Forex Trading UK

Forex Trading in UK is legal & regulated by FCA (Financial Conduct Authority). FCA regulated Brokers can offer CFDs on Forex, Commodities and Indices.

Read our below guide to get started with forex trading in UK to know how to get started and what are the risks etc.

What is Forex Trading?

This is an online trading activity where you can potentially make profit (or loss), by speculating on the movement of exchange rates in the global forex market.

Forex traders aim to either hedge their risk in other investments, or to speculate on price changes with the aim of making a profit from their positions.

When you pair two currencies together, you can speculate whether one currency will rise or fall in value against the other.

For example, if you think that British Pound is going to appreciate in value against the US Dollar due to rising interest rate differential, you can Buy GBP/USD currency pair.

You buy a currency with the hope that its value will appreciate so that you can sell it for a profit later in the future. This process is known as “Going Long” on a currency pair.

You can also sell a particular currency, if your thesis suggests that it will depreciate in value in the future, and you buy it back at a cheaper price. This process is known as “Going Short”.

Who Trades in the Currency Market?

A 2022 Bank of International Settlement (BIS) survey revealed that the average daily turnover in the forex market reached $7.5 trillion per day. The market is so large that more than 170 currencies are traded globally.

The participants can be Central Banks, Private Banks, Businesses, Hedge Funds, CTAs, Retail Speculators.

For example, if a Hedge Fund has exposure, for example to the Bond market, and they fear their Bond portfolio may lose value, they could enter into a counter trade in the forex market and take a position to reflect this view.

By doing this, if they lose in the Bond market, they use the gain from the forex market to offset the loss. This is called hedging risk.

The retail forex trading (done by individuals) on which this guide focuses is just a small portion of the entire forex market, as it only accounts for 5.5% of the entire market. This means that large banks who can sway the market in any direction, are the market makers and liquidity providers.

The 2022 BIS survey also showed FX swaps carried out between big banks, accounted for 51% of market turnover in 2022, while other products such as currency swaps, derivatives, etc., used by retail traders accounted for just 2%.

The United Kingdom up till now is the country with the largest hub of forex trading. The UK accounts for 38% turnover of the market globally according to the 2022 BIS survey.

What Moves the Forex Markets?

The global forex market is volatile because it is influenced by several factors such as monetary & fiscal policies, economic crises, political events, interest rates, geopolitical activities, war, etc.

For example, particularly in 2022, the US Federal Reserve was on a fast rate hiking cycle, which caused massive moves in the forex market, and caused the US Dollar Index to rise.

Many factors create intraday volatility in FX markets, which greatly affects the movements of exchange rates, hence making retail forex trading is very risky for individual traders.

Activities of Big banks and Hedge funds who enter the market with their large orders (in Billions), can also cause a spike in volatility as these big players used advanced trading algorithms that trade with lightning fast speed.

For example, if a bank in the UK has a client that wants to buy $5 Billion Euro in exchange for GBP at best fill, then this large order can create a massive support on EUR/GBP.

According to the 2022 BIS survey, the following are major forex trading instruments and their turnover in 2022

• FX Swaps: 51%
• Spot: 28%
• Outright Forwards: 15%
• Currency Swaps: 2%
• Derivatives: 4%

Firstly an FX swap is used by big corporates to hedge exchange rate risk. If a business in the UK needs US dollars, and a business in the US need British Pounds, they can enter a swap agreement.

If the amount in question is $1m and GBP/USD spot exchange rate is 0.82, the US based business sends 820,000 pounds to the UK business.

The UK business also sends $1,000,000 to the US based business using the same 0.82 exchange rate. They hold on to this money for an agreed period of time

Upon expiration of the holding period, both businesses return the funds back to each other but at a different exchange rate this time. This rate is called a forward rate, and would have been agreed upon before the transaction took place.

By doing this the businesses hedge any unfavorable exchange rate movement, that would have occurred during the holding period. It is cheaper than taking a bank loan and FX swaps accounted for 51% of all forex transactions in 2022.

Secondly, the Spot market is where you trade currencies at the current exchange rate. Everything is concluded immediately and not carried over till the next day. It accounted for 28% of all forex transactions in 2022.

Thirdly, outright forwards refer to an Over the Counter (OTC) contract between two parties, to trade currencies at a specified exchange rate, and specified future date.

The parties could be you and your bank, and is useful for hedging exchange rate risk. It accounted for 15% of all forex transactions in 2022.

Fourthly, Currency swaps involve two parties exchanging notional amounts of two currencies for a period, and repay it at an agreed interest rate.

Alternatively, the parties could decide to exchange interest rate payments on a loan of same notional value, so as to hedge against any sudden interest rate changes.

The party with a fixed interest rate could decide to swap with the party with a variable interest rate. This is done for hedging risk and not for speculation. It made up 2% of all forex transactions in 2022.

