We live in an era where people try really hard to earn some extra money and many see their chances online. Some of the most common ways of earning extra cash involve trading something. A lot of trading options have been developed in the past years, even decades and Forex is one of the most popular trading options. Forex is short for “foreign exchange”. As the name suggests, with Forex you trade currency, and the choice that you make depend on speculations that a certain currency may gain or lose value in the near future. In this respect, it is similar to trading shares on the stock market. There you buy or sell shares based on the assumption that the value of the stock in question will have its value either raise or decrease in the future and with Forex you buy or sell currency, based on the same assumptions.
What is Foreign Exchange (Forex)?
The absolute values of currencies are measured against gold. On the market, people are more interested in the relative values of currencies, i.e. the values that one currency has when measured against another. When it comes to currencies and trade of currencies, there is not central depository where such transactions take place. Currencies can be traded by different market participants in different locations. It is highly unlikely that two currencies will have an equal relative value for a longer amount of times. In Forex trading, the rates of currencies change constantly. Let us just give you one example, in 2011, over the course of four months the euro’s value relative to the American dollar increased by around 10%.
This is how Forex trading works. You take two currencies, let’s say GBP and EUR. When you write them like GBP/EUR, the pound is the base currency and the euro the counter currency. If the quote reads 1.41100, that means that the value of one pound sterling expressed in euro is 1.41100. The movements in the Forex quote may be caused by a movement in the value of either currency, whether an increase, or a decrease. When you’re trading Forex prices, you would buy or sell currency pairs and not an individual currency. So, if you have say GBP/EUR as the currency pair, you should buy it if you believe that the base currency will increase its value compared to the counter currency and, similarly, sell it if you believe that the base currency will lose its value against the counter currency.
One should be aware that most brokers set the quotes to a certain number of decimal places, usually 5 decimal places, and a ‘pip’ is when a currency pair changes from the fourth decimal. Pip is an abbreviation from percentage in points. So, if a pair moved from 1.411000 to 1.411110, one can say that it was an increase of 11 pips. Whereas the spread is the difference between the bid and the ask price. So if GBP/EUR is traded at 1.41100/1.41109, then the spread is 0.9 pips, or 0.00009. Some brokers quote some currency pairs to a different number of decimal places. So, GBP/EUR may be set at 5 decimal places, whereas CHF/JPY could be set at only 2.
Advantages of Forex
Why is the Forex trading so popular and lucrative? Well, for start, the market is completely open, and trading currencies is just like trading other assets and commodities. The values of currencies may fluctuate depending on the supply and demand for the particular currency, just like every other commodity on the market. The point is that these fluctuations may be caused by events in world that influence the value of a particular currency. Things like monetary policy, economic and political stability of the country in question, as well things like natural disasters (volcanic eruptions, earthquakes, monsoons, etc.), may influence the fluctuations in the value of a certain currency. People who have insider knowledge on the upcoming trends in the value of a particular currency may earn significant amounts of money with Forex.
Here are some of the main advantages of trading Forex. First of all, Forex trading is available 24 hours a day, during all working days. This is due to the fact that different countries have different time zones, and since there isn’t a centralised entity that regulates Forex trading, you are allowed to trade any time of the day. This ensures that there won’t be any significant leaps and falls, since the trading is open the whole time and there’s no gap period where serious changes in trading prices may occur. Trading is available as soon as working hours in Australia and Japan begin on a Monday and then it lasts up to the closing hours in New York on a Friday.
In addition to the fact that you can trade whenever you want, you should know that you also have the ability to short sell, since in Forex trading there are no limitations concerning short selling of currencies. So, if you think that a currency is going to fall, all you should do is sell it and if you feel that it might be going up, you should buy it, no hassle there. Forex is also famous for the low trading costs. The commissions and fees are fairly low and the spread is quite small as well. You get the quotes directly from the broker and there are no hidden fees or additional costs that you should take into consideration.
On top of that, Forex trading also offers unparalleled liquidity. Since most people are focused on few of the world’s most renowned currencies it is more than easy to enter and exit Forex trading. There’ll always be people willing to buy what you’re selling or selling what you’re buying, even if you trade larger amounts. The liquidity of the market also accounts for the leverage that you get with trading Forex. You can benefit from the slightest change in the market. Beware of the leverage effect though, for as much as it useful when you are making a profit, it may also cause you to lose a significant amount of money.
