We can answer the ‘what is forex trading’ question in many different ways. But the goal of this post is not to answer that question. Instead, it’s to get you curious enough about forex trading to want more information.
A lot has been written about how easy or difficult it might be for a beginner to succeed with forex and where they should start. There are dozens of blogs dedicated solely to the topic of forex trading, and you can get all kinds of information from those blogs.
I know there are tons of articles about how to start with forex trading; however, for our purposes here, we’ll be talking about why it’s not always easy for beginners to succeed in this marketplace and what steps one should take before they give up hope (the bit I really want you to read).
What is the forex market?
The forex market is the largest and most liquid in the world. It’s traded worldwide in major financial centers such as London, New York, Tokyo, Zurich, Frankfurt, Hong Kong and Paris. Prices change constantly as market hours differ by time zone. For example, when it’s 7am in New York City, it’s already 11pm in Sydney.
Forex trading runs 24 hours a day, seven days a week on a global market for trading currencies in more than 180 different currencies.
Currencies are essential because they enable the purchase of goods and services locally and across borders. International currencies need to be exchanged to conduct foreign trade and business.
Forex trading is the process of buying and selling currencies to make a profit. Anyone can do it through various methods, but most people use online platforms to do it. Forex traders make money by correctly predicting whether a currency will go up or down in value relative to another currency. To trade successfully, you need to understand the factors that influence currency prices and plan for entering and exiting trades.
A short history of forex
Forex has been around for centuries, with people exchanging goods and currencies to purchase services and goods.
This means the forex market has been around for centuries. Still, the modern form of forex trading is a relatively recent invention, with the first formal exchanges taking place in the 1970s after Bretton Woods.
Currencies are not fixed in value like they were in the past- their values are now determined by the demand and circulation of each currency. To monitor these values, financial institutions have created foreign exchange trading services that allow people to buy and sell currencies with each other.
Commercial and investment banks conduct most trading on behalf of their clients, but there are also speculative opportunities for individual investors.
Currencies can be traded as an asset class because they offer two distinct features: the opportunity to earn interest rate differentials and profits from changes in exchange rates.
Forex trading has been around for centuries, and it can be a very profitable venture if traded correctly. However, forex trading also carries a significant amount of risk. For this reason, it’s essential to do your research before getting started in the forex market.
How does forex trading work?
Forex, or foreign exchange trading, is the buying and selling of currency pairs to make a profit. To be successful in forex trading, you should first understand how it works.
Essentially, traders make predictions on the future price movements of an asset and then speculate without taking ownership of the asset. This allows for more flexibility and opportunities to profit from short-term changes in the market.
Forex trading is the buying and selling of currencies on the global market, and forex is the world’s largest and most liquid market. There are many different ways to trade forex, including trading in the spot market, futures, and currency pairs.
Transactions occur directly between two parties in an over-the-counter (OTC) market.
The most popular way of trading forex is by speculating on price movements using derivatives such as a rolling spot forex contract.
Transactions take place across four major forex trading centers in different time zones: London, New York, Sydney and Tokyo. Most traders who speculate on the forex prices do not take delivery of the physical currency itself; instead, they make predictions about price movements and trade accordingly.
A summary of forex markets
The FX market is where currencies are traded, and it is the only genuinely continuous and nonstop trading market in the world. In the past, the forex market was dominated by institutional firms and large banks, who acted on behalf of clients.
However, it has become more retail-oriented in recent years, and traders and investors of many holding sizes have begun participating in it.
An exciting aspect of world forex markets is that no physical buildings function as trading venues for the markets. Instead, it is a series of connections made through trading terminals and computer networks.
The foreign exchange market is considered more opaque than other financial markets as currencies are traded in OTC markets, where disclosures are not mandatory.
Currencies are traded in pairs, with the value of one currency being determined by its comparison to another currency, and the value of a currency is always relative to another currency. The most common way to trade currencies is through spot trades.
In addition to choosing how to trade forex, you can pick a different market for each currency pair. The two main types of forex markets are spot and futures.
