Important Tips for Forex Trading.
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| Important Tips for Forex Trading. |
Forex Trading - Tips for Currency Trading
Most investors are only familiar with currency trading from their vacations. However, the foreign exchange market is many times larger than the stock market. In Forex trading, investors speculate on changes in exchange rates. In this article, you will learn how Forex trading works and how you can become a Forex trader. We have also provided a clear overview of the best Forex broker offers. Right from the start, we provide you with the best recommendations and tips.
FOREX TRADING - THE MOST IMPORTANT POINTS
The foreign exchange market is the largest in the world, with four trillion US dollars changing hands daily.
In currency trading, you can achieve high profits with minimal investment, thanks to leverage.
Always calculate the maximum risk you are willing to take. We explain how to successfully use leverage in Forex trading.
To participate in Forex trading, it's important to know key terms like lot and pip. Here, we understandably explain both terms.
FOREX TRADING - HOW TO UTILIZE THE FOREIGN EXCHANGE MARKET
You're probably familiar with the currency exchange booths where you can convert money into a different currency while on vacation. When going to the USA, you exchange euros for dollars. If you fly to Japan, Japanese yen becomes the preferred means of payment. However, as an investor, you can also conveniently trade currencies from the comfort of your home.
With even a small investment, you can achieve substantial profits thanks to leverage. But how do you utilize the foreign exchange market, also known as the Forex or "FX" market? What should you consider in Forex trading, and what advantages does the FX market offer to genuine currency traders?
ADVANTAGE NO. 1: TRADING HOURS IN FOREX TRADING
There are no breaks in the foreign exchange market. Have you ever eagerly awaited the opening price of a stock? True Forex traders have no waiting time. This is because currency trading takes place around the clock, with few exceptions. And you can participate in Forex trading practically at any time through your Forex broker.
ADVANTAGE NO. 2: LIQUIDITY IN CURRENCY TRADING
In addition, there are other conveniences: You don't have to wait long for your order to be executed. The foreign exchange market is by far the largest financial market in the world, offering abundant liquidity. Currencies worth around four trillion (4,000 billion!) US dollars change hands daily, which is many times the trading volume of stock markets.
And if you're now wondering where the heart of currency trading lies, where the transactions are brought together, the answer is somewhat sobering: Currency trading spans the entire globe. Currency transactions mostly take place in the over-the-counter interbank market through electronic systems. Therefore, unlike stock markets, there is no single "Forex exchange."
WHAT CURRENCY PAIRS DOES FOREX TRADING OFFER?
Around eighty percent of currency trading takes place in the major currencies: US dollar, euro, yen, pound, and Swiss franc. These currencies are referred to as the "majors." The rest consists of exotic currencies. With exotic currencies, you buy or sell a major currency, such as the US dollar, against the currency of an emerging market country. For example, the US dollar against the South African rand (USD/ZAR) or the US dollar against the Thai baht (USD/THB).
PRICE FORMATION IN THE FOREIGN EXCHANGE MARKET
THE INFLUENCE OF CENTRAL BANKS ON CURRENCY TRADING
In addition to currency pairs, Forex traders need to be familiar with the key players in the foreign exchange market: central banks. Whether it's the European Central Bank (ECB), the US Federal Reserve (commonly known as the "Fed"), the Bank of England (BoE), or the Bank of Japan (BoJ), they significantly influence the attractiveness of their currency through interest rate policy.
For example, if the US Federal Reserve raises interest rates, the US dollar should tend to appreciate against other currencies. Those who hold US dollars during periods of interest rate hikes can earn above-average profits in Forex trading.
In contrast, investors in the stock market may temporarily suffer because rising interest rates make money more expensive and hinder investments, which can negatively impact stock prices. They may need to anticipate falling stock prices. This comparison between the stock and foreign exchange markets shows that engaging in foreign exchange transactions can be a valuable addition to your investment portfolio.
INFLATION OR DEFLATION: THE INFLUENCE OF THE ECONOMY ON Forex
While central banks are key influencers in Forex trading, there are other important factors to consider. It is essential to take a look at the economic situation. Whether it's producer or consumer prices, the number of home sales, or money supply growth, it always revolves around the future purchasing power of the foreign currency.