Forex Brokers – MM and ECN
Before getting to choose your Forex broker and start trading currency pairs, you should first become familiar with the work of a Forex broker. What do they do, how do they do it, what is their job, basically? Since you can’t access the Forex market without a Forex broker, these questions are more than important. By understanding the difference between Forex brokers and the services that they provide, you’ll be able to achieve a better understanding of the Forex market itself, and essentially, increase your chances of earning money by trading currency pairs on the Forex market.
Forex trade is exclusively done online, there is no other way of foreign exchange trading. Once you have hired a Forex broker you provide him with your estimation and then it is up to him to fill in the detail and then wait on the outcome. As a trader you have no other means of accessing the foreign trading other than via an online broker. There are two main types of Forex brokers- ECN or electronic clearly network and MM or market makers. The ECN brokers are the highly rated ones, they are one class above the MM brokers. The ECNs would usually offer thinner spreads and more options, with a better access to the market, but they’ll charge higher commission fees and a larger initial deposit. So if you’re aiming to trade on a large scale, you should be looking for an ECN broker.
On the other hand, if you are new to Forex trading and/or you don’t plan on trading with larger amounts of money, then maybe you should consider MM brokers. For start, MM brokers would not charge high fees and commissions and they may even offer options like demo accounts, designed especially to attract new traders. However, they’ll have wider spreads, which essentially means higher trading prices, because since they don’t charge fees, or charge very small fees, they earn all their money by increasing the spreads. Never underestimate the experience you can gain from trading via a demo account. Practice is the best way to get better in Forex trading. Therefore, it is more than wise to start with a MM broker and then gradually move up the ladder if you feel like it.
Choosing Your Forex Broker
Now that we’ve established the difference between MM and ECN brokers, let’s see at all the other criteria that one should take into consideration before choosing a Forex broker. First we will give you a few general tips that may seem like something that is too obvious, but often people forget and neglect the obvious. First you need to research the brokers that you are considering, see what they’re offering, consider as many brokers as possible and then narrow the choice down to as few as possible. Of course, one thing that you should never forget is to check whether the broker in question is registered and certified by the authorities of the country. For example, if we’re talking about a UK based broker, then you should see if he’s registered with the Financial Service Authority.
Always carefully consider all the details that the broker offers. Leverage and margin are crucial and your further gains or losses may depend on that. The leverage, to put it simple is the loan that is extended by the broker, it can be 45:1, 100:1, 150:1, etc. For example, if the leverage is 60:1, it means that with an account of £1,000, you can keep a position that is worth £60,000 or sixty times the amount you have available. Be careful though, because leverage can magnify your earnings, but it can also increase your losses. Always treat leverage carefully. Of course, when you compare you should compare an MM broker against another MM broker, or an ECN broker against another ECN broker, since MMs and ECNs are not even in the same category as we mentioned above.
We already mentioned commissions and spreads. Beware when it comes to the spread, because even tiny amounts may make a huge difference, especially if the trades aren’t small. Some brokers have fixed spreads, no matter what is the pair of currencies in question, whereas others have different spreads for different pairs of currencies. If you know that you’ll be trading one particular currency pair, at least most of the time, then you should look for a broker that offers the best spread for that particular pair, otherwise, look for a broker that has a good spread margin in general. Pairs that are traded more often will generally have smaller spreads.
Most brokers will allow you to open a trading account with a very small amount of money, sometimes even as little as 50 pounds. Then the leverage will allow you to have a purchasing power much higher than the deposited amount. Some brokers will offer different types of accounts, with different options available for each type. The types are based on the amount that you are willing to deposit and they can be standard, micro, mini, special, gold, etc.
Then, of course, there’s the notion of banking options, or how easy it is to make a deposit to your Forex account and then to withdraw money from it. Brokers accept major credit cards, PayPal or other e-Wallet payments, wire transfers, cheques for deposits. Usually there are fewer withdrawal options. Some of the banking options may involve fees and the amount of time required may vary. You should consider the available options and choose the one that suits you best.
The number of currency pairs available is also important. Most brokers will have all the major currencies, whereas some would even offer currencies that are a bit more “exotic”. It all depends on what currency pairs do you plan on trading. Customer service and the customer service options are another issue. They’re dealing with your money, so you’d want to be able to reach them as quickly as possible without too much hassle. Finally, check their trading platform. It should definitely be user-friendly. You would want your trading to be a pleasant experience. Make sure that you consider every issue, every important aspect and only then reach a well-informed decision.