banknotes in EUR

04 Feb 2021

What is forex and how does it work? Ken FX Freak explains

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Ken FX Freak is a financial analyst and professional forex trader. The views expressed in his Skrill News column are not intended as financial advice.

Let's jump straight into an example or scenario that most of us have faced.

You've packed up your bags and you're ready to go on holiday. In this example, you are based in the UK and travelling to the United States of America. 

You're ready to exchange your pounds (GBP) for dollars ready to spend in the United States. This is called a foreign currency transaction and will involve you visiting an exchange bureau to find out how many dollars you can get for your pounds.

USD banknote

In this scenario, the bureau offers you a rate of 1.2500. For every £1, you get $1.25 back. 

So when you exchange £1,000, the exchange bureau will give you $1,250 in return.

The next week, let’s say you arrive back from holiday and, miraculously, you were treated by whoever you went with to the United States, and you didn't spend a penny. You’ve still got the full amount of money – $1,250.

When you left, the rate was 1.2500. Upon your return, the rate has dropped down to 1.2000, so effectively the pound has weakened versus the dollar. The exchange rate has come down to 1.2000, so the pound is weaker versus the Dollar. 

You then exchange these dollars that you've got – the $1,250. You then exchange the money for pounds because you've returned back to the UK.

With a new rate of 1.2000, the $1,250 (when you convert that back to pounds) gives you a rate – or a pound value – of £1,041.66. To get this we simply do $1,250 divided by 1.2000 and that gives us this figure here: £1,041.66.

On your initial currency that you had exchanged from pounds to dollars – you've now profited. You’ve gained profit on your capital of £41.66. The reason why is you were holding an asset which appreciated in value, in this case the USD.

Ok, so that is effectively an example of what forex is. And, in terms of this rate (1.2500), this is what you will be speculating on when you're trading foreign currencies. So, you're speculating either that the GBP/USD rate is going up or is coming down.

How to get started

How can you get started? Well, like with any craft that you want to become good at, you need to learn. 

Check out free forex learning resources

Start off by doing a quick Google search for ‘free forex education’. 

There are a ton of free resources out there. Check out YouTube; there are a lot of great content creators who can help you become familiar with exactly what forex is and the way in which the prices move. So, education, firstly, is key. 

Set aside a sum of cash (that you can afford to lose)

Then, of course, in the Forex market we need cash. We need capital with which to trade.

So it's important that you're able to set aside a sum of cash, whatever you can afford to lose. I always say “what you can afford to lose” because there is a high failure rate in forex. It’s a tough craft to master but it can of course be mastered. Myself, and other people within my network have done so, but always be aware that you may incur losses on the way.

Set aside some money that you can afford to lose. In time, once you continue to nurture your craft and build your skills, you’ll be able to deposit more, or even compound on the gains you’ve made. 

Set up an account with a broker

You need to set up an account with a broker. 

A broker is a company that you're going to conduct your trades with – your buying, your selling of your GBP, dollars, euros, etc. Whatever currencies that you're looking to trade, you’ll need to find a broker. 

As well as a broker, you will need to choose a trading system. The most common trading system is MT4 (MetaTrader 4) and this is where you'll be doing all of your trades. 

So you’ll have a broker, who’ll be doing the execution for you, and MetaTrader 4 is where you'll actually be conducting your trade. 

To familiarise yourself with MT4 and how it works with the buying and selling of assets, watch their demo videos.

two banknotes on scales

What it takes to become a forex trader

Aside from all that I’ve mentioned, there is something that a lot of people overlook: psychology. In trading, you can learn all the theory but where you’re really going to become a master of forex trading is if you can conquer mindset.

When trading, you experience strong emotions because you're risking your capital. It’s down to you to deal with the wins without becoming overconfident and allowing your ego to run.

Meanwhile, you must also deal with losses without feeling beaten up and like you need to chase those losses. It's about keeping emotions balanced. 

No one is saying you won't be emotional, but you will need to detach yourself and make decisions based on logic – not emotion. In my opinion, psychology accounts for 80% of traders’ success. 

Many underestimate the power of mindset – don’t be one of them.

I hope that gives you a good understanding of the forex market. Go and do plenty of reading; there are a lot of resources out there.

Author: Ken FX Freak Forex influencer Ken FX
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