Foreign exchange trading, usually known as forex trading or FX, is a worldwide market for exchanging currencies. Forex is the world’s biggest market, and the deals that take place in it impact everything from the cost of apparel imported from China to the cost of a margarita while on vacation in Mexico.
What Exactly Is Forex Trading?
Forex trading is comparable to currency exchange while going overseas in that a trader buys one currency and sells another, and the exchange rate swings regularly depending on supply and demand.
The foreign exchange market, a worldwide marketplace operating 24 hours a day, Monday through Friday, is where currencies are transacted. All forex trading is done over the counter (OTC), which means there is no physical exchange (as there is for stocks), and the market is overseen by a worldwide network of banks and other financial organizations (instead of a central exchange, like the New York Stock Exchange).
The great bulk of forex trading activity takes place between institutional traders, who work for banks, fund managers, and multinational organizations. These traders don’t necessary aim to take actual ownership of the currency themselves; they may merely be speculating on or hedging against future exchange rate swings.
A forex trader may purchase US dollars (and sell euros) if she feels the dollar’s value will rise and she will be able to buy more euros in the future. Meanwhile, an American corporation with European operations may utilize the forex market as a hedge if the euro decreases in value, lowering the value of their revenue produced abroad.
How Are Currencies Traded?
All currencies are given a three-letter identifier, similar to a stock ticker symbol. While there are more than 170 currencies in the world, the US dollar is engaged in the great bulk of forex trading, therefore knowing its code is very useful: USD. The euro, which is recognized in 19 European Union nations, is the second most popular currency in the forex market (code: EUR).
Other prominent currencies are the Japanese yen (JPY), British pound (GBP), Australian dollar (AUD), Canadian dollar (CAD), Swiss franc (CHF), and New Zealand dollar (NZD).
All forex trade is stated in terms of the two currencies being swapped. The following seven currency pairings, known as the majors, account for over 75% of forex trading:
- EUR/USD
- USD/JPY
- GBP/USD
- AUD/USD
- USD/CAD
- USD/CHF
- NZD/USD
How Are Forex Trades Quoted?
Each currency pair indicates the two currencies’ current exchange rate. Here’s how to analyze such data, using the EUR/USD (or euro-to-dollar exchange rate) as an example:
The base currency is the currency on the left (the euro).
The quotation currency is the currency on the right (the US dollar).
The exchange rate shows how much of the quote currency is required to purchase one unit of the base currency. As a consequence, the base currency is always stated as one unit, however the quotation currency fluctuates depending on the current market and how much is required to purchase one unit of the base currency.
If the EUR/USD exchange rate is 1.2, it indicates that €1 will purchase $1.20 (or, in other words, $1.20 will cost €1).
When the exchange rate increases, it signifies the base currency’s value has increased compared to the quote currency (since €1 now buys more US dollars), and when the exchange rate falls, it means the base currency’s value has decreased.
Just a brief note: Currency pairings are typically presented with the base currency first and the quote currency second, while certain currency pairs have a historical standard for how they are stated. Conversions from USD to EUR, for example, are reported as EUR/USD rather than USD/EUR.
Three Forex Trading Strategies
Most forex transactions aren’t done to exchange currencies (like you could at a currency exchange when traveling), but rather to speculate on future price changes, similar to stock trading. Forex traders, like stock traders, try to acquire currencies whose values they believe will rise compared to other currencies and sell currencies whose buying power they believe will fall.
There are three strategies to trade forex that will suit traders with diverse objectives:
- The current market. This is the principal forex market, where currency pairings are exchanged and exchange rates are decided in real time based on supply and demand.
- The futures market. Rather of completing a deal right away, forex traders might engage into a binding (private) contract with another trader to lock in an exchange rate for an agreed-upon quantity of currency on a future date.
- Futures trading. Similarly, traders may choose a standard contract to buy or sell a specified quantity of a currency at a certain exchange rate at a future date. Unlike the forwards market, this is done on an exchange rather than privately.
- Forex traders who wish to speculate or hedge against future price fluctuations in a currency utilize the forward and futures markets. These markets’ exchange rates are determined by what happens in the spot market, which is the biggest of the forex markets and where the bulk of forex deals are performed.
Forex Definitions
Each market has its own dialect. Before you start trading forex, you need be familiar with the following terms:
- The currency pair. A currency pair is included in all forex trading. There are less frequent deals in addition to the big (like exotics, which are currencies of developing countries).
- Pip. A pip, which stands for percentage in points, is the smallest conceivable price fluctuation within a currency pair. A pip is equivalent to 0.0001 since forex prices are stated to at least four decimal places.
- The bid-ask spread. Exchange rates, like other assets (such as stocks), are established by the greatest amount that buyers are prepared to pay for a currency (the bid) and the minimum amount that sellers must sell for (the ask). The bid-ask spread is the difference between these two amounts and the price at which deals will finally be performed.
- Lot. A lot, or standardized unit of currency, is used in forex trading. The standard lot size is 100,000 units of currency, however micro (1,000) and mini (10,000) lots are also available for trading.
