FOREX TRADING: WHAT IS FOREX?
Forex trading is a term used to describe a group of people engaged in the active exchange of foreign currencies, most times for financial benefit or profit. Sometimes, they can be in the form of speculators looking to leverage the fluctuations in the price of currencies, or they can be a hedger protecting their accounts due to an adverse move against their currency positions.
The term ‘forex trader’ may describe an individual trader on a retail platform, a bank trader utilizing their institutional platform, or hedgers managing their own risk or outsourcing that function to a bank or money manager to manage the risk for them.
FOREX TRADING: THE FX MARKET
The foreign exchange market, otherwise known as forex (FX), is a decentralized marketplace where the buying and selling of different currencies occurs. This activity takes place over the counter (OTC) instead of on a centralized exchange.
Unknowingly, you may have participated in the foreign exchange market by importing goods such as cars, items of clothing or buying foreign currencies when you are on vacations or probably when you are schooling abroad.
Traders engage in trading for numerous reasons. Some of which include;
- Low cost of the transaction involved during the trading
- Different levels of volatility
- An array of currencies to trade
- The size of the FX market
FOREX TRADING: TWO SIDES TO EVERY MARKET
One interesting and unique aspect of the Forex Market is how the prices are quoted. These currencies are uniquely quoted by pairing them with other currencies. This price quotation may be confusing at first but becomes normalized over time when individuals work with this two-sided convention.
Forex trading in a pair offers the trader a bit of flexibility as it allows the trader the choice to pick their trade against the currency they feel most comfortable with.
Let’s take the British Pound, for example; let’s say a trader is highly optimistic about the performance of the British Economy and would like to get long the currency, but this investor is also bullish for the Canadian Economy and at the same time has bearish sentiments for the Japanese Economy. Given this example, the trader is expected to take a long position on the GBP/JPY.
This flexibility provides the investor with some bit of variety concerning having a wide range of currencies available in the market at every point in time to take advantage of, either going long or short depending on the traders’ sentiments or projections on the Economy’s performance.
FOREX TRADING: BASE VERSUS COUNTER CURRENCIES
One major distinction about a forex quote is the convention; The base currency of the pair is usually the first currency listed in the quote and this is the asset being quoted while the second currency in the pair is known as ‘counter’ currency.
The counter currency is the convention of the quote or simply put; the currency being used to determine the value of the first currency in the pair.
LET’S TAKE GBP/JPY AS AN EXAMPLE…
The Pounds is the first currency in the quote so the Pounds will be the base currency in the GBP/JPY currency pair.
The Japanese Yen is the second currency in the quote, and this is the currency that the GBP/JPY quote is using to define the value of the Pounds.
So, let’s say that the GBP/JPY quote is 120.500. That would mean that £1 is worth ¥120.50. If the price moves up to 120.510 – then the GBP would have increased in value and, on a relative to the Japanese Yen (which would have declined in value).
FOREX TRADING: THE FOREX MARKET EXPLAINED
In summary, the foreign exchange market works like many other markets in that it’s driven by supply and demand. for instance, if there is a strong demand for the British Pounds from Japanese citizens holding Yen, they will exchange their Yen for Pounds.
The value of the British Pounds will rise while the value of Yen will fall. It is important to note that this transaction only affects GBP/JPY currency pair and will not cause the British Pounds to depreciate against the Canadian dollar.
FOREX TRADING: WHAT DRIVES THE FLOW?
The above example is one of the factors that move the Forex market. Others include economic events like the election of a new president or country-specific factors such as the prevailing interest rate, GDP, unemployment, inflation and the debt to GDP ratio, Government debt, Trade-Weighted Index etc.
Top traders are updated about important economic decisions that can influence the market through economic calendars.
From a longer-term perspective, interest rates from the related economy are one major driver of Forex prices because they can directly influence holding a currency, either long or short.
WHAT EXPLAINS THE POPULARITY?
The foreign exchange market is very popular because it allows large institutions, governments, retail traders and private individuals to exchange one currency for another. The core of the FX market is the interbank market,, where liquidity providers trade amongst themselves.
A major feature of the Forex market is its availability to be traded round the clock all through the week (Monday-Friday) between global banks and liquidity providers.
As the trading session in Asia comes to a close, the European and UK banks come online before handing over to the US. The full trading day ends when the US session leads into the Asian session for the following day.
The availability of liquidity round the clock makes the Forex market very attractive to traders as they can easily enter and exit positions due to the numerous buyers and sellers in the FX market.
FOREX TRADING: HOW DOES IT WORK?
Trading in the Forex market is very similar to other markets: If a trader thinks the value of a currency will go up (appreciate), he or she can buy the currency. This phenomenon is known as “taking a long position”. (buy) If a trader feels the currency will go down (depreciate), you sell that currency. This phenomenon is known as going “short”.
FOREX TRADING: WHO ARE THE MAJOR PLAYERS?
There are two major types of traders in the foreign exchange market: hedgers and speculators.
Hedgers are known for avoiding extreme movements in the exchange rate while speculators are willing to take risks. The speculators are usually looking for sporadic movements in the price of the market. These include large trading desks at the big banks and retail traders.
