What Is Forex Trading And Currency Exchange?
Beginning forex traders have difficulty understanding how forex trading works or whether currency trading really works.
This article explains in detail the Foreign Exchange Market, commonly known as FOREX.
What is Forex? Definition & Explanation
Forex (Foreign Exchange) is the foreign exchange market, where currency pairs such as EURUSD or GBPUSD are traded. Forex is an over-the-counter (OTC) market where investors or speculators will buy and sell currency pairs.
Forex is the currency market and currencies, unlike most other tradable assets, are economic instruments as much as they are economic indicators.
Basically, if countries were companies – currencies would be their shares.
Basic Terms of Forex Trading
Knowing the language of Forex brokers won’t make you an excellent trader, but it will help you understand the data needed to become one.
Here are the most important terms in Forex Trading:
- Currency Pairs
- A Forex Quote
- The Pips
- The Spread
- The Margin
- Forex Leverage
- The Swap
- The Lot or size of the contract
- Forex Platforms
Any investor who wants to get into currency trading needs to understand how forex works and the basic terms of this market. Testing forex trading on a demo account is a way to learn and better understand forex.
Forex Quotes – Explanation
The currency pair is a key notion for the foundations of Forex trading. For example the EUR/USD pair. The euro is called the base currency.
The US dollar is called the counterpart currency. The valuation of the base currency against the counterparty gives us the Forex quote.
If we look at EURUSD or other currency pairs on the trading terminal, we note two numbers, the bid and ask rate.
They look like this: EUR/USD 1.1234/1.1240. This quotation tells us that we can buy one euro with 1.1240 USD because this is the amount requested by the bank – the bid rate.
At the same time, we can sell one euro for 1.1234 US dollars – the bid rate. It is easy to note that, in general, a bank buys a currency for a lower rate and sells a currency with a marginally higher cost. Banks can do this because they have more influence than brokers.
You can’t just buy or sell EUR/USD, as you would for example with shares in a company. That’s because the EUR/USD currency pair doesn’t exist. The currency exists alone, not in pairs. Traders simply speculate on future price movements, without actually buying currency.
In Forex, profit is made by the appreciation or depreciation of the value of one currency against the other. Let’s say you buy euros and sell US dollars (using the EUR/USD currency pair). To make a profit, you have to sell the US dollars once the euro has appreciated against the dollar.
There are two things to consider. First, traders never buy or sell physical currency. Second, buying and selling take place in all foreign exchange transactions.
What currencies are traded on Forex?
This guide on how Forex works would be incomplete without a review of the most popular assets available to a trader.
The world’s most popular currency pairs – the US Dollar, Euro, Pound Sterling, Japanese Yen, and Swiss Franc are part of a group of major currency pairs: EURUSD, GBPUSD, USDJPY, and USDCHF.
There are three other currencies that are common in Forex trading: New Zealand dollar, Canadian dollar, and Australian dollar. If they are associated with the US dollar, we get a group of minor currencies: NZDUSD, USDCAD, and AUDUSD.
All other currency pairs present in Forex trading are generally referred to as “exotic currency pairs” and account for less than 10% of all foreign exchange transactions.
Who trades Forex?
The most important players in the forex market are:
- Central Banks
- The States
- The other banks
- Hedge Funds
- Investment Funds
- The Brokers
- Professional and Individual Investors
Among the participants in the foreign exchange market, central banks have the most influence on the formation of foreign exchange prices.
A central bank is, in fact, the supplier of money for the country in which it operates and is, therefore, the supply side of the market. These decisions have a very important impact on the price of currency pairs.
Small investors, such as individual traders, influence the market very slightly, but this influence is obvious due to their large number.
In order to understand forex, you need to know that the supply and demand of currencies are constantly changing and you can see the price movement on a ticks chart on the trading platform for example.
Understanding the Currency Market
In the economy, supply and demand is a model that explains the formation of prices in a free competitive market. The same principle applies to the foreign exchange market.
Each time a currency is bought, more demand is created in the market, which pushes the price up.
Similarly, each time a currency is sold, an excess of supply is created, which pushes the price of the currency down.
The impact of each purchase and sale on the forex market is directly proportional to the trading volume of each transaction.
The equilibrium price philosophy is the key to understanding how online currency trading works, as all economic events in the world, have an impact on the market.
Factors that influence FOREX
The forex market and currency prices are influenced by several factors:
- Interest rates
- Political and economic events and natural disasters
- Economic growth rates
- The supply and demand of a currency pair
Forex Explanation – the Online Brokerage Industry
The functioning of the currency market could be imagined as a constantly changing ocean. There are much fish in this ocean. From the largest to the smallest, depending on their purchasing power.
There are many major players, such as national banks, multinationals, hedge funds and so on.
There are also medium-sized fish – private investors, companies that need forex to protect themselves against exchange rate risk, etc.
There are also even smaller players – online brokers, smaller banks and smaller investors.
Most of the market participants mentioned above have direct access to the interbank forex market. They can do so simply because they exceed a certain threshold of funds. This means that they can trade currencies with each other directly, without intermediaries.
The smallest player – indeed, the plankton of the financial ocean – floating around, trying to survive long enough to grow is the currency trader – that is, the individual investor.
The buying power of a proprietary trader is usually so insignificant compared to the big fish, that he needs a Forex broker or a bank that provides a leveraged trading account and real access to the market through a trading platform.
To understand forex, you need to know that there is no private individual trading as a private individual without a forex broker.
What is Forex Trading
Forex Trading is the activity of buying and selling currencies. Forex Trading is done for speculative purposes or to hedge currency risk through a trading platform.
How to Analyze Forex?
The analysis is not only the key to successful trading. The analysis is, to some extent, trading itself. It is the only thing that makes currency trading really work.
