A Beginner's Guide to Forex Trading

The foreign exchange market (sometimes known as the forex or FX market) is a market for exchanging foreign 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, at its most basic, is analogous to the currency exchange you could perform when traveling abroad: A trader buys one currency and sells another, and the exchange rate varies continually due to 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 is conducted by institutional traders, who work for banks, fund managers, and international organizations. These traders may not plan to take actual ownership of the currency; instead, they may be speculating 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 issued a three-letter identifier, similar to the ticker symbol of a stock. 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: USD is extremely useful. 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).

Every forex transaction is stated as a combination of the two currencies being exchanged. The following seven currency pairings, known as the majors, accounting for around 75 percent 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 the data, using EUR/USD as an example (the euro-to-dollar exchange rate):

• 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.

A short note: Currency pairings are typically presented with the base currency first and the quote currency second, while certain currency pairs have a historical tradition for how they are written. Conversions from USD to EUR, for example, are reported as EUR/USD rather than USD/EUR.

Three Forex Trading Methods

Most forex traders aren't designed 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 spot 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 forward market. Instead of completing a deal right away, forex traders may engage in a binding (private) contract with another trader to lock in an exchange rate for an agreed-upon quantity of currency at a later date.

• The market for futures. 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. The exchange rates in these markets are determined by what is going on in the spot market, which is the biggest of the forex markets and where the bulk of forex deals are performed.

Forex Terms You Should Know

Every market has its jargon. Before you start trading forex, you need to be familiar with the following terms:

• The currency pair. A currency pair is included in all forex trading. Aside from the big, there are other less frequent deals (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 money, is used to trade forex. 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. Trading using leverage, on the other hand, is not free. Traders must put money down as a deposit, which is known as a 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, which allows traders to respond to news that may not affect 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

Because forex trading needs leverage and traders employ margin, it has more risks than other forms of assets. Currency values are continually moving, but only in extremely little quantities, requiring traders to execute big deals (using leverage) to profit.

If a trader makes a successful wager, this leverage may greatly increase earnings. However, it has the potential to multiply losses, potentially to the point of surpassing the original loan amount. Furthermore, if the value of a currency falls too much, leverage users expose themselves to margin calls, which may compel them to sell stocks acquired with borrowed cash at a loss. Aside from potential losses, transaction charges may build up and could eat into a winning deal.

Furthermore, bear in mind that people who trade foreign currencies are little fish in a pond of sophisticated, 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 percent 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 percent of retail FX traders lose money on average. As a result, forex trading is frequently a method best left to specialists.

Why Forex Trading Is Important for Ordinary Consumers

While the ordinary investor should certainly avoid the forex market, what occurs there affects all of us. The price we pay for exports, as well as the cost of traveling overseas, will be influenced by real-time activity in the spot market.

If the value of the US dollar rises about 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). On the other hand, when the dollar falls in value, it becomes more costly to fly overseas and import things (but companies that export goods abroad will benefit).

If you're planning a large purchase of imported goods or a trip outside the United States, it's a good idea to keep an eye on the exchange rates established by the forex market.