READING A FOREX QUOTE
All traders need to have a good understanding of how to read a forex quote as this determines the price an individual enters or exits a trade.
If you study the currency quote below, the first currency in the EUR/USD pair is known as the base currency, which is the Euro, while the second currency in this pair (the USD) is known as the variable or quote currency.
For most FX markets, prices are offered up to five decimals but the first four are the most important. The number to the left of the decimal point indicates one unit of the counter currency, in this example, it is the USD and therefore is $1. The following two digits are the cents so in this case 13 US cents. The third and fourth digits represent fractions of a cent and are referred to as pips.
It’s key to note that the number in the fourth decimal place is known as a ‘pip’. Should the EUR depreciate against the USD by 100 pips, the new sell price will reflect the lower price of 1.12528 as it will cost less in USD to buy 1 Euro.
Another way of saying the above-quoted bid price is: The value of One Euro, in terms of US Dollars, is One Dollar, 13 cents, 52 pips and 8/10th’s of a pip.
WHAT IS A ‘PIP’?
Pip stands for ‘percentage in point,’ or “price interest point,”. It represents a tiny measure of the change in a currency pair in the forex market. A pip is a standardized unit and is the smallest amount by which a currency quote can change.
For currency pairs in which USD is the counter currency, or listed second in the quote, the pip value or cost will often be $1 for a 10k lot of currency, which would also mean a pip value or cost of 10 cents for a 1k lot and $10.00 for a 100k lot.
So, if an investor buys a 1k lot of EUR/USD, each pip gained or lost would be worth 10 cents. If the same investor buys a 10k lot of EUR/USD, each pip gained or lost would be worth $1/each. And if the investor buys a 100k lot, the pip value would be $10/per.
Running with this example: Let’s say that the investor that bought EUR/USD saw a 50 pip gain. Well, if the investor was using a 1k lot, that 50 pip gain would amount to $5 ($.10 X 50 = 5.00); and an investor using a 10k lot would have a gain of $50 ($1 x 50 = $50). And if the same investor was working with a 100k lot, that gain would be $500 ($10.00 x 50 = $500).
Pip cost or value is an extremely important data point for forex traders to be aware of, as this is how spreads are communicated; so it’s very important for traders to ‘know their pips.’
FOREX TRADING ON DEMO ACCOUNTS: GAINING EXPERIENCE WITHOUT RISKING HARD CAPITAL
Trading can be a very daunting task, and it comes with a lot of risks. The risk that comes with financial loss is ever-present when it comes to trading on a live account. Losing a huge amount of money can be very expensive and discouraging for beginners who are just learning their ways in the journey of trading FX.
Several Forex brokers offer demo accounts for new or prospective traders to get acquainted with the dynamics before ever depositing their own money to trade in a live account.
Fictional capitals are made available by Forex brokers to new traders to implement their strategies while they implement their trades. A demo account can be a suitable platform to learn the dynamics of Forex trading, trigger positions, set stops, and scale-out of trades.
FOREX TRADING: FIVE REASONS WHY YOU SHOULD TRADE FOREX
Forex trading has many advantages over other markets as explained below:
- Low cost of transaction: Typically, forex brokers make their money on the spread, but forex trading is cost-effective when weighed against a market like equities, which attracts a commission charge.
- Small Start-up Capital: Forex business doesn’t require huge investment. With a small amount of capital, an individual can open a trading account. Forex trading allows you to start slow at your own pace and then grow big with the help of forex affiliate programs. The sky is just the starting point in this forex business. Many traders started with 100$ and grew it to 6 figures. You have to be consistent, smart, and be willing to learn in your Forex journey.
- The flexibility of time: Forex trading business offers convenience in terms of time, and this is one of the top reasons you should start a Forex trading business. The forex market remains active throughout the day. It operates 24 hours each day as digital or electronic currencies of different countries worldwide are readily available in this market. Time flexibility allows an individual to enter or exit a trade whenever they want. Hence, you can start trading whenever you have time. Forex is one of the few businesses that gives you the luxury to trade anytime.
- High Liquidity: With over 6 Trillion dollars daily in the FX market, the foreign exchange market is one of the most liquid financial markets in the world. The number of buyers and sellers determines the liquidity of a financial market. A large number of buyers and sellers are matched within a fraction of a second. This enables traders to have greater opportunities to win a trade by getting a fair price to buy and sell their currency pairs. That is why the forex market is extremely liquid. High liquidity means a low risk of price manipulation by a few big players. Due to the high liquidity and large size of the market, it’s almost impossible to manipulate prices.
- Anyone can trade Forex: It’s highly risky and difficult to start any business without the proper knowledge and experience. However, when it comes to forex trading, much experience is not needed. It is open to anyone regardless of their experience and knowledge. Although having knowledge is an extra advantage, but as beginners, one can start with a few pounds of investment and then grow gradually by gaining experience over time. No special skills or experience is needed to get started. Consistency and the ability to learn are needed to help you become a better trader. Joining a Forex trading community with a trademark of excellence is also a plus as it will help you grow.
It is important to have a disciplined approach and practice risk management when trading FX.