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Forex trading explained
Foreign currency exchange, better known as Forex, is probably not as complicated as it is made out to be. Akin to how you would wait for the best exchange rates at a money changer before swapping your SGD to something else, Forex trading involves trading currencies at the optimal price to turn a profit.
What is Forex trading and how does it work?
Forex trading requires you to concurrently buy one currency and sell another via a broker. In order to do that, currencies are paired. These are called exchange rate pairs and an example would be the EUR/USD. In Forex trading, what you’re doing is hedging against the strength of an entire nation’s economy instead of a single company a la the stock market.
Why do investors like it?
Firstly, Forex trading can be performed 24 hours a day, 5 days a week because currencies are traded across all financial centres in the world. Furthermore, the Forex market is extremely large, clocking in at US$6.6 trillion (S$8.9 trillion) as of September 2019. Lastly, liquidity is high due to the large amount of activity that takes place daily. This lets traders enter and exit positions with ease.
Pros and cons of Forex trading
Forex trading is good for its accessibility, but whether it is a suitable vehicle or not depends on your risk appetite and knowledge. For starters, the market is open almost 24/7. It’s naturally tailored to your schedule and as a result, various trading styles can be applied. Contrary to popular belief, you don’t need to stare at charts for an entire day lying in wait for large price shifts.
Additionally, Forex trading is an excellent way to diversify your investment portfolio. The barrier to entry is low because:
1. There’s an abundance of learning materials and research tools to get you off the ground quickly.
2. The cost is low because brokers don’t charge commission or brokerage fees. They use spreads instead: a built-in cost referring to the difference between the bid and ask price of currencies.
3. There’s a variety of currency pairs that can be traded. A total of 28 pairs can be created just from the 8 major currencies alone. Additionally, commodities such as gold and silver can be paired with currencies and traded in the same manner.
Firstly, you’ll need to select a Forex broker. The rule of the thumb is to pick a credible one that offers low spreads. Sign up for an account and start demo trading for several months to a year before you invest actual money. Demo trading lets you familiarise yourself with the broker’s features and tools along with the unique characteristics of the currency pairs that you would like to trade.
More importantly, demo trading lets you apply what you have learned and experiment with different trading styles or systems at no cost. Becoming proficient in Forex trading takes a considerable amount of time and patience because of its steep learning curve and the relatively high risk involved.
The Forex market is much larger than the stock market and affords much more flexibility for retail traders, because of low costs and ease of access. However, every asset class has its advantages and disadvantages – Forex is no different.
Stocks, especially blue chip stocks, offer much more stability than the various currency pairs in the Forex market. Additionally, leverage for Forex trading is much higher than stocks. Although this can translate into much greater returns, don’t forget that it can also mean higher losses.
Forex trading is incredibly lucrative due to its large market size and how flexible it is. Whether you’re a long-term trader or short seller, night owl or early bird, opportunities to turn a profit are plentiful. However, keep in mind that forex trading is not a get-rich-quick-scheme.
Although it’s possible to hit the jackpot with a high-leverage hundred-pip trade, a large amount of time will be spent studying and researching in order to develop an efficient trading plan instead. A sufficient amount of capital needs to be invested too, even though some brokers allow you to open an account with a deposit of less than S$100.