What is Forex Trading?
Forex Trading, also known as the Foreign exchange market, is the marketplace where the exchange of two currency pairs takes place. You will need a currency exchange when you travel from one country to another. A forex trader buys exchange one currency for another, due to which the exchange rate changes depending on the supply and demand ratio. It is a marketplace that runs without any break from Monday to Friday, 24 hours a day. It is an over-the-counter trade meaning that there is no physical exchange of currencies due to its decentralization. A global network of international banks and other financial regulatory authorities regulate this volatile market.
Things to Know About Forex Trading
People Involved in the Trade
Forex trading occurs between institutional traders working for banks, fund managers, and multinational trading corporations. They don’t have physical possession of currencies as they may be speculating about or hedging against future exchange rate fluctuations. For example, a forex trader buys the U.S Dollar as he believes the dollar will show a surge in price and will buy more Euros with dollars in the future. Meanwhile, an American company with European operations will use the FX market as a hedge when Euro shows a price downfall and lowers their earned income.
Currency Pairs Traded in FX Market
All currencies worldwide have a three-letter code that denotes that particular currency, like a stock’s ticker symbol. The U.S Dollar is the King of forex trading out of 170 currencies worldwide, and its code is USD. Euro is t second traded currency in the forex market and is accepted in 19 countries of the European Union. Other trading currencies are
- the Japanese Yen (JPY),
- the British Pound (GBP),
- the Australian Dollar (AUD),
- the Canadian Dollar (CAD),
- the Swiss Franc (CHF), and
- the New Zealand Dollar (NZD).
Forex trading involves a currency pair like EUR/USD, where one is bought, and the other is sold. There is a total of seven currency pairs making 75% of the total FX trade. These include EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CAD, USD/CHF, and NZD/USD.
Quotation of Forex Trade
A currency pair denotes the current exchange rate for the two currencies. Let us take an example of the EUR/USD or Euro to Dollar rate to understand the quotation:
- Euro on the left side of the pair is the base currency.
- The U.S dollar is on the right side and is called the quote currency.
- The exchange rate is the rate that shows the amount of quoted currency required to buy a single unit of the base currency. The base currency is always considered as 1 unit, while the value of the quote currency keeps changing according to the market conditions.
- For example, if the EUR/USD exchange rate is 1.2, you must pay $2.20 to buy 1 EURO.
- Higher exchange rates indicate the high value of the base currency relative to the quote currency. The fall of the exchange rate is an indicator of the low price of the base currency.
Trade in 3 Forex Markets
Exchanging currencies is not the sole cause of forex trading; you might trade to speculate about future price movements, similar to stock trading. Forex traders buy the currencies whose value they think will have a heave relative to other currencies shortly. You can trade forex in three ways to accommodate your goals;
- The Spot Market: The primary forex market is used to swap the currency pairs and determine exchange rates in real time according to supply and demand.
- The Forward Market is a market where traders can enter into a binding contract with another trader and lock the deal on an exchange rate for a set amount of currency on a future date.
- The Future Market: In the future market, traders can have a standardized contract to buy and sell a determined amount of currency at a particular exchange rate. The deal is made on the exchange rate, not privately, similar to the forwards market.
Major Forex Terms to Know
- Currency Pair: Forex trade is made through a currency pair which involves two major currencies used to trade in forex. Moreover, less common trade like exotics, the currencies of the developing countries, are also traded here.
- Pip: It stands for percentage in points and refers to the smallest possible price change in a currency pair. As the forex prices are quoted out in four decimal places, one pip will be equal to 0.0001.
- Bid-Ask-Spread: Like other markets, exchange rates in forex trading are determined by the amount buyers will pay for a currency (the Bid) and the minimum amount a seller can sell (the ask) that currency. The whole procedure is known as the bid-ask spread.
- Lot: A Lot is a standardized unit of currency used to trade in forex, and its typical size is 100,000 units of currency. There are also micro and mini lots to trade.
- Leverage: Due to large lot sizes, traders may not want to invest much money to make a trade. Leverage is the borrowed money taken from the Brokers to take part in the forex market without requiring further money to invest.
- Margin: Margin is the money traders must deposit to enter the market. It is the money taken to provide security to traders.
- Brokerage: A broker is an organization that provides you a platform to do your trade without any risk and, in return, charges some fee. You must choose the best Nasdaq broker with a high reputation and should be regulated by a regulatory authority to ensure security.
Forex trading is a marketplace used to buy and sell currency pairs simultaneously. It is the most active marketplace where traders can invest their money and earn a reasonable profit on their investment. In this article, we have described all the things that a trader must know before entering into this liquid and volatile market. We hope this article will let you understand the forex market.