Must-read before trading Forex: Five core understandings from scratch

“Can you make money trading forex?” This is the most frequently asked question by many novice investors. The answer is: yes, but only if you understand this market.

As the world’s largest and most liquid financial market, the forex market’s daily trading volume exceeds $6 trillion, far surpassing the combined volume of futures and stock markets. In the past, forex investment was mainly monopolized by financial institutions and high-net-worth individuals. But with the advancement of the internet and technology, now anyone can participate. Today, over 30% of forex trading comes from retail traders, including derivatives like futures and contracts for difference(CFD), which have directly driven explosive growth among retail investors.

But the reality can be quite harsh: statistics show that over 70%-90% of individual investors experience losses in forex trading. This isn’t because the market has problems, but because investors’ understanding of this market is still insufficient.

Three Entry Paths into Forex Investment

If you want to play forex, first clarify which path you will take. Forex investment is not limited to just one method; from low risk to high risk, it roughly divides into three levels.

First Level: Currency Exchange

This is the most basic way to participate in forex. Simply put, it involves exchanging one currency for another. For example, if you travel to Japan, you need to exchange New Taiwan Dollars for Japanese Yen. This process is forex trading. This method involves no leverage and no risk, but the returns are minimal because the exchange rate difference is small.

Second Level: Foreign Currency Fixed Deposit

If you want to step up a bit, you can open a foreign currency fixed deposit account at a bank. This method allows you to earn the exchange rate difference and interest income, representing a basic form of “spot forex trading.” Banks usually offer multiple terms, with large transaction volumes, and a balanced risk and return profile, making it especially suitable for beginners new to forex.

But note: each bank has minimum deposit limits for different currencies, and early withdrawal may result in some interest loss. It is recommended to use idle funds that are not needed in the short term.

Third Level: Forex Margin Trading

This is the most common way to play forex and also the highest risk and reward. Forex margin trading, simply put, is what many call “forex speculation”—profiting from the difference in exchange rates by analyzing price trends.

By depositing a certain margin, you can trade positions much larger than your capital. This is the most attractive feature for retail traders: low entry threshold, 24-hour trading, long and short options, and high flexibility.

For example: if you believe the euro will appreciate, you buy EUR/USD; if you are bearish on the euro, you sell EUR/USD. If the price moves in your favor, you make money; if not, you lose.

But this flexibility also amplifies risk. The most frightening aspect of forex margin trading is the “liquidation”—a sudden market move can wipe out your principal. Therefore, trading forex on margin requires risk control, setting stop-loss and take-profit points, and using leverage wisely.

Additionally, when choosing a broker, beware of scams. There are many unregulated platforms in the forex market, which may use fake brand names or induce investors to deposit funds via LINE. The golden rule for selecting a broker is: verify whether they hold a license issued by a financial regulatory authority. Legitimate brokers will not engage in manipulative practices like managing trades for clients, giving trading guidance, calling signals, or refusing withdrawals.

Leverage and Margin: A Double-Edged Sword

Many beginners’ losses stem from not fully understanding what leverage and margin are, and how they can magnify both gains and risks.

What is leverage?

Leverage allows you to open larger positions with less capital, achieving “small capital, big position.” For example, a broker offering 20:1 leverage means your trading position can be 20 times your account balance. If you want to buy 40,000 units of EUR/USD, you only need 2,000 euros to open the position.

What is margin?

Margin is a financial derivative, usually expressed as a percentage of the total position size. Brokers might say they offer 2%, 5%, or 25% margin, corresponding to leverage ratios of 50:1, 100:1, etc.

Let’s look at some specific examples:

50:1 leverage: For every $1 you deposit, you can open a $50 position. With $500, you can trade $25,000.

100:1 leverage: Typical for standard accounts. With $2,000, you can trade $200,000.

200:1 leverage: Common for mini accounts. Most brokers require a minimum of $500 deposit.

400:1 leverage: High-risk setting, allowing $1 to control $400.

Now, see the actual effect of leverage. Suppose you deposit $1,000 to trade EUR/USD, and the market moves 5%:

See? Leverage not only amplifies gains but also proportionally increases losses. Leverage magnifies not just numbers but also investors’ fear and greed.

Professional forex traders need systematic learning and thorough training to handle leverage properly. For beginners, the most prudent choice is: use lower leverage and start with small lot sizes. Experienced traders usually keep leverage below 10:1. Never start with 500:1 leverage on your first account—that’s gambling.

