When we hear about forex trading, we tend to think about the profit potential and risk of losses. Trading in the forex market may look like a complex task to an average beginner, as the currency pairs are known for their volatile and unpredictable nature. But this complexity can be reduced by learning about the basic yet important concepts that lay the foundation of forex trading. You won’t be able to get started with trading without understanding these key concepts. Hence, I have made this comprehensive beginner’s guide to help you grasp all the relevant concepts in a simplified manner.
- Pips
We can refer to pips as the basis of all forex-related transactions and trading activities because the forex market is moving throughout the day with constant fluctuations in the exchange rates of different currencies. Keeping track of all these movements is only easy with a common measurement unit. This measurement unit is what we call pip or price interest point. Pip is also the abbreviation for percentage in point, as the currency price movements are so minor that they have to be expressed in percentages and decimals.
Pip calculators can help you understand currency price fluctuations better as they provide the actual monetary value of a certain number of pips in the currency you wish to trade in. It would be ideal to depend on this automated tool as the pip value keeps changing based on the currency pair being traded and the trade size in lots. Otherwise, the process of pip calculation will be time-consuming, and you also run the risk of getting incorrect values due to manual errors.
Pip calculations are essential for a trader as they are used to calculate the profits and losses of a trade as well. The number of pips you gain or lose in a trade will determine the amount of profits or losses at the end of a trade. Traders will also be using pip as a metric for placing Stop Loss and Take Profit orders. To share the most basic information about pips, one pip is equivalent to 0.0001 for all currency pairs except the one including the Japanese Yen, where 0.01 is the value of one pip.
- Lot
While explaining the concept of pips, I mentioned trade size in lots. Lot is another unit of measurement in forex, and it determines the size of a trade or the amount of money risked for a trade. Since the trading instrument in forex is international currency pairs, assessing the amount being risked with the conversion and exchange rate differences would be difficult. Hence, lot size is used as a standard metric.
There are three types of lots in forex: standard, mini and micro. The standard lot is the biggest, and your trade will be worth 1,00,000 units of currency here. If you choose a mini lot, it will be 10,000 units of currency; micro is the smallest with just 1000 units of currency. A standard lot is the most common, and the number of lots you choose to trade with is crucial in deciding your profits or losses in the end.
A bigger lot size increases your profit potential, but it also increases your risk of loss. Lot size is also referred to as position size and proper position sizing, and it is an integral part of risk management.
- Position
The next important forex term you should learn about is position, which can imply two different things. The first one is lot size or position size, which we have already discussed, and 2nd one is the type of position that you choose to open. The type of position you choose as a trader tells about the direction in which you want to move to make profits. If you are anticipating a rise in the value of a currency pair resulting in an upward price movement, you will be taking a position to buy that pair. This is referred to as a long position in forex, and traders say it as going long on a pair.
If you think the pair is about to experience a fall in value with a downward price movement, you will try to make profits by selling the pair, and here, you will be opening a short position. Traders refer to this as shorting a pair in anticipation of a price fall. Long positions are typically associated with bullish sentiments and uptrends, whereas shorting is a result of a bearish outlook and the possibility of a downtrend. Traders do a lot of market analysis to decide the type of position that should be opened for making profits. We will discuss market analysis in another section.
- Margin Trading
Margin is the amount of funds you should have in your account while opening a trade. This margin acts as collateral for entering a trade, and the margin requirement will depend on the currency pair you choose for trading, along with the lot size. If you want to trade in a different currency than what you usually trade in, then you should know its price in your own currency, for which you can use a currency calculator. This is a tool that quickly converts one currency’s price into another, making it easier for you to determine the margin requirements. You will be choosing a forex broker, opening your trading account and executing trades. Thus, the margin requirements will also be dependent on the terms and conditions of the broker you choose.
If your account balance falls below the margin levels, your broker will ask you to deposit additional funds and will close the existing trade positions if you don’t add the required money in time. Margin trading is actually the use of borrowed money or leverage for the purpose of trading. The broker will allow you to open trades with a larger lot size with a smaller margin in your account.
You can calculate this metric using a margin calculator, an essential tool to use before every trade. Otherwise, you may encounter a margin call situation, which is stressful for a trader. When you avail a higher leverage, the margin requirement for a trade will be lower, but the risk of loss will be higher as you risk the amount you don’t have in your account.
- Technical and Fundamental Analysis
Market analysis is the most important step in the process of trading, as this is the phase that decides the type of position that you will be opening as a trader. There are two types of market analysis that you can do in the forex market. First is technical analysis, where you will be relying on historical and real-time price data to identify patterns that suggest the direction in which the market will move for a currency pair. You will be able to predict this by identifying trends and potential trend reversals. Technical analysis is all about price action; being good at it gives you an edge as a trader.
Fundamental analysis involves the study of various economic events and indicators that have an influence on currency prices. The long-term market trends will be heavily dependent on the geopolitical and economic situation, and thus, fundamental analysis is crucial for traders following long-term strategies. An economic calendar is a useful tool for fundamental analysts as it tells you about relevant news releases and events along with their potential impact.
- Japanese Candlestick Charts
The next forex concept is about the most popular and common tool that technical analysts in the forex market use. Technical analysis is done by using visual tools that present the market data in a chart, making pattern recognition easier. The market trend and potential price movements will be predicted based on the patterns that are formed by the price changes. You will have to spend enough time learning about candlestick charts and decoding the information provided in these charts, which is the very essence of technical analysis.
Japanese candlestick charts are the most detail-oriented chart types; thus, technical analysts rely on them for in-depth analysis. Here, you will be seeing individual candlesticks (candles) providing information about high, low, opening and closing prices for a particular timeframe, such as minute, hour, day or week. Learning the meaning of each candle and the patterns formed by a bunch of candles is important to carry out technical analysis.
- Spread
Spread can be referred to as the cost of trading in simple words. It is the difference between the bid price (buy) and ask price (sell) of a currency pair. Different currency pairs have different spreads, and brokers depend on this price difference to make profits.
Conclusion
So, these are the most basic yet important concepts you must learn as a forex trader. This guide is just a starting point; you have much left to know and learn before trading. Take your time to understand what you learned and demo trade until you feel confident.
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