Forex Trading: Forex (FX) stands for foreign exchange. It’s when you change one type of money into another, like switching dollars to euros. People do this for reasons like business, trading, or travel. In 2022, a big bank called the Bank for International Settlements said that every day, people around the world traded about $7.5 trillion worth of different currencies. If you want to know more about forex and how to start trading, just keep reading.
What Is the Forex Market?
The foreign exchange market is where people trade different types of money. What makes this market special is that it doesn’t have one main place where trading happens. Instead, traders use computers to trade electronically, which means they trade online with others from all over the world.
This market stays open all day, almost every day of the week. People trade money in big financial centers like Frankfurt, Hong Kong, London, New York, Paris, Singapore, Sydney, Tokyo, and Zurich. Since these centers are spread out in different time zones, the forex market is active almost all the time. It starts in Tokyo and Hong Kong after the trading day in the U.S. ends. This means prices of money change a lot, and the forex market can be very busy no matter when you look at it.
How Does the Forex Market Work?
The FX market is a trading market that never stops. Before, big companies and banks mainly traded in the forex market for others. But nowadays, regular people like traders and investors of all sizes also take part in it.
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Where Is It?
A cool thing about global forex markets is that there aren’t any actual buildings where trading happens. Instead, people use computers and connected terminals to trade. The ones trading can be big companies, investment banks, regular banks, and normal people who invest, all from different parts of the world.
Who Trades on It?
Before the internet, trading money was tough for regular people. Big companies, rich individuals, and special funds did most of the trading because it needed a lot of money.
Even now, banks mainly trade money for their customers. But professionals and regular people can also trade different money types against each other.
Types of Markets
Forex trading mainly happens through three types of markets: spot, forwards, and futures. The biggest one is the spot market, which is like the main market. The other two, forwards and futures, are based on the spot market.
When people mention the forex market, they’re usually talking about the spot market. The forwards and futures markets are liked more by businesses and financial companies. They use these markets to protect themselves from risks with money exchange that might happen in the future.
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The spot market is where people buy and sell currencies at their current trading price. This price depends on how many people want to buy and how many want to sell, and it’s figured out using different things like:
- How much interest is being paid now
- How well the economy is doing
- What people think about politics and countries working together
- Guesses about future prices
When a deal is finally made in the spot market, it’s called a spot deal. This deal is between two parties, where one gives a certain amount of one currency and gets back a certain amount of another currency, all at a specific exchange rate. After the deal is done, they settle it by giving each other money.
Even though the spot market is about trades for right now, these trades actually take two days to be completed.
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Forwards and Futures Markets
A forward contract is like a secret deal between two people. They agree to buy a certain amount of money at a set price on a later date. This happens in a special market where deals are private, and the two people decide everything themselves.
A futures contract is a bit different. It’s an agreement between two people to get a certain amount of money on a future date at a certain price. But this deal is not secret and it happens on a special market called an exchange.
In the futures market, the deals are standard and follow rules. They have specific details, like how much money is involved and when it will be given. These rules can’t be changed. The exchange helps make sure the deals are fair and works as a middle person between the traders.
Both types of deals are serious and have to be done, but sometimes they can be finished early. This kind of trading helps people be safer when they’re dealing with different money types.
Other than forwards and futures, there are also options. These are like special deals for specific types of money. With options, people can choose to make a trade later on but they don’t have to if they don’t want to.
Using the Forex Markets
Currencies, like things you can invest in, have two main things that make them special:
- You can get money from the difference in interest rates between two currencies.
- You can make money when the value of one currency changes compared to another.
Because of these things, you can make money by taking advantage of the difference in interest rates between two countries. You do this by buying the currency of the country with a higher interest rate and selling the currency of the country with a lower interest rate.
For example, a while back before a big financial problem in 2008, many people were selling the Japanese yen (JPY) and buying British pounds (GBP). This was because the difference in interest rates was really big. This kind of strategy is sometimes called a carry trade. It helps people earn money from the difference in interest rates and how money values change.
