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As readers of my blog know, I am all about passive investing. When it comes to putting money away for the long-term, a good plan is needed that includes low cost investments. But even with my main investment accounts invested this way, I still have an investment account where I buy individual stocks and play around.
My success in playing around is what I would call average. I’ve owned some stocks that have had nice, big returns and others that did nothing but drop like a rock. I’ve even ridden a few into bankruptcy, falling victim to the hope that one day, the stock price will come back.
I credit my “play” account with giving me the success that I experience with the stock market. My “play” account allows me to trade stocks and take chances with my money, most of which never pay off.
In other words, my “play” account is funded with money I am comfortable losing. The goal of course is to make money, but I’m no Warren Buffett.
When it comes to my regular, long-term investing, I stay the course and have seen great success because I don’t try to time the market or chase returns. My play account has shown me that I am much better off in the long run by using a buy and hold approach as opposed to a trading approach.
Getting Started In Forex Trading
Over the past few years, one of the areas of trading I have tried out is the world of Forex trading. Forex trading is simply the trading of currencies. I was introduced to Forex trading in my graduate international finance course.
My professor gave us all $100,000 (in play money, not real money!) and access to a Forex account at the beginning of the semester. We would trade in the account as we saw fit throughout the semester. At the end of the semester, we would present our experience to the class and see who did the best.
Up until this point, I knew what Forex was, but I never used currencies as an investment.
The goal of this exercise wasn’t to have the biggest account balance, but to see what everyone learned. Some made a gamble early on and never recovered. Others, including me, took a more practical approach.
At the time, the Greek debt crisis was in overdrive. As a result, I was shorting the Euro and buying up just about every other countries currency. I did fairly well for myself and was happy about it.
It was very interesting getting started in Forex trading. It made me to look at the news in a different way. Before, I would just read the news. But when trading currencies, I would read stories with the thought of “I wonder how this impacts the currency between two countries” in the back of my mind.
When I started trading, it was easy to see when bad news was coming out of Europe, I was able to short the Euro against the US Dollar. As time went on, I realized that more money could be made trading currencies other than the US Dollar and the Euro and I began to trade in other currencies.
When the course ended, I turned my $100,000 into $120,000. Others in my class had done the same. One classmate lost almost everything because his first trade was for a large amount of money and he didn’t fully understand how things worked yet.
Because of this, it’s important that you understand what you are doing. Below is some more information about Forex trading to help you better understand how it works and what to look out for.
How Does Forex Trading Work?
Forex is the use of trading currency pairs. The most common is EUR/US, or Euros and United States Dollars.
Other common pairs include:
- Great British Pounds/United States Dollar
- Canadian Dollar/United States Dollar
- Japanese Yen/United States Dollar
Of course, you can trade almost any currency you want. When trading pairs, you either buy a currency you think is going to rise in value or you sell a currency you think is going to fall in value.
As I mentioned above, when I was trading during my finance course above, the Greek Debt Crisis was in full effect. This was putting tremendous downward pressure on the Euro, so I was selling that currency and buying US Dollars and even Australian Dollars.
What Are The Benefits of Forex Trading?
The overall goal of Forex trading is to make money. But there are many benefits to trading currency over the traditional stock market. Some of these include:
- Liquidity: The Forex market is the largest in the world, so it is very liquid. This means it is easy to get your money into the market and out of the market.
- 24 Hour Trading Day: The Forex market trades 24 hours a day. This is nice for those that work during the day because they can still trade Forex at night or first thing in the morning before they head out to work.
- Leverage: This is nice because it allows you to make larger trades than you have money for. This means that if you have $100 in your account, you could theoretically trade up to $1,000 at a time. This allows you to really make sizable gains.
- Low Costs: When trading Forex, your only cost is the spread, which is the difference between the bid and ask prices. There are rarely ever added commissions to the trade like when trading stocks.
What Are The Drawbacks of Forex Trading?
Of course, there are drawbacks to Forex trading. The main ones include:
- Leverage: While it is nice to use leverage to your advantage to increase the size of your gains, if you invest wrong, you could be in trouble. Think about having $100 but having to pay $2,000. Ouch.
- Learning Curve: With Forex, you need to understand the terminology and how the system works if you want to succeed. Because of the learning curve, many Forex brokers offer a free demo account for you to practice with so you can get your feet wet. You can read more about this below.
- Fast Paced: With traditional investing, you can buy and hold for the long term and come out fine in the long run. Not so with Forex. You have to stay on top of the news throughout the world because things happen fast and any delay can cost you your investment.
- Regulation: The Forex market is not as regulated as the stock market. Because of this, there are some scammers out there. What this means is that when you invest in stocks or ETFs with Motif Investing or Schwab, you know you are dealing with a firm you can trust and rely on. This isn’t the case with firms that trade Forex. Make sure you research any firm you plan to trade with and understand how they are regulated.
Understand The Terminology Used
Terminology is important when getting started in Forex trading and how things work. One misconception can cost you thousands of dollars. If definitions and financial terminology are not your strong suit, keep a cheat sheet close by.
List of common terminology with brief explanations:
- PIP: In short, PIP denotes the smallest incremental move an exchange rate can make.
- Leverage: Used to increase buying power, leverage allows you to trade one dollar as if it were fifty.
- Margin: This is the amount of credit a broker will extend to you as a trader for use as leverage.
- Margin Call: If the markets begin to drop, the broker may make a margin call. This means you will have to return any money you have traded on margin with them.
- Spread: A simple term to understand, a spread is the difference between the bid and offer (ask) prices3
- Bid: The price at which a buyer is prepared to purchase.
- Offer (Ask): The price at which a seller is prepared to sell.
- Long: Going long means that a trader buys a currency with the expectations of it profiting well over a period of time, usually a week or longer.
- Short: This is a quick purchase that is sold with a small rise in price to gain a bit of revenue. This is done with the expectation of the commodity to decline rapidly to help the price per share to regain value.
It is best to keep this terminology handy. You should also clearly understand what these terms mean in order to avoid a financial loss. If you want to understand more terms related to Forex, check out this in-depth guide.
Being Wary Of Costly eBooks and Courses
As in any industry, there will be people who wish to profit from their knowledge. When new traders enter the markets they are at their most vulnerable, which can make them susceptible to costly products.
If it seems too good to be true then it probably is. It’s always worth remembering that there is a wealth of information available for free online and in most instances it’s a lot more useful than expensive online courses or eBooks.
A number of these offers, although not all, are selling a dream as opposed to the information they claim. There is no easy route to success. Financial trading demands dedication and patience.
Knowing When To Trade And When Not To Trade
While there is an element of risk involved in any form of trading, you won’t be taking huge risks on a daily basis. In fact, you are required to exercise patience just as much as you are risk. The most successful traders don’t trade on a daily basis and when the risk is high they sometimes opt to only place small trades. Of course, the reverse is also true.
You’re best strategy at first is to take advantage of the free demo accounts the brokers offer and fully understand the terminology. Once you feel more comfortable, then you can start trading for real.
But don’t get too full of yourself. Take things slow and always continue to learn.
I don’t trade in Forex as much as I did after that class. Getting started in Forex trading takes some time and education. Working a full-time job, writing for a few blogs and hanging out with friends hasn’t left me with enough free time that I would want in order to be successful at Forex trading.
I would suggest to others that have some free time to look into trading in Forex in their “play” account. As I pointed out above, it helps you to think and see the news in different ways and can be a fun, new way to trade.