Forex, also known as foreign exchange or currency trading, is a decentralized global marketplace where all the currencies in the world are traded. The foreign exchange market is the largest and most liquid market in the world, with an average daily trading volume of over $5 trillion. Here is a guide for beginners in forex market.
Forex Trading and the Forex Market
Forex trading is the act of buying and selling currencies. Forex is the largest market in the world, and the transactions that take place in it affect every aspect of life.
In any forex trade, you need to choose two currencies and speculate that the value of one currency will rise or fall relative to the other.
Participating in the foreign exchange market is the easiest and most efficient way to exchange currencies. You don’t have to queue at a currency dealer and pay an undue premium to trade funds. Instead, all you need is computing power, an internet connection, and a Forex broker to participate in the global currency market.
If you’ve ever traveled abroad, you’ve already traded foreign exchange. For a trip to France, you can exchange pounds for euros. When you do this, the foreign exchange rate (based on supply and demand) between the two currencies determines how much you can exchange pounds for euros. And the exchange rate keeps fluctuating.
There are several key differences between exchanging currencies abroad and buying and selling foreign exchange.
- The first is convenience. The foreign exchange market is a decentralized electronic exchange. Therefore, participants can trade currencies anytime and anywhere the market is open.
- The second is efficiency. Forex traders enjoy maximum liquidity, which promotes tight spreads, regular volatility and rock-bottom pricing.
How does Forex Trading Work?
The foreign exchange market is not a physical market. Rather, it is a decentralized global network where transactions take place in a specialized electronic format. Buy and sell 24 hours a day, 5 days a week. In the foreign exchange market, traders buy and sell “currency pairs” based on each other’s value.
When you buy or sell in the foreign exchange market, you exchange one currency for another. People buy currency based on their belief that the currency will change in value.
Many factors affect the value of a currency in foreign exchange; factors such as inflation, economic growth, consumer confidence in a given country, jobless claims, and housing prices all affect a currency’s position in the market.
How to Start Forex Trading?
All foreign exchange transactions involve two currencies because you are betting on the value of one currency against another.
You will always see two prices because one is the bid price and one is the ask price. The difference between the two is the spread. When you click Buy or Sell, you are buying or selling the first currency in the pair.
The following are seven major currency pairs – account for about 75% of trading in the foreign exchange market:
Suppose you think the euro will appreciate against the dollar. Your currency pair is EUR/USD. Since the euro is number one and you think it will go up, you buy EUR/USD. If you think the euro will depreciate against the dollar, you sell EUR/USD.
If EUR/USD is bid at 0.70644 and ask at 0.70640, the spread is 0.4 pips. If the trade goes in your favor (or against you), then once you cover the spread, you can make a profit (or lose) on the trade.
Three Ways of Forex Trading
The purpose of most foreign exchange transactions is not to exchange currencies, but to speculate on future price movements. Similar to stock traders, forex traders try to buy currencies that they believe will increase in value relative to other currencies, or to get rid of currencies that they expect to lose in purchasing power.
There are three different ways to trade Forex:
- Spot market. This is the main foreign exchange market where these currency pairs are exchanged and exchange rates are determined in real time based on supply and demand.
- Forward market. In addition to executing a trade now, a Forex trader can enter into a binding (private) contract with another trader and lock in the exchange rate for an agreed-upon amount of currency at a future date.
- Futures market. Likewise, traders can choose standardized contracts to buy or sell a predetermined amount of currency at a specific exchange rate on a future date. This is done on an exchange rather than privately as in the forward market.
Forward and futures markets are primarily used by foreign exchange traders who want to speculate or hedge against future price changes in a currency. The exchange rates in these markets are based on the conditions of the spot market, which is the largest foreign exchange market and where most foreign exchange transactions are performed.
Pros and Cons of Forex Trading
Like all markets, Forex has a unique set of advantages and disadvantages. It is important for any aspiring currency market participant to conduct adequate due diligence and determine whether foreign exchange trading is suitable.
- Flexibility and variety can be two of the strengths of Forex trading. The ability to open long or short positions in the world’s leading major, minor or exotic currencies provides traders with countless strategic options.
- Remote access, limited capital requirements and low operating costs are some of the advantages that attract all types of traders to the Forex market. Additionally, Forex is the largest market in the world, which means consistent depth and liquidity are all but guaranteed. Retail traders enjoy a high degree of strategic freedom given the variety of products.
- First, the availability of enhanced leverage and a wealth of trading options can seriously test one’s discipline. Past performance is not indicative of future results – forex trading is always changing, emphasizing the need for sound strategies and strong risk management.
- In addition, price movements can be rapid and violent, creating the risk of quick, significant losses. Because Forex trading requires leverage and traders use margin, Forex trading carries additional risks than other types of assets. Currency prices are constantly fluctuating, but with small fluctuations, which means that traders need to execute large trades (using leverage) to make money.
- What’s more, most of the few retailer traders who work on Forex are struggling to make money from Forex. CompareForexBrokers found that, on average, 71% of retail forex traders lose money. This makes forex trading a strategy that is usually best left to the professionals.