Foreign exchange is one of the most popular financial markets worldwide with more than 10 million active forex traders. Two reasons why it’s so favoured by traders are its high liquidity and the tendency for brokers to offer narrow spreads.

However, the market can be highly volatile and comes with many risks, so it’s generally recommended for more experienced traders with well-developed skills. In this article, we cover the basics of foreign exchange (FX) trading and some of the key skills that you will need to trade effectively within the forex market.

What is forex trading?

Forex or FX trading is the act of exchanging multiple currencies on a decentralised market. As forex is always traded in pairs, the aim of traders is to speculate whether one currency’s value is due to strengthen or weaken relative to the other.

For example, let’s say a trader is opening a position on EUR/USD, one of the world’s most popular FX pairs. If they think the price of the dollar will rise against the euro, they could open a long (buy) position. Conversely, if they think the euro will rise against the dollar, they could open a short (sell) position. Depending on whether the market moves in their favour or against them, they will either make a profit or a loss.

Understanding the basics is essential for those new to forex. Trade Nation's 'What is forex trading?' offers a straightforward guide on getting started in the forex market, making complex ideas easy to grasp.

What are the different methods of trading?

There are several ways you can get involved in the market, including through derivatives or spot FX trading. These are explained in more detail below.

• Spread betting: this is a derivative product that allows you to trade tax-free in the UK and Ireland. When spread betting, users do not take direct ownership of the asset but instead bet on the price movements of the currency pair.

• Contracts for difference (CFDs): this is another derivative product which shares similarities and differences with spread betting. CFD trading is available in more countries worldwide, such as across Asia and Europe, but comes with capital gains tax (CGT), meaning it’s less cost-efficient.

• Spot FX: this is an agreement to trade currencies at the current or ‘cash’ exchange rate through a broker. The market is open 24 hours per day and typically comes with tighter spreads than the futures market.

• Futures: the opposite to a spot or cash contract, a futures or ‘forward’ contract is an agreement to exchange a currency pair for a specific price at a specific date in the future. These have expiry dates and any interest rate differential is factored into the price of the contract.

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What are some skills a forex trader should have?

Analytical skills

This doesn’t just apply to forex – traders of any market should have competency in numeracy and technical analysis, whether it be for shares, indices, or commodities.

Seeing as the market moves so quickly, forex traders will spend a lot of time sifting through data, analysing historical and current price charts, and calculating entry and exit points. It therefore pays off to understand how to interpret these types of data and at a rapid pace. Many forex traders decide to use short-term strategies such as day trading and scalping, so the ability to apply indicators and tools to charts to study price action is a very valuable skill to have.

It’s also useful to have fundamental analysis skills. Although this isn’t as commonly needed in the forex market due to its fast pace, traders can benefit from following news announcements, important events and general trends in order to forecast potential changes in price action. For example, if the Federal Reserve is due to announce an interest rate hike, this could wildly affect the value of the US dollar, so you should always stay aware of social and political factors.

Planning skills

Traders often make a plan before opening a forex trade. This is because the market can be unpredictable and emotions can get in the way of the trader, causing them to make mistakes, doubt themselves or let greed overtake their strategy. This way, they’re able to better anticipate the outcome of their plan and create clear overall goals. Some things to consider include:

• Which currency pair/pairs will they trade?
• How long do they want to hold the position for? This could be anywhere from a few seconds to a few months.
• What is the maximum amount of capital they’re willing to risk?

Risk-management skills

Forex traders should be vigilant of the hazards surrounding them – so risk awareness is perhaps the most important skill to focus on.

Traders can apply risk-management orders such as stop-losses and take-profit orders to price charts which will, in turn, close out their position at the exact price specified if the market is moving against them. For example, if a trader sets a stop-loss at 5% below the buy price, it helps to limit losses to 5%. Guaranteed stop-losses (GSLOs) ensure that this even takes place regardless of market volatility or gapping, but these come with a premium charge.

In order to mitigate risks as much as possible, some brokers such as CMC Markets offer traders the opportunity to practise on an online forex demo account, which is a simulated environment using virtual funds. This allows the trader to familiarise themselves with the products, markets, and platform before diving into a trade.

Decision making skills

It’s important that a trader is able to make quick decisions, especially when the market is highly liquid and there is a large number of buyers and sellers waiting to exchange their currencies – you wouldn’t want to miss out. Extra short-term traders such as scalpers need to identify entry and exit points every few seconds or minutes, so time management is essential. The ability to focus is equally key when studying intricate price charts.

Keeping a diary with records of previous trades also helps to plan for the next. For example, traders could write down what went well, what caused them to lose money, or even what caused them to panic, in preparation for next time. Traders should be willing to learn from mistakes, rather than getting caught up in losses.

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The bottom line

These are just some basic skills to get you started, but full-time and experienced forex traders will not be limited to these and will have many other tricks up their sleeve. It’s important to have a good understanding of how forex trading works and how you can protect your capital before entering the fast-paced market.

As a wise man once said:

“It’s not whether you’re right or wrong, but how much money you make when you’re right and how much you lose when you’re wrong” – George Soros

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