How to Make Money Trading Forex

How to Become a Successful Forex Trader

Gordon Scott has been an active investor and technical analyst or 20+ years. He is a Chartered Market Technician (CMT).

Starting in the forex market often results in a life cycle that involves diving in head first, giving up, or taking a step back to do more research and open a demo account to practice. From there, new traders may feel more confident to open another live account, experience more success, break even, or turn a profit. That is why it’s important to build a framework for trading in the forex markets, which we outline below.

Key Takeaways

  • New forex traders should often start by opening a demo account to get used to trading and using the tools involved in trading.
  • Forex traders may be interested in short-, medium-, or long-term investing, depending on their interests, skills, time commitments, and risk tolerances.
  • When considering a forex trading plan, master the platform from which you will execute your trades, setting the most useful indicators and other tools to your greatest advantage.
  • Even with a perfect forex trading strategy, no system is foolproof so expect volatility in the market.

The Basic Forex Trading Framework

Forex trading is basically about catching the changing values of currency pairs. So if you think the value of the pound will increase against the U.S. dollar, you can buy them with dollars and make a profit by selling the pound when it rises. Forex trading is commonly used by speculative traders and as a hedging strategy.

The framework covered in this article focuses on one central concept: trading with the odds. To do this, we look at a variety of techniques in multiple timeframes to determine whether a given trade is worth taking. Keep in mind that this is not intended to represent a mechanical/automated trading system. Rather, it’s meant to be a discretionary system.

You may choose to act on signals you observe or dismiss them. The key is finding situations where all (or most) of the technical signals point in the same direction. These high-probability trading situations will, in turn, generally be profitable.

Focus on Medium-Term Forex Trading

Why do we foxus on medium-term forex trading rather than long- or short-term strategies? To answer that question, let’s take a look at the following comparison table:

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Finding Forex Trading Entry and Exit Points

The key to finding entry points is to look for times all of the indicators points in the same direction. The signals of each timeframe should support the timing and direction of the trade. There are a few particular bullish and bearish entry points:

Bullish

  • Bullish candlestick engulfing or other formations
  • Trendline/channelbreakouts upwards
  • Positive divergences in RSI, stochastics, and MACD
  • Moving average crossovers (shorter crossing over longer)
  • Strong, close support and weak, distant resistance

Bearish

  • Bearish candlestick engulfing or other formations
  • Trendline/channel breakouts downwards
  • Negative divergences in RSI, stochastics, and MACD
  • Moving average crossovers (shorter crossing under longer)
  • Strong, close resistance and weak, distant support

Placing the Trade

It is also a good idea to place exit points (both stop losses and take profits) before even placing the trade. These points should be placed at key levels and modified only if there is a change in the premise for your trade (oftentimes as a result of fundamentals coming into play). You can place these exit points at key levels, including:

  • Just before areas of strong support or resistance
  • At key Fibonacci levels (retracements, fans, or arcs)
  • Just inside of key trendlines or channels
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Money Management and Risk in Forex Markets

Money management is key to success in any marketplace, but particularly in the volatile forex market. Many times fundamental factors can send currency rates swinging in one direction – only to have the rates whipsaw into another direction in mere minutes. So, it is important to limit your downside by always utilizing stop-loss points and trading only when your indicators point to good opportunities.

Here are a few specific ways in which you can limit risk:

  • Increase the number of indicators that you are using. This will result in a harsher filter through which your trades are screened. Note that this will result in fewer opportunities.
  • Place stop-loss points at the closest resistance levels. Note that this may result in forfeited gains.
  • Use trailing-stop losses to lock in profits and limit losses when your trade turns favorable. This may also result in forfeited gains.

Examples of Forex Trading

Let’s take a look at a couple of examples of individual charts using a combination of indicators to locate specific entry and exit points. Again, make sure any trades that you intend to place are supported in all three timeframes.

