"Trading forex can be lucrative for reasons which we covered in one of the previous sections. But now comes the question of how traders make money in the forex markets. We have already discussed some basic concepts about what is traded in forex. In this article, we build upon the concepts even further we explain in a step by step process of how traders make money and also manage their risks in the forex markets. Consider this article as the first basic step in your move to making your first trade. By the end of this article, you would be able to analyze how to read the forex charts and also be able to identify potential money-making opportunities. But do not get ahead of yourself. There is still a lot more to learn about before you can start trading on your own. The whole purpose of this article is to illustrate how money is made trading forex."
When you are asked the question about how to make money in a financial market, the first thing that comes to mind is to buy low and sell high. Thankfully, the forex markets are no different from this.
To make money in forex, you are essentially going to be buying when the price of a currency pair is low and then sell it for a profit when the price rises. It might sound simple and could potentially tempt you into trading right away. After all, what could be simpler than this? Right?
But hold on!
There is a bit more that goes behind this than just buying and selling. How do you determine if a currency pair is good to buy? And how do you know when to sell? Most importantly, where do you draw the line into accepting your losses?
When it comes to answering these questions, there is more than one right answer.
First, let’s briefly touch upon some concepts that are commonly used in the forex markets (they are also used in other markets as well).
What is fundamental analysis in forex?
Fundamental analysis is a study for understanding the reason behind the price movement. There are a number of reasons why price behaves the way it does. The study of fundamental analysis basically looks into what are the reasons behind the movement in the currency markets.
Because we are dealing with currencies, the obvious answer in the general economy. When an economy is performing well, the currencies tend to show that by appreciating in value against other currencies.
This is basically done by the central bank which raises interest rates and thus makes the currencies more valuable.
Conversely, when the economy is not working so well, the central banks cut rates making the currencies less valuable. This leaves the currencies to depreciate in value against its peers.
With fundamental analysis, you are basically studying the economy, by looking into key indicators such as the gross domestic product (GDP), inflation, labor market and health of the consumer.
Fundamental analysis is also commonly used in stocks, but there it is different. Fundamental analysis in stocks basically focuses on one stock and studies the cashflow to see if the stock is undervalued or overvalued. In a way, there is a bit of a similarity between the fundamental analysis of stocks and of forex. The approach and the tools used to study these are different.
What is technical analysis in forex?
Technical analysis is the sibling of fundamental analysis. Technical analysis focuses on studying past price history to predict future price movement. As you can see, technical analysis is a completely different ball game compared to fundamental analysis.
While the former focuses on what is moving the markets, the latter focuses on predicting price based on how it behaved in the past.
In forex trading, traders make use of technical analysis in their trading. This includes using multiple tools known as technical indicators. These technical indicators are based on various mathematical formulae such as moving average, measuring the momentum of the currency pair and so on.
Based on a combination of two or more technical indicators, traders are able to understand when to buy and when to sell.
One of the most common argument among forex traders is which of these two is better. For example, a day trader doesn’t quite have to focus on the fundamental analysis, while a swing trader is better off focusing on the fundamentals.
This argument is wrong. To be a successful trader, you need to have the ability to use both fundamental analysis and technical analysis in your trading. Without one, you will only be able to half understand what the markets are doing.
As outlined earlier, making money in forex is all about buying low and selling high. By combining the concepts of fundamental analysis and technical analysis, you would be able to trade with more confidence, knowing what the markets are most likely to do.
One of things to bear in mind when talking about making money in the forex markets is that you should also pay attention to other concepts such as risk management and your psychology.
It might seem hard to believe at this point, but risk management and psychology are just as important as the tools that you use in trading. Many traders make the mistake of leaving risk management and psychology at the very end. This often comes at a price of losing big in the forex markets.
In the later sections of this forex education course, we will go into much more details about the concepts that are outlined here.