Most people are familiar with investing, especially in properties and stocks. But not many have heard about Forex trading. The idea of Forex trading as a living is even more absurd. However, there are many people out there who are doing Forex trading for a living. Yes, trading as a full-time career because it is lucrative! If you are thinking about venturing into Forex trading, here is our beginners’ guide for you. It has everything on the essential things you need to know about Forex trading before getting started.
1. What is Forex trading?
Each country has its own type of fiat currency. These currencies fluctuate on a daily basis due to the underlying demand and supply for the currency. Forex trading is an investment activity where one tries to profit from the price movements of two different currencies. If you have ever gone on a holiday, you would have had some experience of Forex trading, e.g. selling SGD and buying MYR.
2. What is a currency pair?
Forex trading involves trading currencies in pairs, which are also known as currency pairs. There are many different types of currency pairs in the market, from popular ones like EUR/USD to more obscure ones like USD/ZAR.
3. Anatomy of a currency pair
One thing you need to know before embarking on any form of Forex trading is to understand what it means to buy and sell each currency pair. A currency pair is quoted in a base/quote currency format in the Forex market. Let’s take USD/JPY for example. In this currency pair (USD/JPY), USD is the base currency while JPY is the quote currency. The price of USD/JPY means the amount of JPY you can get in return for US$1. If we take an example closer to home like SGD/MYR, the price of SGD/MYR reflects how much MYR you can get for S$1.
4. What actually happens when a currency pair moves?
There are four ways in which a currency pair can move, i.e. the base currency and quote currency can either strengthen or weaken. For example, the base currency strengthening will give the same price effect on the currency pair as the base currency quote currency weakening.
Most beginners are confused about the price effect when the base or quote currency strengthens/weakens. One way to understand it is by visualizing the price movement as a seesaw movement. When the base currency strengthens, it means that the currency on the left is getting “heavier”. This will cause the right side of the seesaw to tilt upwards, which means that this will have a positive effect on the price of the currency pair. Logically, when the base currency strengthens, it means that every dollar of the base currency is now worth more dollars of the quote currency.
5. What is a pip?
If you are interested in Forex trading, then you MUST know about pips. Pip, or point in percentage, is a standardized unit that measures the amount of change in the price for a currency pair. A pip is usually calculated as the last decimal point of a currency pair. In most cases, a pip refers to the fourth decimal place of the price of a currency pair (i.e. 0.0001). In some cases (like JPY-related currency pairs), a pip refers to the second decimal place of the price of a currency pair.
6. Buying and selling a currency pair
Just like in stocks, you can also take long (buy) and short (sell) positions. Because of the currency pair nature of Forex trading, it gets a bit more complicated. When you buy a currency pair, it means that you are anticipating that either the base currency will strengthen, quote currency will weaken or both. When you sell a currency pair, it means that you foresee that either the base currency will weaken, quote currency will strengthen or both.
7. What are the fees you need to pay in Forex trading?
While Forex trading also requires you to go through a broker, it does not necessarily mean that you need to pay a fixed commission fee. However, brokers do charge a fee based on the spread and the volume that you are trading on the currency pair. The estimated cost of fees in Forex trading can be calculated by taking the volume and multiplying it by the spread on the currency pair. For beginners, spread is the difference between the current market bidding price and asking price, i.e. bid-ask spread.
8. Leveraged trading is a double-edged sword
Because of the relatively small price movement of Forex currency pairs compared to stocks, Forex traders typically take advantage of leverage trading to increase their returns. The idea of leveraged trading is simple. Firstly, you need to decide how much leverage you want to take on. This will be dependent on your own risk tolerance. In Singapore, the brokers are regulated to offer a maximum leverage of 50:1. A 50:1 leverage means that for every S$100 that you have, you can trade S$5,000 worth of currency pairs. This will increase your returns by 50 times. However, it also means that you can lose your money 50 times faster.
If you’re new to investing and want to learn more, check out our other articles here.