Forex for Hedging
Companies that work in other countries can face problems when money values change while they’re buying or selling things outside their own country. To handle this risk, they can use foreign exchange markets. These markets offer a method to protect against currency problems by setting a specific rate for their deals.
A trader can decide to buy or sell money from different countries before the deal even happens. This locks in an exchange rate, which means they know exactly how much they’ll get when they actually do the deal.
Doing this helps companies avoid losing money or make even more, depending on how the money values change. It all depends on which money gets stronger or weaker compared to the other.
Forex for Speculation
Several things can make money values go up and down, like how much interest a country gives, how much they trade, how many tourists come, how well their economy is doing, and how safe things are in that country. All of this makes the money market change a lot every day, which can be a chance to make money. If the value of one money goes up or down compared to another, it can make people earn more or lose less.
For instance, if someone thinks one money will get less valuable, it’s like saying the other money will get more valuable. So, if a trader believes money values will change, they can either bet that one money will go down (short) or that it will go up (long). This way, they can make money from the change in values.
How to Start Trading Forex
Forex trading is kind of like trading stocks. Here’s how you can start trading forex:
- Learn about forex: Forex trading isn’t super hard, but you need to know a lot and be willing to learn.
- Get a trading account: You’ll need a special account with a trading company to start forex trading.
- Make a trading plan: You can’t always guess what will happen in the market, but having a plan can help guide you.
- Keep track of your money: When you start trading, look at what you’ve done at the end of the day. Many trading programs show you what you’ve traded each day. Make sure you don’t have any unfinished trades and that you have enough money for future ones.
- Stay in control: When you’re new to forex trading, you might feel really excited or worried. Train yourself to know when to stop trading.
The first step to start your journey in forex is to learn the words people use. Here are a few terms to begin with:
- Forex account: This is like a special bank account for trading money from different countries. There are three types based on how much you trade at once:
- Micro forex accounts: These let you trade up to $1,000 worth of money in one trade.
- Mini forex accounts: These let you trade up to $10,000 worth of money in one trade.
- Standard forex accounts: These let you trade up to $100,000 worth of money in one trade.
- Ask: Ask means the lowest price you’re okay to pay for a currency.
- Bid: Bid means the price you want for selling a currency.
- Contract for difference (CFD): A CFD is a kind of deal that lets you guess where money values will go without actually owning the money.
- Leverage: Leverage is like using someone else’s money to make your money bigger. In forex, you can use a lot of leverage to make your trades stronger.
Basic Forex Trading Strategies
The simplest kinds of forex trades are called long and short trades. In a long trade, the trader thinks a currency’s price will go up, so they want to make money from that. A short trade is when the trader believes the currency’s price will go down. Traders can also use special plans that use technical analysis, like looking at patterns or averages, to make their trades even better.
Based on how long and how many trades they make, trading plans can be divided into four more types:
- Scalp trade: These are super quick trades, just for seconds or minutes. The profit is usually small, measured in pips.
- Day trade: In this type, traders buy and sell on the same day, sometimes for hours or minutes.
- Swing trade: Traders in this category hold onto their money for more than a day, often for days or weeks.
- Position trade: These traders keep their money for a very long time, maybe for months or even years.
Charts Used in Forex Trading
Three types of charts are used in forex trading. They are:
Line charts help find overall trends in currency values. They’re the simplest and most common type of charts used by forex traders. These charts show how much a currency was worth at the end of a certain time. The lines on the chart can show if prices are going up or down, and this can help make trading plans. For instance, you can see if prices break out of a pattern or if the trend is changing from going up to going down.
Even though they’re helpful, line charts are usually just the beginning of studying trading.
Bar charts show more about prices compared to line charts. Each bar on the chart is for one day of trading and has the starting price, highest price, lowest price, and ending price (OHLC) for that day. On the left side, a short line shows the starting price, and on the right, another short line shows the ending price. Sometimes, colors are used to show if prices went up (green or white) or down (red or black).