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In Figure 2, above, we can see that a multitude of indicators are pointing in the same direction. There is a bearish head-and-shoulders pattern, a MACD, Fibonacci resistance and bearish EMA crossover (five- and 10-day). We also see that Fibonacci support provides a nice exit point. This trade is good for 50 pips and takes place over less than two days.

Image

In Figure 3, above, we can see many indicators that point to a long position. We have a bullish engulfing, Fibonacci support, and a 100-day SMA support. Again, we see a Fibonacci resistance level that provides an excellent exit point. This trade is good for almost 200 pips in only a few weeks. Note that we could break this trade into smaller trades on the hourly chart.

How Volatile Is the Forex Market?

Volatility in the forex market refers to changes in the value of currencies. The forex market tends to be very liquid, which means it is very active. As such, the market is characterized by multiple traders who actively trade large volumes each day. Higher liquidity tends to make the market less volatile. That’s because more active traders in the market lead to smaller increases and decreases in price and volume. The market is also susceptible to different types of risk, which can increase volatility. They include geopolitical risk, exchange rate risk, and interest rate risk.

What Are the Risks Associated With Forex Trading?

The forex market involves trading currencies based on speculation and hedging. If a trader thinks the value of Currency 1 will rise against Currency 2, they will use Currency 2 to buy Currency 1. When the first currency’s value increases, they can sell it to make a profit.

This sounds simple enough, but there are risks involved. One of the main risks in forex trading is the change in exchange rates, which is constantly changing. Other risks include interest rate risk, geopolitical risk, and transaction risk.

How Much Experience Should I Have Before Trading Forex?

Foreign exchange trading can be fairly complicated, so it may not necessarily be a good place for beginners to start. Trading in the forex market involves a lot of speculation, which can lead to substantial losses if things don’t go your way. Exchange rates can also impact the potential for profits because of how quickly they change.

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If you want to get your feet wet and try your hand at forex trading without risking capital, consider trying a forex trading simulator. You can practice forex trading and gain valuable experience without losing money.

The Bottom Line

Anyone can make money in the forex market, but it requires patience and following a well-defined strategy. Therefore, it’s important to first approach forex trading through a careful, medium-term strategy so that you can avoid larger players and becoming a casualty of this market.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read our warranty and liability disclaimer for more info.

How to Make Money Trading Forex

The forex (also known as FX or foreign exchange) market refers to the global marketplace where banks, institutions, and individuals speculate on the exchange rate between fiat currencies.

The forex market is the largest financial market in the world.

How does forex trading work?

As a forex trader, you are speculating on whether one currency will rise or fall in price against another currency.

So “forex trading” can be defined as the process of speculating on currency prices to try and make a profit.

The value of a currency is influenced by economic, political, geopolitical events, and trade and financial flows.

Placing a trade in the foreign exchange market is simple.

The mechanics of a trade are very similar to those found in other financial markets (like the stock market), so if you have any experience in trading, you should be able to pick it up pretty quickly.

How To Make Money Trading Forex

And if you don’t, you’ll still be able to pick it up….as long as you finish School of Pipsology, our forex trading course!

The objective of forex trading is to exchange one currency for another in the expectation that the price will change.

More specifically, the currency you bought will increase in value compared to the one you sold.

Here’s an example:

Trader’s Action EUR USD
You purchase 10,000 euros at the EUR/USD exchange rate of 1.1800 +10,000 -11,800*
Two weeks later, you exchange your 10,000 euros back into U.S. dollars at the exchange rate of 1.2500 -10,000 +12,500**
You earn a profit of $700 0 +700

*EUR 10,000 x 1.18 = US $11,800
** EUR 10,000 x 1.25 = US $12,500

An exchange rate is simply the ratio of one currency valued against another currency.

For example, the USD/CHF exchange rate indicates how many U.S. dollars can purchase one Swiss franc, or how many Swiss francs you need to buy one U.S. dollar.

How to Read a Forex Quote

Currencies are always quoted in pairs, such as GBP/USD or USD/JPY.

