Forex, short for foreign exchange, is nothing more than the conversion of one currency into another. Read this guide to find out everything you need to know about forex trading, including what is forex trading is, how to trade and with what tools.
What is forex trading?
Trading forex online means exchanging one currency for another. When doing general forex trading, you always exchange currency pairs, that is, you sell one currency to buy another.
The currencies in the forex world are listed according to their international denomination, that is, with a three-letter capital code. Generally, the first letters indicate the country of the currency, while the third letter symbolizes the currency itself. So USD stands for US dollar, JPY for Japanese yen and so on.
If you display a currency pair in this USD / JPY order it means that you are buying US dollars and selling Japanese yen.
This is just one of the many most popular currency pairs in the forex world. Other popular pairs are USD / EUR and GBP / EUR - GBP stands for British pound.
To tidy up, most providers divide currency pairs into the following categories:
- Major pairs - Seven major currency pairs representing approximately 80% of world forex trading. They are: EUR / USD, USD / JPY, GBP / USD, AUD / USD, USD / CHF, NZD / USD and USD / CAD.
- Exotic Pairs (Exotics) - They are called exotic pairs, when an important currency is exchanged compared to one coming from a small or emerging economy. These pairs are: USD / HKD, USD / SGD, USD / THB, USD / MXN, USD / ZAR, USD / NOK and many more.
- Minor pairs - Minor pairs traded less frequently, often have major currencies against each other, rather than against the US dollar. This includes: EUR / GBP, EUR / CAD, EUR / YEN, EUR / AUD, EUR / CHF, GBP / CHF, GBP / JPY, AUD / JPY, CAD / JPY and others.
Most of the trading or mirror trading is done by banks or private individuals, who seek to buy a currency which they think will increase in value relative to the currency they sell. For example, if you traveled abroad and changed your money, you also traded without knowing it.
How does forex trading work?
Institutional forex trading takes place directly between two parties in a so-called over-the-counter (OTC) market. This means that the exchange is not centralized (like trading on the stock market), since the trading library is managed by a global network of organizations and banks.
Those who work in day trading do so in four different time slots for the four main forex markets: Tokyo, London, New York and Sydney. Since forex trading is not centralized, it is possible to trade or trade automatically 24 hours a day.
Most of the forex traders don't actually buy a currency, but speculate on the pair's price. That is, they make a prediction on the price that one currency will have in respect of the other in a given period of time, short or long term.
The easiest way to do forex trading is to open an account with a professional broker, who offers beginner trading apps, if you are a beginner, or professional trading app for the more experienced.
Most of these brokers not only offer forex trading, but will also allow the user to do commodity trading, bitcoin trading, CFD trading and much more. Among the most popular brokers we undoubtedly have eToro, which among its proposals also includes copy trading, or the possibility of copying what the most experienced traders do.
Derivatives in the world of trading allow the operator to speculate on the movement of the price of a currency, without actually owning it. For example, when doing forex trading with a platform, you can bet on the direction of the price towards which that pair will move. If the prediction is correct it determines a profit, otherwise there will be a loss.
Three different types of forex market
You can trade forex in three different ways: spot, forward and future.
- Forex spot market: the physical exchange of a currency pair, which takes place at the exact point where the transaction is settled, or on the spot (literally "on the spot" in English). Derivatives based on the spot forex market are offered over-the-counter by providers such as eToro and Plus500.
- Forex forward market: it is a contract in which you agree to buy or sell a currency for a certain amount and to be determined on a future date or in a range of future dates.
- Forex futures market: an exchange-traded contract to buy or sell a certain currency for a specified amount at a price and date set in the future.
Base currency and listed currency
The first currency listed in a forex pair is called a base while the second is called a quoted currency. The price of a forex pair is how much a unit of the base currency is worth in the quoted currency.
Here's an example:
In the GBP / US pair, GBP is the base currency while USD is the quoted currency. If the GBP / USD is trading at 1,35361 it means that a pound is worth $ 1,35361.
If the value of the pound increases relative to the dollar, a single pound will be worth more dollars and the pair's price will increase.
If it drops, the pair's price will drop. So if you think that the base currency in a pair can strengthen against the listed currency, you can buy the pair (going in Long). If you think it will weaken, you can sell the pair (by going in Short).
What is leverage in forex trading?
In the spot forex market there is a very important advantage, namely the possibility of opening a position on the basis of a predetermined financial leverage. Leverage allows the operator to increase its exposure compared to the market, without having to commit as much capital.
When trading with leverage, there is no need to pay the full amount in advance. Rather, a small sum called Margin is invested. When closing a leveraged position, the profit or loss is based on the entire size of the trade.
This means that leverage can increase profits, but also losses. Also, in the worst case, losses can exceed the start deposit. It is therefore important to trade with leverage, especially to learn how to manage risk.
Speaking of learning, if you plan to trade forex and be as successful or lucky as when you first enter a casino, you are wrong. You need to study, take an online trading course at least to learn the basics. Forex trading is not a betting market, although many think so (before losing all their capital).
What makes the forex market move?
As in most financial markets, forex is driven first and foremost by the supply / demand force. Understanding what influences these factors is important for success in forex trading.
The offer is controlled by central banks, which, when they announce the adoption of new measures, have an important impact on the price of currencies. The so-called "quantitative easing", for example, involves the introduction of new money into an economy, consequently lowering the price of its currency.
Central banks also control the basic interest rate for an economy.
If you buy an asset in a currency with a high interest rate, you can get higher returns. This means that if a country raises its interest rates, most investors will do business in that country while improving its economy and the value of the currency itself.
However, higher interest rates can also make operations such as lending money more difficult. If it costs a lot to borrow money, investors are more reluctant and the currency itself may weaken.
Banks and other investors tend to want to put their capital into economies that have better prospects (obviously). For this reason, if positive news hits the markets of a particular region, it will encourage investments and increase the demand for the currency of that region.
Unless there is an increase in supply for the currency in parallel, the disparity between supply and demand will increase its value. Likewise, bad news can discourage investors and lower the value of the currency. As a result, the value of the currency reflects in most cases the health of the region it represents.
Among the most important news and that most influence the markets, we undoubtedly find:
- Inflation data
- Production reports
- Retail sales
Market sentiment, which usually reacts to news, can also play an important role in determining currency prices. If traders think that a currency is heading in a certain direction, exchanges will be made in this direction and could persuade other investors to follow them, increasing or decreasing demand.
Forex trading is quite different from cryptocurrency trading in that it can be predicted with greater precision. However, to be successful it is necessary to understand its operation, practice (perhaps with a demo account) and study a lot, starting from ABC.