What is Forex Trading? Complete Beginner’s Guide

Forex is arguably the most significant financial market in the world, with a daily turnover of over $5 trillion. Commonly referred to as foreign exchange, Forex is the art of buying or selling one currency in exchange for another. The exchange process, which goes around the world, is what results in the biggest market in the world.

The total amount of money traded in the currency market, is more than the entire GDP of some economic powerhouses in the world. Forex is also the most, liquid market in the world. Unlike the equities market, forex market never shuts down during the regular business days. What this means is that people are continually trading throughout the day all over the world, without any restrictions.

Trades in the forex market take place between people holding currencies rather than via exchanges, as is the case in the stock market. For this reason, the market cannot be restricted to regular businesses hours as there will always be people around the world, at any given time, willing to buy and sell currencies.

Forex Trading

While the forex market is open all day long during business days, there are hours when it is most active. Currency pairs involving U.S dollar tend to move on massive volume during U.S business hours, which is between 16:00 and 24:00 GMT.

European majors made up of the Euro, British Pound, Swiss Franc tend to move the most during European Business hours, which is 8:00 and 16:00 GMT. Australian Dollar, New Zealand and Japanese’s are most active between 00:00 and 08:00 GMT.

Currency Pairs

Currency pairs are the critical components of the forex market. Price movement of a currency pair essentially measures the value of one currency against another. While there can be endless currency pairs in the market, the commonly traded currency pairs in forex trading are those pegged on the big five economies in the world.

For that reason, currency pairs are classified into three main categories the Majors, Minors, and Exotics. The majors entail currencies of the biggest economies in the world.  They include USD-US Dollar, EUR- the Euro, JPY-The Japanese Yen, GBP- the British Pound, CHF- the Swiss Franc, CAD- the Canadian Dollar, AUD- the Australian Dollar and NZD-The New Zealand Dollar.

A significant currency pair will contain a US Dollar as its vital component they include, i.e., EURUSD, GBPUSD, USD/JPY, and CADUSD. The minors, on the other hand, are currency pairs that do not include the US dollar EURCHF, EURJPY, AUD/ZD, EURGBP, etc.

Exotic currency pairs entail currencies of countries that are not part of the big economies’; they include the Hong Kong Dollar, the Rubble, the Chinese Yuan, etc.

When it comes to forex trading, it is common for people to focus on major currency pairs. It is because such currencies come with high daily volatility and tight spreads.

How Forex Trading Works- Bid and Ask Price

If you visit any forex trading platform that allows the buying and selling of currency pairs, you are likely to encounter Bid and Ask prices. The Bid Prices is a connotation used to indicate the price one is likely to buy a currency. The price fluctuates throughout the day in line with forces of demand and supply in the market.

The Ask Price is a connotation used to describe the price one is likely to sell a given currency pair. Just like the Bid price, it is always fluctuating in line with forces of demand and supply.

In case you are purchasing currency in a given trade, then you are mainly in a long trade. The hope, in this case, is that the price will continue going higher so that you can be able to make money on selling at a much higher price.  You get to make a profit on subtracting the price you entered on the final higher price.

In case you are selling a currency pair, one is said to be short on a trade. The hope, in this case, is that the price of the pair will continue to drop such that the final price is much lower than the value that one entered the trade. The profit, in this case, will be the difference between the two prices.

Forex Screen

Forex Must Know Terms

The world of Forex trading can be a little overwhelming to newcomers, so you will need to spend some time getting to know the language used and read up more on each term you hear.

Here are some common terms you will need to know when trading Forex.

What Is A Pip?

A pip is a commonly used term in forex that refers to change in value between two currencies. For example, if the EURUSD is priced at $1.1213 and then moves to 1.1214, the difference, which in this case is .0001, is referred to one Pip.

A Pip essentially refers to the last decimal place of a quotation of a currency pair. Most Pips are quoted in the standard four and two decimal places. However, there are those that are also quoted at the five and three decimal places.

For instance, GBPUSD price may appear as 1.30547 and then move to 1.30548 in this case the .00001 USD price change is referred to as One Pipette.

What Is A Spread?

The difference between the buy and sell price in Forex, is what is known as spread. For example, if the Bid price of the EURUSD is 1.13345 and the Ask price is 1.13346, then the spread, in this case, would be 0.0001 or one pip.

While trading, the price of a currency pair will have to cross the spread for a trade to become profitable. For example, given above, a long trade will only become profitable on the price of EURUSD rising above 1.13345. Conversely, a short trade will just become profitable on the price of EURUSD dropping below the 1.13346 level.

The spread should be as small as possible for one to be able to make a profit with ease on small price movements. It is for this reason that people tend to trade the major currency pairs as they come with thin spreads.

For minor currency pairs, the spread tends to be much higher. For instance, the bid price of EURCZK could be 23.4565 while the Ask price is 23, 4315. The spread, in this case, is 0.0200 or 200 pips which are slightly high.

Margin

Margin depicts the amount of money in a trading account that allows one to open trades of given sizes. In other words, it is the good faith deposit in a trading account that acts as collateral for trading. Contrary to perception, it is not a fee or a transaction cost for trading.

