Quick Introduction to Forex Trading Market
What is Forex?
"Forex" stands for foreign exchange; it's also known as FX. In a forex trade, you buy one
currency
while simultaneously selling another - that is, you're exchanging the sold
currency
for the one you're buying. The foreign exchange market is an over-the-counter market.
Currencies trade in pairs, like the Euro-US Dollar (EUR/USD) or US Dollar / Japanese Yen (USD/JPY). Unlike stocks or futures, there's no centralized exchange for forex. All transactions happen via phone or electronic network.
What is Forex trading market?
It is the largest financial market in the world with more than 4 trillion dollars traded each day across the world. Since it is the biggest market with high amount of transactions, it provides high liquidity to the traders in it. They can easily enter and exit a trade. Though there are many currencies in the world there are eight major currencies USD, EUR, GBP, JPY, CHF, CAD, AUD and NZD. The majority of the trading volume in Forex market takes place due to transactions of pairs belonging to these major currencies.
In equities and stocks, there are thousands of possible choices to choose from but in foreign
currency
trading there are only a few
currency
pairs to choose which makes Forex trading less complicated than other ways of online trading.
Who trades currencies?
Daily turnover in the world's currencies comes from two sources:
Foreign trade (5%). Companies buy and sell products in foreign countries, plus convert profits from foreign sales into domestic
currency
. Speculation for profit (95%).
Most traders focus on the biggest, most liquid
currency
pairs. "The Majors" include
US Dollar
,
Japanese Yen
,
Euro
,
British Pound
,
Swiss Franc
,
Canadian Dollar
and
Australian Dollar
. In fact, more than 85% of daily forex trading happens in the major
currency
pairs.
How Does Forex Trading Work?
Forex trading is typically done through a broker or market maker. As a forex trader you can choose a
currency
pair that you expect to change in value and place a trade accordingly.
Why Forex Trading?
With average daily turnover of US$4 trillion, forex is the most traded financial market in the world.
A true 24-hour market from Sunday 5 PM ET to Friday 5 PM ET, forex trading begins in Sydney, and moves around the globe as the business day begins, first to Tokyo, London, and New York.
Unlike other financial markets, investors can respond immediately to
currency
fluctuations, whenever they occur - day or night.
What are the benefits associated with Forex trading online?
Forex market is the biggest financial market in the world and therefore it provides high liquidity to the traders trading in Forex field. There are many benefits associated with this form of financial trading. Here are those:
It is easy to enter the foreign
currency
trading field due to low amount of initial capital required. It can range to few hundred dollars
Forex trading allows you to trade in high trade amount with less deposit amount known as margin.
There are some seven to eight major currencies and therefore less number of
currency
pairs to deal with. This lower number of options allows less confusion as compared to stocks and equities which have thousand options to trade.
Why Trade in Currencies?
There are 10 major reasons why the currency market is a great place to trade:
1. You can trade to any style - strategies can be built on five-minute charts, hourly charts ,daily charts or even weekly charts.
2. There is a massive amount of information - charts, real-time news, top level research - all available for free.
3. All key information is public and disseminated instantly.
4. You can collect interest on trades on a daily or even hourly basis.
5. Lot sizes can be customized, meaning that you can trade with as little as $500 dollars at nearly the same execution costs as accounts that trade $500 million.
6. Customizable leverage allows you to be as conservative or as aggressive as you like (cash on cash or 100:1 margin).
7. No commission means that every win or loss is cleanly accounted for in the P&L.
8. You can trade 24 hours a day with ample liquidity ($20 million up)
9. There is no discrimination between going short or long (no uptick rule).
10. You can't lose more capital than you put in (automatic margin call)
What are you really selling or buying in the currency market?
The short answer is "nothing". The retail FX market is purely a speculative market. No physical exchange of currencies ever takes place. All trades exist simply as computer entries and are netted out depending on market price. For dollar-denominated accounts, all profits or losses are calculated in dollars and recorded as such on the trader's account.
The primary reason the FX market exists is to facilitate the exchange of one currency into another for multinational corporations that need to trade currencies continually (for example, for payroll, payment for costs of goods and services from foreign vendors, and merger and acquisition activity). However, these day-to-day corporate needs comprise only about 20% of the market volume. Fully 80% of trades in the currency market are speculative in nature, put on by large financial institutions, multibillion dollar hedge funds and even individuals who want to express their opinions on the economic and geopolitical events of the day.
Because currencies always trade in pairs, when a trader makes a trade he or she is always long one currency and short the other. For example, if a trader sells one standard lot (equivalent to 100,000 units) of EUR/USD, she would, in essence, have exchanged euros for dollars and would now be "short" euros and "long" dollars. To better understand this dynamic, let's use a concrete example. If you went into an electronics store and purchased a computer for $1,000, what would you be doing? You would be exchanging your dollars for a computer. You would basically be "short" $1,000 and "long" one computer. The store would be "long" $1,000 but now "short" one computer in its inventory. The exact same principle applies to the FX market, except that no physical exchange takes place. While all transactions are simply computer entries, the consequences are no less real.
What is a currency carry trade?
Carry is the most popular trade in the currency market, practiced by both the largest hedge funds and the smallest retail speculators. The carry trade rests on the fact that every currency in the world has an interest rate attached to it. These short-term interest rates are set by the central banks of these countries: the Federal Reserve in the U.S., the Bank of Japan in Japan and the Bank of England in the U.K.
