ForexForex Investing

What to Know Before You Invest in Forex?

4 Mins read

Forex trading is one of the most popular markets. Every website and social media has announcements of online brokers that offer you accounts even without minimum deposits. Different sources estimate that there are almost 14 million traders worldwide, and every day there will be even more as the technology reaches new territories. 

This puts literally in your hands the possibility of making money from your phone or computer with little investment. However, none of this means that this is an easy job. Let’s go through this entire piece to learn what you need to know to make it as a trader.

What is investing in forex?

Forex investments are any activities that profit from the difference between the purchase and sale prices of currencies. According to your forecast, the most traditional way of trading is opening a trading account with an online broker and starting trading pairs of currencies. However, different transactions indirectly qualify as forex trading, like foreign saving accounts or foreign bond funds. What makes this activity forex investment is the exchange of your base currency for another’s country’s coins.

What five things to know before investing?

A staggering majority of traders often fail in the forex market. More than 95% of investors lose money every year. Many reasons explain that phenomenon, but undoubtedly, the false promise of quick earning we see online is responsible for a big part of that. Traders enter into this world without really understanding what it is about.

So, to avoid becoming one of the many failed traders, here are some basic things you need to learn before investing in forex.

Investment risk

Forex investments involve several risks that can’t be left aside. Currencies are tied to countries and sometimes continents. Hence, many factors affect the price of a currency pair. Then, you have the particular risks linked to the broker, the pair, and the trader. 

Different brokers have different options for the trader to minimize its risk. It’s up to the trader to choose the broker that offers the best tools and use them. Also, risks are not the same for every pair. While you can exercise transactions in popular pairs like USD/CAD almost immediately, exotic pairs like EUR/NZD don’t have the same liquidity, and the risk of slippage is greater.

All these factors can result in losses. Therefore, every risk should be considered by the trader when operating in FX.

Trading fees

A reasonable question is ‘How do online brokers make money’? Of course, they don’t offer their services for free. Still, some brokers claim their services are commission-free, so what do they do to be profitable?

The most common way brokers make money is by manipulating the bid and ask price on their platform. This idea is old and has been the way exchange houses profit. This happens every time you travel. 

When you exchange your money for the local currency, the exchange houses don’t charge you for the service directly, but they profit from the rate they offer you. That’s exactly what online brokers do. Although, some brokers do charge you depending on the service. For example, most traders charge you to maintain a position for the next day, known as the Cost of Carry.

Leverage used

It is a key element of trading. This tool allows us to manage money several times bigger than the money we have in our accounts. Due to the size of our position, every pip we gain represents more money for us. However, every pip against us multiplies our losses by leverage. If we use it wrong, it can ruin our account quickly and even make us lose more money than our initial investment. The reason why leverage is so popular is that the movement in the pair is just of a few pips, so, to get significant profits, you need to put down a lot of money. 

To be able to use leverage, you need to open a margin account and comply with the requirements of the brokers. The best way of limiting your losses when using leverage is by putting stop-losses at a level where you can tolerate the losses. That way, you can be sure that the market will not go against you more than you can take.

Margin requirements

It is the amount of money the broker asks you to invest in the position. The ratio of leverage varies depending on the broker and the amount of money invested in the position. For example, a 50:1 ratio means that your broker will loan you 50 times your investment. So, if you want to buy $100,000, you need to put down $2,000 and the other $98,000 you will borrow from your brokers. Those $2,000 is the margin required by your broker.

Profit or loss per pip

Pips are the basic units of FX quoting. This is the smallest amount a pair can change in its quotation. This way, the size of the fluctuation is often measured in terms of pips. 

For most pairs, pips are the fourth decimal position of the price. The movement in pips determines the profits or losses of traders. For example, if a trader buys two lots of euros (€ 20,000) with dollars, at a rate of 1.1602 EUR/USD, he would have to pay $23,204. If the price increases one pip, when the trader closes the position, he will now get €20,000 x 1,1603 = $23,206.

The EUR/USD is one of the most popular pairs in FX
The EUR/USD is one of the most popular pairs in FX

So, he got a profit of two dollars over a fluctuation of one pip. If the price dropped ten pips, the trader would have received €20,000 x 1,1592 = $23,184. And the net loss would be $20.

Pros & cons

The rewards associated with trading are attractive, but the truth is that there are many risks hidden behind it. So let’s see some of the pros and cons of FX trading.

Trade long or short
When you trade FX, you can make money whether the market goes up or down.
Risk of leverage
This is a great advantage that increases our earnings but also ruins many accounts. The losses can be huge if the trader uses leverage incorrectly.
Instant execution orders
Since this is the most liquid market globally, you execute orders instantly.
Need a lot of money
The trader has to put a lot of money down to make a reasonable profit since the fluctuation in the most popular markets is not too big.
Always open
This market is open 24 hours a day.
Not regulated
There is no regulatory institution, so you are on your own if a problem happens.

Final thoughts

No one should begin in the FX market without even knowing the basic concepts. Those who believe that trading is a simple thing that will make them rich soon will hit reality sooner than later. 

Investing like a professional requires a lot of study and discipline. Reading articles like this is an excellent start to preparing yourself to trade in the future.

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