These charts help traders see if there are more buyers or sellers in the market for currency trading.
Back in the 18th century, Japanese rice traders were the first to use candlestick charts. These charts look nicer and are easier to understand than the ones we talked about before. A candle on the chart has two parts: the top part shows the starting and highest price, and the bottom part shows the ending and lowest price. When prices went down, the candle is red or black, and when prices went up, the candle is green or white.
The shapes and patterns on these charts help figure out where the market is going. Some common shapes are called “hanging man” and “shooting star.”
Pros and Cons of Trading Forex
- Largest in terms of daily trading volume in the world
- Traded 24 hours a day, five and a half days a week
- Starting capital can rapidly multiply
- Generally follows the same rules as regular trading
- More decentralized than traditional stock or bond markets
- Leverage can make forex trades very volatile
- Leverage in the range of 50:1 is common
- Requires an understanding of economic fundamentals and indicators
- Less regulation than other markets
- No income generating instruments
Forex markets are the biggest when it comes to the amount of trading happening every day across the world. This means there’s a lot of money moving around, making it easy for people to buy or sell currencies quickly and smoothly.
This high activity lets traders get into or out of a deal for a small difference in price. You can do this in just a tiny amount of time, often less than a second.
The forex market is open 24 hours a day, five and a half days a week. It starts in Australia and ends in New York. This long time period lets traders from different places make deals and try to make money. Big trading centers are in cities like Frankfurt, Hong Kong, London, New York, Paris, Singapore, Sydney, Tokyo, and Zurich.
In forex trading, you can use something called leverage, which means you can use a little money to control a lot of money. This lets you make more money quickly. Also, forex trading works a lot like regular trading but needs less money to start, making it easier to begin.
Unlike traditional stock or bond markets, the forex market doesn’t have one big place where all the trading happens. This means there’s less chance for people to cheat by using secret information.
Using leverage can make forex trading much more risky compared to trading without it. In the forex markets, banks, brokers, and dealers allow traders to control large trades with only a small amount of money.
Usually, traders can use around 50 times their money as leverage, but some brokers allow even more. However, using too much leverage can be dangerous. Many beginners have lost a lot of money because they used too much leverage.
Being successful at trading currencies means knowing about the basics of economies and indicators. A currency trader should understand how different countries’ economies work together to make money values change.
Forex markets are not as controlled as other financial markets because they’re spread out. The level of control and rules can depend on where the trading happens.
Unlike some investments that give regular income, forex doesn’t offer things like dividends. This can attract people who want big returns instead of regular payments.
Are Forex Markets Volatile?
The forex markets are some of the easiest to move money around in. This means they can be less likely to change quickly compared to other markets, like real estate. How much a currency changes is because of a lot of things, like the way a country’s politics and economy work. If something big happens, like a country not being able to pay its debts or having problems with trading partners, the value of a currency can change a lot.
Are Forex Markets Regulated?
Forex trading rules are different depending on the place. For example, in countries like the United States, there are strong systems and markets for forex trading. In the U.S., forex trading is carefully watched by two groups: the National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC).
Because of the way leverage is used a lot in forex trading, countries like India and China have rules that limit who can do forex trading and how much money can be used. In Europe, the biggest place for forex trading, the Financial Conduct Authority (FCA) keeps an eye on things in the United Kingdom.
Which Currencies Can I Trade in?
Currencies that are highly liquid are easy to trade and their prices usually move smoothly when something happens. The U.S. dollar is the most traded currency globally. It’s used in six out of the seven pairs of currencies that are traded the most.
On the other hand, currencies with low liquidity are harder to trade in big amounts because their prices can change a lot with even small trading actions.
The Bottom Line
Traders, especially those with not much money, might find it simpler to do day trading or swing trading with small amounts in the forex market compared to other markets. But if you have more money and are thinking of the long-term, trading based on big-picture economics or something called a carry trade could make money. To succeed, it’s important to know about the big factors that affect currency values, as well as learn about technical analysis. This can help new traders in forex make more money.
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