What is forex trading?
Forex trading is the largest and most liquid financial market in the world involving the changing of one currency into another, often with the anticipation of making a profit in doing so.
The foreign exchange market, also known as the FX market or forex market, is the global market for the exchange of one currency to another. This can be conducted for commerce, trading, or tourism reasons and forex is usually traded as exchange rate pairs. An example of an exchange rate pair or currency pair would be GBP/USD which is the pair for trading the Great British Pound against the U.S dollar.
In contrast to a stock market, with forex trading, there is no central marketplace. Currency trading is conducted electronically over the counter (OTC) via computer networks among traders from across the globe. This means the market is open 24 hours a day for five and a half days a week with price changes constantly moving. This allows for speculative opportunities for trading one currency against another for professional traders and retail investors.
How to trade forex
There are two ways to trade currencies. The first is to earn the interest rate differential between two currencies. This works by buying the currency with the higher interest rate, and shorting the currency with the lower interest rate.
The other way to trade currencies is to profit from changes in the exchange rate.
These fluctuations in the price of a currency will depend on the supply and demand from banks participating in the spot market. These large trade flows prevent rogue traders from having any influence on the price of any given currency, which in turn helps to provide some transparency for investors.
What influences price changes in the FX market?
The value of any particular currency is based on supply and demand, however, there are some currencies such as the Chinese renminbi which have a fixed exchange rate. Currencies without a fixed exchange rate are known as floating currencies, and this is the case for most advanced economies, including the UK pound.
Floating currencies are constantly moving up and down in value against other currencies. These are usually small changes in movement, as small as a fraction of a cent higher or lower at the end of a trading day. However, this can change dramatically at the hands of extreme economic or political news. In this instance, there can ensue wild swings in price, such as a fall in value of 10% the day after the UK voted to leave the European Union. This encouraged traders to sell the pound quickly, decreasing its demand, and thus its value.
Another example of a market influencer are economic developments such as data that reveals the economy is growing faster than predicted, which in turn could lead to the Bank of England increasing interest rates. Higher interest rates lead to a greater return on your money and therefore increases demand, boosting its value. This is how financial markets ebb and flow in line with economic, financial and political news.
The best forex trading platforms will often include live news feeds in their suite of tools to enhance retail traders capacity for profit. This is also the reason why mobile trading is so important, so traders can react instantly to changes that may affect the price of currencies.
Why is FX trading so popular?
Forex trading is arguably one of the most popular forms of investment with a daily average trading volume of about $5 trillion.
The main reason for this demand among investors is that forex is one of the largest financial markets in the world with the potential for quick, large returns on your investment. This is largely due to the high volume of currencies being traded which in turn creates liquidity. However, there is a downside to this amount of liquidity, and potential investors should always be aware that with the potential for high gains, comes the potential for high losses and most platforms will report that more retail investment accounts lose money when trading CFDs and forex than gain money.
However, this all comes down to strategy, and the right amount of knowledge can result in significant profit. This alongside the fact that the forex market is available for trading 24 hours a day for five and a half days of the week means individual investors can react quickly to market influencers such as political and economic factors.
These rapid movements set the bar for potential immediate gains, unlike the stocks and shares market whereby time in the market is more of an influence to your success than timing the market.
In addition to this, the forex market benefits from leveraged trading, whereby investors can open a position on a larger portion of the forex market, without risking the full investment amount usually required.
This increased exposure can lead to increased gains, without having to risk the same amount of money that would usually be needed for such a trade. However, it is important to fully understand how leverage trading works and how you can benefit from it, as this increase in profits can just as easily lead to an increase in losses.
Is FX trading legal in the UK?
Yes, FX trading is legal in the UK, although each platform will have its own level of regulation and this is always worth checking. On the whole, forex brokers in the UK are regulated by the Financial Conduct Authority (FCA) who are responsible for ensuring that all UK forex brokers are licenced and are providing a trading environment that is in the best interests of the traders that use it. Regulation by the Financial Conduct Authority also provides protection of your funds under the Financial Services Compensation Scheme (FSCS) which aims to compensate traders for the loss of their trading funds in the event the broker runs into insolvency issues.
