In simple words, Forex trading is the trading of one currency for another. Such trading takes place in the foreign exchange (also known as FX or forex) market- the largest financial market in the world. Due to the global reach of commerce, trade, and finance, the forex market is the most liquid asset market. This decentralized global marketplace is where a network of buyers and sellers transfer currency between each other at an agreed rate.
A lot of foreign exchange takes place for practical purposes, but some exchanges take place with the aim of earning a profit. The forex market is constantly in flux as exchange rates fluctuate by the second. This can create price movements of some currencies extremely unpredictable, one of the main reasons why forex attracts traders.
Forex market is open 24 hours a day, five and a half days a week. With price quotes changing regularly, major financial centers witness active participation of traders throughout the day. These financial centers are situated in every time zone- London, Tokyo, New York, Hong Kong, Paris, Sydney, Singapore, and more.
Technological developments have made forex trading easily accessible. Anyone with a computer and internet access can start trading Forex. However, the dynamics of the markets and trading is quite complicated.
If you, too, are eager to know more about forex trading, then it is advisable to gain familiarity with the foundational knowledge of such trading.
Who Trades Forex?
Central banks & Governments
Central banks in every country work in harmony with government policies. The central bank determines the course of the country’s financial policy- such as interest rates and can change the supply of their currency.
It is the responsibility of central banks to maintain huge reserves of other currencies and stocks of value, such as gold bullion. This implies that they hold certain powers that, when executed, can influence the currency market. Such intervention can cause a rise or fall in demand for the domestic currency in the market, thus affecting inflation.
To trigger currency movements under special circumstances, sometimes a verbal intervention is also taken as a preferred step. Devaluing their currency is much easier for the central banks than maintaining or increasing the value.
Any remarks by central bank policymakers should be observed closely as they can have important consequences on a country’s currency.
Commercial and investment banks
Commercial banks also play an important role in forex trading. Compared to an individual trader, their scope and reach are comprehensive and broad, but their agenda is not very different. Commercial banks, as well as individual traders, seek to maximize their profits during currency transactions in the forex market.
Commercial banks trade forex mainly to minimize their risks from market exposure and to oversee the portfolios of their clients. Through risk management, hedging, arbitraging, or a combination of various other procedures, banks trade to seize the maximum benefits.
To maintain solvency, banks also trade currencies amongst themselves. This interbank lending forms much of the global currency trade and is practiced to curb financial risk.
Due to the availability of valuable ‘insider’ information, banks have an upper-hand in dealing with their clients. Nevertheless, no financial institution is greater than the market and can stay unaffected by any volatile event.
Businesses & Corporations
Another large group of traders in the forex market are corporations and businesses that deal with exports and imports. These market players include small as well as multinational firms. To address their business needs, they all engage in the currency market.
Through their strategies, they stir the markets and can influence the future value of the goods they are moving. They apply forex strategies to reduce their exposure to uncertainty across the currency markets. Their active participation has a bearing on the price-formation of foreign exchange rates.
Companies often engage in forex trading to counterbalance the losses incurred due to the exchange rate disequilibrium. A company’s ability to generate profit may suffer in the event of an appreciating domestic currency.
Corporations, like hedge funds and investment managers, also trade with banks. Larger corporations deal with larger banks, while smaller businesses deal with smaller banks. In the string of dealing, forex brokers come under corporations.
Many multinational corporations need to make currency transactions despite their non-involvement in international trade. They are forced to participate because their profits may be exposed to the peril of fluctuations in currency exchange rates.
Speculators
Rather than hedging their foreign exchange risk, speculators focus on taking advantage of the exchange-rate fluctuations. They usually trade in significant quantities. Even a minor fluctuation in the exchange rate can generate a huge amount of profits or losses for them.
Investors and speculators trade either through a direct forex broker or through an online forex platform.
Hedge funds are known as the most controversial class of speculators. They often engage in using riskier and market-sensitive strategies to earn large returns. Given this condition, they can have a significant impact on any country’s forex market.
Despite holding a small market share, speculators and individuals contribute to the overall liquidity of the forex under specific circumstances.
10 Benefits of Forex Trading
Largest Financial Market
We all know that the forex market is the biggest financial market. This is the reason why the foreign exchange market is used to project a snapshot of global trade and economic activity. On average, between $4 and 5 trillion is traded every day. It is indeed the single most globally accessible market for traders participating from all over the world.
Anyone Can Trade
If you want to become a forex trader, you don’t require a lot of money. This is why forex trading is more appealing to traders when compared to trading stocks. This type of trading is available to an average individual, even without needing much start-up funds. Nevertheless, the accessibility doesn’t mean that you will become a great trader overnight. It will take time for you to learn and become experienced.
High Volume & Liquidity
The forex market is huge and highly liquid in nature. It means that at any stated time, due to the bulk trading and under normal market circumstances, you do not have to wait. With a click, you can purchase and sell as you will usually find someone on the other end, ready to trade back. You also have the option to automate your trading.
Nobody Owns the Market
No single institutional dealer can dominate the market price for an extended time. Based on several factors, the market instantly calibrates itself. Furthermore, this market has no middlemen and is decentralized. You can trade directly with another participant, and a retail forex broker will solely act as a facilitator.
