What Is Forex Trading And How Does It Work: Forex Trading Basics
For novice traders, it is necessary to know what is Forex trading and how does it work.
In the currency market, traders and investors buy, sell, and exchange one currency to another one. Forex market determined the Forex exchange rate. However, the market is decentralized.
Not only traders but also different financial instruments are in the part of this currency trading market. The daily Forex market turnover is more than $5 Trillion. In general, it is the most liquid market in the world.
Traders can open a trading position without any legal rules and regulation. However, almost all broker platforms are regulated by regulatory bodies.
This article will help you to know more about forex trading and its features. You will also get to know, how Forex trading works.
Let’s start with the basics of Forex trading.
What Is Forex Trading
Forex is a short form of the Foreign Exchange. The foreign exchange market is a “Place” where currencies are traded.
Similarly, exchanging one currency with another currency is known as Forex. In Forex trading, investor’s only exchange currency rather than exchanging commodities.
In Forex, currencies are quoted in pairs.
- Base Currency
- Quoted Currency
The base currency is a transaction currency. It is the first currency against exchange rates, that generally quoted in a given country. Example: USD/JPY.
On the other hand, the Quoted currency is the second currency pair in Forex.
Let me explain the process of currency quotation.
Suppose you are trading with EUR/USD. Here, the base currency is EUR and the quoted currency is USD.
The ask or bid price for a currency pair represents how much you will get from the quoted currency for selling one unit of the base currency. So, traders need to pay 1,2200 US dollars in exchange for One EURO.
Because of frequent currency fluctuation, the FX market considers as the most volatile market.
Based on the demand and supply, currency rate changes. Moreover, currency market assists international trade and investments by enabling currency conversion.
How Forex Trading Works
As we mentioned before, currencies are quoted as pairs in the Foreign Exchange market. In the Forex market, you have to go long with one currency pair and also go short with another currency pair.
For a novice, we would also like to recommend you to trade with one currency pairs rather than investing as many.
A position in which the base currency is bought by expecting to sell at a high price is known as going long in Forex. Example: USD/JPY.
Also, if you want to buy USD that means you are going long for these currency pairs.
In a short position, traders sell the base currency. The short position is the opposite side of a long position. Example: USD/JPY.
To sell JPY, traders need to go for a short position.
Generally, you have to open an account before trading. The account will help you to trade in the Forex marketplace.
In Forex trading, you have to open a position depending on the trading lot. The lot size is also known as the contact size.
You can open a trading account depending on the broker platform. Brokers will give you facilities to choose your trading margin, leverage, minimum deposit, and other features.
Eventually, in the forex marketplace, you will get these following types of accounts:
- Mini Account
- Standard Account
- VIP Account
- ECN Account
- Zero Spread Account, and so on.
Each account has its unique features. Apart from all account types, you will find a demo account facility from all brokers.
A Forex demo account is helpful for both novice and expert traders. Trading with virtual money will give you a risk-free trading environment.
Without having a clear vision, it’s better not to deal with the currency market.
Trading forex is similar to the stock market. As we mentioned before that you have to open a trading account to place order.
Let’s see how to trade forex by following a few trading processes.
How To Trade Forex
Suppose your account is ready to trade and you want to open a position. So, to trade forex, you have to deal with margin, leverage, and other few terms.
As we mentioned earlier, each trading account is different along with its services. Via online, you can trade forex in multiple ways.
- Understand the Forex terminology properly.
- Choose a regulated broker
- Know more about currencies, especially those which you are going to trade.
- Analyze the market properly. It is wise to use a demo account to understand the platform and its features.
- Place your order by setting up a proper stop loss and take profit.
Here, Forex trading works after considering a few following principles:
- Trade when the market is Bullish. Through the Bullish market, traders enter to buy financial products. The bullish market helps traders to earn a profit. Moreover, in the Bearish market, traders sell financial products so that they can buy at a lower price.
- In Forex, profit or loss is calculated depending on the PIP value. A pip measures the amount of change in the exchange rate for a currency pair. Traders calculate the pip value by using the last decimal point.
- A lot refers to the position size. It means, how much you are buying and selling.
- Spread is the difference between the buying price and the selling To calculate profit or loss, you have to count spread.
- Forex margin is increasing your buying power. A Margin is a deposit amount to open a new position with the broker. It is a percentage of the full amount of a position. Traders calculate the total leverage, based on a margin amount.
