‘Forex’ or ‘FX’, an acronym of Foreign Exchange, is simultaneously buying one currency while selling another based on market analysis, news and overall market sentiment. Depending on a number of market factors, currency values will appreciate and depreciate. Your goal as a Forex trader is to profit from these value changes of currencies against each other as to how you expect the forex prices will turn in the future. Most financial markets have a physical location or central exchange, but not the over-the-counter (OTC) Forex market. This means the Foreign Exchange Market trades 24-hours a day and that currency prices are constantly shifting in value against each other, which in turn offers numerous trading opportunities.
How does Forex Trading work?
Forex trades can be placed through a broker or market maker. Signing up with a broker will allow you to place trades through their platform and with a few clicks an order can be placed. The broker will then pass the order along to the Interbank Market or simply take the opposite side of your trade (Market Maker). Once you close the trade that you have placed, also called a round trip, the broker will then close the position and either credit your account with a profit or a loss.
24-Hour Forex Trading
The main factor behind Forex’s popularity is the fact that Forex markets are open 24-hours a day from Sunday evening through to Friday evening. Following the clock, trading opens on a Monday morning in New Zealand progressing through to the Asian trade, moving to London and eventually closing on Friday in New York. During these times multiple markets, not considered as major markets, open and close. Price gapping, when a price climbs from one level to the next without trading in between, is less due to the 24-hour availability to trade and this ensures that traders can execute an order whenever they please without worrying about a lack of liquidity. Due to adequate liquidity market gaps are not that common and mostly occur when the market opens after the weekend. This can be due to many factors such as news and economic events.
Basic Terms used in the Forex Industry
Forex is a leveraged or margined product, allowing you to open large positions with a smaller start-up capital. Common leverages offered by brokers are 400:1. Depending on your location this may differ. Higher leverage can equal big profits or large losses. Leverage can sometimes be a downfall when greed kicks in. Make use of your leverage in a realistic and safe manner.
All currency pairs consist of two currencies, also referred to as the ‘base’ and ‘counter’ currency. The first currency in the equation is called the ‘base’ currency while the second is the ‘counter’ currency. An example of this would be EUR/USD, with EUR being the base currency and USD being the counter currency. Price movement is based on appreciating and depreciating of currencies weighed up against each other. In layman’s terms, it all comes down to supply and demand. When making calculated decisions whether a currency’s price will rise or fall, you would buy a currency pair if you expect that the base currency will strengthen against the counter currency and vice versa.
Examples of Major Currency Pairs:
EUR/USD – Euro against the United States Dollar. The value of 1 EUR indicated in USD.
GBP/USD – Great British Pound against the United States Dollar. The value of 1 GBP in USD.
All currency pairs are quoted to 5 decimal places, with the exception of the YEN (GPY). The 4th digit (0.0000) is called a ‘pip’ with the exception of the YEN crosses which is the 2nd digit (0.00). The 5th digit or the 3rd digit in the case of the YEN is called fractional pips (1/10) or also called pipettes.
The spread is the difference between the BID and the ASK price (Bid = Buy, Ask = Sell). The ASK price is where traders are willing to sell at, whereas the BID price is where traders are willing to buy at. Where the BID and the ASK price match up, a trade can be executed. This is also called a Market Order. A pending order can also be set at a specific price and will only be executed once that price is reached.
For example, if the EUR/USD has a bid of 1.33800 and an ask of 1.33808 would be a 8 pip spread (0.0008).
What Affects Forex Prices?
There are multiple different factors that can influence Forex prices, from international trade to economic conditions. These factors make forex trading interesting and exciting. High market volatility means that prices can change on a dime in response to news, economic and political events, allowing for ample trading opportunities.
Although all of this information might be overwhelming, it is worth learning and understanding. This should simplify the understanding you have of the Forex Market.