Foreign exchange trading, also known as forex trading or FX, is the international market for the exchange of foreign currencies. The foreign exchange market is the largest market in the world, and its trades affect everything from the cost of imported goods to holiday essentials.
So what exactly is Forex?
Have you ever been to a different country and swapped your money for the currency of that country? When I first started traveling, getting my hands on the cash of a different nation was such a thrill. Yes, recall that time when thinking about Forex. In currency trading, a trader buys one currency and sells another, and the buying and selling prices of the two currencies are continually changing as a result of supply and demand. Supply and Demand, this is truly what it’s all about. The foreign exchange market (Forex) is a global marketplace where currencies are traded around the clock, Monday through Friday. Foreign exchange (FX) trading takes place entirely through over-the-counter (OTC) transactions, unlike the stock market, which relies on a physical exchange. Instead, the market is regulated by a worldwide system of banks and other financial organizations (instead of a central exchange, like the New York Stock Exchange).
We’ve reached what might be the most crucial point in the entire article. Did you know that in 2022, even though there are more than 10 million forex traders worldwide, they still make up the minority in terms of their influence on the market? Governments, large banks, and institutional traders are the true drivers of market prices. I’ll spare you years of perplexity. In the event that you are just starting out. Discover “Smart Money Concepts”. Institutional traders, including those at banks, fund managers, and multinational organizations, account for the vast bulk of daily volume in the foreign exchange market. These investors may be speculating on or hedging against future changes in the exchange rate rather than intending to take physical possession of the currencies themselves.
When trading foreign exchange, one currency is bought (and another sold) based on the expectation that the value of the purchased currency will increase in relation to the other. Meanwhile, a U.S. firm with European operations may protect itself from a decline in the value of its euro-denominated earnings by investing in the foreign exchange market.
How Foreign Exchange Works?
Most foreign exchange trading involves the U.S. dollar, so knowing its code, USD, is especially helpful. The euro, which is used in 19 countries in the European Union, is the second most-traded currency on the foreign exchange market (code: EUR).Other popular currencies include the Japanese yen (JPY), the British pound (GBP), the Australian dollar (AUD), the Canadian dollar (CAD), the Swiss franc (CHF), and the New Zealand dollar (NZD) (NZD).All foreign exchange transactions are expressed as a mixture of the two currencies involved. About 75% of all trading on the forex market happens with these seven major currency pairs below:
Currency Exchange Rates & Quotes
Let’s take the EUR/USD exchange rate, between the euro and the US dollar, as an example to clarify what that means:
The Euro (€) is the “base” currency.
The dollar shown to the right is the quoted currency.
One unit of the base currency can be purchased for a given amount of the quote currency, as shown by the exchange rate. Therefore, 1 unit of the base currency is always expressed, while the quote currency varies according to the state of the market and the amount required to purchase 1 unit of the base currency.
A rate of 1.2 between the Euro and the US Dollar indicates that one euro can be purchased for 1.20 US dollars.
A higher exchange rate indicates that the base currency is more valuable than the quote currency (because one euro can now be exchanged for more U.S. dollars), whereas a lower exchange rate indicates that the base currency is less valuable than the quotation currency.
It is common practice to list the base currency first and the quote currency second when presenting a currency pair, while some currency pairs follow a different historical norm. Examples include the listing of EUR/USD rather than USD/EUR for USD to EUR exchange rates.
Forex Trading: Three Approaches
Akin to stock trading, foreign exchange (FX) trading involves betting on the direction of prices in the future. Foreign exchange (FX) traders, like stock traders, aim to profit from the rise or fall in the value of currencies by buying and selling them. Consider again the law of supply and demand. To continue, consider the premium and the discount. It’s the article’s most important takeaway. Essentially, you should buy cheap and sell expensive. You’ll be glad you read this afterwards. Foreign exchange (FX) traders can achieve their goals through one of three strategies:
Position trading; the spot market. This is the main foreign exchange market where buyers and sellers interact in order to establish a price for the exchange of one currency for another.
Futures trading. Foreign exchange (forex) dealers can agree to a private, legally binding contract with another trader to lock in an exchange rate for a predetermined quantity of currency at a specified future date, rather than immediately executing a trade.