- Leverage consider as a ratio in Forex trading. When a trader borrows money from brokers, it is known as leverage.
Basics of Forex Trading with Opportunity
Via a trading platform, you can trade currency from anywhere you want. Moreover, it is an enormous opportunity for those people who want to work from home.
Apart from the extra income, there are also some other opportunities which encourage people to invest money into currency trading.
Forex market is the most liquid market so, price moves very frequently.
So, to predict the price movement, you can use the Future market tools. With the help of these tools, you can predict a short time price movement.
Not only the forex trading but also, for many trading classes, demo account works as a practice tool.
Traders can easily practice their trading by using virtual money.
Keep on the eye when the market is changing. Similarly, research on the price movement of the market depending on your trading types.
For day traders, it is necessary to check the market throughout the day.
Trading opportunities depend on the market direction. You will find the right market direction by using different trading tools.
Trading tools will help traders to analyze the market chart. In the Forex market direction, economic news or events have a great impact.
Trading time is flexible in the Forex market. You can trade whenever you want from Monday to Thursday.
Moreover, you can also trade forex during weekends. Because the forex market operates it’s business 24 hours.
Most of the traders are attracted to trade Forex only because of its accessibility. Forex is a source of profit for both professional and novice traders.
Even more, you can start trading with a small amount.
Day trading is another short term trading type. You don’t need to hold an overnight position in day trading.
Traders start and exit the trade on the same day. With a small amount, you can start your first trade with a regulated broker.
You can learn about Forex trading from different websites. Most of the website has customer care services to furnish you more precisely.
In Forex trading, real-time charts are available to give proper information to their traders.
Why Forex Trading Is Popular
Forex trading opportunities are quite accountable for its popularity. Traders from around the world can get access easily to the Forex market.
The market is open almost 24 hours a day. So, you can trade anytime depending on the trading time-zone.
Another key point the market is open somewhere in the world if it is close to your region.
Traders can trade with the help of a computer or mobile device. Anyone can trade if they have an internet connection.
There are so many Forex platforms which are designed perfectly for trading. The market is monitored by different regulatory bodies. Moreover, the regulation helps traders to avoid scam activities.
Forex Market Size
The Forex exchange market is unique because of the following reasons:
- The trading volume
- Geographical reason
- Trading hours
- Leverage uses
- Exchange rate.
Liquidity means how much money is flowing through the market. In terms of liquidity, the currency marketplace is the largest one.
The entire market is running on electronic devices. Traders can trade from anywhere by using smartphones or laptops.
There is no interbank or central exchange to control this market. Forex market is a worldwide living exchange market. So, no central location available. In Forex trading, the most liquid currency is U.S Dollar compare to the other currencies.
USD approximately traded 85% in Forex and EURO traded approximately 6%-7%.
Difference Between Other Market And Forex Market
There are multiple types of markets like Indices Market, Commodity Market, and the Stock Market.
In Forex trading, trade depends on our flexible time. Trading the FX market will have a great opportunity to earn a profit. Forex market does not have any end day calculation. So, you can trade from anywhere in anytime.
Depending on the real-time buy and sell rates, you can open a position.
In the stock market, you will get hundreds of markets, where Forex has no interbank market. You can invest any amount depending on the broker preference.
The first difference between Forex and other markets is its sheer size. Forex spreads are always transparent and minimum.
Also, you can trade without any broker’s commission. Brokers will earn their profits from fixed or variable spreads.
Major currencies are the most traded currencies. The pip changes depend on Gold and Oil price.
Benefits Of Investing In Forex Trading
Expert says “The bigger your capital, the larger your trade size”. Globally, the Forex market is the most liquid market which we have repeated many times.
Forex trading market is a place to exchange of global currency. Investing in the Forex market also has some advantages. These are:
In Forex, broker charges fees based on the spread. Costs vary from brokers to brokers. Few brokers do not accept spread. They charge a commission from traders.
Moreover, the commission in Forex either can be a fixed fee or a relative fee.
The forex market allows its traders to trade directly into the investment market. You don’t need to trade via any middleman.
However, traders open a trading position with the help of trading brokers. Via the platform, they enter into the market to execute a trade.
In the Forex market, no fixed lot size is available. You can invest in a standard lot or a micro lot. You will determine your lot.
