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Foreign Exchange, also popularly known as Forex or FX, is the act of buying and selling currencies. Forex trading is done in currency pairs. For example, if we want to buy US Dollar (USD), we need to base it against another currency. The base currency does not have to be our local Singapore Dollars. In fact, it is usually against another well-used currencies such as the Euro, Japanese Yen or others.
If we choose to pay using Euro (EUR), this means we are trading the EUR/USD and expecting the USD to appreciate against the EUR. If the EUR/USD is currently trading at 1.20, this means 1 EUR costs 1.20 USD. If it goes down to 1.15, the USD would have appreciated against the EUR and this means we make money on our trade. If it goes up to 1.25, this means that the USD has depreciated against the USD and we are making a loss on our trade.
Forex Trading Is A Zero-Sum Game
An important thing to note is that unlike investing in asset classes such as stocks, bonds or indices, forex trading is a zero-sum game. For one person to make a profit on his trade, there must be someone else on the other side of the trade who makes the corresponding loss. This is unlike other asset classes, where prices can appreciate over time.
That said, we should remember that most participants in the forex market are not looking to make a profit from the exchange. For example, many businesses and people deal with foreign exchange when we purchase overseas goods. We make these transactions with no intention of making a financial gain from the forex conversion.
Another area worth noting is that, in general, the forex market is usually quite stable in the long-term. For example, over the past 5 years, if we look at the USD/SGD, it has traded between a range of 1.30 to 1.40, so if you use your SGD to buy and hold a particular currency (e.g. USD) over the last 5 years, you won’t be making or losing much. In contrast, an individual stock can gain or lose significant value during this period.
However, in the short-term, there is always some volatility in currency pairs. This allows traders to make profits from the constant price movements in the forex market even if prices don’t change much in the long-term. To capture higher returns, most traders also deploy leverage. Leverage trading refers to the use of borrowed capital to increase a trader’s position. This can increase your potential returns and risk, so it’s vital that you manage your risk well.
Opening A Forex Trading Account
If you want to trade in the forex market, you need a trading account. While most trading platforms offer what appears to be somewhat similar (e.g. they would allow you to trade major currency pairs such as EUR/USD, GBP/USD, USD/JPY), there are certain factors that you should not ignore.
To protect retail traders in Singapore, the Monetary Authority of Singapore (MAS) has strict regulations in place. If you are keen to trade Forex in Singapore, it’s advisable that you trade through a broker such as IG that is licensed and regulated by MAS.
As explained by IG, brokers make their money through spreads. Like traditional moneychangers, they pay a slightly lower price for your foreign currency and sell it to you at a slightly higher price. This is known as the spread. However, unlike traditional moneychangers, the bid-ask spread offered by brokerage firms in the financial markets is extremely competitive. Ideally, you want to trade with a broker that is able to offer you a low spread. For example, we observed that the spread offered by IG is about 0.6 pips (100 pip = 1%, 1 pip is 0.01%).
Screenshot taken from IG on the EUR/USD
When you are trading forex, you don’t actually own the underlying currencies. For example, if you deposit $1,000 in your IG account today, you can take up a currency position of up to $20,000 – as long as the forex margin (5%) is maintained. If you have a trading position of $100,000 across all your Forex trades, you will need a minimum of $5,000 in capital.
However, this is money that you don’t own. Rather, what you own are the profits (or losses) from the trade positions that you take on. This is electronically recorded down by your Forex broker and attributed to your account. It’s also the reason why it’s vital that you work only with a reputable provider.
Which Trading Platforms Will You Be Using?
Before opening any brokerage account, you may also want to consider the trading platforms offered by the broker. This is important because choosing the trading platform that you want to use is similar to deciding whether you want to use iOS or Android for your phone. While they generally do the same thing for you – call your loved ones, access apps, text your friends – the experiences of using them can be quite different. And once you are familiar with one platform, you may not want to keep switching. Even if you are new to trading, ensure that the broker you open an account with has the trading platforms you wish to use.
The most common trading platform for Forex traders is MetaTrader4. The platform is suitable for traders of all skill levels and offers advanced technical analysis tool, trading signals, mobile and algorithmic trading and much more. MetaTrader4 is also available on mobile app for those who like to trade on-the-go.
Another popular trading platform is ProRealTime. This is a desktop-based platform that allows you to analyse everything from price to volatility with over 100 indicators so it’s particularly useful for traders who like to do in-depth technical analysis. IG is one of the provider in Singapore that offers ProRealTime.
You can find out more about the various trading platforms offered by IG here. Also, if you want to learn more about the different technical tools you can use, you can download the Bloomberg ebook – Getting technical: A guide to trend trading written by Bloomberg in partnership with IG.
Start With A Demo Forex Account First
If you are new to Forex trading, starting off with a demo account first makes sense. A demo account allows you to familiarise yourself with the trading platform you are using, whether it’s MetaTrader 4, ProRealTime or other platforms. More importantly, it allows you to try out the various forex trading strategies and see if they can give you the desired outcome you want before you put in actual money for your trades. The IG demo account allows you practise trading with $200,000 of virtual funds.
Best of all, even with a demo account, you can gain access to the IG Academy which provides you with online courses and live sessions to help you increase your knowledge. You can also join the IG Community to meet, share and discuss trading ideas with other like-minded traders.