The two main methods of market analysis are Fundamental analysis and Technical analysis.
Fundamental analysis is an advanced form of financial auditing, only on a country or, sometimes, a global scale. It is the oldest form of price forecasting that looks at an economy: its current stage in the cycle, relevant events, future prognosis and the weighted possible impact on the market.
The fundamental analysis covers national GDP and unemployment rates, interest rates and export amounts, war, elections, natural disasters, economic progress, etc.
The fundamental analysis is based on the current state of the economy, the current state of the cycle, relevant events, the future prognosis and the weighted possible impact on the market.
Fundamental analysis requires an understanding of the international economy, deals with factors that are not yet taken into account by the forex market and works for long-term investment and trading.
The disadvantage of this type of analysis is the element of uncertainty created by so many parameters.
Technical analysis is a younger form of market analysis that deals with only two variables: time and price. Both are strictly quantifiable, explained by the market and are undeniable facts.
This is why for many currency traders studying charts works better than doing fundamental analysis.
When you draw support and resistance lines, identify key levels, apply technical indicators or compare candlesticks – you discover how online forex trading works without examining the causes of supply and demand.
To put it simply, fundamental analysis is an economic detective with elements of future forecasting, while technical analysis is the visual archeology of price-time combined with statistics.
How Forex Works – Gains Favour the Informed
Lack of training is the reason why so many novice forex traders fail before they understand how forex trading works.
Some people, due to the nature of their business, often present forex as a pseudo-scientific gambling attraction that is essentially like flipping a coin, an attraction that has a better methodology to some extent, is more fun, has more prestige and has the potential to make a lot of money very quickly.
As a result of such marketing, newcomers with little or no training, expect to make fortunes starting at $10, with a few decisive clicks.
They jump into the market full of hope and the market hits them hard and empties their pockets. This is neither good nor bad – that’s why the market exists. Every time you close with a profit, someone else has to close with a loss.
What is Forex Trading?
Forex trading is a stock market investment activity available to any trader who has a computer and an internet connection.
Understanding the word trading is simple: it is about placing orders on the stock market. Trading means an exchange between different investors on the stock exchange, who trade different financial assets.
The word Forex is a term that refers to the currency market, where different investors trade currencies and some other financial assets.
Currency exchange is a common activity that takes place every day 24 hours a day on a global scale. Governments make forex, banks make forex. Even individuals make forex.
Trading takes place through computer networks between all the traders in the world electronically.
The reason that forex is the most liquid market in the world is that it is the most accessible market in the world. Therefore, it is the most difficult stock market to manipulate.
How to Trade Forex?
The logic of forex trading is simple. A trader buys a currency pair in the hope that its price will rise. The trader sells the currency pair when he thinks the currency pair will fall.
For example, the EUR is at 1.0895 today. The trader believes that the price of the EUR will rise in the next 24 hours. The trader places a buy order.
Tomorrow the EUR is at 1.090 and the trader closes his position with a profit of 5 points. The amount of the profit depends on the size of the trader’s contract for this order. The profit can be 50 cents or 50,000 euros, depending on the size of his order.
Looking in detail at this process of investing in currencies, one can understand that investing in forex is a little more complex than just placing an order.
The CFD is an instrument that has transformed the financial market into what we have today. It is a financial instrument that allows you to invest in the rise and fall of a financial asset, such as currencies for example.
The forex trader does not hold the underlying asset, he only receives the difference between the entry and exit price of the position. This makes it possible to also speculate on falling currency prices.
After finding his forex broker, choosing his trading account, a trader installs his forex software and funds his account.
Multiple trading instruments are now available to the trader to start trading forex online. If the trader wishes to trade a particular currency pair, such as the EUR/USD, or a particular market configuration, such as a support or resistance level, the trader should prepare for a forex order!
Haste in investing is strongly discouraged, although it may be compatible with certain trading styles or forex market configurations.
Technical or fundamental analysis is of crucial importance in online investing.
One can start by analyzing the market conditions favorable for entering a position, money management, the duration of the trade, an estimate of volatility for the period, expected macroeconomic events, and most importantly, the timing of exiting a forex trading position.
All this thinking needs to be done before placing orders on the stock market.
Once again, analysis is the key to online forex trading! It is essential in the psychology of the trader and in the evolution of the trading account balance.
It is the same as the business plan for an entrepreneur who wants to start a business. The ability to find, analyze and synthesize all this information is essential in online forex investing! Mastering these aspects of trading is what makes the difference between success and failure in online trading.
Once the trading strategy is well established, placing an order is a simple click of the mouse on the trading software. Order placement is the least important part of trading in the currency market.
What are the advantages of Forex Trading?
You are in control! You decide where you want to live when you want to work and how much you want to work. The word “unemployment” no longer scares you. And when people ask you what you do for a living, you answer: I buy and sell money.
The crisis is no longer a threat to you! Why isn’t it? Because during financial crises almost all assets move in the same direction.
This is the market trend. While the general public prefers bullish trends, forex traders don’t care about the market trend – they can trade profitably both up and down.
For example 2008. Your real estate assets are depreciating. Some currencies lose value. All this at the same time as crude oil climbs from all-time highs.
If you are an online trader, you know the three golden rules of trading in times of crisis: sell currencies, keep your real estate assets and buy oil.
Remember: financial speculation is a freedom of the capitalist world.
In the highly capitalized environment, CFD currency trading is one of the activities available to proprietary traders against economic tsunamis, earthquakes, and wars. Provided you know, of course, what you are doing.
Why invest in Forex?
The market is open almost 24 hours a day, 5 days a week.
Forex is the most liquid market in the world.
Brokerage fees are lower compared to other stock markets
You can trade forex from home, all you need is a trading account with a forex broker.