Transaction cost is limited in Forex trading. Retail transaction cost in approximately 0.1% if the market is stable.
Similarly, larger dealers don’t cost more than 0.07%. Here, the transaction cost depends on the leverage.
The foreign exchange market is huge. There is no single entity can control the market. It is a marketplace, where no central exchange or central bank related.
People trade here by using their electronic devices.
Leverage is an important weapon in Forex trading. As earlier, we said, you can earn profits by investing a small amount.
Forex exchange is the best for liquid transactions. Euro/USD, USD/JPY, GDP/USD have high transaction rates.
Thus there are a huge number of investors in the Forex market but barriers are minimal. Online Forex brokers offer “Mini” and “Micro” trading accounts. The minimum investment amount starts from $5 depending on the broker’s criteria.
Some brokers offer no deposit balance as well.
Forex trading is providing the newest platform in the trade market. Brokers use the latest technology for traders so that, traders can invest more and also can get enough information through the internet.
Traders can close their positions automatically. They can set a stop-loss order to close their position at once they reach in their desired profit.
When Can You Trade Forex
Forex market hour and the trading session is an important factor while placing a trade. As we mentioned before, in the Forex market, investors can trade 24 hours.
London is the main trading center. The trading market starts from the morning (Monday) in Australia and ends in New York (afternoon). Forex market opens in 5 days a week.
As a part-time trader, you can trade morning, evening, and even when you are in your bed with soft pillows.
We are in the middle of this article. Still, we need to go far away with some valuable information which is related to the Forex market.
Now, we are going to disclose the main participants of Forex Trading.
Who Trade The Currency Market
Forex can be traded by anyone. A large number of people with a big capital are now dominating the Forex market.
However, here are four levels of participants who trade Forex. Firstly, in the intermediate level, normal traders are trading Forex.
Secondly, different types of financial institutions and banks are involved in the market as a medium level of investors.
In the third level, the international Foreign Exchange brokers are trading the FX market.
Finally, in the last level, the central bank trades forex. We are going to present a list of these participants below:
- Central Banks
- Commercial and Investment Banks
- Business and Corporations
- Fund Managers
- Hedge Fund Managers
- Internet-based Trading Platform
- Online Retail Brokers
- Financial Institutions
- International Companies
- Import- Export Business
- Multinational Companies
The biggest foreign exchange dealer is Bank. The financial center also performs an important role in Forex trading.
Trades with foreign exchange dealers can be very large; involving hundreds of millions of dollars.
For example, an importer is importing goods in China from the USA. He needs to pay the amount based on the current rate of Dollar.
If the dollar price increases, then the importer will be a loser and the exporter will be a gainer.
It is an appreciation of the dollar. On the other hand, for traders, it is the transaction risk.
How To Buy And Sell Currencies
Beginners are puzzled to take a decision on which currency they will buy and which they will not.
Forex trading is all about buying and selling currencies. You are betting one currency against another one. As a result, one currency is the base currency and another one is the quoted currency.
You have to know the current market positioning before opening a position. Suppose you want to trade EUR/USD. The currency pair is the most demandable currency pair among all.
After judging the market trend if you think that the Euro will go up, then you will buy EUR/USD.
Similarly, if you think that Euro will go down against the U.S dollar, then you will sell EUR/USD.
In the foreign exchange market, selling is noted as the Bid price and currency being bought at the Offer price. In offer price, traders buy currency from brokers. The difference between the bid and offer price is spread.
It might help you to know that the buy price is always higher than the selling price.
Types Of Currency Pairs
Now, you know a little more about Forex. There are a few major currencies, few cross currencies, and a few exotic currencies.
Let’s explain one by one:
Currency pairs that we are listed below considered as “Major” currency pairs. These pairs are widely used by traders.
There are 8 major currencies pairs. These are:
Sometimes the U.S dollar performs as the base currency and sometimes performs as a quoted currency. Undoubtedly, major pairs are widely traded around the world as they have very narrow spreads.
Currencies that do not have the U.S dollar is known as a cross-currency pair. Example: GBP/JPY. For trade purposes, the EUR/GBP and EUR/CHF are common cross currency pairs.
There are three major crosses named EUR, JPY, and GBP.
These cross currency pairs are widely used in the Forex Market.
Exotic currencies are not traded as often, because of its high transaction costs. The currencies are liquid, lack of market depth, and trade at low volumes.
