Forex is also known as FX trading or foreign exchange and is one of the most popularly traded markets in the world, with around $5 trillion traded daily. Generally, FX trading enables you to predict price fluctuations in the global currency market over time. You can trade currencies and buy and sell one against the other.
Usually, forex traders seek to gain from the changes in currency strengths, speculating on if one currency’s value, such as the US dollar, will go up or down with regards to another, like the pound sterling. As mentioned earlier, the exchange market is highly dynamic and liquid. With this high market liquidity, it implies that prices can fluctuate rapidly with short-term events and news, creating a variety of trading opportunities for retail FX traders.
How Does Forex Trading Work?
Generally, forex is quoted in pairs that are in terms of a particular currency vs another. For instance, USD/GBP (US dollar vs sterling), the change in the exchange rate between these two currencies is the profit that the trader looks to make. “The base,” which is the first currency, is the one that you speculate will go up or down against “the quote,” which is the second currency.
When trading currencies, you can predict on the market’s future direction, taking either a short (sell) or long (buy) position based on if you think the value of the currency will go up or down. Usually, the thing that triggers the forex price movements is the currencies either strengthening in value (appreciation) or weakening in value (depreciation).
Buying-Going long
If you decide to trade currencies, it would be a smart idea to buy a currency pair if you thought that the specific base currency would appreciate with respect to the counter currency, or you speculate the weakening of the quote currency in relation to the base currency.
If you believed, therefore, that the Euro will actually strengthen compared to the US dollar, then it would be smarter to opt for a buy trade or go long. Consequently, for every pip, or point that the Euro rises compared to the dollar, you’ll make some profit. Similarly, don’t forget that if the Euro’s price weakens against the USD, you will lose for every pip it falls.
Selling
You could, alternatively, sell a currency pair if you thought that the base currency’s value would weaken with respect to the counter currency. So, if you believe the Euro’s value will decrease compared to the US Dollar, you would instead place a sell trade. You will then make a profit for each pip the Euro falls with respect to the US Dollar. In case the Euro’s value rises against the dollar, you would lose for every pip it rises.
Leveraged Forex Trading
Forex is generally a margined product, which implies that you can place a small amount of money to manage a relatively larger amount. That also means that you can leverage your money even further, but losses will also be magnified. You should, therefore, control your risk accordingly. So, make sure that you’re fully aware of the dangers of leveraged trading.
Which Currency Pairs?
Traditionally, commonly traded currency pairs are divided into three main groups in terms of liquidity and popularity: majors, minors, and exotics. Read on to learn more.
Majors
They’re the most actively traded (most liquid currencies) consisting of approximately 85% of the overall trading volume in the FX markets. In general, the spreads for these are tighter than less traded minor currency pairs.
Minors
They’re not heavily traded like the major currencies; therefore, they often fluctuate. Minor currency pairs also have a wider spread because of the medium-sized liquidity in the market, in comparison to major currency pairs.
Exotics
They’re the rarely traded currency pairs. Exotic currency pairs are illiquid because of the low volumes of trade and tend to be relatively expensive to trade with wider spreads. A majority of traders tend to think that exotic currency pairs have much higher risk profiles than commonly traded currency pairs.
Who Is Forex Trading Suitable for?
FX trading is an excellent option for those investors who want the chance to trade on a market that’ always open while lowering the trading costs and potentially gaining from fluctuating markets. It contains, however, huge risks to your investment and isn’t suitable for everyone. It’s prudent to start trading on a demo account and read reviews first before trying it with your money.