- Leverage. Because of the enormous lot sizes, some traders may be unwilling to put up such a significant sum of money to complete a deal. Leverage, which is another name for borrowing money, enables traders to engage in the forex market without having to invest large sums of money.
- Margin. However, trading using leverage is not free. Traders must put money down as a deposit, which is known as margin.
- What Influences the Forex Market
- Currency prices, like any other market, are determined by the supply and demand of sellers and purchasers. However, other macro factors are at work in this market. Interest rates, central bank policies, the rate of economic development, and the political atmosphere of the nation in question may all impact demand for certain currencies.
The forex market is open 24 hours a day, five days a week, allowing traders to respond to news that may not effect the stock market until much later. Because so much of currency trading is based on speculation or hedging, traders must be aware of the factors that might trigger significant currency surges.
Forex Trading Risks
Forex trading involves more risks than other forms of assets since it needs leverage and traders employ margin. Currency values are continually moving, but only in very little quantities, thus traders must execute massive deals (using leverage) to profit.
If a trader makes a successful wager, this leverage may greatly increase earnings. It may, however, increase losses to the point where they surpass the original amount borrowed. In addition, if a currency falls too much in value, leverage users put themselves vulnerable to margin calls, which may compel them to sell their stocks acquired with borrowed cash at a loss. Aside from potential losses, transaction charges might build up and could eat into a winning deal.
Furthermore, bear in mind that currency traders are little fish in a pond of expert, professional traders—and the Securities and Exchange Commission cautions about possible fraud or information that may be misleading to beginning traders.
Perhaps it’s for the best that forex trading isn’t as popular among ordinary investors. According to DailyForex data, retail trading (a.k.a. trading by non-professionals) accounts for just 5.5% of the total worldwide market, and some of the largest online brokers don’t even provide forex trading.
Furthermore, of the few retail traders that participate in forex trading, the majority fail to make a profit. According to CompareForexBrokers, 71% of retail FX traders lost money on average. As a result, forex trading is frequently best left to specialists.
Why Forex Trading Is Important for Ordinary People
While the ordinary investor should generally avoid the forex market, what occurs there affects all of us. The spot market’s real-time activity will affect how much we pay for exports as well as how much it costs to fly overseas.
If the value of the US dollar rises in relation to the euro, for example, it will be less expensive to go overseas (your US dollars will buy more euros) and purchase imported items (from cars to clothes). When the dollar falls in value, it becomes more costly to go abroad and import things (but companies that export goods abroad will benefit).
If you intend to make a large purchase of an imported goods or travel outside the United States, it’s a good idea to keep an eye on the exchange rates established by the currency market.
Forex trading involves a lot of risk and is not for everyone. Below are some risks discussed to make you ready for forex trading, should you choose to accept them. The first is that you will lose everything you put in.
Money for Forex Trading!
If traders are telling you that you don’t need any money to trade forex, then they are not telling the truth! You need money to trade forex, but you can start off with a small amount of capital. Some brokers allow you to open a mini account with as little as $500 or $250 to start with. Remember that you are buying at mini-trade or micro-trade, which will give you $1 or $0.1 per pip. This is a good way to start live trading, but it will take a longer time for you to gain an adequate amount to sustain your expenses.
For starters, $1k on 0.1 lot trading is a good start, where you earn about $1 per pip. Similarly, your losses are -$1 per pip. Trade, learn, and increment your trade to 0.2 lots once you hit $2,000 or $3,000, and repeat this to grow your trade to 1 lot and more. For advanced traders, starting with $10,000 on 1 lot trading is a good place to start. If you are interested in automated Forex trading, you should start with $10,000 and set a monthly target of 1000 pips trading at 0.1 lot. If you calculated the margin, you may be able to load 3 EAs that give you 300 to 400 pips every month, which works out to 1000 pips or $1k every month.
Time!
In forex trading, you need time to look at the chart and check your trading rules before you can execute a trade. There is a buy stop and sell limit that lock in your trade, and it will execute when the buy or sell price is reached. But you still need plenty of time to go through your chart and your trading rules. In some cases, the rules are forming but not yet ready, and you need to wait for another bar or a few more bars in order to start your trade. This will take you another hour or so, depending on the charting time frame you are using. There is time required for trading, whether you are technical or fundamental.
There is another way which is automated Forex Trading. You don’t spend time executing the trade or looking at charts with indicators. The strategy is all coded and runs automatically on your MT4 trading platform. (MT4 is one of the popular forex trading platforms.) Instead, you spend time looking at executed trades, trade summaries, and closing trade profits and losses. The time spent is on analyzing these close trades, reinforcing winning strategies, and reorganizing losing strategies. You see, time is now spent on closed trades rather than searching for trades that match your criteria. You will have more time to concentrate on strategies that work and improve those that don’t.
Fear!
There is risk, and so there is fear of losing. No forex trader will win every time. There are bound to be winning and losing trades. The point is to overcome the fear of losing that is causing you to make repeated, similar trades. Always look at statistics and trends. Forex trading is about repeating profitable trades, re-configuring some trading rules along the way, and remaining consistent with money management. Fear has to be removed from every trade; instead, forecast or estimated results should be anticipated in your feelings. Cast fear aside and trade without emotion.
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- Warren Buffett
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