Trading an exotic currency can be expensive; as the bid-ask spread is usually large. Traders should apply caution when they want to trade exotic currencies.
Let’s have a look at the categories of different types of Forex market.
Types Of Foreign Exchange Market
Forex market determines the Foreign Exchange rate. With the help of Forex market, traders trade their currency pair.
There are 3 types of Forex markets named Spot, Future, and Forward market.
Let’s have a short brief on Forex Market.
In the spot market, two parties have agreed to buy or sell currencies in the present or current market price. The spot market has the quickest transaction market.
Therefore, this transaction involves immediate payment. The spot market is the largest marketplace among other currency markets.
In the spot market, traders close their deal within two days or 48 Hours. The Spot market runs its function in continuous based or clockwise. There are no holidays in the spot market from Monday to Wednesday. The rate at which transactions are settled is known as the Spot Exchange Rate.
Spot market participants are:
- Commercial Banks.
- Central Banks
- Dealers, Brokers, Speculators.
The forward market is a marketplace where financial assets take place or traded for future delivery.
The forward market is not located in any specific place. Some specific dates are mentioned by the traders.
Approximately, after 90 days of the deal, the forward market allows more flexibility.
Contracts can be more customizable by the trader.
Forward market primarily deals with those currencies which are frequently used by the traders.
In the Forward Forex market, no margin is required.
Bank agrees to exchange one currency for another, at a future date. In which rate Banks enter into a forward contract with an investor, is known as the Forward Exchange rate.
Any kinds of developing country’s currencies are not allowed in the forward Market.
There are so many similarities between a Future market and a Forward market.
Future market is centralized. In the Future market, two parties buy or sell assets on a given amount at a predetermined price at a set date in the Future. It means traders buy or sell currencies in Future date agreed upon price.
Future market is popular among those traders who trade a large amount of money.
The assets which are often underlying futures contracts include commodities, stocks, and bonds.
In the end, we can summarize that the spot market is for those traders who have a little amount of money or for big capital investors.
Future and Forward market are for big companies who have lots of investments. On the other hand, the Spot market is popular only for its simplicity.
Some factors can affect Forex currencies demand which we mentioned in our next phase.
Factors That Can Affect Currency Demand
Thus there are many factors that can affect the demand level of Foreign currencies, the market is evergreen.
The Exchange rate is interpreted as in which rate one currency is converted to another currency.
The fluctuation of the exchange rate depends on the supply and demand of the Forex market.
Central Bank holds the supply of Foreign Exchange rate.
Here is the list of those factors that can affect the demand level of currency over either the short-term, medium or long-term time frame.
In risk appetite traders are willing to trade or invest in higher interest rate.
In Forex, volatility means how much risk is involved in the short change of exchange rate. Volatility describes the fluctuation of an exchange rate. Higher volatility contains higher currency risk.
Inflation and interest rate are related. Currency demand changes when the interest rate changes. Higher interest rate provides higher rates to brokers.
Political risk will affect the currency exchange rate if one country is not stable in political issues. It is really difficult to avoid the political situation.
Economic growth plays a vital role in the exchange rate. When a country has bad economic growth then the interest rate will fall.
In the global marketplace, people buy and sell products from different countries. We all have that intention to buy foreign country’s products. We import products which are higher than the export. The higher number of product import will push our currency price down.
In market sentiment, every trader has their own personal opinion about changing market sentiment. This issue is a key point for changing exchange rate. No matter how much they are confident, they will end up losing money if they do not follow the market flow.
Changes in market inflation cause changes in the currency rate. Lower inflation rate helps to raise currency demand.
When a country’s currency value is expected to rise, the investor will try to invest more in that currency. Due to the increasing demand, the currency exchange rate will increase.
Government debt is one kind of public debt. When a country has higher debt then this will lead that country in inflation. National debt is owned by the Central Bank. This will decrease the value of the exchange rate when the foreign investor will sell bonds or stock in the open market.
Finally, we can say that-
“Invest in yourself because Your Career is the Engine of Your Wealth”.
In this article, we tried to cover up the basic things of Forex. Forex trading basics are mandatory to know if you take Forex trading seriously.
Forex trading is different from other financial investment for its exclusive features.
If you are passionate about Forex trading, then you can win a trade.
However, it is not possible to win every trade.