Trading the foreign currency exchange market, commonly referred to as Forex, presents new traders with many items for consideration before getting started. These include your approach to select a broker, trading platform and risk management strategy among many more. Below are some initial questions to ask yourself as you prepare for online forex trading.
1. What Forex Pair Should I Trade?
When deciding on a forex pair to day trade, liquidity is an important factor to evaluate. Liquidity is the ease at which you can both buy and sell a financial instrument in the market. One measure of forex liquidity is the ‘spread’ or difference between currency prices in a pair.
The more liquid a currency pair is, the less the spread is, making it easier and less costly to enter and exit a forex position.
Examples of forex pairs with high liquidity include:
- Euro and the United States Dollar – EUR/USD
- United States Dollar and the Japanese Yen – USD/JPY
- United States Dollar and the Great Britain Pound – USD/GBP
Volatility is the degree of price movement by a financial instrument, such as a forex pair. When a pair is highly volatile, there is an increase in price movement. This can either be good or bad based on the amount of experience a trader has. Less experienced traders should avoid forex pairs with greater volatility until they are more familiar with the pair’s trading patterns during volatile periods.
Examples of forex pairs with historically high volatility:
- Great Britain Pound and the Japanese Yen – GBP/JPY
- Euro and New Zealand Dollar – EUR/NZD
- Great Britain Pound and Australian Dollar – GBP/AUD
Examples of forex pairs with historically low volatility:
- Euro and Great Britain Pound – EUR/GBP
- New Zealand Dollar and United States Dollar – NZD/USD
- Euro and Swiss Franc – EUR/CHF
2. Which Online Forex Broker Should I Trade With?
Free, unlimited access to a trading simulator along with free, live market data are features of great value to new traders as they:
- Allow for risk free practice trading
- Facilitate the developing of a trading strategy
- Help with deciding which forex pair to trade
Spreads are the key pricing element to keep in mind when trading forex. A spread is the difference in price between the bid and the ask.
- Bid Price: the value of a forex pair at which you can exit a position
- Ask Price: the value of a forex pair at which you can enter a position
Low or “tight” spreads are preferred as this means there is less of a difference between the bid and the ask.
In addition to the spread, markups, fees or commissions may be applied that can affect the cost of placing the trade.
As for margin, this is usually based on the particular forex pair you are trading and may vary from broker to broker.
3. What Should I Consider When Deciding on Forex Trading Software?
If new to trading and this is your first forex trading software (link to: http://ninjatrader.com/Trade), be sure to look for a platform that caters to both new and experienced to traders. When getting started, you will want to simplify your platform but as you gain experience, you will want more advanced capabilities that you can begin to leverage.
Initials features to think about are:
There are many ways to submit forex orders to the market. An ‘FX board’ is the most popular tool for submitting forex pair orders. Some traders choose to enter trades directly from a chart. Being able to use and test a variety of order submission tools on one forex trading platform will be helpful with developing your order submission strategy/method.
Below is an example of the NinjaTrader FX board:
When first getting started, be sure to keep your charts as simple as possible. You will soon build up to more complex charts featuring multiple indicators and forex pairs, but keep it simple to start!
Data Connection Options
Though you will more than likely be provided with a data connection from your forex broker, you may find that researching and finding an additional backup data source is a good strategy.
Obviously, there is a lot to take in. Be sure to check on the support resources and tools available from your trading software provider. Live webinars and on-demand videos can really come in handy. User forums also can not only help you address some questions, but are also a sign that the software provider takes support of their users seriously.
4. How do I Develop a Forex Trading Strategy?
There are two concepts to think about when beginning to develop your forex trading strategy:
Entering a Forex Trading Position
- ‘Going Long’: Buying a forex pair with the opinion that the currency on the left of the pair (ex. EUR/USD) will gain in value vs the currency on the right of the pair
- ‘Going Short’: Selling a forex pair with the opinion that the currency on the right of the pair (ex. EUR/USD) will gain in value vs the currency on the left of the pair
Exiting a Forex Trading Position
- ‘Stop Loss’: Entering a trading order that ‘fills’ or trades only if a predetermined amount of loss or gain occurs or price level is reached. Stop Loss orders also help ‘lock in’ potential profits or limit a potential loss.
Support and Resistance are two fundamental trading levels that can help you develop a base for a forex strategy. By identifying these levels, you have a starting point to determine what ideal trade entrance and exit price levels may be.
If a forex pair breaches either the predetermined support or resistance level, you may decide to use this as a signal for selling or buying the pair.
By backtesting support and resistance levels on a particular forex pair using historical market data, you can determine if using these levels on that pair would have resulted in an effective trade.
See the chart below of the EUR/USD forex currency pair for an example of support and resistance levels:
Once you feel comfortable with your understanding of support and resistance levels, incrementally adding complementary trading indicators to your backtesting strategy will help to provide more insight into the mechanics of the market.
Forex platform providers usually offer many different types of technical trading indicators. Two examples of forex trading indicators are Stochastics or momentum indicators and Relative Strength Index (RSI).
Backtesting on charts with indicators and SIM trading support and resistance levels, you should begin to gain a sense of how much market movement you are comfortable trading in. This is an extremely important step since the forex strategy you eventually decide on should be custom fit to the amount of risk you are willing to tolerate.
Keep in mind that although backtesting can serve as a basis for building a forex trading strategy, it does not always lead to successful trades. Past performance is not indicative of futures results and you should only use discretionary funds for trading. It is very important to maintain and use the knowledge of how much risk you can handle while trading your strategy.