A detailed Forex Trading Beginners guide to educate yourselves about all you need to know about Forex prior to starting trading.
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What is forex trading?
Forex, or foreign exchange, can be explained as a network of buyers and sellers, who transfer currency between each other at an agreed price. It is the means by which individuals, companies and central banks convert one currency into another – if you have ever traveled abroad for example, then it is likely you had to exchange your currency to the currency of that county, thus you have made a forex transaction.
Currencies are important because they allow us to purchase goods and services locally and across borders. International currencies need to be exchanged to conduct foreign trade and business.
If you are living in the United States and want to buy a car from France, then either you or the company from which you buy the car has to pay the French for the car in euros (EUR). This means that the U.S. importer would have to exchange the equivalent value of U.S. dollars (USD) into euros.
While a lot of foreign exchange is done for practical purposes such as the ones we just described , the vast majority of currency conversion is executed with the aim of making a profit. The amount of currency converted every day can make price movements of some currencies extremely volatile. It is this volatility that makes forex so attractive to traders: as it creates a greater chance of high profits, but at the same time increasing the risk.
How Does the Forex Market Work?
Unlike stocks, commodities or cryptos , forex trading does not take place on exchanges but directly between two parties, in an over-the-counter (OTC) market. The forex market is run by a global network of banks, spread across four major forex trading centers in different time zones: London, New York, Sydney and Tokyo. Because there is no central location, you can trade forex 24 hours a day for 5 days a week, with the exception of some holidays.
There are three different types of forex market:
The Spot forex market: which is the physical exchange of a currency pair, and takes place at the exact point the trade is settled – ie ‘on the spot’ – or within a short period of time
The Forward forex market: in which a contract is agreed to buy or sell a set amount of a currency at a specified price, to be settled at a set date in the future or within a range of future dates
The Future forex market: in which a contract is agreed to buy or sell a set amount of a given currency at a set price and date in the future. Unlike forwards, a futures contract is legally binding
Most traders speculating on forex prices do not plan to buy the currency itself; instead they make exchange rate predictions to take advantage of price movements in the market.
What is a base and quote currency?
A base currency is the first currency listed in a forex pair, while the second currency is called the quote currency. For example in the EUR/USD pair EUR is the base currency and US Dollar is the quote currency.
Forex trading always involves selling one currency in order to buy another, which is why it is quoted in pairs – the price of a forex pair is how much one unit of the base currency is worth in the quoted currency.
Each currency in the pair is listed as a three-letter code, which tends to be formed of two letters that stand for the region, and one standing for the currency itself. For example, EUR/USD is a currency pair that involves buying the Euro and selling the US dollar.
So in the example, EUR is the base currency and USD is the quoted currency as we mentioned earlier. Now If EUR /USD is trading at 1.11626, then one Euro is worth 1.11626 dollars.
If the EUR rises against the dollar, then a single EUR will be worth more dollars and the pair’s price will increase. If it drops, the pair’s price will decrease. So if you think that the base currency in a pair is likely to strengthen against the quoted currency, you can buy the pair (going long), and vice versa If you think it will weaken, you can sell the pair (going short).
To keep things in order , most providers split pairs into the following categories:
Major pairs, which include Seven currencies that make up 80% of global forex trading, and those are EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD and AUD/USD
Minor pairs, which are less frequently traded, often feature major currencies against each other instead of the US dollar. Includes: EUR/GBP, EUR/CHF, GBP/JPY
Exotics which are a major currency against one from a small or emerging economy. Includes: USD/PLN (US dollar vs Polish zloty) , GBP/MXN (Sterling vs Mexican peso), EUR/CZK
Regional pairs which are Pairs classified by region – such as Scandinavia or Australasia. Includes: EUR/NOK (Euro vs Norwegian krona), AUD/NZD (Australian dollar vs New Zealand dollar), AUD/SGD
How does forex trading work?
There are a plethora of different ways that you can trade forex, but they all work the same way: by buying one currency while selling another. Traditionally, a lot of forex transactions have been made via a forex broker, but with the rise of online trading you can take advantage of forex price movements using derivatives like CFD trading.
CFDs are leveraged products, which enable you to open a position for just a fraction of the full value of the trade. Unlike non-leveraged products, you don’t take ownership of the asset, but take a position on whether you think the market will rise or fall in value.
Although leveraged products can magnify your profits, they can also magnify losses if the market moves against you.
Now let’s have a dive on some major terminology around trading Forex, like spread, lot, leverage, margin and pip, as it is essential you understand these terms prior trading forex.
So, What is the spread in forex trading?
The spread is the difference between the buy and sell prices quoted for a forex pair. Like many financial markets, when you open a forex position you’ll be presented with two prices. If you want to open a long position, you trade at the buy price, which is slightly above the market price. If you want to open a short position, you trade at the sell price – slightly below the market price.
What is a lot?
Currencies are traded in lots – batches of currency used to standardize forex trades. As forex tends to move in small amounts, lots tend to be very large: a standard lot is 100,000 units of the base currency. So, because individual traders won’t necessarily have 100,000 pounds (or whichever currency they’re trading) to place on every trade, almost all forex trading is leveraged.
And since the word leverage mention let’s dive to it.
Leverage is the means of gaining exposure to large amounts of currency without having to pay the full value of your trade upfront. Instead, you put down a small deposit, known as margin. When you close a leveraged position, your profit or loss is based on the full size of the trade.
Another major term is margin.
Margin is a key part of leveraged trading. It is the term used to describe the initial deposit you put up to open and maintain a leveraged position. When you are trading forex with margin, remember that your margin requirement will change depending on your broker, and how large your trade size is.
Margin is usually expressed as a percentage of the full position. So, a trade on EUR/USD, for instance, might only require 1% of the total value of the position to be paid in order for it to be opened. So instead of depositing USD $100,000, you’d only need to deposit USD$1000.
What is a pip in forex?
Pips are the units used to measure movement in a forex pair. A forex pip is usually equivalent to a one-digit movement in the fourth decimal place of a currency pair. So, if EUR/USD moves from $1.11530 to $1.11540, then it has moved a single pip. The decimal places shown after the pip are called fractional pips, or sometimes pipettes.
Forex market is quite fascinating, and the most amazing thing about forex is that Approximately $5 trillion worth of forex transactions take place daily, which is an average of $220 billion per hour, making forex the world’s biggest and most liquid financial market.
