It involves speculating on the rise and fall of the currency fluctuations. It has become really popular in Nigeria with an estimated daily trading volume of ₦300-450 million. You may be attracted to forex trading because it offers opportunities/potential to make good profits in less time (minutes & hours instead of months) with your investment.
But is trading in the forex market really profitable for small individual investors? How much income can you earn from trading forex part time or full time? What are the risks?
What is Forex Trading?
Forex trading is the buying & selling of currencies with an aim to make a profit. Traders can place their trades in the forex market, which is an over-the-counter market that allows investors to trade currencies. This is a platform for investors, institutions, banks, and traders.
Foreign Exchange Market is the largest trading markets and has an average turnover of US$5 trillion on a daily basis around the world. This is larger than all the stock markets in the world combined together. Trading activities are conducted through the “Interbank Market” which allows you to execute trades 24 hours in a day, for 5 days a week from Monday through Friday.
Real Life example of Forex Trading
Have you traveled overseas? If you have then the chances are that you have already traded currencies before. This is because you need to acquire the currency of the country you are visiting by exchange the currency of your home country.
Let’s say that you change ₦350,000 to US Dollars for travelling, and you get 1000 USD from the exchanger. In this example you are physically buying USD by exchanging your Nairas. When you change your Naira into a different currency to spend money on your trip, you are actually making a forex transaction.
The rate that you get from your exchanger is decided on the basis of the real time exchange rates plus the profit margin of the money changer. If the current market rate is NGN340 per USD, then you would probably get around ₦350 rate from your changer. The difference of ₦10 (350 – 340) for each USD is your changer’s profit margin.
In theory, this is what online forex trading on the internet is all about, but still a bit more than exchanging currencies through a Money Changer.
Advantages & Risks of Forex Trading
Forex Trading, like any other investment has many benefits but also carries significant risks.
On the positive side, forex trading has the potential to bring good income if you trade with a working strategy. And you don’t even need very high capital to start.
On the downside, one bad trade without proper money management can be disastrous, or trading with real money without practising on demo. These are just the few risks.
Let’s analyse the benefits & risks of trading Forex!
1- Start with Low Capital: You can start trading in the forex market with as low as NGN 1000, as brokers these days have very low minimum deposit & very high leverage. But it is highly recommended that you only start trading with a capital of atleast ₦50,000 & never risk more than 5% of your capital on a single trade.
2- Huge Trading Volume: Forex market is the largest market in the world with close to 5 Trillion USD daily trading volume. This makes it very liquid & you can easily place very large orders as well & close them without having to worry about price volatility because of your trade (unless there is some major event).
3- Buy/Sell: In forex, you can open take both short or long position to make a profit. If you feel that the particular currency is on the way up, you can buy it and go long. On the other hand, if you feel that a currency is not performing well, you can sell it and go short.
4- Open 24 hours: Another key benefit of forex trading is the ability to trade 24 hours, for five days in a week. These trading hours are much longer compared to traditional stock exchanges which allow you to place an order or close it during limited trading hours. In forex, you can place a trade & close it anytime during the week instead of waiting for the markets to open during the day. You might want to check out our guide on best time to trade forex in Nigeria as the opportunities to make profits are higher during certain market hours.
5- Currency choices: Another major benefit is that forex trading allows you to trade in a wide range of currencies from around the world. This includes the traditional major currencies such as EUR and USD as well as exotic ones such as CZK and MXN.
RISK TRADING FOREX
1- High Risk with Leverage: Forex brokers offer very high leverage, as high as 1:1000 in many cases. This means that you can place $1000 worth of trade in the market with just $1. Using very high leverage puts your trading capital at huge risk of depleting very fast with even a single bad trade. Ex: Let’s say that you deposit $100 in your trading account, and you use 1:1000 leverage to place a 1 standard lot buy trade on EUR/USD. In this example, you can lose your full capital if the price goes just 10 pips against you. We advise you to use proper risk management & never risk more that 5% of your trading account’s balance on a single trade.
2- Avoid Bad Brokers: There are so many forex brokers out there that lack transparency & are not even regulated. You should definitely avoid brokers that promote get rich quick schemes. Be wise enough to choose a broker that is regulated by Government bodies like FCA, CySec etc, has years of experience, must have good reviews & is transparent in their dealing of any issues.