In addition to this, the FCA requires that a multi-asset trading platform keep its operating capital separate to that of its traders to ensure this is protected should the platform experience financial difficulty.
However, it may be the case that some forex brokers are regulated by a similar body outside of the UK. These regulators will be responsible for the same level of regulation as the FCA and can include:
- Securities and Exchange Commission (SEC) and the National Futures Association (NFA) in the USA
- Australian Securities and Markets Authority (ASIC) in Australia
- European Securities and Markets Authority (ESMA) in the European Union
- Autorité des Marchés Financiers (AMF) in France
- Comisión Nacional de Mercado de Valores (CNMV) in Spain
- The Financial Services Agency (FSA) in Japan
- The Securities and Futures Commission (SFC) in Hong Kong
This level of regulation should be considered a minimum when selecting a forex trading platform in order to ensure correct levels of protection for you and your funds. This can be confirmed on the FCA’s own website where they supply a register of all forex brokers in the UK who adhere to these standards.
Despite these regulations, it is crucial to understand that trading CFDs, FX and cryptocurrencies comes with a high degree of risk, and providers are required to publish the percentage of retail investor accounts that lose money when trading CFDs on their platform.
How to choose the best trading platforms for forex
Trading forex has become accessible for all levels of experience, due in large to the plethora of forex brokers and mobile apps available. This is good news for retail investors who can take advantage of platforms in an increasingly competitive forex trading industry.
However, when considering any platform for forex and CFD trading, there are some key elements that you should take into consideration.
Regulation
As mentioned previously, the gold standard for regulation within the United Kingdom is the Financial Conduct Authority. It is always advisable to check that any of the forex trading platforms you are considering have this level of regulation. The best way to check this is via the FCA website where there is a published list of FCA regulated brokers.
Trading Costs
Platform costs and trading costs can start to erode away at your gains and it is therefore important that the UK forex broker you are considering is competitive in this respect. You will need to be aware of commissions and spreads.
Commissions are usually calculated as a percentage of the spread. The spread is the difference between the bid and ask price of a forex pair. If the broker does not charge a commission then it is worth checking the spread as this is often where they will make their money.
Spreads are often depicted as a pip. A pip is the minimum unit of price change in forex. Look for a forex broker that has tight spreads.
Currency pairs offered
There are a vast number of currency pairs available, but not all UK forex brokers will offer all the pairs. The most common pairs trade with the greatest liquidity and include EUR/USD, GBP/USD, USD/JPY and USD/CHF.
Trading platform
Check the reviews on platforms such as Trustpilot to ensure the FX broker you are considering is reliable and trades can be executed with ease. Usability and layout are all important elements, as are the tools such as automated trading options, strategy builders, and alerts.
A demo account offers an opportunity to get to the grips with the platform before risking any of your own funds. Demo trading accounts will usually offer a sum of virtual money with which to trade.
Minimum deposit
Some forex accounts will support a low minimum deposit, however other platforms will require a large minimum deposit. Due to leverage, the buying power is far greater than the minimum deposit, and therefore you should ensure you are aware of the minimum deposit and whether that is suitable for your trading requirements. This is especially true for beginner traders who may not wish to commit to a large investment amount.
Deposit and withdrawal times
It is wise to check the deposit and withdrawal policy on any given platform as times and costs can vary significantly. Funding can often be done online using a credit card, ACH payment, PayPal, wire transfer, or bank cheque. Withdrawals are often done using cheque or bank transfer. Check the average withdrawal times as well as customer reviews to ensure the platform is operating within their published times.
Customer service
FX trading takes place 24 hours a day for five and a half days a week. Therefore, many brokers will offer 24 hour customer service so you can access help when you need it. However, this is not always the case and is therefore worth checking. Also check the method of contact the forex brokers are offering. These should include phone, email, and live chat.
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