The spot market is the live market where currencies are traded.
The forward market is an agreement to trade at a set price in the future.
The spot market is for immediate settlement, while the forward market is for settlements at a future date.
The spot market is a real-time market where transactions are settled immediately. On the other hand, the futures market is a contract-based market where transactions are settled at a later date.
Forex trading in the spot market has always been the largest because it trades in the most significant “underlying” real asset for the forwards and futures market. Previously, volumes in the futures and forwards markets surpassed those of the spot market.
However, the trading volumes for forex spot markets received a boost with the advent of electronic trading and the proliferation of forex brokers. When people refer to the forex market, they usually refer to the spot market.
The forwards and futures markets tend to be more popular with companies that need to hedge their foreign exchange risks out to a specific date in the future.
How does the spot market work?
The spot market is where currencies are bought and sold based on their trading price. In the spot market, buyers and sellers exchange currency pairs and complete the transaction immediately. The spot market is considered the most liquid market because of its immediacy, as transactions can occur in seconds and at any time of day.
That price is determined by supply and demand. It is calculated based on several factors, including current interest rates, economic performance, sentiment towards ongoing political situations (both locally and internationally), and the perception of the future performance of one currency against another.
A finalized deal is known as a “spot deal.” It is a bilateral transaction by which one party delivers an agreed-upon currency amount to the counterparty and receives a specified amount of another currency at the agreed-upon exchange rate value.
After a position is closed, the settlement is in cash. Although the spot market is commonly known to deal with transactions in the present (rather than the future), these trades actually take two days for settlement.
Forwards and futures markets
Unlike the spot market, the forwards and futures markets do not trade actual currencies. Instead, they deal in contracts that represent claims to a particular currency type, a specific price per unit, and future dates for settlement.
A forward contract is a private agreement between two parties to buy a currency at a future date and a pre-determined price in the OTC markets. In the forwards market, contracts are bought and sold OTC between two parties, who determine the agreement’s terms.
In the futures market, futures contracts are bought and sold based upon a standard size and settlement date on public commodities markets, such as the Chicago Mercantile Exchange. In the U.S., the National Futures Association regulates the futures market.
Futures contracts have specific details, including the number of units being traded, delivery and settlement dates, and minimum price increments that you cannot customize. The exchange acts as a counterpart to the trader, providing clearance and settlement.
Both types of contracts are binding and typically settle for cash at the exchange in question upon expiry, although contracts can also be bought and sold before they expire.
How currencies are traded
Currency trading is the buying and selling of one currency for another currency, and it is a highly speculative business.
Currencies are assigned a three-letter code much like a stock’s ticker symbol. While there are more than 170 currencies worldwide, the U.S. dollar is involved in a vast majority of forex trading, so it’s beneficial to know its currency code: USD.
The second most popular currency in the forex market is the Euro, the currency accepted in 19 countries in the European Union (currency code: EUR).
Other major currencies, in order of popularity, are the Japanese yen (JPY), the British pound (GBP), the Australian dollar (AUD), the Canadian dollar (CAD), Swiss franc (CHF), and New Zealand dollar (NZD).
All forex trading is expressed as a combination of the two currencies being exchanged. The following seven currency pairs—which are known as the majors—account for about 75% of trading in the forex market:
Currencies are traded in pairs, and the value of a currency is based on the country’s economy that issues it. Trading occurs when one party agrees to buy or sell a currency at an agreed-upon price and time.
Bid and ask prices
The bid price is the price at which you can sell the base currency, and the ask price is the price at which you can buy the base currency.
To understand how forex trading works, it is vital first to understand bid and ask prices. The bid price is the amount of the counter currency you can buy when you sell one unit of the base currency, and the ask price is how much of the counter currency you will need to receive to sell one unit of the base currency.
The difference between these two prices is called the spread.
The ask price is always higher than the bid price because the trader who wants to sell a security (the asker) does not want to sell it at a lower price than what they paid for it. The spread is the difference between the ask and bid prices, and it is always less than the ask price.
