Forex stands for foreign exchange. Sometimes it’s also called FX.
A simple way to understand the Forex market is to think of it as changing money when you travel abroad.
When you change money, you sell one currency and buy another at the current exchange rate.
This is because the value of your own currency is not equal to the value of the currency you wish to buy.
In effect, you have traded currency and this is very similar to Forex trading.
One of the largest financial markets in the world
Currencies constantly need to be exchanged in order to conduct business and for there to be trade between countries.
This makes the Forex market one of the largest, most liquid financial markets in the world.
To put this into context, the daily volume of trades on the London Stock Exchange is USD7 billion, whereas the daily volume on the Forex market is USD4 trillion.
Unlike other financial markets, such as stocks or commodities, the Forex market has no central location or exchange.
The market is so large that it’s unlikely to be affected by one person or one company – it takes much bigger processes to influence the direction of the market.
What is Forex trading?
In simple terms, it’s the simultaneous buying of one currency and the selling of another.
When you trade Forex, you can trade with a broker through a trading platform.
Currencies are always traded in pairs, for example GBPUSD (trading the British pound against the US dollar).
The first currency in the pair is known as the “base” currency, the second one is the “quote” currency.
They are also often referred to as “buy” and “sell” or “offer” and “bid”.
A GBPUSD price of 1.5531 means that GBP1 buys you USD1.5531.
The most traded currency pairs are USD, EUR, GBP, CAD, CHF, JPY, AUD and NZD.
- Over 50% of Forex transactions are conducted in the UK and US.
- The most commonly traded currency pair in the world is EURUSD – the euro against the US dollar.
You trade currencies in pairs
All currencies are traded in pairs and each currency has an official abbreviation, for example GBP for British pound, USD for US dollar and EUR for the euro.
The “base currency” is the first currency in the pair and the “quote currency” is the second currency.
These are commonly referred to as the bid and ask price.
Price differences create trading opportunities
You can trade currencies because the values of currencies change.
The exchange rate tells you how much of one currency you need to pay to buy one unit of another.
In Forex trading, exchange rates are displayed as the bid and ask price for a currency pair.
The difference between the bid and the ask price is known as the spread and it’s how your broker generates much of its revenue.
Know what’s behind the spread
It’s important for you to understand how spreads are measured.
For example, if GBPUSD has a bid price of 1.5530 and an ask price of 1.5533, the spread is three points. Although in Forex trading, most people call them pips.
A point or pip is the smallest movement up or down in the price of a currency.
You can trade in bullish and bearish markets
When you trade Forex, you’re buying one currency and selling another at the same time which means you can speculate on rising and falling markets.
This is one of the major advantages of Forex trading.
You are likely to hear Forex traders talk about bullish and bearish markets.
When a market is rising or believed to be about to rise we call it “bullish”; when it’s falling or believed to be about to fall it’s called “bearish”.
How you can place your first trade
First of all, consider whether the currency you wish to trade is likely to rise or fall.
This forms the basis of your trading strategy.
In a buy position, you believe that the value of the base currency, in our example the euro, will rise against the quote currency, the US dollar.
Let’s assume the price of the EURUSD is 1.3038 on the bid price and 1.3040 on the ask price. Therefore, the spread is two pips.
When you buy, your trade is entered at the ask price of 1.3040.
Later you decide to close your trade and the bid price of the EURUSD pair is 1.3072 and the ask price is 1.3074. Your trade has gained 32 pips.
If each pip was worth one US dollar, you would have made a USD32 profit.
Now let’s see what happens with a sell position. You believe that the value of the base currency will fall against the quote currency.
Using the same example, this means you believe the price of the euro will weaken against the US dollar.
The current value of the EURUSD pair is 1.3038 on the bid price and 1.3040 on the ask price.
As you’re selling, your trade is entered at the bid price of 1.3038.
Later in the day, you look at the position and the EURUSD is now at 1.3072 on the bid price and 1.3074 on the ask price. Your trade has lost 36 pips.
You decide to close your position at the current price of 1.3074 and accept your losses.
If each pip was worth USD1, you would have lost USD36.
You can trade 24 hours a day, five days a week
The Forex market runs 24 hours a day, five days a week, because at any given time of the day or night the market is open somewhere in the world.
That means you can trade whenever you want, from anywhere in the world.
You can trade both rising and falling markets
One of the reasons to why trade Forex is that you can find opportunities in both rising and falling markets – you can trade when you believe the price of the currency pair is going up, or when you think it’s going down.
If you think the price is going up, you buy, and if you think it’s going down, you sell.
You can find opportunities in high volatility periods
Sometimes you can observe periods of volatility when a market opens or closes.
That means that the prices can change very quickly and unexpectedly.
High volatility can create trading opportunities, but it also increases risks.
Ask yourself, why not?
If you’re asking yourself, why trade Forex, then the answer is simple – you can find great opportunities in the Forex markets.
If you’re interested in the world of business and you keep up with the latest news, then Forex could be your ideal market to make your moves.