Over the past few years, the number of people who engage in forex trading has significantly increased and many of us might be wondering what makes the currency market so attractive for people around the world. The trading volume is in trillions and steadily rising as the market continues to grow and expand. Is it because of the round-the-clock nature which removes the limitation of market hours? Or is it because of the high-profit potential? Why is forex trading becoming so popular and whether you should also consider it as a revenue source? What are the things that you need to know about forex to build a successful career in trading?
All your questions will be answered in this article as I am going to talk about the top three things that you should know about the forex market before becoming a trader.
There is high liquidity and enough volatility
The first reason that makes the forex market an attractive trading place is the high liquidity. Liquidity in general would mean the ease with which an asset can be converted into cash without any difference in the market price. But when it comes to trading, liquidity means the ease with which you can buy or sell an instrument at a desired price. In forex trading, you will be opening a trade position to buy or sell a currency pair of your choice and the liquidity depends on the trading volume and market activity at the time of placing the trade.
Major currency pairs are the most liquid as they are the most traded ones in the forex market and liquidity also depends on the trading session. The liquidity is at its highest during major sessions and session overlaps as traders from different time zones are active at the same time. With that, you get a lot of matching orders, which allows your broker to execute the orders of their clients at the best prices. Trading with a broker providing access to a deep liquidity pool is important to get favourable trading conditions in forex.
Another thing to consider while choosing a broker is the availability of leverage which allows you to enter bigger-sized trades with only a smaller amount of capital in your account. The high amount of leverage that forex brokers offer is another reason that makes the forex market a favourite place for traders. The margin requirement for a trade is brought down by leverage as it amplifies your trade size and profit potential. While availing leverage, you need to use a margin calculator that provides you with accurate data about the margin that you need to maintain to keep a trade open.
Now, coming back to the reasons for pursuing forex trading, just the market being liquid does not make it the best one for trading as we also need enough volatility to find profitable trading opportunities. Forex market perfectly fits this criterion as well with the currency pair prices that keep moving throughout the day and even during the weekend when the market is closed. The weekend gap also gives us some trading opportunities when the market re-opens and this level of volatility surely increases the profit potential.
Now, the volatility is not going to be the same for every currency pair and it even changes based on the market situation. There are times when the market is very volatile which causes a lot of price movements and sometimes you will see very little volatility with only sideways movements. We can also refer to it as choppiness or the market being stuck in a tight range without any clear trend. In any case, the number of pips by which the currency pair moves is crucial for estimating the volatility and you can use a pip calculator to make the pip value calculation easier.
Economic data is very impactful
The volatility that we talked about earlier happens because of many reasons and one of them is the influence of economic data and global economic events on the currency market. Whether it is CPI data (Consumer Price Index) giving valuable insights about the inflation in an economy or GDP showing the overall strength or weakness of an economy, all of these will have an influence on the value of currencies that are being traded in the forex market. The exchange rate fluctuations are often caused by economic factors and thus you need to consider them.
Hence, you should be aware of the impact of economic data before diving into forex trading. The geo-political events and political events that take place in different countries can also cause volatility in the global currency market. Those who are more well-versed in the market will be able to make accurate predictions about the potential price movements based on how the market will respond to an economic event or the numbers in an economic data release. Those who follow strategies like news trading will be keeping a close eye on any economic event or data release.
Another thing that we need to pay attention to while making trading decisions is the monetary policy of Central Banks and meetings that announce interest rate policy revisions. The interest rate of a currency being high or low can make a significant impact on the currency prices as it reveals the level of inflation that is there in the economy. The decisions of top authorities like the Federal Reserve or ECB are always based on the current economic situation and this gives us an idea about what kind of fluctuations will happen for a currency pair.
One tool that can help you to understand the impact of economic data or events on the forex market is an economic calendar which includes the date and time of key economic data releases along with a forecast on how they may impact a currency pair. You just need to know about the economic events or data releases that can cause volatility in the prices of the currency pairs that you are trading with and that way you can make informed trading decisions.
Fundamentals drive the market
We talked about how impactful the economic data is when it comes to currency price fluctuations and it will be right to say that the forex market is driven by fundamentals. The majority of traders depend on technical analysis for finding trade setups as they interpret the market situation by looking at the patterns formed on a price chart. However, an in-depth analysis of the market scenario is not possible unless you consider fundamental factors like economic indicators. All the economic factors that we talked about earlier are crucial for fundamental analysis.
Technical analysis is more suitable for identifying short-term trends that only last for a short span of time. Technical analysis is perfect when we are trying to decide the entry and exit points for trade based on key support and resistance levels. But if you are planning to trade longer timeframes by following strategies like position trading, you need to focus on the fundamentals as you can’t anticipate the long-term trends with technical analysis alone. Because technical analysis is more about real-time price movements and does not consider the factors causing the fluctuation.
Technical analysis may look easier for a beginner as there are a lot of indicators that you can rely on but having some surface-level knowledge about the fundamentals is important to navigate the volatile market. Even the strategy that you devise for executing trades needs to consider both technicals and fundamentals due to the dynamic nature of the forex market. The market situation can change anytime and you need to remain flexible and adapt to the changes by modifying the strategy. Otherwise, your strategy can stop working due to a fundamental change.
But you don’t need to get too involved with the fundamentals if you are trading shorter timeframes as it will be hard to analyse the impact of fundamentals in such a short duration. The sudden volatility that we see in the charts with shorter timeframes can either be due to a news event or it can also be caused by market sentiments. Market sentiments can be referred to as the psychology of the market as a whole based on the direction in which the market is about to move according to the traders. However, it is better to consider all the possibilities before opening a position.
Final Thoughts
So, these are the top three things that you need to know and learn about to mark a successful beginning to your trading journey. You will have to study these aspects on a deeper level to apply the trading concepts and theories to the actual trading process. Thankfully, there are many reliable sources of information which you can rely on to know more about the market and find the best strategy that will suit your needs and requirements while also being well-aligned with your trading goals and risk tolerance.