Moreover, many currencies have specific characteristics. For example, the South African rand, Canadian dollar, and Australian dollar are often referred to as "commodity currencies." Their exchange rates are particularly sensitive to price changes in commodity markets. Forex traders know that the South African rand always benefits from rising gold prices.
FOREX FUTURES AT FAVORABLE TERMS:
In the past, Forex trading was limited to investment banks or pension funds, and it was predominantly conducted among institutional investors. The barriers to entry were very high. However, the internet and global connectivity have made currency trading accessible and affordable for individual investors for quite some time. In the context of a comprehensive investment strategy, it has become an attractive addition to portfolio management. With sophisticated Forex strategies, traders can generate returns independent of the ups and downs of the stock market. It is an interesting and exciting component for portfolio diversification and asset allocation.
FOREX BROKER SELECTION: COMPARING COSTS AND SERVICES
More and more Forex brokers are entering the market, offering Forex trading at favorable terms. There are many paths to engage in currency trading. When selecting your Forex broker, they must meet the essential basic requirements. These include competitive fees, good accessibility, the ability to place orders through multiple channels, low spreads (the difference between buying and selling prices), and responsive customer service.
BASICS OF FOREX TRADING
FOREX TRADING: AN EXAMPLE OF TRADING EUR/USD
Here's how currency trading works with your Forex broker. For example, you anticipate that the US dollar will rise against the euro shortly. In the short term, the significant technical analysis in currency trading also supports a rising US dollar. And based on your conviction, a rising interest rate in the US will further weaken the euro in the medium term. Therefore, you sell euros against US dollars. The means to achieve substantial profits is a powerful leverage. But first, let's learn two terms.
UNDERSTANDING LOTS AND PIPS
They are called lots and pips, and they are crucial in Forex trading. A lot refers to the size of the currency transaction: 100,000 units in the base currency. However, there are smaller lot sizes available now: a mini-lot consists of 10,000 units, and a micro-lot only contains 1,000 units.
On the other hand, a pip is the smallest possible price movement. Unlike when paying for goods at a supermarket, where the smallest price change is exactly one cent, the minimum increment in the foreign exchange market is much smaller: currency trading goes up to the fourth decimal place. In Forex trading, even the hundredth of a cent plays a role.
THE EURO-DOLLAR STRATEGY IS WORKING
Returning to our Forex strategy of buying dollars: As a Forex investor, you have familiarized yourself with the basics and now proceed with caution as a strategic thinker. For now, you want to acquire only two lots of euros against the US dollar at a rate of 1.1280 US dollars.
This transaction has a volume of 200,000 US dollars (2 x 100,000 units). This means you buy 200,000 US dollars and exchange them for 177,304 euros (200,000 / 1.1280). Of course, you don't have to pay the entire volume (contract size).
Since it is a foreign exchange forward contract, you only need to deposit a margin with your broker in Forex trading. Let's assume it is one percent of the contract size. That means you only deposit one-hundredth of the contract size but still fully participate in the price movement. Consequently, you trade with a powerful leverage of one hundred.
Important note: Since 2018, retail investors are only allowed to use leverage up to 30 times their invested capital. Higher leverage is exclusively reserved for professional market participants.
Our tip: Pay attention to a low margin when choosing a Forex broker. This way, you never tie up more capital than necessary.
THE FIRST FOREX TRADE CLOSED WITH PROFIT
Back to our FX trade: As a forex trader, you are now not only well-versed in the subject matter, but your position is also developing in your favor: the US dollar is rising. This means, in turn, that the euro is falling. Specifically, it has dropped from 1.1280 to 1.1272 US dollars per euro. Consequently, you have earned eight pips (1.1280 - 1.1272). You now exchange your acquired two lots back into euros and receive 177,430 euros. "Closing the position" is what the forex trader calls this. Compared to the initial investment of 177,304 euros, you have thus realized a profit of 126 euros. Sounds small? But it isn't! Based on a margin of only around 1,773 euros, this translates to a profit of approximately 7.1 percent, resulting from the minimal currency fluctuation.
