Forex, which is short for foreign exchange market, is the biggest and most liquid market that exists at the moment. Spanning over the time zones, it connects a number of huge financial centers around the planet, making forex available to prosperous international buyers and sellers at any time of the day or night.
Since you are reading this article, you have probably heard about forex from one of your business partners, colleagues or friends, and you are yet to learn about the basic facts related to foreign exchange market trading.
If the idea of forex sounds interesting to you and you wish to understand how things work in that line of business, you should simply continue reading because the goal of this article is to present you the foundations of the market, as well as how to get started from a scratch.
What is forex?
In short, the foreign exchange market is a place where the currency of one country is exchanged for the currency of another. Forex connects thousands of banks, companies, governments, hedge funds, and traders into a single large group, allowing them to conduct their business on an international level.
Not so long ago, forex market was available only to high-powered companies, well-known banks, and countries with thriving economies. However, the development of the new technologies, such as the expansion of the internet and easy access to the World Wide Web, made forex available to absolutely anyone who shows an interest in the online currency trading.
It is true that big players, such as those previously mentioned banks and companies, still do the majority of the transactions, but the small and individual traders are becoming more and more prominent.
What is traded on forex?
Just like any other market, forex deals with exchanging goods. In this case, the goods are currencies from a number of different countries. Of course, you are not trading with the actual physical currencies. You are actually agreeing upon the contracts whether you are buying or selling a currency. For the deal to be completed there ought to be a settlement between the two parties involved in the transaction.
The currencies are always traded in pairs. The first currency in the pair is the base currency, while the second one is called counter currency or quote currency. The base currency is your domestic currency and quote currency represent the amount of units you would receive if you decide to sell a single unit of your base currency.
It is important to remember that your base currency is always calculated singularly. For instance, imagine that you live in the United States and therefore, US dollar is your base currency. You wish to exchange the US dollars you have on your account for Canadian dollars.
That particular currency pair should look like this: USD/CAD = 1.1600
Therefore, the number 1.1600 represents the amount of Canadian dollars you would receive for a single US dollar.
The movement of the quotes is something you need to pay close attention to. That term will be explained by using the previous example. Let’s say that the quote from USD/CAD currency pair moves up to 1.1650. That change would mean the US dollar is getting stronger and the Canadian dollar is getting weaker. But if the quote goes down to 1.1590, it would indicate that the worth of US dollar is weakened and the Canadian dollar is growing stronger.
Of course, there is no need for your domestic currency to always be set as your base currency. You are allowed to trade in whichever currencies you choose. This sort of exchange is called cross exchange. That means you could be a citizen of the United States and choose GBP/JPY currency pair for trading.
Some currencies are more liquid than the others. The most liquid ones are called the majors and those currencies are a part of 90% of transactions done on forex daily. Most regularly used pairings are USD/EUR, GBP/USD, USD/CHF, AUD/USD, and our previously mentioned example – USD/CAD.
The quotation of a currency pair is divided into two prices. The bid price is the amount of money you, as a seller of the currency, would receive when you exchange your base currency for the quote currency. The ask price is the price of the base currency the brokerage firm is offering you in exchange for the quote currency.
Understanding the lots and pips are also very important. Lot or contract size is the smallest trading amount. There are usually two contract sizes – mini and standard. Mini forex account is typically recommended for beginners who are planning to enter the foreign exchange market. Those mini accounts are attractive because they are not too risky and they allow the trader to participate in the market using the smaller contract sizes (usually 10,000 units). The standard contract size usually has 100,000 units.
Pip or point is the smallest number in a quotation. If you want to know how much money you can earn from a pip, you need to know the contract size and the currency pairing you plan to use and then calculate the amount.
What is influencing the changes on the forex trading market?
There are many factors influencing the exchange rates and thriving investors and traders are closely following all of them. However, it all comes down to the supply and demand. Those are constantly changing and the prices are going up and down regularly. Forex trading market is extraordinary because it is the market which corresponds to various changes happening in the world on a daily basis.
There are three factors which are significant in relation to the foreign exchange market trading. Those are:
Political climate – international or regional changes in political climate can have vast influence on the prices in currency market. If there is a major change or any kind of turmoil within a country, or if the government is not stable, both of those factors can negatively influence the status of the currency on the market. On the other hand, if the new government is elected and if they seem keen on developing the economy of the said country, that may improve the standings of the domestic currency.
Economic factors – a trader can follow the economic factors of one country simply by showing an interest in studying the economic reports issued by the government agencies or the central banks. Economic reports usually contain the planned budget and monetary policies which are intended to advance the growth of economy within a country.
Psychology of the market – it is valuable to know how the psychology of the traders works. For instance, if there is any sort of unfavorable event connected to the political climate of a country, the traders would probably start trading the domestic currency of that country, creating a higher demand and eventually – the higher price. Also, studying different charts and analysis can be beneficial since most of the successful investors are already doing so, and you would be able to see for yourself how they think and plan their strategies.
Why should you choose to trade on forex?
There are numerous benefits when it comes to trading forex:
One of the reasons why forex market became so popular is because you are able to trade whenever you want, at any time of the day (except on the weekends since the online market is then closed).
The market is liquid meaning that the exchanges are happening all the time. You would rarely be stuck with an unwanted currency.
There are no fees or the middle man. Brokerage firms do not charge the trading but they do earn money from the spread.
Leverage allows you to get started even if you don’t have a lot of money on your account. When you use leverage, the amount of money you are trading with is bigger and therefore, you can have a larger profit. But you need to be cautious if you choose this option because if you make a wrong judgment, your losses will also be greater.
The essentials you need in order to start trading
First of all, you need a personal computer or any type of a device that has an option to connect to the internet, such as notebooks or tablets. It is also important to have a fast and stabile internet connection.
Secondly, you need to find an online brokerage firm which fits your needs. It is important to do a lot of research and make a right decision. Reviews from the trusted sources can provide you with the guidance. Also, you need to be cautious since this market also draws attention of hackers and people who want to scam you out of your money. If you are having doubts about a brokerage firm, it is better to move on and look for another one.
And a final piece of advice for the beginners who are planning to jump in the world of currency trading is to take it slowly and open a demo account first. If you do so, you wouldn’t be spending any real money but you would still be involved in forex trading. This is a great way to learn about the trade and the way the market works.