Lastly, derivatives are the instruments widely used by retail forex traders for speculation. The Currency futures contract is a derivative that lets you trade an agreed quantity of currency, at an agreed exchange rate and future date.

The currency option is a derivative contract that gives you the right but not obligation, to buy (call option) or sell (put option) an agreed quantity of currency, at an agreed exchange rate (strike price) and future date.

An option contract is bought upon payment of a premium which can be forgone, if the market moves against you- hence there is no obligation to follow through. There are also options on futures contracts where the underlying asset becomes the futures contract.

A contract for difference (CFD) is another derivative contract that most retail forex traders use purely for speculation.

With a CFD, you don’t need to own the underlying currency, and you can speculate on rising and falling exchange rates. When you think the exchange rate will rise, you buy CFDs and when you think it will fall, you sell CFDs.

One CFD contract is equivalent to one currency pair, so if you want to go long on say 100,000 units of EUR/USD, you buy 100,000 EUR/USD CFDs

However, CFDs are very risky instruments, because since exchange rates move in very little decimals, most speculators/traders use very high leverage to open bigger positions if you are to make any meaningful profit.

The use of leverage means you are trading with borrowed funds from your broker, and any losses will be multiplied by the leverage you’re using. A 1:30 leverage means losses are amplified 30 times.

CFDs are even more dangerous when you are trading on a stock because they let you short sell when you take a short position by selling CFDs on a stock. The danger with short selling is unlimited upside risk if the stock price continues to climb.

While brokers in Asia and Africa allow leverage of up to 1:2000, the FCA has strict leverage cap that regulated forex brokers can offer you. It is restricted to a maximum of 1:30 for retail traders, because of the dangers of high losses.

Although Professional traders can open trading accounts with higher leverage, but this requires you to prove your technical & financial adequacy.

Basic Forex Market Terminologies

It is very important that before engaging in forex trading, we familiarize ourselves with the basic terminologies used in the trade. The terminologies are numerous, but let’s take a look at the most common ones.

1) Currency Pair: Term used for two different currencies that are traded together. One currency is bought, the other is sold. For example in the EUR/USD pair, USD is sold to buy EUR when going long, and EUR is sold to buy USD when going short

2) Exchange rate: This is the rate at which one currency (of the pair) is exchanged for the other currency. If EUR/USD exchange rate is 1.0800 it will require 1.08 USD to buy one EUR

3) Long Position: This is when you buy a currency hoping that its value will appreciate. If you go long on EUR/USD, you are selling USD to buy EUR with the hope that EUR will appreciate in future for you resell the EUR at a profit.

4) Short position: This has to do with selling a currency pair at the current market price, hoping that its exchange rate will fall so you rebuy it at a discount and close your position. Your profit is the sell price minus the rebuy price. Taking a short position is also known as short selling.

5) Appreciation: A rise in the in the exchange rate of a currency pair.

6) Depreciation: A fall in the exchange rate of a currency pair. Let’s say the EUR/USD drops from 1.20 to 1.05, then the Euro has depreciated against the US Dollar.

7) Gapping: This is when an opening price changes substantially (rising or falling) compared to the previous day’s close without any trading in between.

8) Major currency pairs: These are currency pairs of major Global economies and one of the currencies must be the US dollar. Examples are EUR/USD (Euro vs US Dollar), USD/JPY (US dollar vs Japanese yen), USD/CHF (US Dollar vs The Swiss Franc), GBP/USD (British Pound vs US Dollar), etc.

9) Minor Currency Pairs: These are currency pairs of crosses of major economies excluding the US dollar. For Example: EUR/GBP, GBP/CAD, CHF/JPY.

10) Bid/Ask Price: The Bid price is the price you can sell the currency pair for after buying it. The Ask price is the price (spread included) your broker will sell the currency pair to you for in order to make himself a profit. The Ask price is always higher than the Bid price.

11) Spread: This represents the difference between the Ask and Bid prices. This difference goes to your forex broker.

12) Pip: The smallest price movement of a currency pair. If EUR/USD moves from 1.0800 to 1.0801 that is a 0.0001 move also known as 1 pip.

13) Leverage: This strategy allows you to control a larger trade position with a small amount of money. The remainder is borrowed from your broker. A leverage of 1:30 means when you put down $1, your broker loans you $30.

14) Margin: The minimum deposit required by the broker for you to open a position and access leverage. You deposit the margin and the broker borrows you the balance. If margin is 2% then it means you put down 2% of contract sum while broker covers the 98% with his funds.

Margin is inversely proportional to leverage so a 2% margin will give you (1/2%) = 1:50 leverage

15) Stop loss: This is an automatic risk management tool that you can use to exit a position when it reaches a particular stop price so as to minimize losses.

For example, you buy GBP/USD at 1.2320 and set a stop loss at 1.2100. With a stop loss in place, you don’t need to monitor price movements for a whole day.