Most important tip: Especially for forex beginners, it is crucial to initially gain experience with small positions. Gradually increase your chances and risks to a level that aligns with your personal risk tolerance.
Key point: Calculate the risk you are taking or willing to take before each trade. Because without discipline, without a plan, and without managing position sizes, you will be at a disadvantage in the trillion-dollar forex trading market!
FOREX TRADING THROUGH LEVERAGE CERTIFICATES:
By the way, you don't need to open a specific forex account to achieve leveraged profits in the foreign exchange market. Knock-out certificates also offer you the opportunity for exceptionally high profits with high, individually adjustable risks.
EXAMPLE: CURRENCY CERTIFICATE ON EURO/US DOLLAR
An example of a knock-out certificate on the currency pair Euro-Dollar illustrates the explosive profit profile of a currency certificate. Let's assume that the euro currently costs 1.1400 US dollars, and based on only moderate economic data in the US, you anticipate declining US interest rates soon. Especially since you know that falling interest rates weaken the attractiveness of a currency and therefore tend to lower its price.
The most important parameter to consider when researching a suitable leverage certificate is the level of the knockout barrier and, in the case of certificates with a limited duration, the remaining time until expiration. The closer the knockout barrier is to the current price, the greater the chance and risk - and with them, the leverage of the currency certificate. You choose a certificate whose knockout barrier is at 1.08 US dollars, approximately five percent below the current price (safety margin).
And since you are essentially only paying for the safety margin, in this example using only one-fifth of your capital but still fully participating in the movement, you achieve a powerful leverage of 20 (100 divided by 5). If you prefer less risk, you can also choose a safety margin of ten percent. In that case, your leverage would be around 10 (100 divided by 10). If the euro-dollar exchange rate then moves in the right direction, you will already achieve a profit of ten or twenty percent with your knockout barrier with a movement of just one percent.
Our tip: Since leverage, like in direct forex trading, works in both directions, you should initially keep it low and set a generous safety margin: Preserving your capital must be the top priority. Therefore, it is crucial to avoid the knockout event in any case. Sell the position if necessary before the currency certificate is knocked out and becomes instantly and irretrievably worthless. By the way, with the right brokerage provider, you can trade knockouts at particularly favorable terms.
FOREX PROFITS WITHOUT CAPITAL GAINS TAX?
Contrary to some circulating rumors, profits from foreign exchange transactions are not tax-free. In most cases, the capital gains tax introduced in 2009 applies, with a rate of 25 percent plus a 5.5 percent solidarity surcharge on the amount of the capital gains tax, and potentially church tax. This results in 26.375 percent (0.25 x 5.5)% + 25% = 26.375%). If your income tax rate is lower, you can reclaim part of the tax paid through your annual tax return from the tax office.
By the way, losses from futures transactions are generally taken into account in the general loss carryforward pot for tax purposes; you can offset them against all other types of capital gains for tax purposes.
However, there are also special situations: If your broker grants you a right to physical delivery of foreign currencies - at least on paper - your income tax rate applies instead of the capital gains tax.
Tip: For tax questions regarding forex trading, it is best to consult a tax advisor. Your bank advisor may also be able to provide you with some advice.
LEVERAGE REGULATION IN FOREIGN EXCHANGE TRADING
Since the European Securities and Markets Authority (ESMA) decision, the maximum leverage allowed in forex and CFD trading is now limited to 1:30. The specific leverage for different currency pairs depends on their volatility, as determined by the ESMA. Here are the maximum allowable leverage levels for currency pairs now:
MAXIMUM LEVERAGE IN FOREX TRADING
- 1:30 for major forex pairs
- 1:20 for other currency pairs
FOREX TRADING - WHAT YOU SHOULD DO
- Familiarize yourself with the key terms of foreign exchange trading and choose the appropriate currency pairs for your investment strategy.
- As a forex beginner, start with small positions. It's important to gain experience! Calculate the risk you are willing to take before each trade.
- Find an online broker where you want to start your forex trading. You can get started quickly with the CFD broker Plus5005.
- Always pay attention to a low margin, so you never tie up more capital than necessary.