The futures exchange. Similarly, investors may choose a standard contract to purchase or sell a fixed quantity of currency at a predetermined exchange rate on a future date. Instead of doing it privately on the futures market, this is done on an exchange.
FX traders who are interested in making a futures or forwards bet or hedging against a currency’s price volatility are the primary users of these markets. Most foreign exchange transactions take place on the spot market, the largest of the forex markets, and so reflect exchange rates seen there.
Currency Pair-Currency pairs are used in all foreign exchange trades. There are also less common trades besides the majors (like exotics, which are currencies of developing countries).
Pip-A pip, which is short for “percentage in points,” is the smallest price change that can happen within a currency pair. Because forex prices are given with at least four decimal places, a pip is equal to 0.0001.
Bid-ask spread-As with other assets, like stocks, exchange rates are based on the highest price a buyer is willing to pay for a currency (the bid) and the lowest price a seller is willing to accept for it (the ask) (the ask). The bid-ask spread is the difference between these two amounts, which is also the price at which trades will be made.
Lot-A lot is a standard unit of currency that is used to trade Forex. The standard lot size is 100,000 units of currency, but you can also trade micro (1,000 units) and mini (10,000 units) lots.
Leverage-Some traders might not be willing to put up so much money to make a trade because the lot sizes are so big. Leverage, which is another word for borrowing money, lets traders take part in the forex market without having the amount of money that would be needed otherwise.
Margin-Using leverage to trade isn’t free, though. Traders must put money down as a deposit, which is called “margin.”
What Drives The Forex Market?
Like any other market, the price of a currency is set by how many people want to buy or sell it. But this market is also affected by other large-scale factors. Interest rates, central bank policy, the rate of economic growth, and the political situation in a country can also affect how much people want to buy or sell a certain currency.
The forex market is open 24 hours a day, five days a week. This means that traders can react to news that might not affect the stock market until much later. Because so much of currency trading is based on speculation or hedging, traders need to be aware of the factors that can cause currencies to jump up and down quickly.
The Risks Involved
Forex trading is riskier than trading other kinds of assets because traders use leverage and margin. Currency prices change all the time, but only by very small amounts. This means that traders need to make large trades (using leverage) in order to make money.
If a trader wins a bet, this leverage is great because it can make profits bigger. But it can also make losses bigger, sometimes to the point where the original amount borrowed is lost. Also, if the value of a currency falls too much, people who use leverage risk getting margin calls, which could force them to sell securities they bought with borrowed money at a loss. Aside from the risk of losing money, transaction costs can add up and cut into what could have been a profitable trade.
On top of that, you should remember that people who trade foreign currencies are small fish in a big pond of skilled, professional traders. The Securities and Exchange Commission warns new traders about fraud and information that could be confusing.
So, maybe it’s a good thing that individual investors don’t do as much forex trading. In fact, retail trading, or trading by people who are not professionals, makes up only 5.5% of the global market, according to data from DailyForex, and some of the biggest online brokers don’t even offer forex trading.
Also, the few retail traders who do forex trading have trouble making money with it. CompareForexBrokers found that 71% of regular FX traders lost money on average. Because of this, forex trading is often a strategy that is best left to the experts. If you’re just starting out and want to save yourself years of losses, and wasted time it’s best to seek mentorship. Always check to see if the company or individual has a Youtube channel where you could get an understanding of their teachings, social media platforms as well as testimonials from real people. Here is a perfect example of an all in one site, http://solo.to/plfcryptofx.
The Forex Beginner’s Checklist
A mentor– Who does not claim to be an expert or “guru” but rather a person who’s results you hope to someday make your own. (Stay clear of too good to be true scenarios. This adds to the financial losses. If you cannot afford mentorship yet. Find 1 or 2 traders and study their free content.
A demo account– Find a broker that you’ve done research on and use their demo account. NEVER start trading with live funds. Gain consistency with a strategy or method that you have been studying, and when you are ready, start with a small trading account.
Trading journal– This could be a simple notebook. Jot down your trades…wins losses, the things that confuse you, your thought process as well as the emotions tied to your experience. This helps build a strong trading psychology and learn from past mistakes
Platform to mark up charts– Tradingview.com what I love about this platform is that you are able to take advantage of their free account service, view ideas, and stay organized.
Understanding of risk– Please do not trade with money that you are not comfortable with losing, and always aim to only risk 1% of your account size.