16) Lot Sizes: This is the standard unit of measurement of currency pairs. The units are measured on a standard, mini, micro, and nano basis. If you don’t want to use standard lots, you can opt for smaller positions. The sizes are:

• Standard lot: 100,000 units
• Mini lot- 10,000 units
• Micro lot- 1,000 units
• Nano lot- 100 units

Steps on How to Trade Forex

In this section, we will take a cursory look at the steps we need to take towards engaging in forex trading.

Step 1: Opening an Account with a Broker

The first step that needs to be taken is to open a trading account with a forex broker, who would serve as a middleman between you and the forex market.

As an individual you cannot approach the forex market directly as you need to be licensed, and meeting licensing requirements is very expensive. Hence you need to pass through a forex broker.

One important thing to keep in mind when choosing a forex broker is the credibility of the broker. You need to ensure that the forex broker is regulated by the relevant agency to avoid being scammed.

In the United Kingdom, forex trading is regulated by the Financial Conduct Authority (FCA), which licenses and supervises forex brokers, and ensures brokers are fit and proper to manage your funds.

Simply take note of the broker’s license number, then head to the FCA website to view the licensing register. Once you input your brokers name or license number in the search bar, lots of information such as address, phone number, email etc. will populate.

For further confirmation you can call the phone number you see on the FCA website, as all brokers are required to notify the FCA when they change numbers or address.

Calling the number on the FCA site helps you avoid cloned website scams, where the legitimate broker’s phone number is changed on the fake website. If the broker is not FCA regulated, no information will come up when you query the FCA register.

Step 2: Choose Your Currency Pair

After choosing your broker, the next step is to choose the instruments you want to use. In this context, I am talking about the currency pairs you want to use to trade.

This aspect of choosing a trading instrument is a key part of the trading process. Choosing the right trading instrument goes a long way in determining your success while trading.Before selecting a currency pair to trade in, you should consider factors such as liquidity, spread, etc.

It is advisable that you trade with the most popular currency pairs in the world, which EUR/USD, USD/JPY, and GBP/USD are on the top. Trading these pairs means you will always have a ready counterparty willing to trade with you.

Step 3: Open Your Order

After choosing a suitable trading instrument, you place your market order. A market order could be either a buy or sell order at the best available price.

If you intend to go long on EUR/USD and your broker gives you a quote of 1.0804/1.0806 it means you buy from your broker at 1.0806.

You see a small loss of 2 pips once you send your order in, which will regularize when you close the position by going short on EUR/USD. This ‘small loss’ is called the spread.

Before you click the buy/sell button, you will be prompted to set your stop loss so you are automatically closed out, if the market moves against you till a certain stop price.

There is also an option to set take profit orders, to automatically take profit when the market moves in your favour at a certain price.

Step 4: Wait for the Market to Move in Your favour

After executing your order, wait for the trade to play out. The waiting period varies depending on your trading strategy.

You could also manage your position by adjusting your stop loss as you wait, if you decide to take on more risk. Trailing stop loss orders do this automatically for you, and you can opt for them.

If you use the scalping style, you wait for seconds or minutes and take advantage of any positive market move within that period.

If you use the day trading style, your waiting period is one day, as you don’t keep positions open till the next day.

If you use the position trading or swing trading styles, your waiting period could be weeks to months.

You should note that the trade could turn out either in the form of profit or loss, because the market is highly volatile. It may swing in your favour or against you.

If the market moves in your favour, you can close your position manually or your stop loss order does it for you automatically. Sometimes you may choose to do it yourself, instead of wait for the stop loss.

If you went long on say EUR/USD when opening your position, you must take an opposite action of going short in order to close your position. This is where liquidity of the currency pair is critical, because you need to find a counterparty willing to trade with you if not you get stuck.

Forex Trading Strategies

We will look into the strategies in two ways: through fundamental and technical analysis.

Fundamental Analysis

The strategy of fundamental analysis has to do with the broader economic outlook such as monetary policies, politics, the rate of unemployment, etc., which go a long way in affecting exchange rates.

What fundamental analysis entails is that if the economic potential of a country looks good and promising, the currency of that country should appreciate and become stronger.

When the economy of a country improves, it would attract businesses and investments into that country, which would give rise to the need to purchase the country’s currency, which makes the currency appreciate against other currencies.

Since currencies are paired in the forex market, their values are determined when compared to the other currencies. Giving a practical example, let’s assume that the US dollar is appreciating greatly as a result of the improvement in the country’s economy.

As the US economy experiences positive growth, the Federal Reserve may decide to hike interest rates to curb inflation. When this happens, US dollar denominated assets would now become more attractive to investors as a result of the higher interest rates.

Foreign investors would begin to sell their currencies and buy US dollar in order to be able to invest in US securities thus making the dollar stronger.

