Currency Trading For Dummies
Overview
Trade currencies like a seasoned pro with this friendly, fact-filled guide to the forex market
Over $6 trillion changes hands in the foreign exchange market every day. You can jump straight into the action with expert guidance from the hands-on Currency Trading For Dummies. You’ll learn how the foreign exchange market works, what factors influence currency values, and how to understand financial data. When you’re ready to create your own game plan for trading currencies, you’ll be able to build it around your investment objectives, experience level, and risk appetite. You’ll also find details on the latest trends in currency trading, including currency ETFs, cryptocurrencies, and currency options.
From essential newcomer knowledge to advanced positioning advice, Currency Trading For Dummies offers straightforward instruction that helps you:
- Source data and market intelligence, employ technical analysis, and use the latest tech to find the most lucrative trading opportunities
- Understand the most recent Securities and Exchange Commission (SEC) rules and regulations governing currency trading
- Avoid common pitfalls and mistakes made by novice and experienced currency traders
- Recognize profitable opportunities in the world of ETFs, currency options, and cryptocurrencies
Successful currency trading is within your grasp. This accessible roadmap to trading mastery provides the foundational knowledge you need to create a structured, winning strategy and conquer the forex market.
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About The Author
Paul Mladjenovic is a national speaker, a consultant, and the author of Stock Investing For Dummies, High-Level Investing For Dummies, and Investing in Gold and Silver For Dummies. He was a Certified Financial Planner during 1985–2021, and he was a financial and business educator for over 40 years. He is the CEO of RavingCapitalist.com.
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currency trading for dummies
CHEAT SHEET
Foreign exchange (or forex) markets are one of the fastest and most volatile financial markets to trade. Money can be made or lost in a matter of seconds; at the same time, currencies can display significant trends lasting several days, weeks, even years. Most importantly, forex markets are always moving, providing an accessible and target-rich trading environment.
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These "beginner" trading mistakes are made by everyone — from total newcomers to grizzled forex market veterans. No matter how long you've been trading, you're bound to experience lapses in trading discipline, whether they're brought on by unusual market developments or emotional extremes.
The key is to develop an intuitive understanding of the major pitfalls of trading, so that you can recognize early on if you're letting your discipline slip.
Here are ten rules that define the best currency traders. Many of these rules apply to traders in any market, but some of them are unique to the currency market. The important idea to keep in mind: No one is born with all these habits. The only way to acquire them is the way other successful currency traders have — through patience, discipline, and experience.
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When people think about risk management in the context of currency trading, the natural tendency is to zero in on the risk of losing money. No two ways about it, that’s the ultimate risk. But traders can head down many different streets before they get to their final realized profit or loss address.
How you navigate the avenues of risk has as much to with trading outcomes as it does with whether you ever reach the final destination.
Medium- and longer-term trade strategies typically benefit from averaging into a position. Averaging into a position refers to the practice of buying/selling at successively lower/higher prices to improve the average rate of the desired long/short position.
The idea here is to allow larger market swings to unfold and use them to establish a larger position at better prices than current levels in anticipation that the market will eventually reverse course in line with your strategy.
Most online forex brokers function as the market-maker for your trading, meaning that the broker is on the other side of every trade — when you buy, you’re buying from the broker; when you sell, you’re selling to the broker. Brokerage firms that are market-makers typically provide both consistent liquidity and execution, which allows you to trade your desired amount at all times.
Many traders like the idea of opening a position by trading at the market as opposed to leaving an order that may or may not be executed. They prefer the certainty of knowing that they’re in the market. Actively buying and selling is also what makes trading as fun and exhilarating as it is hard work.
Deciding whether to enter now (at the market) or wait for better price levels (using orders) depends greatly on the nature of your strategy.
Online currency trading is offered by dozens of different retail trading brokerage firms operating from all over the world, so you have many options to choose from. Here are some key questions to ask when you’re choosing a broker:
How good are trading executions? The key to evaluating any brokers is the speed and reliability of your trade executions.
Foreign exchange (or forex) markets are one of the fastest and most volatile financial markets to trade. Money can be made or lost in a matter of seconds; at the same time, currencies can display significant trends lasting several days, weeks, even years. Most importantly, forex markets are always moving, providing an accessible and target-rich trading environment.
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Here is a strategy for the position trader called trading the Ichimoku cloud. You may hear people talk about trading the cloud. They’re referring to Ichimoku clouds (short for Ichimoku Kinko Hyo, which translates to “one-glance equilibrium chart”).
How it works
It’s a moving average–based trend identification system composed of five different lines, two of which form the system’s main component, the cloud.
The first step is to commit to making time for market analysis. The more regular your analysis, the greater the feel you’ll develop for where the market has been and where it’s likely to go. Also, the more regularly you update yourself on the market, the less time it’ll take to stay up to speed.
It’s a lot easier updating yourself every day than it is trying to catch up on several days’ worth of market news, data, and price developments.
