If you have heard at all about investing, then it’s possible that you have heard of Forex Trading.
Forex stands for foreign exchange trading and in this article, we are going to explain what forex trading is, how it works, and how to get started forex trading.
What is Forex?
Forex (Foreign exchange) trading is the exchange of currency between buyers and sellers at an agreed price. The forex market is a worldwide financial market with different currency exchanges happening daily. On an average day, the forex trading volume is about $5 Trillion!
Forex allows you to trade two currencies against each other; you can call it gambling currencies. Besides, a simple exchange to local currency when you fly into a foreign currency is a foreign exchange. For example, when you fly into Europe, you will need to change your dollars into Euros on the Foreign exchange Booths at the airport from the United States. In simple terms, you are selling dollars to get euros.
The Foreign exchange trade market is open 24 hours a day for five days of the week, unlike the stock exchange market. In this market, there are no brick walls or defined physical areas that represent the market. Instead, the trading and exchange are conducted electronically over the counter and between traders via computer globally. There is no centralized marketplace, and trading occurs across every time zone.
Foreign exchange trading and exchanging currency at the foreign exchange booth in a foreign country are two different things. Exchanging currencies in a local booth or to buy something online from another country only requires you to buy the local currency. But trading requires keenness and understanding of numbers to make smart predictions on a currency.
How Forex Trading Works
Forex Trade involves a pair of currencies that you are selling or buying against each other. These currency pairs are in a three-letter code that gives the country’s identity and its currency. For example, JPY stands for Japanese Yen, where the first two letters represent the country and the last letter represents the currency.
Eight significant currencies are instrumental in trading globally and standard for new traders. However, many currencies come in handy. Some of the major currencies and their respective countries are as below:
- USD – United States of America’s dollar
- EUR – Eurozone’s Euro
- JPY – Japan’s Yen
- GBP – Great Britain’s Pound
- CHF – Switzerland’s Franc
- CAD – Canada’s Dollar
- AUD – Australia’s Dollar
- NZD – New Zealand’s Dollar
As stated above, trading involves a pair of currencies. For example, the most common pairs are EUR/USD, GBP/USD, and GBP.
Types of Forex Pairs
- Major Pairs: These pairs make up 80% of the currencies in the global foreign exchange trading. They include USD/JPY, EUR/USD, USD/CHF, and GBP/USD. These pairs have the highest trading volume. Major pairs are associated with stable economies and are not prone to manipulation. Volatility is low, and liquidity is high.
- Cross Pairs: These pairs are traded less frequently and involve combining the major currencies minus the US Dollar. They are EUR/GBP, GBP/JPY, and CHF/GBP.
- Minor pairs: These pairs involve the most traded pairs in the foreign exchange market like the New Zealand Dollar, Canadian Dollar, and The Australian Dollar with significant currencies like the USD. Examples of these pairs include NZD/USD, AUD/USD, and CAD/USD.
- Exotic Pairs: These pairs involve currencies from small or emerging economies paired with a major currency like the USD. Examples are USD/PLN, GBP/MXN, CHF/NOK, EUR/TRY, and EUR/CZK. They also make up less than 10% of the foreign exchange trading volume.
Exotic pairs are more volatile and less liquid; therefore, trading with them is risky. They are also more vulnerable to manipulation. The price of currencies for the pairs is one against the other one. The base currency and counter currency are what make up the pairs a trader uses to bid.
Foreign exchange trading is determining whether the base currency will gain or depreciate against the counter currency. If your prediction is a currency will appreciate, you can buy it or sell if your forecast is a depreciation. When you have an account on a foreign exchange trading platform, you will see quotes of currency prices on the site. For example, if your pair is EUR/USD, the platform’s price is how much a euro is worth in US dollars. There will be a buying and selling price.
Understanding Forex Trading Terms
In foreign exchange trading, you will meet specific terms commonly used to describe buying and selling prices. Commonly used words include spread, pip, leverage, margin, and lot.
When you see price listing on a foreign exchange trading platform, one is the buying price, and the other is the selling price of a specific currency for the pair. Their difference is what is called a spread.
Pips are the units of measurement for the spread. In a foreign exchange trade, currency prices have a quote of up to 5 decimal points. Therefore, if for a EUR/USD pair, you have a buying price of 1.44800 and a selling price of 1.44804, the spread is 0.4 pips. A pip is a movement in the fourth decimal place of currency. In the example here, we say the move is 0.4 pips.
After the fourth decimal in the currency pair price, the decimals are called micro pips and stand for a fraction of the pip. For currencies like the Japanese Yen with smaller denominations, the second decimal place movement represents a pip.
Currencies are traded in batches to regulate trade; these batches are called lots. A standard batch is 100,000 units of currency, but there are mini lots or micro-lots for individual traders. A lot represents the total unit of money for the base currency in a pair. For example, if trading with EUR/USD, a 1000 lot is equal to €1000.