At any given time, the amount of margin needed to be able to open and hold a position will come down to the trade size. An increase in a trade size will most of the times call for more capital to be able to hold a given position.

The fact that most retail, forex traders lack the necessary margin required to trade high volumes, prompts traders to offer leverage.

What is Leverage?

Leverage is essentially the amount provided by a broker, which goes a long way in bolstering one’s trading volume.  For example, a 1:10 leverage imposed on initial capital of $1,000 would allow one-trade currency pairs worth $10,000.

In case, of a thriving trade, the 1:10 leverage would maximize one’s profit by a factor of 10. Conversely, the same leverage would multiply ones loses by 10. It is for this reason that leverage acts as a double-edged sword.

How to Trade Forex

The actual process of starting to trade Forex is quite simple, most brokers are easy to signup for and get started and many of them have indepth educational material available on the site and some also offer demo accounts so you can practice your strategies and acclimatize yourself.

Open a Forex Brokerage account

The first step to engaging in the business of buying and selling currency pairs involves opening a Forex Brokerage Account. Just as is the case in the equity market, different brokers offer different services as well as accounts for forex trading.

We have covered a lot of brokers on our sister site Blockonomi, take a look at the indepth reviews we have created of most of the top brokers:

When opening a brokerage account, it is essential to consider some factors. Leverage on offer by a broker is of great importance. It is because it is impossible to open trades with small amounts of capital.  The standard leverage offered by most brokers is 50:1; some do offer 250:1 or 500:1 leverage.

The spread on offer to trade currency pairs should also be taken into considerations. While forex brokers do not charge commissions on trades, they make most of their money from spreads. It is thus essential to go with a broker that offers lower or tight spreads as this will ensure one maximizes returns on each trade.

Besides, it is essential to review the different levels of services offered as well as programs in addition to the fees.

Trading Platform Software

Once you have opened a brokerage account, the next step is depositing some capital to be able to buy and sell currency pairs. Upon funding a trading account, a broker should provide a download link to a trading platform from where you will be able to execute trades. The most commonly used platform in forex trading is MT4 Trading platform.

Meta Trader Software

Upon setting up the trading platform, you should be able to get into the actual business of buying and selling currency pairs based on trade size of choice.  In addition to buying and selling currency pairs, you can be able to purchase derivatives that track the movements of currency pairs instead of buying or selling currency pairs outright.

Types of Orders

Below are some of the basic types of trading orders available in most trading platforms

  • A Market Order is a type of order that allows a trader to acquire a currency at a price prevailing in the market. Traders use a Limit Order to buy or sell a currency pair at their preferred price. In this case, one can specify in advance the entry price for a short or a long trade.
  • Take Profit order allows one to set the price where they wish to take profits be it in short or a long trade. On setting a profit take order, a trade would automatically lock in the gains once the price reaches the fixed level.
  • Stop Loss order is used to prevent the accumulation of losses. The order allows traders to determine in advance, how far a trade should go against them before closing down a position.

Benefits of Forex Trading

  • 24 Hour Market – Unlike most markets, Forex market remains open all the hours, during normal business days. Trading continues around the world, from when the markets open on Sunday in Australia to when they close in New York on Friday.
  • High Liquidity – Forex trading stands out in part because of the high levels of liquidity on offer. High levels of liquidity make it easy to enter and exit positions at minimal price movements.
  • Low Transaction Costs – Forex market comes with no clearing fees, exchange fees, government fees or commissions. For this reason, it is a considered a low-cost market that allows people to walk away with optimum returns.
  • Leverage – Forex brokers allow traders to open positions that in normal occurrences their capital would not accommodate thanks to Leverage. With a capital of about $1000 and an advantage of 50:1 one can open positions worth $50,000.
  • No Middlemen – Unlike in the stock market, one does not need to go through intermediaries to buy and sell currency pairs, in the forex market.

Disadvantages of Forex Trading

  • Risk Factor – Just like in other markets, there is a risk factor associated with forex trading. The use of high levels of leverage can work to ones’ disadvantage when losses start to accumulate
  • Price Determination – Price determination process can at times be a big challenge to novice traders. To be able to make profits in the markets, one must be able to leverage technical knowledge as well as indicators.
  • High Volatility – High levels of volatility in the forex market at times act as a precursor for disaster as it always leads to wild price swings.

Conclusion

Forex trading promises big returns when done in the right way. Being double-edged sword, so can losses accumulate fast, in case of a small mistake. When it comes to forex trading one must be mentally strong technically equipped and have a hawk eye for reading potential price movements.

Ruchi holds a first degree in Accountancy and Post Graduate Diploma in Business Administration (First Class) from the International School and Business and Media in India. Proficient in financial databases like ThomsonOne, CapitalIQ, Factiva, and has also worked on Bloomberg and Datastream. She has previously worked as Assistant Manager at Genpact India, providing content in support of credit risk assessment of existing and potential clients of GE.


ruchi@moneycheck.com

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