Many have been said about forex. But, what is forex trading and how does it work? This could be one of your biggest questions when you think about venturing into the business. Perhaps you’ve heard and come across a lot of misleading information about the business.
But, guess what, you aren’t alone. There are thousands, if not millions looking for the same answer. With more than a decade of experience in the currency trade, we’ll help you understand what is forex trading and how does it work?
Let’s get rolling…
What is Forex Market?
Forex, also known as FX, is short for foreign currency exchange and refers to the transaction of converting one foreign currency into another. Most forex traders buy and sell currencies for commerce, tourism, and trading reasons. Notably, the forex market is the largest financial market worldwide, with a daily turnover of about $6.6 trillion as of 2019.
The place where the foreign exchange currencies are traded is what is popularly referred to as the forex exchange market.
What Does the Forex Markets Look Like?
The forex market is a platform where most of the global currencies are traded. Currency trades are performed electronically over-the-counter (OTC markets). Typically, Forex transactions are conducted between traders over computer networks where traders buy and sell currency pairs in a 24-hour market, five days a week, excluding weekends.
Unlike other trades with a centralized market, there’s no centralized exchange market for forex traders. As such, all transactions between forex traders are purely through computer networks.
For instance, if you live in France and want to purchase a product from the U.S, either you or the foreign company you’re transacting with has to pay the U.S product in dollars (USD). Therefore, you’ll have to exchange an equivalent value of euros (EUR) into U.S dollars before you can pay for your product abroad.
When and where was it Invented?
When did forex trade begin? And where did it begin? These are some of the obvious questions a forex beginner will always ask.
Well, let’s make it clear.
While forex trading might sound like a new thing to beginners, it isn’t today’s event. It dates decades back.
Forex started in the earlier days when people exchanged currencies and goods to buy other goods and services. Since then, the market has seen massive transformations, from barter trade to the metal age and eventually to money.
The modern forex market was invented in the early 1970s in the U.S when the dollar was allowed to float freely in the market against other currencies.
What Makes Currency Trade a Popular Venture?
Currency trade is popular due to many reasons: Usually trade, commerce, or tourism. Since currencies vary with geographical locations, using one type of currency to conduct trades isn’t practically feasible. Therefore, you will have to convert your curry to that accepted by your supplier or service provider.
And that’s where currency trade comes in handy.
As such, people can always purchase products and services in foreign markets 24 hours a week without suffering currency barriers.
Apparently, the FX market is considered the world’s most liquid financial market, larger than other asset markets like bonds, commodities, and stocks.
And without mentioning, forex trading has become a popular and convenient way for people to make money online for many people by investing as little as $100 and getting their money back in multiples.
As a beginner, you need to understand how different national currencies work and relate. You can succeed if you are self-disciplined, dedicated, and hard-working.
Forex Markets: Overview
Forex market is the only continuous 24-hour trading market globally. The formally institutional firms-dominated market has nowadays become more retail-oriented, with more traders and investors of diverse volume holding becoming significant participants,
Unlike in the past when banks and other financial institutions acted on behalf of their clients, the recent thrive in the use of the internet for business has given even small deposit traders the opportunity to close trades and make significantly huge profits.
Interestingly, there are no physical markets for conducting forex trade transactions. Instead, there’s a series of interconnected trade terminals made over computer networks.
Unlike other financial markets, foreign currency trade is considered more opaque since disclosures aren’t mandatory since currencies are traded in OTC markets. Additionally, the market features enormous liquidy pools from large financial institutions.
Even though people often presume the country’s economic parameter as a standard criterion for determining the country’s currency value, the notion isn’t true. In one of the studies conducted in 2019, the motives of large-scale financial institutions played a critical role in determining the value of currencies.
How Large is Forex Market?
The forex market is the world’s biggest financial market, with a net worth of over $2.4 quadrillion. According to DailyForex, the daily turnover for foreign exchange rose from $1.2 trillion up to a whopping $6.6 trillion in 2019.
According to data, the most common include the EUR/USD, NZD/USD, AUD/USD, USD/JPY, and USD/CDA.
Traders use the forex market for various reasons – to expand portfolios, speculate geographical events, and hedge against interest rate and financial currency risk. Major market participants include individuals, money managers, commercial banks, hedge funds, and central banks.
Three Ways You Can Trade Forex
Are you interested in Forex trading and wondering, “what is a forex, and how does it work?” Here are three ways you can trade forex and make a profit out of it.
Spot Market
The spot market, also known as the over-the-counter market, is the most significant because it involves actual asset trading for futures and forwards markets. The spot market operates around the clock on an electronic platform. There is no central location of the exchange; thus, traders transact directly with counterparts.
How Does Forex Spot Market Work?
In a spot market, traders buy and sell currencies according to their prices. Supply and demand are the major determinants of price, determined based on economic performance, current interest rates, future currency predictions, and political situations.
Forex Rollover
The rollover trade is the action of rolling a trading position over to the next delivery day. In this case, your trading account is charged an interest rate (the rollover rate) for holding an open position overnight.
Depending on the nature of your trade – short or long position you may get a rollover interest or end up paying the interest.
Forwards and Futures Markets
The forwards and futures are both forms of contracts between two parties used to buy and sell assets within a specified time and price. A forward agreement is customized and private and traded OTC, while a future agreement operates on standardized terms, and the price is calculated every day till the contract ends.