The reason they are quoted in pairs is that, in every foreign exchange transaction, you are simultaneously buying one currency and selling another.

How do you know which currency you are buying and which you are selling?

Excellent question! This is where the concepts of base and quote currencies come in…

Base and Quote Currency

Whenever you have an open position in forex trading, you are exchanging one currency for another.

Currencies are quoted in relation to other currencies.

Here is an example of a foreign exchange rate for the British pound versus the U.S. dollar:

GBP/USD forex quote

The first listed currency to the left of the slash (“/”) is known as the base currency (in this example, the British pound).

The base currency is the reference element for the exchange rate of the currency pair. It always has a value of one.

The second listed currency on the right is called the counter or quote currency (in this example, the U.S. dollar).

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When buying, the exchange rate tells you how much you have to pay in units of the quote currency to buy ONE unit of the base currency.

In the example above, you have to pay 1.21228 U.S. dollars to buy 1 British pound.

When selling, the exchange rate tells you how many units of the quote currency you get for selling ONE unit of the base currency.

In the example above, you will receive 1.21228 U.S. dollars when you sell 1 British pound.

The exchange rate or “price” represents how much of the quote currency is needed for you to get one unit of the base currency

If you buy EUR/USD this simply means that you are buying the base currency and simultaneously selling the quote currency.

In caveman talk, “buy EUR, sell USD.”

  • You would buy the pair if you believe the base currency will appreciate (gain value) relative to the quote currency.
  • You would sell the pair if you think the base currency will depreciate (lose value) relative to the quote currency.

With so many currency pairs to trade, how do forex brokers know which currency to list as the base currency and the quote currency?

Fortunately, the way that currency pairs are quoted in the forex market is standardized.

You may have noticed that currencies quoted as a currency pair are usually separated with a slash (“/”) character.

Just know that this is a matter of preference and the slash may be omitted or replaced by a period, a dash, or nothing at all.

For example, some traders may type “EUR/USD” as “EUR-USD” or just “EURUSD”. They all mean the same thang.

“Long” and “Short”

How Trading Forex Works

First, you should determine whether you want to buy or sell.

If you want to buy (which actually means buy the base currency and sell the quote currency), you want the base currency to rise in value and then you would sell it back at a higher price.

In trader talk, this is called “going long” or taking a “long position.” Just remember: long = buy.

If you want to sell (which actually means sell the base currency and buy the quote currency), you want the base currency to fall in value and then you would buy it back at a lower price.

This is called “going short” or taking a “short position”.

Just remember: short = sell.

How to make money trading forex by going long and short at the same time.

Flat or Square

If you have no open position, then you are said to be “flat” or “square”.

Closing a position is also called “squaring up“.

Forex Square Trade

The Bid, Ask and Spread

All forex quotes are quoted with two prices: the bid and ask.

In general, the bid is lower than the ask price.

EUR/USD forex quote

What is “Bid”?

The bid is the price at which your broker is willing to buy the base currency in exchange for the quote currency.

This means the bid is the best available price at which you (the trader) can sell to the market.

If you want to sell something, the broker will buy it from you at the bid price.

What is “Ask”?

The ask is the price at which your broker will sell the base currency in exchange for the quote currency.

This means the ask price is the best available price at which you can buy from the market.

Another word for ask is the offer price.

If you want to buy something, the broker will sell (or offer) it to you at the ask price.

What is “Spread”?

The difference between the bid and the ask price is known as the SPREAD.

On the EUR/USD quote above, the bid price is 1.34568 and the ask price is 1.34588. Look at how this broker makes it so easy for you to trade away your money.

  • If you want to sell EUR, you click “Sell” and you will sell euros at 1.34568.
  • If you want to buy EUR, you click “Buy” and you will buy euros at 1.34588.

Here’s an illustration that puts together everything we’ve covered in this lesson:

Now let’s take a look at some examples.

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