Some new traders may even decide to trade exotic forex pairs, which include the currency of a developing country such as Mexico or Vietnam. Trading exotic pairs are harder, as they are not as easily available and less liquid, but your strategy may include trading these pairs, particularly if you are based in a region that uses one of these currencies.
Here at Learn CFDs, we encourage new traders in any market to learn the basics of technical analysis. Understanding technical indicators and being able to use a few of the most appropriate ones is vital. This enables you to monitor the markets and can make all the difference when it comes to being successful at any kind of trading. With forex trading, fundamental analysis is also important, as there are so many external factors that can affect currency prices.
New forex traders will do best if they: