What is Forex Trading?
Most of us have traded forex, if not to make profits, then for practical reasons if you have travelled abroad or bought anything from a different country. Trading, in simplest terms, is buying and selling. As such, Forex trading involves speculating on the price movements of currency pairs. Based on analysing different fundamental factors or previous price movements, traders buy and sell currencies to profit from the difference between interest rates. This exchange of currencies can be done through trading platforms like MT4 and MT5 after opening a trading account with the forex broker. Let’s take the example of EUR/USD to understand how forex trading works.
In this case, EUR is the base currency, and USD is the quoted currency. If you believe the base currency (EUR) will increase in value compared to the quote currency (USD), you will buy the forex pair. On the other hand, if you think the base currency will decrease in value against the quote currency, you will sell the pair.
To continue with our example, if you expect the euro to strengthen against the dollar, you will buy the EUR/USD pair. Conversely, if you anticipate the dollar to strengthen against the euro, then you would sell the pair.
It may seem to you that forex trading is all about predicting the direction of a currency pair and collecting profits. But it’s not that simple. You should have an effective trading strategy to guide you with entry and exit points and a solid risk management strategy to protect you from unwanted losses.
6 Advanced Forex Trading Techniques
Hedging: Hedging is one of the very popular techniques that experienced traders often use to manage risk. But you should know that this strategy is not for generating profits but for managing the losses. You can use different trading tools to determine position size, leverage and other details to ensure a solid hedge. To give you an idea about how hedging works, let’s take an example of two pairs this time, GBP/USD and EUR/USD. Both these currency pairs have a positive correlation. You can offset the risk by taking positions on both pairs in opposite directions.
Suppose you have a short position on EUR/USD, but the currency pair appears to be gaining strength and could move upward. To hedge your exposure to the US dollar, you can open a long position on GBP/USD. Now if EUR/USD continues to rise and the US dollar weakens, any potential loss on your short position would be offset by the profit on your long GBP/USD position. Conversely, if the euro fell against the dollar, your long position on GBP/USD would incur a loss, but it would be balanced by the profit on your EUR/USD position.
It’s important to understand that while both of your positions are open, the net profit of the two trades may be below zero.
Position Trading: Position trading is a long-term approach where you buy and hold a trade for an extended period, ranging from months to years. Unlike shorter-term trading styles, position trading relies on fundamental analysis, which involves studying a country’s economic data, central bank policies, and overall economic outlook.
You should ensure you have enough funds in your trading account when engaging in position trading. This is crucial because position trades can experience short-term price fluctuations, and having enough funds will help you avoid margin calls and potential account liquidation.
In position trading, your focus is on your overall exposure to a specific currency pair. You speculate on the price movements of the forex market using contracts for difference (CFDs), which allow you to profit from both rising and falling markets.
To support your position trading strategy, you can utilise various technical indicators. For instance, trend trading is a common technique using tools like moving averages to identify favourable entry and exit points for your trades. Another technique you can consider is support and resistance analysis, which involves identifying levels in the market where prices are likely to reverse or consolidate.
Ichimoku Clouds: Ichimoku clouds are useful indicators in technical analysis that you can select on both MT4 and MT5 trading platforms. It’s better to use the MT5 trading platform if you want a broader array of trading indicators. It helps you assess market trends, momentum, and potential support or resistance levels. This indicator combines multiple calculations and plots five lines on a price chart to form a cloud-like shape.
The five lines used in Ichimoku clouds are:
- Tenkan-sen, also known as the conversion line.
- Kijun-sen, referred to as the baseline.
- Senkou span A, also called the Leading Span A.
- Senkou span B, also called the Leading Span B.
- Chikou span, also called the lagging span.
By plotting these lines on a price chart, the Ichimoku indicator creates a cloud-like area. This cloud serves as a visual representation of potential support and resistance levels. For example, if the Leading Span A rises above the Leading Span B and forms a bullish cloud, it confirms an uptrend. Conversely, if the Leading Span A falls below the Leading Span B and creates a bearish cloud, it confirms a downtrend.
When analysing the position of the candlestick in relation to the cloud, certain patterns can be observed. If the price is above the cloud, it indicates a higher likelihood of an upward trend. Conversely, if the price is below the cloud, it suggests a tendency towards a downward trend. When the price is inside the cloud, it signals a state of transition or consolidation in the market.
Trading Forex Options: Trading forex options allows you to secure the right to buy or sell a specific currency pair at a predetermined price and time. Unlike traditional transactions where you immediately settle and transfer funds to a third party, forex options allow you to exercise your right later.
One advantage of forex options is that you’re not obligated to exercise the option. This means you have the freedom to decide whether to buy or sell the underlying currency pair specified in the options contract. If you choose not to exercise the option, you will only lose the premium you initially paid for the option, which acts as your deposit. This limits your risk to the amount of the premium.
Forex Scalping: Forex scalping is a strategy which involves quickly opening and closing multiple positions throughout the day. You can open these positions on one or more than one currency pair. The idea is just to enter and exit quickly within seconds or minutes with the aim of capturing small price movements. To implement a forex scalping strategy, there are several indicators you can use, such as Bollinger Bands, Moving averages and the stochastic oscillator. The goal of scalping is to accumulate small profits, known as pips, at a time. A pip refers to the smallest change in the price of a currency pair, typically the fourth decimal place. For example, if a forex pair’s price decreases from 1.2687 to 1.2688, it has dropped by one pip.
Scalpers often use leveraged CFDs, allowing you to open positions with a fraction of the total value. The benefit of trading CFDs is that you can trade forex pairs that are either rising or falling in value. When you anticipate a price increase, you open a “buy” or “long” position, and when you expect a price decrease, you open a “sell” or “short” position. Since CFDs are complex instruments, you can practise trading on a demo account to improve your trading skills.
Nonfarm Payrolls (NFP) T rading: NFP (Nonfarm Payrolls) trading revolves around an important economic indicator that reveals the number of jobs created in the non-agricultural sector of the United States during the previous month. This report is highly anticipated in the global forex market because it provides insights into the economic growth of the US.
The NFP report reflects the overall activity and health of the American economy. If there is increased demand for the US dollar, its value tends to rise; if there is reduced demand, its value may decline.
In advanced forex trading, you go beyond the basics and explore a variety of tools and techniques to improve your trading strategies. Although forex trading is all about predicting whether a currency will rise or fall in value against another currency, it’s not that easy. Therefore, you must use the above-mentioned advanced strategies to make informed trading decisions.
Disclaimer:This article is not intended to be a recommendation. The author is not responsible for any resulting actions of the company during your trading/investing experience.