Forex Basics
What is Forex?
As mentioned earlier, forex is a market where currencies are traded. Anyone who has ever exchanged money on vacation has done a forex transaction. The forex market includes banks, financial institutions, central banks, investment firms, trading companies, retail investors and international trade.
How does Forex work?
The forex market works on the principle of currency pairs, where the value of one currency is expressed through the value of another currency. For example, EUR/USD is a currency pair where the Euro (EUR) is the base currency and the US Dollar (USD) is the quoted currency. If the EUR/USD exchange rate is 1.10, this means that one euro is equal to 1.10 US dollars.
The currency is traded on the foreign exchange market, which is a global market open 24 hours a day from Monday to Friday. Forex trading takes place over-the-counter (OTC), which means that there is no physical exchange (as with stocks) and the market is overseen by a global network of banks and other financial institutions (instead of a central exchange, such as the New York Stock Exchange).
The majority of trades in the foreign exchange market are between institutional traders such as employees of banks, asset management companies and multinational corporations. These traders are not necessarily interested in the physical holding of currencies, they may only be speculating or hedging against future changes in exchange rates.
How to trade on forex?
For example, a trader on the forex market could buy US dollars (and sell euros) if he believes that the value of the dollar will strengthen and thus he will be able to buy more euros in the future. Whereas a US company with operations in Europe could use the foreign exchange market as a hedge in case the euro depreciates, which would mean that the value of their profits would fall.
Currency trading
Each currency is assigned a three-character code, similar to a stock ticker symbol. Although there are more than 170 currencies around the world, the US dollar is involved in the majority of forex trading, so it's useful to know its code: the USD. The second most popular currency in the foreign exchange market is the euro, which is accepted in 19 countries of the European Union (code: EUR).
Other major currencies, by popularity, are the Japanese yen (JPY), the British pound (GBP), the Australian dollar (AUD), the Canadian dollar (CAD), the Swiss franc (CHF) and the New Zealand dollar (NZD).
All trades on the forex are expressed as a combination of the two currencies traded. The following seven currency pairs, referred to as the major currencies, account for approximately 75% of trading on the forex market: EUR/USD; USD/JPY; GBP/USD; AUD/USD; USD/CAD; USD/CHF; NZD/USD
How are trades on the Forex listed?
Each currency pair represents the current exchange rate for both currencies. Here's how to interpret this information using the EUR/USD pair (euro/dollar exchange rate) as an example:
The currency on the left (euro) is the base currency.
The currency on the right (US Dollar) is the quoted currency.
The exchange rate represents how much of the quoted currency is needed to buy 1 unit of the base currency. Therefore, the base currency is always expressed as 1 unit, while the quoted currency changes according to the current market and how much is needed to buy 1 unit of the base currency.
If the EUR/USD exchange rate is 1.2, this means that €1 will cost $1.20 (in other words, it will cost $1.20 to buy €1).
When the exchange rate rises, it means that the base currency has risen in value against the quoted currency (because €1 will be worth more US dollars) and conversely, if the exchange rate falls, it means that the base currency has fallen in value.
How to Trade Forex
1. Education
The first step to successful forex trading is education. There are many resources online where you can learn the basics of forex, including currency pairs, market analysis, technical and fundamental analysis.
2. Choosing a broker
Choosing the right forex broker is key. The broker should be regulated by reputable financial authorities, offer competitive fees and a reliable trading platform. It is also important that the broker provides good customer support.
3. Demo account
Before you start trading with real money, you should try trading on a demo account. This way you will get hands-on experience without the risk of losing money.
4. Trading Plan
A good business plan should include your business objectives, risk tolerance, analysis methods and risk management strategies. Consistent adherence to your trading plan will help you stay disciplined and avoid emotional trading.
5. Market analysis
Successful forex traders constantly monitor the market and its dynamics. They use technical analysis, which involves studying price charts and using technical indicators, and fundamental analysis, which involves watching economic news and events that may affect the markets.
6. Risk management
One of the keys to success in forex is effective risk management. You should never risk more than you can afford to lose. Traders often use stop-loss orders to limit the potential loss on a particular trading position.
Conclusion
Forex trading offers tremendous opportunities, but also significant risks. Successful trading requires not only an understanding of the market and effective strategies, but also discipline, patience and continuous learning. Like any form of investing, Forex trading should be done with caution and careful planning.