In addition, the spread between the two prices is tighter when it is better for the investor. For example, if a broker widens its spreads by raising the ask price, it will negatively affect an investor’s earnings and losses (measured in pips).
What is a pip?
A pip is the smallest price movement within a currency pair, and it is usually measured in terms of the fourth decimal point, so a pip value of 0.0001 would represent a movement of one penny per dollar.
A pip is the forex version of a point, and a pip’s value depends on the trade lot and the currency pair.
If you’re trading a pair that has the USD as the counter currency, the pip values are:
Micro lot (1,000 units): pip = 10 cents.
Mini lot (10,000 units): pip = $1.
Standard lot (100,000 units): pip = $10.
How forex investors make (and lose) money
Forex investors make money when they buy a currency at a lower price and sell it at a higher price. The forex market is based on supply and demand. When there is a currency surplus, the price will be low, and when there is a need for a currency, the price will be high.
Forex trading is risky as you’re making a bet that what you buy will go up in value. With forex, you want the currency you’re buying to go up relative to the currency you’re selling.
If you bought a mini lot of a currency and it goes up one pip in value, your investment would be worth $1 more, and if it goes down one pip, your investment would be worth $1 less.
Forex trading is a high-risk investment, and most people who try it lose money. However, with an effective strategy and discipline, investors can generate returns through forex trading. It’s crucial for beginners to start off with micro-lot sizes until they better understand how the market works.
Using your leverage
Leverage allows you to borrow money from the broker to trade more than your account value. Using leverage allows you to buy more with less cash upfront, increasing your return if the currency goes up. The downside of leverage is that it also increases your losses if the currency goes down.
Many brokers offer leverage of up to 50:1 on significant pairs, allowing you to initiate trades up to 50 times larger than the balance in your account.
Managing your risk
Here are a couple of strategies to minimize your risks when trading forex:
1. Use stop-loss orders and take profit orders to help manage your risk:
When trading on the forex market, it is essential to use stop-loss orders and take profit or limit orders to manage your risk. Stop-loss orders are placed with a broker to sell a security when the price falls below a certain level. This will help you protect your profits and limit your losses. Take profit or limit orders are placed with a broker to buy a security when the price reaches a certain level. This will help you lock in your profits and ensure that you do not lose any money on the trade.
There are three types of stop-loss orders: standard, trailing and guaranteed.
A standard stop-loss order, once triggered, closes the trade at the best available price. Therefore, there is a risk that the closing price could be different from the order level if the market prices gap.
However, a guaranteed stop-loss for which a small premium is charged upon the trigger guarantees to close your trade at the stop loss level you have determined, regardless of any market gapping.
2. Hedge risks by using derivatives or diversifying your portfolio:
To put it another way, “not putting all your eggs into one basket” means to spread out your investments and take on various risks. That way, if one investment fails, you won’t lose everything. It’s important to remember this when trading on the forex market because if you focus all your attention on one currency pair and the market moves against you; you could lose a lot of money very quickly.
3. Use limit orders:
A limit order is a type of order that is placed by a trader who intends to buy or sell an asset at a specific price or better. Limit orders are the most expensive type of order but often provide the best price. A limit order is an instruction to close out a trade at a better price than the current market level, and standard stop losses and limit orders are free to place.
Orders can be implemented in the dealing ticket when you first place your trade, and you can also attach orders to existing open positions.
4. Don’t get upset if you lose at first:
Myopic loss aversion is the idea that people are affected more by losses than gains. For example, we get more upset by losing $50 than the amount of happiness we feel by winning $50. This can make us evaluate our outcomes more regularly in trading, which can have two implications.
Can a beginner make money in forex?
Absolutely. Any beginner can enter the world of forex trading. We recommend setting up at least one demo account to learn the tricks of the trade before you risk losing actual money.
And with all of the educational resources that online brokers provide, you can gather solid investment advice that will help you become a pro.