This short guide is intended for beginning traders, it is intended to explain the basic concepts of forex trading.
The fastest and easiest way to learn about forex trading is to open a free demo account. Simply download a trading platform onto your computer and place your first orders with fake money.
It only takes about 2 minutes to open a demo account. There are many different brokers and trading platforms in the forex market. For now, let's just take an example with the MetaTrader 4 platform (MT4), which is the most common one offered by forex brokers.
We'll talk later about the criteria you want to look out for when choosing a broker and opening a real account. For now, you just need to open a demo account with a forex broker that offers the MetaTrader 4 platform.
Launch the MT4 platform to see the trading charts. You can open new charts in the menu: File + New Chart.
The left image is a chart of the euro against the dollar (EUR/USD). Each candlestick displays 1 hour of trading.
There are other types of charts and other time units. (see the types of charts page).
If a trader believes that the euro will appreciate in value against the dollar (if the price rises on the chart), he or she can buy euros in order to sell them at a higher level (long position).
Conversely, if a trader expects a decline in the euro, he or she may sell the euro (short position) in order to repurchase it at a lower price.
Currency pairs and the exchange rate
On the forex exchange, currencies are quoted in pairs. The most traded currency cross is the euro against the dollar (EUR/USD). The base currency is always the left one (EUR) against the right one (USD) which is called the quote currency. During a transaction on the EUR/USD, we buy or sell euros (base currency) and the method of payment is the dollar (quote currency).
The exchange rate is the price of one unit of the base currency in terms of the quote currency. For example, when EUR/USD = 1.4050, that means that 1 euro = 1.4050 dollars.
The smallest increment of variation is a pip, it is the fourth number after the decimal, except for pairs with the yen, in which case the pip is the third number after the decimal. Sometimes the broker display prices with fractional pips (5 digits after the decimal point and 4 for pairs with the yen such as the USD/JPY).
Prices are always shown with two quotations: EUR/USD = 1.4050/1.4052. The price on the left is what you can sell it for (BID), the price on the right is what you can buy it for (ASK).
The difference between the BID and ASK prices is called the spread (2 pips in our example). The spread is what the broker collects as compensation.
With most brokers, the size of a standard lot is 100,000 units of the base currency (the currency on the left). Some brokers also offer standard lots of 10,000 units and others offer cent-denominated accounts, the size of a transaction can therefore differ according to these parameters. You can see these on our broker comparison chart.
If your broker uses standard lots (almost all do):
If you buy (go long) 1 lot on the EUR/USD which is quoting at 1.3500, you are buying 100,000 euros, which have a value of 135,000 dollars (100,000 x 1.3500).
If you buy a mini lot (0.10 standard lots) of EUR/USD which is quoting at 1.3500, you are buying 10,000 euros which have a value of 13,500 dollars (10,000 x 1.3500).
The goal, of course, is to sell this lot at a higher price to make a profit. You can also sell the euro (a short position) with the intention of buying it back later cheaper. You can therefore bet on a rise (long position) or fall (short position) of the euro against the dollar.
Depending on the size of the transaction, each variation of a pip represents a certain amount. For example, for a 1 lot position, each pip is worth $10: if the price goes from 1.3500 to 1.3501 a long position wins $10 and a short position loses $10. The value of a pip is different if your account is denominated in euros (see our tools to calculate the value of a pip).
How are pips calculated?
Simply divide the amount of the transaction in the base currency by 10,000 (or 100 for pairs with the yen).
A transaction (EUR/USD) of 100,000 euros/10,000 = $10. The value of each pip is therefore $10 or the equivalent in euros if your account is denominated in euros.
Another example, a EUR/GBP (Euro/Pound) trade of 100,000 euros/10,000 = 10£. 1 pip will be equal to 10 GBP, but you then have to convert these 10 GBP into the currency of your account.
On the forex exchange, currency fluctuations rarely exceed 1% per day. The leverage that forex brokers offer allows one to make big profits from small changes in the market, but it can be extremely dangerous if it's not mastered.
Transactions that use leverage (or margin trading) allow traders to invest with amounts greater than what they have in their accounts.
For example, let's look at a margin-based transaction with a 10,000 euro account and leverage of 1:200 (a margin requirement of 0.5% of capital). If you invest 1000 euros of your capital on the EUR/USD with 1:200 leverage, the amount invested in the market is therefore 1000€ x 200 = 200,000€ (2 standard lots of 100,000 units).
The margin required to open a 2-lot position is 1000, you'll still have 9000 usable margin after opening a 200,000€ position on the market! The balance on your account is a guarantees that covers your losses.
You must distinguish:
It is recommended that new forex traders do not use effective leverage over 10; ideally, you should start out without using any leverage at all. For example, if you have a 10,000€ account, you should start out by taking a 10,000€ trade (0.10 lot), or a maximum of ten 0.01 lot positions. The higher the leverage is, the greater the potential for quick losses or profits.
Keep in mind that the main risk in forex is leverage. You'll understand the enormous potential for profits, but also losses, once you've performed your first trade on a demo account.
Open your MT4 platform, browse for a chart and push F9 to display the order window.
In this example, we are initiating a long trade ("Buy") 1 lot ("Volume") with "Market Execution" ("Type") at the market price of 1.3220/1.3222. The desired profit level ("TakeProfit") is placed at 1.3250 (28 pips away from the purchase price of 1.3222), the maximum loss ("StopLoss") is set at 1.3200 (22 pips away from the purchase price).
Then, simply click to Buy by Market to initiate the position.
If the EUR/USD price rises up to the take profit (TP) at 1.3250, you earn $280 (28 pips), since for a 1-lot position, each pip is worth $10.
If the price goes down to the stop-loss at 1.3200, you lose 22 pips, or $220.
It is also possible to close the position at any time or to modify the TP and SL settings: simply double-click on the position's line in the order window.
Pending orders allow an order to be executed automatically when the price reaches a certain level.
You must always set a Stop Loss to manage the risk you're taking on each trade and to avoid being subjected to a margin call.
If the funds in your account are close to being insufficient to cover your trade's losses, your broker will send you a warning (known as a margin call).
If the margin required to maintain your open positions is insufficient, the broker performs a stop out, which consists of automatically closing out your positions to prevent your account from becoming negative. Thanks to this system, you won't be able to lose more than your account balance.
Stop out levels vary according to brokers, for example, if it is set at 20%, the funds available in your account (that is to say the capital minus the latent loss) must represent at least 20% of the margin that is used.
There are of course many other things to learn, if you have any questions, feel free to register in our forum so that you can ask questions in the "New Traders' Café" section.
Margin trading is highly speculative and risky, do not invest any money that you cannot afford to lose.
It can take months and even years of practice before one can make money on the forex exchange.
If you don't have the patience to learn, no risk capital available or if you have a gambler's profile, stay away from forex trading because you will lose your money.