In currency trading, it’s frequently said that timing is everything. Truer words were never spoken. But that line applies to trying to time your entry and exit to capture tops and bottoms in the market — market timing, in other words.
The time of day and the day of the week can frequently influence how prices behave and how your ultimate trade strategy plays out.
One way to follow the market from a distance is to set rate alerts from either your charting system or your trading platform. A rate alert is an electronic message that alerts you when a price you’ve specified is touched by the market in a currency pair you specify. Rate alerts are a great way to keep tabs on the market’s progress.
Knowing the fundamental drivers of currency rates is the foundation of understanding price movements. This is very important to understand if you want to trade currency as an investment. Here are some suggestions:
Get to know the major economic data reports from all the major economies.
Understand the importance of expectations versus actual outcomes.
Currency traders rely on orders to take advantage of price movements when they’re not able to personally monitor the market and also to protect themselves from adverse price movements. If you’re going to be trading currencies, odds are that you’ll be relying on orders as part of your overall trade strategy.
The two main types of orders are limit orders, used to buy or sell at rates more favorable than current market prices, and stop-loss orders, which are used to buy or sell at worse rates than prevailing levels.
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The first step in trading on a breakout is to identify where breakouts are likely to occur. Pinpointing likely breakout levels is most easily done by drawing trend lines that capture recent high/low price ranges.
In many cases, these ranges will form a sideways or horizontal range of prices, where sellers have repeatedly emerged at the same level on the upside and buyers have regularly stepped in at the lower level.
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Identifying trading opportunities and planning each trade from start to finish is essential to success in currency trading. When you trade currency as an investment tool, remember to:
Maintain trading discipline by formulating — and sticking to — a complete trading plan: position size, entry and exit (stop loss and take profit) before you enter a trade.
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Regardless of the outcome of any trade, you want to look back over the whole process to understand what you did right and wrong. In particular, ask yourself the following questions:
How did you identify the trade opportunity? Was it based on technical analysis, a fundamental view, or some combination of the two?
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As you develop your trading plan, look ahead to see what data and events are scheduled during the expected life of the trade. If you follow that simple advice, you strongly reduce the chances of having your trade strategy upset by largely predictable events. More important, you’ll be able to anticipate likely catalysts for price shifts, which will give you greater insight into subsequent price movements.
Forex markets function alongside other major financial markets, such as stocks, bonds, and commodities. Although these financial markets have seen higher long-term correlations with forex in recent years, short-term correlations are far less reliable.
But there are still important fundamental and psychological relationships between other markets and currencies, especially the U.
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Leverage refers to the multiple applied to your available margin collateral, which translates into the maximum size of your market position. Leverage is typically expressed as a multiplier rate (like 10 times or 20 times) or a ratio (like 10:1 or 20:1). If the leverage rate is 10-times/ratio is 10:1, for example, and you have $1,000 of available margin, you’re able to hold a maximum position equal to $10,000.
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Three things make you a good currency trader: platform, methodology, and psychology. Often traders have the first two covered, but they come up short in the psychology department.
Do you ever think that trading is too hard? That you can't seem to make money or make a good decision? If so, that's good! It means you're a perfectly normal trader who shares the doubts and fears of traders all over the world.
When you’ve identified a trade opportunity and developed a risk-aware trading plan, you’re going to have active orders out in the market to cover your position one way or the other (stop-loss or take-profit). Depending on your trading style and the trade setup, you can reasonably follow a set-it-and-forget-it trade strategy where your orders will watch the market and your position for you.
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Forex market liquidity will vary throughout each trading day as global financial centers open and close in their respective time zones. Reduced liquidity is first evident during the Asia-Pacific trading session, which accounts for only about 21 percent of global daily trading volume.
Japanese, Chinese, or Australian data or comments from regional finance officials may provoke a larger-than-expected or more-persistent reaction simply because there is less trading interest to counteract the directional move suggested by the news.
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Many trading books recommend avoiding averaging into, or adding on to, a losing position — and with good reason. The tactic can lead to dramatically higher losses on smaller incremental price movements. Also, if you’re adding on to a losing position, you’re missing out on the current directional move. In other words, not only are you losing money, but you’re also not making money, which is the opportunity cost of averaging.
On the most basic level, every trade ends with either a profit or a loss. Sure, some trades finish flat, which is when you exit the trade at the same price you entered, producing no gain or loss. Most of the time, though, you’ll be dealing with the agony of being stopped out or the ecstasy of taking profit.
Taking profit too soon or not at all
Taking profit is usually a positive experience for most traders.
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The Favorite Fib is a Fibonacci-based strategy that takes advantage of momentum. It can be used on various time frames and markets, including forex majors, stock indices, and commodities, providing the trader with endless opportunities.
The strategy could be used, for example, after some major economic news — ideally, at the earlier stages of the move following the news.
