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Be conservative in the FX markets

Foreign-exchange trading – also known as currency trading, forex, or FX – is a particularly popular choice with people who are new to online trading. But it’s also a very risky choice for a beginner, says Natalie Stanton.

Foreign-exchange trading also known as currency trading, forex, or FX means betting on exchange rates. It's a particularly popular choice with people who are new to online trading and are attracted by the idea of making large profits quickly. But as they soon learn, it's also a very risky choice for a beginner. In fact, most new FX traders end up losing their money, even though FX trading itself is not especially complicated.

How FX trading works

Currency quotes are usually quoted to four decimal places. But a few currencies, including the yen, are quoted to just two. A "pip" or a "tick" is the final digit in a quote. So if the USD/JPY is quoted at 120.27 and it moves to 120.21, that's six pips. As with other forms of trading, currencies are quoted with a spread. You'll have noticed this when buying currency to go on holiday. You will also have noticed that the price at which you can buy is significantly higher than the price at which you sell your leftover holiday money. Luckily, the spreads for FX trading are narrower than you will usually find at your local bureau de change. For example, at the time of writing, Bloomberg was quoting GBP/USD at 1.5321-1.5323 a two-pip spread.

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One reason FX trading appeals to traders is because it's a highly liquid market that's open 24 hours a day, from Monday to Friday (although the best liquidity is concentrated in the smaller windows when Asian trading hours overlap with European ones, and European hours with US ones). Many traders are also attracted to FX because long-term trends are driven by economic fundamentals. So they can make decisions based on macroeconomic trends, such as inflation or interest rates, rather than getting bogged down in details of individual companies.

Beware of the risks

Instead, the danger most of the time is that moves are relatively small and so new traders pile on lots of leverage to compensate (meaning that they bet with large amounts of borrowed money).

Some providers let you use leverage as high as 500:1. But using leverage like this is insanity and taking such an aggressive approach will ultimately lead to large losses. Most experienced traders keep their risk at a more sensible level and run their account with maximum leverage of 10:1 or 20:1. Those who have suffered through market shocks in the past will often be far more conservative. Beginners should be even more so.

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