Forex trading is based on attempting to glean profits from exploiting the relative values of a currency pair. Keep in mind these three guidelines to forex trading for beginners:
– Leverage can also deliver losses much larger than the initial investment
– Significant price movements can negate carry trade gains
– Minor currency pairs can be subject to spotty liquidity
Leverage is a powerful double-edge sword. If a trade is unwound when in the red, leverage can wipe out far more than the dollar amount initially invested. Of course, profits are similarly magnified, making even small currency pair index hiccups potentially lucrative.
Carry trades take advantage of the fact that currency interest rates often differ. Borrowing money in a low-rate currency that costs one percent, and then investing the funds in a higher-interest currency that yields four percent, a trader stands to make three percent gain on the transaction. The relative value of the currencies is a complicating factor since currency pair indexes constantly fluctuate with market conditions. Adverse currency pair index movements can negate carry trade gains, especially if leverage is substantial.
These guidelines to forex trading for beginners have to emphasize the following note of caution: enthusiastic traders will quickly realize that there are only a few major currency pairs to trade. Aside from the majors, traders can dabble in other currency pairs. However, nominal paper gains will not be realized if there isn’t someone on the other side of the trade when one desires to turn unrealized gains into cash. With major pairs, this is not an issue. Minor and relatively obscure currency pairs are not traded nearly as often, especially not by retail investors. This potentially crippling liquidity crunch makes real gains more sparse than a favorable index movement might imply when it comes to minor currency pairs.