For forex traders who engage in carry trades interest rates are important. Carry traders borrow a low interest rate currency, to buy a strong high interest rate currency and hold the position open for nights in order to earn an interest rate differential.

From this, we can deduce that interest rate differentials, which are the difference in interest rates between two countries, are a core part of the fundamental analysis for which you can use a trading strategy.

Technical Analysis

This is the analysis that serves as the framework within which you can effectively monitor and study price movements, with a view to ensuring successful trading.

Technical analysis goes hand in hand with charts and graphical representations, which are developed using past price movements.

The theoretical framework is that as traders, we can study historical price movements, and use the direction to determine the current possible price movements and the general conditions of the market.

As a technical analyst, your belief is that all major market information is reflected in the price. Technical traders have the notion that “it’s all in the charts!” because some of the information is shown through charts. Some of the popular technical indicators are:

200 Day Moving Average Indicator

This is a technical indicator that we can effectively use to know and study long-term trends in the forex market. It is about the average closing price of a currency pair, in the last 200 days.

If the price of the currency pair trades above the 200 day price, it means you should look out for opportunities to buy, but if it is below the 200-day average, it means there are selling opportunities.

Bollinger Bands Indicator

The Bollinger band has a moving average, and 2 Standard deviations of price.

For example, if you are using default settings of 21 moving average, and 2 STD, then you bands will show you when the price detail highly deviated from the mean.

If the price on the chart moves towards the upper bands the currency pair is said to be overbought, and if the price moves in the direction of the lower bands it is considered oversold.

Also when the bands are far apart, as in an uptrend, it means volatility in the market is high. But if the moving averages & the bands are flat, then the market is sideways.

Below is an example of chart of currency pair GBP/USD with Bollinger bands. The price is clearly in a uptrend. The trend is considered overbought when the price cuts the upper band.

Moving Average Convergence/Divergence (MACD) Indicator

The MACD compares two moving averages (26 day vs 12 day) and gets the difference in price which its displays visually as a histogram.

When the currency pair is overbought, the MACD histogram forms a visual peak, and when oversold it forms a trough or low.

Pivot Point Indicator

This makes us know the demand-supply balance levels of the currencies we are pairing for trade. If the price moves to the point of the pivot, it means that the demand and supply of the traded pair are now equal.

Standard Deviation Indicator

This is used to estimate how prices are scattered around the average price in the forex market. The higher the standard deviation, the higher the fluctuations in the prices, and vice versa.

Risks of Forex Trading

The Risk of Leverage

Forex brokers offer you leverage, which allows you to trade in larger volumes. However, it is very essential to know that it is a double-edged sword because it can also expose you to high risks and multiply your losses.

In a nutshell, leverage can be very risky in such a way that it can make you lose money. It can also lead to what is known as a “margin call,” where you are warned to fund your account or risk your open positions being closed.

Risk of Market Gaps

Market gaps occur when the exchange rate quickly moves from one price to another in between a weekend or public holiday when there are no trading activities.

Market gaps happen as a result of volatility in the market. For instance, a major news event, political event, or crisis might have taken place during the weekend and cause the price to change when trading resumes on Monday with a new price.

Market gaps cause your stop-loss orders to be executed at inferior prices. The order may be executed at higher or lower prices than you had anticipated.

Risk of Scams

Many people have fallen victim to scammers. People who fall victim most are the beginners, who don’t understand much about how the market works. They may not know that the broker they are dealing with and the trading are fake.

As beginners in forex trading, you should be very careful when choosing the type of broker you want to work with. That’s why it is very important that before you decide to use a particular forex broker, you run a background check to know if they are regulated.

Transaction Risk

This type of risk has to do with the difference in time between the beginning of a contract, and its settlement. Forex trading involves global activities that take place round the clock, and time is different worldwide.

Therefore, due to the duration of time, exchange rates can change before the settlement of a trade. The degree of the duration of time between entering and settling a trade, goes a long way towards determining the level of transaction risk.

There is also the issue of latency which has to do with network speed. If you have a poor network connection, you face transaction risk as prices could change before your order is executed.

Interest Rate Risk

When a country hikes its interest rate, investors rush to invest in the country and this leads to an increase in the demand for its currency, which makes it appreciate against other currencies.

On the contrary, when a country reduces interest rates, foreign investments will be withdrawn, as investors seek higher returns from other places. This causes the value of the currency to depreciate.

Country Risk

The economic or political risk of a country may affect the value of its currency, especially if the currency is among the major currencies used in Forex trading, such as the dollar, euro, or pound sterling.

For instance, if a country faces a major political crisis or constant payment deficits, its currency may experience considerable depreciation. When this happens, investors may withdraw their investments out of fear of losses, and this would in turn have significant effects on the forex market.

Frequently Asked Questions on Forex Trading UK