This post comes from a Personal Profitability partner.
Forex trading, also known as foreign currency trading, can be a lucrative hobby for those interested in putting in the time and effort.
Today, you do not need deep pockets to get started. There are online forex brokers and platforms that cater to small-scale traders, and you can open a real-money trading account with them even if your bankroll is small. You have quite a lot of brokers to choose from if you can make a $200 first deposit, and some brokers accept even less than this – such as $100 or even a mere $10.
Doing it small-scale to begin with and gradually building up a bankroll makes it easy to follow the #1 rule: do not risk money you can not afford to lose. Putting money on the line through forex trading always entails risk, and there are no “safe bets”.
Therefore, proper risk management is essential for long-term profitability. If you have a small bankroll, choose a forex broker that permits small trades. For example, if you only have $100 in your account, you should go with a broker that allows you to make tiny trades – otherwise, you have to risk far too much of your total capital on each trade, which makes proper risk management impossible.
What is forex trading?
Forex trading is the same as foreign currency trading. The global forex market is huge and decentralized, and the bulk of the trading is carried out by enormous entities such as central banks, investment banks, and hedge funds. All in all, currency worth around 6.6 trillion USD will be traded on the global forex market during an average trading day.
The trading on the forex market is based on currency pairs. The most traded currency pair is EUR/USD, which accounts for roughly one-quarter of the total trading. This currency pair is traded so heavily because it represents two of the world's largest economies: the European single market and the United States of America. These two currencies are also widely used outside Europe and the United States.
Examples of other well-known and heavily traded currency pairs include:
- The United States dollar and the Japanese yen: USD/JPY.
- The British pound sterling and the United States dollar: GBP/USD.
- The United States dollar and the Swiss franc: USD/CHF.
- The Australian dollar and the United States dollar: AUD/USD.
- The United States dollar and the Canadian dollar: USD/CAD.
- The New Zealand dollar and the United States dollar: NZD/USD.
Base currency and quote currency
In a currency pair, the first currency is the base currency, and the second is the quote currency.
Example: In the currency pair EUR/USD, Euro is the base currency, and the US dollar is the quote currency. In the currency pair USD/JPY, the US dollar is the base currency, with the Japanese yen as the quote currency.
0.9844 USD/EUR means that you have to pay 0.9844 Euro to get 1 USD.
A wide range of financial instruments are based on forex. Here are a few examples:
- Basis swap
- Currency future
- Currency swap
- Foreign exchange binary option
- Foreign exchange forward
- Foreign exchange option
- Foreign exchange swap
- Forward exchange rate
- Non-deliverable forward
- Power reverse dual-currency note (PRDC)
Comparing forex brokers
Below, we will look at a few points that are good to keep in mind when comparing forex brokers. It is good to keep in mind that you do not need to find a broker that fits all your needs. If you employ two different trading strategies or trade with two other currency pairs, do not hesitate to sign up with two different forex brokers instead of compromising. The forex broker that is ideal for your first strategy might be unsuitable for your other strategy, and so on.
Asset, strategy, and associated trading costs
- Does this broker offer the currency pair I want to focus on?
- Does this broker offer the type of instrument I wish to use for my forex trading (e.g. Contracts for Difference)?
- Is this broker suitable for my strategy (e.g. scalping)?
- What would it cost to employ my trading strategy with this broker for this currency pair?
It is important to look at all the costs. For example, a broker luring you in with promises of zero spreads might charge a higher-than-average commission and vice versa. Also, be vigilant about small fees that may add up in the long run, such as deposit and withdrawal fees, platform fees, etcetera.
The trading platform
Use a free demo account with play-money to test out the trading platform risk-free. It is important that you like the platform and that it is easy to use.
A platform that is difficult to navigate or where it is easy to accidentally put in the wrong order will be especially detrimental for fast-paced day traders who employ a trading strategy where every second counts. Fortunately, many brokers will allow you to open a free demo account. It will be filled with play money so that you can make play-money trades on the platform. It is a great way to learn and experiment without risking any real money.
If your plan is to do most of your trading on your phone or tablet, make sure you test-run the trading platform on that device. Some trading platforms have a nice interface for desktop traders but sub-par trading apps for mobile devices.
Do you carry out technical analysis? Is it important that the platform provides historical trading data and a lot of tools for technical analysis?
If you do not wish to make a big first deposit, make sure you select a forex broker who does not require this. Some forex brokers cater to micro-traders and accept very small first deposits, e.g. $10.
Does this broker accept a method for deposits and withdrawals that you are comfortable with? Are there any deposit and/or withdrawal fees for this method?
Do you get to make at least one withdrawal per month without paying the fee? What are the minimums for deposits and withdrawals?
Most hobby traders are on a small budget when they start out, and it is important that you select a broker that will allow you to make trades small enough for proper risk management. Even if you have $1,000 in your account, it is not wise to stay with a broker where each trade must be $1,000 or nearly that. Do not put all your eggs in one basket. Select a broker where you can properly manage risk and only put a fraction of your total bankroll into each trade.
- Not all brokers offer phone support nowadays, so if this is important to you, make sure you select a broker who does. Also, check if you will be required to make a potentially expensive phone call to another country to reach the support by phone.
- If you want to be able to get help in real-time, make sure the broker offers phone support or live chat – not just email support.
- Check if support is available in a language you are okay with using.
- Check if the support is staffed when you are most likely to trade. It is nice to be able to sort out issues directly, even if they occur outside normal office hours.
- Is the broker licensed by a reputable license authority? Examples of license authorities that have a good reputation among the traders are CySec, BaFin, UK FCA, FINMA, and ASIC.
- Is the broker licensed by a licensing authority in your part of the world? If you live in Country A and pick a broker company that is based in Country B and licensed from Country C, you are putting yourself in a complex legal situation.
Please note: Many large broker corporations have set up subsidiaries within the European Union and are licensed from one or more member countries. The subsidiary must adhere to the EU regulation, including MiFID II, so the legal framework is pretty straightforward even when a subsidiary does not have a license from the member country you live in.
Does this broker have a good reputation among the traders online?
All restaurants – even the truly great ones – have at least a few angry customers posting scathing reviews online, and the same is true for forex brokers. You would be hard-pressed to find a broker with 100% happy clients giving nothing but 5-star reviews. (That might actually be a bit of a red flag in itself.) With that said, try to get a feel for the general reputation of a broker. Does this broker seem to, in general, have a good reputation? When clients complain, what are they complaining about, and do the complaints seem to be well-founded? Are the same issues popping up over and over again?