For traders who cannot pay the amount required for lots upfront, some foreign exchange platforms offer leverage. The leverage enables traders to deposit a small percentage instead of the full payment. It gives traders exposure to the financial market without the risk of committing a large amount of capital.
However, even when trading on leverage, profits or losses are based on the trade’s full size. It is possible to amplify profits with leverage trading, but you can also suffer significant losses that exceed your deposit. For leverage trading, knowing the risks, and learning how to manage them is crucial.
Margin is the initial deposit you place in a leveraged trading position. It is determined as a percentage of the position’s total value and varies according to the trading pair, size, and broker. An example of a typical margin in leverage trading is on EUR/USD, which requires a 2% deposit of the total value to open a trading position.
Types of Forex Markets
There are three ways institutions and individuals trade on the foreign exchange: the spot market, forwards market, and futures market.
It is the biggest market in foreign exchange trading and involves the physical exchange of a currency pair. The transaction is initiated and completed on the spot trough over-the-counter dealers. This market is where buying and selling transactions occur according to the current price. Most people who hear or talk about foreign exchange trading refer to the spot market.
Current prices in the spot market reflect economic performances, interest rates, and political conditions. Once a trade position is closed, you receive an offer of a cash settlement.
The futures market does not deal with actual currencies but a contract. It is a contractual agreement to buy or sell specific amounts of a currency at a set price in a future date. This type of market is best suited for large corporations that want to be secure against future exchange rate instabilities. When the date of maturity arrives, you have to settle the contract in cash.
The forwards market also involves contract buying, but between two parties who agree on the terms and settlement dates themselves. Like the futures market, the contract’s settlement is in cash upon the arrival of the expiry date.
Once you are in the foreign exchange trading business, it is vital to know market analysis factors that tell you when to trade and when to pull out of a trade. These factors can also help you predict your biddings to avoid risky trades. The two are technical and fundamental analysis.
The fundamental analysis revolves around factors that influence an economy’s performance and its impact on the foreign exchange market. The indicators are:
- The Gross Domestic Product of a country.
- The political situation and sentiments surrounding it.
- The unemployment rates.
- Current interest rates in banks.
- Retail sales
- Inflation figures
Technical analysis focuses on what the charts are showing. There are three charts in the foreign exchange: a candlestick chart, a bar chart, and a line chart. The standard variables for the charts are time and price. In this market, technical analysis is more common among traders, especially those with short term trading periods.
Foreign exchange earnings depend on your starting capital, the market prices, and their fluctuations. It is imperative to understand when to buy or sell to make profits. On a good day, leveraged trading can magnify your earnings if the currencies shift in your favor.
Benefits of Forex Trading
Liquidity: Foreign exchange markets are the largest globally, and with 24 hours of operation, there is high liquidity. You can expect fast order executions and matches within seconds.
Easy Accessibility: The initial deposit you require to start foreign exchange trading is low compared to other investment options that may need higher capital. Besides, you can always increase your lot amounts for better trading positions.
Support Community: Foreign exchange trading has gained popularity, and there are many brokers and traders in the industry. It has encouraged the connection between traders to share information and gain tips and tricks of the market. Some many blogs and articles have come up due to these support communities all over the world.
Available on a demo-account: If you are ready to start trading, you can use a demonstration account to learn the ropes before you dive deep into the art of trading. These demo accounts give you a risk-free yet live experience into the market structures of foreign exchange trade.
You can trade anytime you want because the market is open 24 hours for five days a week. Foreign exchange markets cover every time zone such that once one has lapsed, you can switch to the next time zone in line.
Better risk management: Because foreign exchange trade allows you to buy mini or micro lots, you can better manage the risks involved by trading in small sizes. It is also an excellent start for a new trader as you learn the foreign exchange trade dynamics.
Best Forex Trading Platforms
If you are looking to trade with an online broker, there are many platforms on which you can create an account. For example:
Some apps can help you trade better and analyze market shifts.
As a trader, accessing market quotes, charts, news, and accounts is vital to keeping up with the volatile currencies.
Specific foreign exchange apps give you easy access to your account and enable you to grab trading opportunities as they come up. Here are examples:
- Admiral Markets App
- Trade Interceptor
- Trading Game
Before diving into foreign exchange trade, you must get knowledge from as many reputable resources as possible. There are educational resources on foreign exchange in webinars, blogs, seminars and workshops, and articles. Researching the right tools to use beforehand also helps prepare you for the market.
The way you choose to trade will determine your success. Other people may seem to be making more progress than you, but the reality is that the market is tricky for everyone. Learning the ropes, knowing when to pull out, and understanding the risks can help alleviate some of the plunges that traders experience due to market fluctuations. Consider that this is also an investment risk that should come as a personal decision.
If you are a beginner, foreign exchange trading should not be a sole source of income because you will need to have some funds at your disposal to keep trading. Remember to practice on a demo account first before officially beginning a trade. Start small when you do, to get explicit judgments on the risks available better while trading, learn from your mistakes, and move on to make yourself better. Otherwise, with practice, the right tools, and a great mindset, you can make some significant profits in this trade.