Pros and Cons of Forex Investment

Advantages of trading forex:

• Bidirectional trading: can go long or short, opportunities in both rising and falling markets.
• 24-hour trading: unlike stocks, forex is open around the clock.
• High leverage: up to hundreds of times the principal, offering high flexibility.
• Low trading costs: OTC structure significantly reduces fees, often no commissions.
• High liquidity: global market, transparent data, hard to manipulate artificially.

Risks of trading forex:

• High risk: high leverage means you could lose all your capital.
• Market sensitivity to news: economic data, political events, central bank policies can cause large swings, often unpredictable.
• Psychological pressure: almost entirely reliant on personal judgment; market moves are rapid and intense, requiring constant decision-making and mental resilience.

Are you truly suited for forex trading?

Forex trading is characterized by flexibility but also high risk. If you approach it with a “part-time hobby” mindset, you may suffer huge losses. Serious investors need continuous learning, effective capital management skills, a solid trading plan, and most importantly, risk tolerance.

Choosing Which Currency to Trade

There are over 180 different currencies worldwide. Based on their characteristics, currencies in forex trading are roughly divided into four categories:

Policy-driven currencies: mainly influenced by national policies and economic changes, e.g., USD, EUR.

Safe-haven currencies: used to hedge against international trade risks, e.g., JPY.

Commodity currencies: affected by exports of commodities, e.g., AUD, Russian Ruble.

Emerging market currencies: under strict government control, relatively stable, e.g., RMB.

New investors are advised to start with the first three categories.

Top 10 most traded currency pairs globally:

These ten currency pairs account for nearly 90% of global forex trading.

Why choose high-liquidity currencies?

Higher trading volume means higher liquidity, which directly offers four benefits:

• Lower spreads
• Lower trading fees
• Faster order execution
• Smoother price movements

But your choice of currency depends on your trading style.

If you are experienced, volatile currencies can offer more trading opportunities and larger profit potential (but also bigger losses). For beginners or less experienced traders, high volatility currencies tend to carry higher risks than average.

It is recommended for novices to start with high liquidity, low volatility pairs like EUR/USD. They offer lower costs, better trading conditions, and faster information access.

Seven Tips for Forex Trading

1. Study fundamental market factors

Many factors influence forex price fluctuations: global politics, interest rate changes, stock market performance, economic data, etc. Market participants include commercial institutions, investment banks, hedge funds, governments, multinational organizations, and individual investors, providing ample liquidity.

As an investor, you must analyze fundamental factors, follow news events, and understand medium- to long-term currency trends.

2. Use the dual-direction trading mechanism

The advantage of forex is the ability to trade both ways. You can profit from rising prices(going long) or falling prices(going short). Even in bear markets, you can find profit points; in volatile markets, you can seize opportunities.

3. Rationally view leverage

Leverage not only amplifies profits and losses but also magnifies human emotions like fear and greed. True investors need long-term systematic learning and training. Beginners should control leverage ratios and avoid being tempted by high leverage.

4. Start with small lot sizes

One of forex’s biggest advantages is trading with small capital. Beginners should start with small lot sizes(low trading amounts), gradually accumulating experience under lower risk, reducing psychological pressure.

5. Develop a trading plan and stick to it

Avoid frequent strategy changes. But also recognize that when market trends change or adverse developments occur, you should adjust your strategy accordingly. The key is to have a clear framework.

6. Never ignore stop-loss and take-profit

Set clear entry and exit points. For example, take profit at 20%, and exit promptly. No matter how the market moves, reach your target and wait for the next opportunity. This is the last line of defense to protect your capital.

7. Practice with a demo account

Beginners must gain experience through demo accounts. Virtual trading allows you to try different strategies, learn from failures without risking real money. It is the most cost-effective way to learn.

Final Words

Forex trading offers opportunities, but risks are equally real. Due to low entry barriers, flexible leverage, and high volatility, more retail traders and individual investors are entering this market.

But the high risk of leveraged trading must be fully understood before entering. You need to ask yourself three questions:

1. Do I truly understand the dual-edged nature of leverage?
2. Do I have a systematic trading plan and risk management skills?
3. Do I have the psychological resilience to face potential losses?

Only if the answers are all “yes” is it worth stepping into the forex market. If you decide to proceed, start with a demo account, use small funds, low leverage, and strict discipline. Take it slow, don’t rush.