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Moving averages are one of the most commonly used technical indicators across a wide range of markets. They have become a staple part of many trading strategies because they’re simple to use and apply. Although moving averages have been around for a long time, their capability to be easily measured, tested, and applied makes them an ideal foundation for modern trading strategies, which can incorporate both technical and fundamental analyses.
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The whole purpose of doing any form of analysis — whether it’s technical, fundamental, or statistical — is to try to identify higher-probability trading opportunities. One such strategy is to use a European opening range. This strategy will typically focus on EUR/USD, but it could be applied to any of the European majors.
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News trading (buying and selling around high-impact economic data) is notoriously difficult, to the point that many traders intentionally close all their trades ahead of major news reports like nonfarm payrolls (NFP) or central bank meetings. To be successful with this style of trading, you need to have a predetermined, disciplined structure — you don’t want to haphazardly place emotional trades.
The forex markets have had a limited form of electronic trading since the mid-1980s. At that time, the primary means of electronic trading relied on an advanced communication system developed by Reuters, known as Reuters Dealing. It was a closed-network, real-time chat system well before the Internet ever hit the scene.
Most every online trading brokerage now provides for click-and-deal trade execution. Click and deal refers to trading on the current market price by clicking either the Buy button or the Sell button in the trading platform. Before you can click and deal, you have to:
Select the right currency pair.
This may sound silly, but make sure you’ve selected the currency pair that you actually want to make a trade in.
When it comes to trading options, knowing how to look for breaks is key. For more details on a zoomed-out look at this, read How to Find a Breakout in Trading.One way to trade a breakout is after the break has occurred. You may not have noticed the significance of a particular technical level, or you may not have left orders in overnight to exploit a break.
After you’ve identified a likely breakout point, you can use a resting stop-loss entry order placed just beyond the breakout level to get into a position if a break occurs. To get long for a break to the upside, you would leave a stop-loss entry order to buy at a price just above the upper level of the range or pattern.
You may think that the $5-trillion-a-day forex market may be too big to get caught up in the movements of other, smaller asset classes, but that's not the case. The forex market doesn't move in isolation — what other asset classes do can have big implications for currency prices. Here's how:
Equity markets: If an equity market is rallying, check the domestic currency — sometimes it can follow suit.
If you’re basing your trading strategies on trend-line analysis, you need to be aware that price levels derived from trend lines will change depending on the slope of the trend line. The slope of a trend line refers to the angle of a trend line relative to a horizontal line.
The steeper the slope of the trend line, the more the relevant price level will change over time; the shallower the slope, the more gradually the price levels will change with time.
Just because you’ve got a well-developed and considered trade plan doesn’t mean it has to be carved in stone. Well, at least the ultimate stop-loss exit should be carved in stone. But when you’re in a position, and the market is moving in your favor, it’s important to be flexible in adjusting take-profit targets and amending stop-loss orders to protect your profits.
If you’re like most traders, after you enter a position you’re keenly aware of every single pip change in prices, at least as long as you’re watching the market. Every little price change, and the attendant change in your unrealized profit and loss (P&L), evokes emotions ranging from joy to despair and everything in between.
Recollections of individual trades can be hazy sometimes. Some traders may tend to favor remembering winning trades, whereas others may remember only the losing trades. The only way to get to the heart of the matter is to look at the numbers — the results of your trades over a specific time period, such as a month.
A breakout or break refers to a price movement that moves beyond, or breaks out of, recent established trading ranges or price patterns captured with trend lines. Breakouts can occur in all time frames, from weeks and days on down to hours and minutes. The longer the time frame, the more significant the breakout in terms of the overall expected price movement that follows.
Volatility is a statistical term referring to price fluctuations (standard deviation) relative to the average price over a specified period of time. Volatility is what makes the trading world go ’round, and without it, speculators would have a lot of time on their hands.
But not all volatility is created equal, and you need to be aware of two main types of volatility that can alter the currency playing field:
Market volatility: Market volatility is the overall level of price volatility in various financial markets at any given time.
The kind of trader you are will affect — or should affect — your trading strategy. It helps to know your trader type so you can trade effectively and in a way that feels right for you. To determine your trader type, take the following quiz.
The quiz
Which statement best describes you when you're competing?
A. I'm aggressive, outgoing, and confident in my abilities whether I win or lose.
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There are thousands of forex strategies, but you need to choose the one that works best for you. At FOREX.com, traders are grouped based on personality types and developed specific strategies for each. They've identified three trader types:
The scalper: A scalper is a trader who looks for short, minimally profitable opportunities in the market that can add up over time.
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Depending on the trade setup, you may be entirely justified in averaging into a position. In fact, with some trade opportunities, you’ll be hoping to have the chance to average into the position at better rates, because if the trade setup is correct, you’ll want to have on as large a position as possible.
Even though certain trade opportunities warrant averaging into a position, you still need to identify the ultimate stop-loss exit point in every trade setup.
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