Forex trading is the term given to the exchange and trade of foreign currencies for profit. While the majority of people have made use of currency exchange services when heading off abroad on holiday or when making an overseas business transaction, there are some who utilise currency exchange services to generate an income. The most traded market in the world, the foreign exchange market (also sometimes known as Forex or fx trading) generates an average turnover in America alone of around $5.3 trillion every single day. Daily turnover is so high that the forex market turns over 10 times as much as other global equity markets, and as the market is extremely liquid it is easy to make deals at both high and low values and in practically every type of currency. Forex trading refers to purchasing one currency and simultaneously selling another for speculation purposes. As currency values appreciate and depreciate against each other because of world economic and political factors, traders profit from such changes by speculating on the way that foreign currency exchange prices will behave. Unlike the stock exchange, the forex market does not have a physical presence and it is able to trade 24 hours a day through individuals, banks and global business networks. This means currencies fluctuate constantly in value offering a host of trading opportunities. Although at first it may seem difficult to take advantage of this lucrative market, Forex trading is something that can be learned, and once the basics have been mastered, potential traders can take advantage of the accessibility that the internet provides to this market.
What you will learn:
Forex Trading Explained
World currencies are given a relative value to each other, with one becoming stronger as the other weakens (see the trends). This means that successful traders can always make a profit if they pay attention to the market. The first step is to choose a currency pair, for example US dollars and GBP (Pounds Sterling). The quote will be written as either USD/GBP or GBP/USD, with the currency to the left of the pair referring to the currency that you believe will be stronger than that to the right. Should the trader should a GBP/USD quote, they will buy Pounds Sterling if they believe that it will rise or sell it if they think that the pound will weaken.
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Traders are quoted a spread for their chosen currencies and then decide how much they are going to bet per point (with the point representing the final digit in the quote). Should their chosen currency strengthen, they could sell the pair and make a profit, however if their chosen currency weakens, they will make a loss.
Who Participates in Forex Trading?
Many companies, individuals and institutions participate in Forex Trading to take advantage of its many benefits (Market Participants PDF). They include:
The majority of commercial Forex transactions are carried out by the interbank market, who are responsible for huge amounts of speculative trading every day. Many large banks trade billions of dollars each day and although some of this is done on the customers’ behalf, much of it is carried out by proprietary traders who trade on the bank’s account.
Companies make use of the forex market to pay for services and goods from overseas as well as to sell services and goods abroad. A vital part of forex activity is from companie who want to exchange currency so that they can transact in other countries.
Governments and Central Banks
The central bank of a country is able to play a key role in the forex market by causing decreases or increases in their own nation’s currency by aiming to control inflation, interest rates or money supply. They can also utilise their foreign exchange reserves in an attempt to stabilise the market.
Big hedge funds speculate on the Forex market every day using billions of dollars.
This includes those who are travelling abroad and are exchanging their currencies at a bank or airport.
Investment firms which manage their clients’ big portfolios use the Forex market to carry out transactions in foreign securities.
Retail Forex Traders
The retail Forex market is increasing all the time as traders recognise the lucrative and accessible nature of online Forex trading platforms. Indirectly accessing the market via a bank or broker, retail Forex traders can use either a broker or a dealer to speculate on the Forex market. A broker works as an agent on behalf of the trader, searching for the best market price and executing transactions on the customer’s behalf. On the other hand, a dealer (also known as a market maker) acts as a counter-party to the trader’s transactions, quoting a price that they are prepared to deal at and taking their own compensation via the spread (the difference between the selling and buying price).
What are the Benefits of Forex Trading?
There are numerous benefits of Forex trading, including the following:
24 Hour Market
One of the greatest benefits of Forex trading is that it has a 24 hour market and therefore traders can trade at any time that is convenient to them, whether that be during the day or during the night. This is very different to stock market trading which can only be carried out during the market hours. The forex market follows the clock by opening in New Zealand on a Monday morning then progressing through Asia via Singapore and Tokyo, moving on to London and then finally closing in New York. As trading is available 24 hours a day, price gapping is much less and traders are able to take a position at any time that they like.
Currencies are always relative to each other which means that there is always a profitable market somewhere in the world. Whereas in stock trading, all of the markets could theoretically collapse at once, this can never be the case in Forex trading.