3- Risk of Volatility: There are a wide range of factors which can influence the value of currencies (causing extreme volatile, especially for the non-conventional currency pairs), not limited to political or macro & micro economic factors. And unfortunately, you cannot control these factors. So it is really important to watch out for any news before placing or closing a trade & have strict stop loss limits in place to control any losses in case of bad event.
All transactions in the forex market are based on the purchase of one currency for the sale of another currency. So you are trading or exchanging the 2 currencies simultaneously for one another, hence known as ‘currency pairs’.
4- Emotional Stress: Let’s face it, forex trading can be extremely challenging emotionally. One bad trade can result in big losses & dealing with losses can prove to be very difficult. This can be emotionally stressful for you.
How you can manage these risks? Be cautious, have a fully tested trading strategy (on demo) and use good risk management to be successful at forex trading.
For example: EUR/USD (Euro & the US Dollar), NGN/USD (Nigerian Nairas & the US Dollar) etc.
There are 100s of currency pairs, including the so called Majors, minors & exotic. It is really important to understand what currency pairs, and how they work before you can start trading Forex.
Types of Currency Pairs
Currency pairs are mainly classified into 3 types:
1) Major Currency pairs: These are the currency pairs that include US Dollar as one of currency in the pair. Almost 85% of the global trading volume is traded in the majors.
Majors include 7 currency pairs: EUR/USD (Euro/US Dollar), GBP/USD (Pound/US Dollar), USD/JPY (US DOllar/Japanese Yen), AUD/USD (Australian Dollar/US Dollar), USD/CHF (US Dollar/Swiss Franc), NZD/USD (New Zealand Dollar/ US Dollar) and USD/CAD (US Dollar/Canadian Dollar).
Since most of the trading is done in majors, so they are highly liquid & it is easier to get in & out of trades. The opportunities to make profits are higher.
2) Minor Currency Pairs: Minors, also called the cross curreny pairs, contain all the currencies in the major pairs except for US dollar. These include EUR (Euro), GBP (Pound), JPY (Japanese Yen) etc.
Examples: EUR/GBP, EUR/JPY, GBP/JPY etc. As you may have noticed that these are the crosses of all the major currencies excluding US Dollar.
The liquidity & volume are lower than majors, so trading opportunities may be lower than with majors.
3) Exotic Currency Pairs: Exotic Currency Pairs are made from one of the currency from major pairs and other one from the emerging economies like: Brazil, South Africa, Mexico, Russia etc. Examples of such pairs include: USD/BRL (United States Dollar/Brazilian Real), USD/HKD (United States Dollar/Hong Kong Dollar), USD/ZAR (US Dollar/South African Rand), USD/RUB (US Dollar/Russian Ruble) etc.
Exotic Pairs usually don’t have high liquidity & trading volume but they have high volatility plus they have high spreads as compared to Major & Minor Pairs.
As a beginner Forex Trader, you need to stick to major pairs only as it offers high liquidity and predictable market movements.
1) Quote by the broker: When you open a trading account with a Forex Broker, they tell you the Bid/Ask price to buy & sell the currency. It will be quoted like this example: EUR/USD 1.2812/15. This price is the quote by the broker.
2) Pip: Pip is the smallest unit in the currency quote (given by the Broker). It is the last decimal in the price. For Example: In the quote 1.2811 moves to 1.2812, the movement in the last decimal is 1 pip.
3) Bid Price: Bid price is the price at which the broker is willing to buy a currency pair from you. At this price, you can sell base currency in the pair. This price is shown on the left side in the quote ticker by the Broker.
For Example: If you see the quote as EUR/USD 1.2812/15, then 1.2812 is the quote price, and it means that you can sell 1 Euro for 1.2812 US Dollars.
4) Ask Price: Ask price is the price, at which the broker is willing to sell a currency pair to you. At this price, you can buy the base currency mentioned in the pair. It is shown on the right side of the quote ticker by the Broker.
For Example: When you see the same quote as above it had 2 values in it: EUR/USD 1.2812/15, the second value tells you about the Ask price, it means you can buy 1 EUR for 1.2815 Dollars.
5) Spread: Spread is the difference between the Bid & Ask Price quoted to you by the broker. So in above example: in which quote is EUR/USD 1.2812/15, the difference between 1.2815 minus 1.2812 i.e. 0.0003 or 3 pips, is the spread.