What is Forex Trading And How does it Work?

What is Forex Trading And How does it Work

Forex, also known as the currency market, is the conversion from one currency to another. It is one of the most active markets in the world, with an average daily turnover of 5 billion dollars. Learn more about forex trading, how the financial market works and how forex leverage works.

What is forex?

Forex, or forex market, can be understood as a network of buyers and sellers that exchange currencies at an agreed price. It is the way in which retail investors, companies and central banks convert one currency to another. If you have traveled abroad, it is likely that you have performed a forex trade.

A large number of operations are carried out for practical reasons, but the vast majority of currency conversions are carried out by investors with the objective of making profits. The number of currencies converted daily can cause the price movements of some of them to be extremely volatile. It is precisely this volatility that makes forex so attractive to investors: it provides greater opportunities to maximize profit, although it also increases risk.

What is Forex Trading/Currency Trading?

Forex trading is the act of buying and selling various currencies. In the forex market, a large number of currency pairs existed. One currency is exchanged for another where the exchange rate can be changed (up/down) in each second or minute.

The forex/currency exchange market provides a platform for the global trading of international currencies. If you want to start trading of the international currencies then you may need to open a real trading account with any reliable forex broker

A broker is a firm/company where we can open a real trading account and deposit some amount for trading. Be careful in choosing the best broker which meets your trading desires. A good broker gives you profit. 

How Forex Trading Works in Foreign Exchange Market?

In the forex/currency market there are large numbers of currency pairs e.g. EUR/USD, GBP/USD, and EUR/JPY, etc. where one currency is exchanged for another. For example, 

Currency Pair Exchange Rate
EUR/USD 1.1390
GBP/USD 1.2740
EUR/JPY 123.570

The exchange rate between two currencies is most significant in forex trading. It fluctuates every second or several times in a minute. When a base currency is strong, then it is trading at a high exchange rate, and its price is usually rising as compared to quote currency. When a base currency is weak, then it is generally trading at a low exchange rate against the quote currency, and its price is usually falling.

There are different types of indicators uses in forex/currency trading which indicates an increasing or decreasing value of the currency in the market. We can open a buy position if a base currency is rising and goes stronger as compare to the quote currency and vice-versa. After a short/long period, we can close our trade by accepting some profit or loss.

How does the currency market work?

Unlike stocks or commodities, forex trading is not carried out in markets but is exchanged directly between two parties in an over-the-counter (OTC) market. The forex market is established through a global network of banks, scattered in four main centers in different time zones: London, New York, Sydney, and Tokyo. As there is no physical place through which operations are processed, you can invest in forex 24 hours a day.

There are three different types of forex markets.

Forex spot market: 

it is the physical exchange of the currency pair, which takes place at the exact moment in which the transaction is settled or after a small margin of time

Forex forward market: 

A contract is established to buy or sell a fixed amount of currency at a given price, and whose expiration is made on an established future date or within a range of future dates

Forex futures market: 

A contract is agreed to buy or sell a certain amount of a given currency at a set price, on a fixed date in the future. Unlike a forward, a futures contract is legally binding

Most forex investors are not interested in receiving the physical delivery of the currency, but make predictions about exchange rates to obtain benefits thanks to price movements in the market.

What is the first currency?

A first currency is the one that precedes the pair, while the next one is called the second currency. Forex trading always involves the purchase of one currency and the sale of another, and therefore they are quoted as pairs: the price of a pair is determined by calculating how much a unit of the first currency is worth in the second currency.

The currencies of a pair are identified with a three-letter code, in which normally the first two correspond to the region and the third to the currency itself. For example, the GBP / USD is a pair consisting of the British pound and the US dollar.

