Intro Guide to Forex Trading – Forex Trading Explained
Trading on the foreign exchange market, which is simply called FX or Forex Trading, is a marketplace that is not centralised and deals with the buying and selling of various currencies the world over. The trading is done through the interbank rather than the typical exchange that is centralised.
You have gone through FX simply by ordering an item that is imported or when you have to purchase foreign currency when traveling. The main reasons that FX trading is popular these days is:
- The large FX market overall
- The many currencies from countries around the world that can be bought and sold
- The various volatility levels
- You can trade in the FX market 24/7
This article is a good benchmark for FX traders no matter if they are beginners or experts. If you are a beginner in the FX market you can gain some valuable knowledge about what it is all about and if you know about it you can build on that knowledge to further your investment endeavours.
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The Forex Market 101
Basically, the FX market works like other markets in it is driven by supply and demand. In an example that is very simple, let’s say there is a big demand for the U.S. Dollar from people that are in Europe that have a lot of Euros they will then look to turn the Euros they have into Dollars. The Dollar value will increase and in turn, the Euro value will decrease. You have to be aware that in terms of this transaction that the Euro and Dollar pairing will not cause either currency to appreciate or depreciate against any other currency.
Explaining the Fluctuation of the FX Market
The example given above is one of a lot of things that can make the FX market move. Other factors are things such as a newly elected president or things that are specific to a certain country, and its currency, such as the gross domestic product (GDP), the unemployment situation, and inflation, and those are only a few things.
The best, and by best the most successful, FX traders use a calendar based on the economy in order to stay abreast of factors such as the ones just mentioned and other key economic information that will make the market fluctuate.
Why is the FX Market Such a Popular One?
The FX market is one that makes it so bigger businesses, governments, traders in retail goods, and the private sector to exchange one currency for another one between banks to make a profit. And the main answer to why the FX market is so popular is that many can make a profit from it.
It is advantageous for FX trading between banks around the world considering it can be bought and sold 24/7. So, the Asian trading session is coming to an end but the banks in Europe will then go online and then the same things happen in the United States. The trading day will conclude when the U.S. session closes while the Asian one is just opening. As you can see, there is no downtime when it comes to FX trading.
Another reason for the popularity of the FX market has to deal with liquidity. By far the most liquid market the world over is the FX one. Currently, the amount traded per day is nearly $7 trillion. This means traders in the market have an easy time buying and selling currencies considering there are always many buyers and sellers in the FX market.
How Does FX Trading Work?
It is pretty easy to show how the FX market works. If you are under the belief that a certain currency will appreciate (increase in value) then you will buy it and this is referred to as going long. On the other side of the coin, if you are under the belief that a currency will depreciate (decrease in value) then you will sell it and that is referred to as going short.
You want to have a good read on the market to see how currencies are performing at the time to see if you can make money buying or selling it.
Who is In the Forex Market?
While many people trade in the FX market the two categories of traders are hedgers and speculators. The hedgers want to stay away from big fluctuations in the FX rate. An example would be big companies and how they always want to have an exposure reduction to the movements of foreign currency. In turn, speculators are more risk-takers, as they are constantly on the lookout for exchange rate volatility to cash in on. A few examples of common speculators are trading desks, larger commercial banks, and traders in retail goods.
How to Read an FX Quote
You have to know how correctly read an FX quote since it will come up with the price entered and then how you buy and sell.
Here is an example of a Euro/US Dollar FX quote:
In this example, the currency that is the base is the Euro, and the variable currency, aka the quote currency, is the U.S. Dollar. Usually, for forex markets, the prices of the currencies will go up to 5 decimals with the first one being the vital one. The number that is left of the decimal point will show a single unit of the variable (quote) currency. In the example shown that is the U.S. Dollar and because of that it is $1. The next two numbers will be the cents and, therefore 14 cents. The numbers that are fourth and after will show the cent fractions and, in terms of FX trading, are called pips.
The pip is a very key term to know in terms of reading an FX quote. In the example above, let’s say the Euro goes down, depreciates, against the U.S. Dollar to the tune of 100 pips. Now the price of sale will show the decreased price of 1.12528 considering the cost is less in Dollars in order to purchase one Euro.
The Main Advantages for Trading in the FX Market
Here are the main advantages of trading in the forex market:
- Transaction costs are very low – Usually, brokers in the FX market will earn money with the spread if the trade opens and closes prior to any charges pertaining to funding that is overnight are applied. Because of that, FX trading can be profitable going up against a market such as an equities one considering that can come with a charge for commission.
- Spreads are on the lower side – Both Bid and Ask spreads are very low for the more popular forex pairs, such as EUR/USD and GBP/EUR, considering they are very liquid. When taking part in an FX trade the spread is the first obstacle to deal with when the market is solid for you. More pips that are advantageous for you are then simply profit.
- Additional profit opportunities – trading in the FX market lets traders make speculation on currencies they believe will increase, appreciate, or decrease, depreciate. Moreover, traders have a lot of options when it comes to seeing trades that can turn a profit considering the many currency pairings.
- Leverage – In FX trading leverage is used, as a trader does not have to pay in full for the trade but rather pay only a fraction of the whole price. This can increase profits but at the same time can also increase losses.
FX Trading Glossary
Here are a few key terms in FX trading:
- Base currency – The first currency is shown in an FX currency pair. For example, the base currency for EUR/GBP is the Euro.
- Variable currency – Also known as the quote currency and it is the second currency in a pair. For example, for EUR/GBP the variable currency would be the Great British Pound.
- Pips – Also referred to as points the pip is a single-digit move that is the fourth decimal in a quote. This is typically how FX traders call movements in a pair of currencies such as EUR/USD increased 100 points on Monday.
- Bid – The bid price is the most the purchaser, one who bids, is willing to pay for a transaction. If you want to purchase a currency pair the bid is typically just to the left of the FX quote and it is usually in the color red.
- Ask – The ask is the direct opposite of the bid in it is the price that is the lowest that the person selling will take. When you want to purchase a currency pair the ask is typically just to the right of the FX quote and it is usually in the color blue.
- Spread – The spread is the difference in price from the bid and the ask that is the official spread in the FX market as well as the spread that is additional and tacked on by the forex broker.
- Liquidity – a currency pair in the FX market is one that is liquid if it is simple to buy and sell since there are many trades going on for that specific pair.
- Leverage – Leverage lets FX traders trade positions and they only have to pay a small amount of the overall value of the FX trade. What this does is let traders have positions that are bigger with an amount of capital that is smaller. Leverage not only increases gains but losses as well.
- Margin – The margin is the money that you will need to open a position of leverage. It is the difference that is between the total value of the position you have and the money that will be lent to you by the forex broker.
- Margin call – The margin call is when the full amount of money (capital) is deposited, as well as any increase or decrease in profits and losses, goes under a certain level, which is the margin requirement.