No Specialist Knowledge Required
Another major advantage of Forex trading over traditional stock market trading is that it requires no complex or insider knowledge. To be successful when playing the stock markets, a trader must spend a lot of time gaining an insight into the companies that they wish to speculate on, learning more about its method of operation, its management and its financial background. This is not only time consuming and complicated but also may put off casual traders who lack the experience and skills necessary to perform this kind of research. The forex market, on the other hand, requires no specialist knowledge whatsoever. Potential traders only need to have a basic awareness of the current political and financial climate in the world in order to take advantage of the forex market and make a profit. This makes it much more accessible to novices than the traditional stock market.
Forex trading has no middleman, which means that traders are able to interact directly with the responsible market for a specific currency pair. This ensures a short execution time as well as eliminating the fees that are often charged when a middleman is brought into play.
No Fixed Lot Size
There is also no fixed lot size, so traders are able to determine their own which is especially useful for those who wish to use very small trade size lots or low deposits. Micro trading accounts are available which allow traders, especially novices, to get started with their venture with very low deposits.
The Forex market is very liquid which means that traders can buy and sell instantly. Online trading platforms can even be set to automatically close the position once a desired profit level is reached or even close a trade if it is going against the trader.
No Cornering The Market
As the Forex market is enormous, it is also impossible for a single entity to control or corner the market for any length of time which is a great improvement over the stock market.
Most Forex trading accounts charge no commission or additional transaction fees for trading currencies either over the telephone or online. In fact, Forex trading has lower costs than those found in any other market.
Leverage and Pricing
Forex trading makes use of leverage which means that traders only have to deposit a fraction of their position’s full value in order to make a forex trade. Different forex trading brokers offer varying amounts of leverage, and this is a useful tool that can be taken advantage of to make increased profit for those traders who are experienced and know how best to make use of this facility. However for those who do not fully understand the concept of leverage, there is the possibility of making spectacular losses. Therefore learning more about risk management is key to success in this area.
All Forex trades are expressed in pairs with the trade being based on the relative value of one against the other. Some of the most popular currency pairs for trading include GBP/USD, USD/EUR, EUR/GBP.
PIPS, or Percentage In Points, refers to the way that currency pairs are quoted. The majority of pairs are quoted to five decimal places and the change from the fourth decimal place usually being called a “pip”.
The difference between the bid and ask of currency pairs is called the “spread”. For example, if a currency pair such as GBP/USD was quoted at 1.34600/1.34606, the spread would be 0.6 pips.
What Can Affect Forex Trading Prices?
There are numerous factors which can affect Forex pricing. These include such diverse aspects as political conditions around the world and international trade policies. It is precisely for these reasons that Forex trading is so exciting as prices are able to change quickly in response to happenings and events around the world and this adds to increasing the trade opportunities for Forex traders. Some of the major factors that have a role to play in affected Forex prices include:
- Economic stability
- Political climate
- Monetary policies
- Currency interventions
- Natural disasters
How to Choose the Best Forex Trading Broker
As there are plenty of Forex brokers online, it can be difficult to know how best to choose one. However, the process is not as complicated as might be expected, with only three basic steps to making the right choice.
Firstly, research is key. A Forex broker should be registered with a regulatory authority in order to demonstrate their reliability and trustworthiness. Potential traders should also find out other key information about their chosen broker, for example whether they are a dealing desk or non-dealing desk broker, whether they offer non-fixed or fixed spreads and the breadth of their spreads. It is also vital to know how much leverage is likely to be offered and whether that amount suits the trader’s particular style. If you are a newcomer to Forex trading, you will almost certainly want to choose a Forex broker that offers the option to trade in micro lots which will allow you to make a lower risk start to your Forex trading venture. Another pertinent question is whether or not your chosen broker credits or debits daily rollover interest and whether or not they offer other premium services like news feeds, charting analysis and live market commentaries if these types of services are important to you.
Once you have narrowed down your options of Forex brokers, you will need to compare the different features and facilities that each can offer you in order to make an informed decision that meets your trading needs. There are lots of online reviews of brokers as well as comparison sites that can help you to find out all the information that you require.
The third step is to open a demo account with a couple of your brokers of choice and take the opportunity to ask any questions that may arise. You should try trading in a range of market environments and take the opportunity to experience all of the features of their trading platforms. You can also use this chance to try out each broker’s customer support teams to see how knowledgeable and helpful they can be.