Forex Forwards Transactions
A forward transaction is a contract between two traders to buy and sell an asset on a fixed future date for a preset price. This agreement is private and is often settled at the end of the agreement. Forwards contracts have less strict terms and conditions and are not subject to price changes.
Forex Futures Transactions
On the contrary to the forward’s contracts, future transactions are subject to daily changes. These contracts are transacted on an exchange thus, traders can settle them within varying dates. Moreover, the futures market is relatively liquid than forwards’, allowing traders to join and exit when they need a break.
Forex for Speculation
Speculative trading is when a trader makes a financial transaction with a high risk of losing value but with an opportunity to generate profit from fluctuations that may impact the value of one currency against the other. Although there is a high risk of losing, the trader often focuses on market value changes to offset the loss.
Typically, things like geographical risk, trade flows, economic strength, and interest rates affect the demand and supply of currencies, making the forex markets highly volatile.
Forex for Hedging
What is forex trading and how does it work? Forex trading for beginners. In most cases, there is a certain level of risk involved when you buy and sell commodities to foreign countries, often caused by price fluctuations.
Fortunately, currency exchange platforms provide a way to insure or hedge transaction risk by fixing currency rates to prevent losses. Hedging is generally a short-term strategy to protect an investor’s position when there is a major concern of market volatility.
What Makes Forex Different from Other Financial Markets?
There are notable differences between forex trading and other financial markets, but it might be hard to identify these differences if you have not yet understood “what is forex trading and how does it work?”
However, we’ve done all the heavy lifting for you.
The first difference is that forex investors use pips to track price fluctuations to tell whether the market is going up or down. On the other hand, other financial markets like the stock market use blue-chip stocks.
Forex trading operates around the clock for five and a half days a week, while other financial markets work on a scheduled daily calendar depending on the type of exchange and location.
Additionally, Forex trading offers plenty of strategies to maximize profits in a short period, like scalping and day trading. On the contrary, these strategies are less common in other financial markets since most of them focus on long-term trading.
Understanding Key Terms in Forex: Beginner’s Guide
What is forex trading and how does it work? Before you start learning how forex works, it is important to understand basic terms.
Forex Account: Types of Accounts
A forex account is a type of account you can open with a forex broker to trade and hold foreign currencies. There are three types of accounts based on the lot size.
Micro Forex Accounts – These accounts can trade and hold up to $1,000 of value in a single lot.
Mini Forex Accounts – These accounts can trade and hold up to $10,000 of value in a single lot.
Standard Forex Accounts – These accounts can trade and hold up to $100,000 of value in a single lot.
Currency Pair
In forex trading, you buy one currency and sell another, which mostly come in pairs. A currency pair is an amount a trader would pay per unit in exchange for another currency.
So, for instance, if you’re trading the British pound against the U.S dollar (GBP/USD), it means you’ll buy the British pound and sell the U.S dollar.
Risk
An FX risk is a potential loss that can occur while trading due to market volatility. Common risks in the currency exchange market include liquidity risk, interest rate risk, credit risk, transactional risk, country risk, and more.
Bid
The bid is the price that a trader pays to buy a currency pair.
Pip
A pip (price interest point/percentage in point) is a standardized measure that shows the smallest amount that a currency pair can change.
Leverage
This is where a trader uses borrowed capital to amplify returns. The FX market offers plenty of leverages that you can use to increase your position.
Spread
A spread is what helps you to make a profit in forex trading. It is the difference between the selling and buying price of currency pairs.
Snipping and Hunting
These are inappropriate practices (buying and selling currencies near preset points) by brokers to hike profits. The solution to this problem is to network with other traders to track such patterns.
Getting Started with Forex
What is forex trading and how does it work? Forex trading for beginners. Forex trading can be profitable only if you learn essential skills and understand how to trade correctly without using emotions. Here is how to get started.
- Get a strong foundation of the FX market – Do your research and learn the ins and out of FX trading. Although FX trading may sound simple, it requires extensive knowledge to learn how to trade and succeed.
- Develop a strategy – Develop a reasonable strategy that matches your finances, situation, and risk appetite. A good strategy will serve as a roadmap to help you predict the market movement.
- Open a brokerage account – As a beginner, you may want to open a micro forex account since it has minimal capital requirements. Remember that forex traders don’t charge any fees but earn money through pips.
- Be informed – Keep track of the latest forex trading news and market trends not to miss anything that may affect your position.
Conclusion
Forex trading is one of the popular businesses that some people make a living in by trading forex. However, if you’re a beginner in the forex trade, the information discussed in this article should give you an informed startup without having to grapple. At Choose Forex, we endeavor to offer you all the necessary knowledge about the forex trade.
Sources
- https://www.investopedia.com/articles/forex/11/why-trade-forex.asp
- https://en.wikipedia.org/wiki/Percentage_in_point
- https://en.wikipedia.org/wiki/Blue_chip_(stock_market)
- https://en.wikipedia.org/wiki/Volatility_(finance)#:~:text=In%20finance%2C%20volatility%20(usually%20denoted,standard%20deviation%20of%20logarithmic%20returns.&text=Implied%20volatility%20looks%20forward%20in,in%20particular%2C%20an%20option)