The idea behind the carry is quite straightforward. The trader goes long the currency with a high interest rate and finances that purchase with a currency with a low interest rate. For example, in 2005, one of the best pairings was the NZD/JPY cross. The New Zealand economy, spurred by huge commodity demand from China and a hot housing market, saw its rates rise to 7.25% and stay there, while Japanese rates remained at 0%. A trader going long the NZD/JPY could have harvested 725 basis points in yield alone. On a 10:1 leverage basis, the carry trade in NZD/JPY could have produced a 72.5% annual return from interest rate differentials, without any contribution from capital appreciation. Now you can understand why the carry trade is so popular!
But before you rush out and buy the next high-yield pair, be aware that when the carry trade is unwound, the declines can be rapid and severe. This process is known as carry trade liquidation and occurs when the majority of speculators decide that the carry trade may not have future potential. With every trader seeking to exit his or her position at once, bids disappear and the profits from interest rate differentials are not nearly enough to offset the capital losses. Anticipation is the key to success: the best time to position in the carry is at the beginning of the rate-tightening cycle, allowing the trader to ride the move as interest rate differentials increase.
How do you read a quote?
Because you are always comparing one currency to another, forex is quoted in pairs. This may seem confusing at first, but it is actually pretty straightforward. For example, the EUR/USD at 1.4022 shows how much one euro (EUR) is worth in us dollars (USD).
What is a lot?
A lot is the smallest trade size available. FXCM accounts have a standard lot size of 1,000 units of currency. Account holders can however place trades of different sizes, so long as they are in increments of 1,000 units like, 2,000, 3,000, 15,000, 112,000 etc.
What is a pip?
A pip is the unit you count profit or loss in. Most currency pairs, except Japanese yen pairs, are quoted to four decimal places. This fourth spot after the decimal point (at one 100th of a cent) is typically what one watches to count "pips". Every point that place in the quote moves is 1 pip of movement. For example, if the EUR/USD rises from 1.4022 to 1.4027, the EUR/USD has risen 5 pips.
What is leverage/margin?
As mentioned before, all trades are executed using borrowed money. This allows you to take advantage of leverage. Leverage of 400:1 allows you to trade with $1,000 in the market by setting aside only $2.50 as a security deposit. This means that you can take advantage of even the smallest movements in currencies by controlling more money in the market than you have in your account. On the other hand, leverage can significantly increase your losses. Trading foreign exchange with any level of leverage may not be suitable for all investors.
Where is the commission in forex trading?
Investors who trade stocks, futures or options typically use a broker, who acts as an agent in the transaction. The broker takes the order to an exchange and attempts to execute it as per the customer's instructions. For providing this service, the broker is paid a commission when the customer buys and sells the tradable instrument.
The FX market does not have commissions. Unlike exchange-based markets, FX is a principals-only market. FX firms are dealers, not brokers. This is a critical distinction that all investors must understand. Unlike brokers, dealers assume market risk by serving as a counterparty to the investor's trade. They do not charge commission; instead, they make their money through the bid-ask spread.
In FX, the investor cannot attempt to buy on the bid or sell at the offer like in exchange-based markets. On the other hand, once the price clears the cost of the spread, there are no additional fees or commissions. Every single penny gain is pure profit to the investor. Nevertheless, the fact that traders must always overcome the bid/ask spread makes scalping much more difficult in FX.
Do and Don't in Forex Trading
Forex trading is generally referred to as an exchange of currencies or what is commonly known as Foreign Exchange. It is not a game of bet like that of balls gaming or pony racing. This is a rewarding business which is open online 24/5 and is an outstanding method for making quick cash. In no time traders can reap the fruits of good trade by timing their trade wisely. Just as in other businesses, a new Forex trader too has to follow certain do’s and Don’ts to become successful in his business.
Do’s:
1. A new forex trader who is all set to begin trading in the market should be ready with a trading plan. The pillars of successful forex lies with sound knowledge and understanding of the entire Foreign Exchange Trade Lifecycle.
2. In order to give a smooth start to their trade business, one should keep in mind the present monetary market scenario and study the dynamics and conduct basic research related to forex trade.
3. A new trader should always begin his trade at a time when the market shows a progressively growing or down
4. Prior to beginning a currency trade, he should always keep in mind the gain and loss ratio.
5. Having a sound knowledge on the Fibonacci Analysis will help a trader to choose the best time of his entry or exit for starting a trade as it enables them to foresee the market fluctuations.
6. A detailed technical and fundamental study of the current trading patterns by using charts, continuation patterns or trend reversal will be beneficial for a new forex trader.
Don’t’s:
1. A trader should be patient and should avoid impulsive decisions.
2. They should not make hasty decisions in order to earn profits, but instead should gradually learn the trick of trading. A forex trader who is not sure about the market trends should not risk their present capital
3. A trader should avoid indulging in trades during inactive market hours as this may incur heavy loss.
4. It will be unwise for a new trader to trade with all his deposit,particularly when he does not have proper understanding of Forex trade. Even a small movement of the market will make him loose all the money on his deposit. You have to trade with the adequate amounts of money to minimize the risks.
5. Being greedy in this form of trade is a big no.Emotions and feelings should be kept apart. Doing trade business primarily based on market feelings is not considered a wise practice.
6. For a reliable trade, traders should avoid entering into currency trade, particularly when bars represented in the charts look unstable or are dipping. You should enter to the market carefully and realize your actions
An effectual forex strategy is essential to boost up a trader’s business. No business can flourish without the aid of proper trading strategies. Selecting an inappropriate trading policy can be a catastrophic mistake. So choosing the right trading strategy and anticipating the best is of paramount importance for a new forex trader. To trade in this arena will be full of rewards yet there are chances that one may lose all that they have invested. Knowing what one should perform and what they should avoid definitely will make things simpler prior to them jumping into the exchange market. Always remember that the forex trade market is not a lottery or getting rich quick scheme. Here a person should learn the ways of trading in forex as well as how to keep themselves safe from losses which are common when it comes to the forex market.