Most providers classify currency pairs in the following categories:

Senior couple These are the seven pairs that makeup 80% of world forex trading, and among which are EUR / USD, USD / JPY, GBP / USD and USD / CHF

Minor pairs. These are operated less frequently, and usually, contain larger currencies that are not the US dollar. They include EUR / GBP, EUR / CHF and GBP / JPY

Exotic couple They are made up of a major currency versus another of a small or emerging economy. They include USD / PLN, GBP / MXN, and EUR / CZK

Regional Peers:

These are pairs classified by region, such as Scandinavia or Australasia. Includes EUR / NOK, AUD / NZD and AUS / SGD

How does the forex market move?

The forex market is made up of currencies from around the world, and the number of factors that can affect price movements makes predictions about exchange rates difficult. However, like most financial markets, forex is mainly affected by the laws of supply and demand, and it is important to understand what and how price fluctuations are caused.

Central Banks:

Central banks control the offer and can take measures that significantly affect the price of their currency. Quantitative expansion, for example, involves injecting money into an economy, which can cause the price of the currency to fall.

News:

Commercial banks and other investors tend to deposit their capital in economies with good prospects. Therefore, if the markets echo positive news about a given region, this will motivate the investment and cause an increase in the demand for the regional currency.

Unless there is a parallel increase in the supply of that currency, the difference between supply and demand will cause its price to rise. Similarly, negative news may mean a brake on investment and a decrease in the price of a currency. For this reason, currencies usually reflect the economic health of the region they represent.

Market Trust:

Market confidence, which is usually related to the news, can also play a leading role in the movement of currency prices. If investors believe that a currency is going to move in a certain direction, they will invest accordingly and can convince others, thus causing demand to grow or decrease.

How does forex trading work?

There are different ways to trade forex, but they all work the same way: buying one currency and selling another simultaneously. Traditionally, forex trades were carried out through a broker, but thanks to online trading providers, you can obtain benefits from currency price movements using derivatives such as CFDs.

CFDs are leveraged products that allow you to open a position by paying only a fraction of its total value. Unlike un-leveraged products, you do not own the asset, but open a trade when you think that the market value is going to go up or down.

Although leveraged products can magnify your profits, they can also magnify your losses if the market moves against you.

What is spread in forex?

The spread is the difference between the purchase price and the sale price of a currency pair. As with other financial markets, when you open a position in forex you are offered two prices. If you want to open a long position, the purchase price operates, which is slightly higher than the market price. If you want to open a short position, the sale price operates, slightly below the market price.

What is a lot in forex?

Currencies are traded in lots, which are batches of currencies used to standardize forex operations. Since forex moves in small quantities, lots tend to be large: a standard lot is worth 100,000 units of the first currency. Individual investors do not always have 100,000 pounds, dollars or euros to perform each transaction, so many forex providers offer leveraged products.

What is leverage in forex?

Leverage allows you to obtain exposure to large amounts of currency without having to commit a large part of your capital. Instead, you pay a small deposit known as margin. When you close a leveraged position, your profit or loss is calculated based on the total size of your position.

Leverage magnifies its profits but also implies the risk of amplified losses, which means that its losses may exceed its margin. Therefore, it is extremely important to learn to manage your risk by operating with leverage.

What is margin in forex?

Margin is an essential part of leveraged operations. It is the term used to refer to the amount of initial deposit that must be paid to open and maintain a leveraged position. Keep in mind that when trading with margin in forex, your required margin will vary according to your broker and the size of your operation.

The margin is usually expressed as the percentage of the entire position. Thus, a position on the EUR / GBP pair, for example, may require you to pay only 3.33% of its total value to open it. In this case, instead of depositing € 100,000, you would only need to invest € 3,300.

What is a pipo in forex?

Pipos are the units of measure of the movement of a currency pair. A pipo usually equals a one-digit movement in the fourth decimal place of a pair. Therefore, if the GBP / EUR moves from € 1.15482 to € 1.15492, a pipo will have moved. Decimals that go after the pipo are called fractional pipos or pipettes.

The exception to this rule is when the second currency is quoted in much smaller values, the most notable example being that of the Japanese yen. In this case, a pipo corresponds to a movement in the second decimal. Therefore, if the EUR / JPY moves from ¥ 106,452 to ¥ 106,462, a pipo will have moved.