Originally the market is determined directly by the economy itself. You can neither corner it nor control it.
Trade Even the Lows
The best thing about the forex market is the fact that you can trade even when the market is low. Some forex trading strategies can be used during this period.
You can find the opportunity to trade in any market condition- when you believe the price is going to rise or when you anticipate it to fall. Some traders even prosper during high fluctuation period. If timed correctly, the abrupt price changes can be profitable.
24-Hour Market
The forex market operates for 24 hours a day and five days a week. The market doesn’t dictate, and therefore, you can trade whenever you want to. There are no opening bells. There are no closing calls.
Trading occurs in a loop- commences with the opening of the Sydney session and concludes with the New York session. This allows you to trade on your own schedule.
No Trade Commissions
There are usually no trade commissions. Similarly, there are also no exchange or clearing fees. Most retail brokers earn their profits through the “spread.”
The Bid price is the price at which we sell the pair on forex. Ask price is the price we pay to buy the pair. Spread is the difference between these two currency prices.
Inexpensive Transaction Costs
As mentioned above, the disparity between the bid price and ask price is the broker’s spread. This is known as the retail transaction cost. Extremely capitalized brokers can offer you ambitious high spreads. This will not only minimize your cost of trading but also maximize your profits.
Leverage
This is one of the most attractive features of forex trading. This powerful tool gives you leverage as you can “borrow money” from your broker to trade with more than your actual deposited funds.
However, increased buying power carries the risk of higher losses. So it is advisable to fully understand the risks of trading with leverage before diving into it.
Risk-free Demo Account
To practice, you can set up a free forex demo account. Trading with a demo account involves ‘play’ money and not real money.
Without risking any actual capital, you can test the waters or even improve your trading skills.
A free demo account can help you understand more about the foreign exchange market and trading.
Top 6 Most Traded Currency Pairs
EUR/USD
This currency pair has a positive correlation with the GBP/USD and a negative relationship with USD/CHF. This is because the Euro, Swiss franc, and the British pound share a positive correlation.
USD/JPY
The second most actively traded pair is USD/JPY. This pair positively correlates to the USD/CHF and USD/CAD currency pairs. This exists because of the US dollar, as it is the base currency in all three pairs.
GBP/USD
This pair has a positive correlation to the EUR/USD but a negative relationship with the USD/CHF. This is because the British pound, Swiss franc, and the Euro, relatively share a positive correlation.
USD/CAD
This currency pair tends to be negatively associated with the AUD/USD, GBP/USD, and EUR/USD pairs. This happens because the US dollar is the quote currency in these other pairs.
USD/CHF
This currency pair negatively correlates with the EUR/USD and GBP/USD pairs. This is due to the substantial positive correlation between the Swiss franc, the Euro, and the British pound.
AUD/USD
This pair mostly has a negative correlation when it comes to USD/CHF, USD/CAD, and USD/JPY pairs. This happens because the US dollar is the quote currency in these cases.
How to trade in the Forex market?
If you want to begin trading in the foreign exchange market, then you will need to have access to the forex market. To obtain this access, you will have to take the following steps:
- Firstly, you will have to create two accounts, which are known as a broker account and trading account. To gain access to the financial market as new traders, we will also need an intermediary (broker). After choosing your broker and account model, you can make your first deposit for commencing forex trade.
- The next step requires you to operate on a trading platform for the purpose of trading. There are many such trading platforms available on the internet. Do extensive research and select one such platform as per your trading needs.
- Now you can begin trading in forex after downloading your trading software. Different currencies have diverse properties, so it is important for you to gather all the relevant information before you buy or sell any currency pair(s).
- You should also devise a trading strategy that is appropriate for the existing market conditions. It is always advisable to limit your trading timeframe.
- As a new trader, analysis should be an important part of your trading process. Your analysis should be comprehensive and should cover the precise conditions under which you would enter the market. You should carefully examine the fluctuation forecast, rules regarding the management of money, and timing. Your analysis should also cover expected relevant economic events and the conditions in which you would close a deal.
Many new traders are so keen to start trading right away that they often pay little to no attention to the process of analysis. Each trading decision must be based on proper research and analysis. By conducting proper analysis, you will be able to detect the most favorable trading prospects and how you can take advantage of them.
Trading becomes gambling if done without a plan. This also eliminates the chances of you getting profitable results on a consistent basis. For successful forex trading, you should discover, examine, integrate, and apply the information collected from studying the market. It will take time, but relevant experience will bring reliable profits on your way in the long run.
Carrying out an actual trade is remarkably simple and can be executed via any trading platform. In the whole trading process, placing your order forms a very small move. The analysis will always be the most crucial part.
Kinds of Trading analysis
If you want to become a successful trader, then the proper analysis should always be a part of your trading process. There are mainly two main kinds of market analysis: Fundamental and Technical.
Fundamental Analysis
This type of analysis is the most traditional form of economic forecasting. Under this form of analysis, various macroeconomic factors, i.e., the prevailing state of the economic cycle, relevant contemporary events, future possibilities, and their potential impact on the market, are studied.
Some of the chief central analysis indicators are Gross Domestic Product of a nation, central bank’s interest rates, unemployment rate, industrial production’s index, political status (elections, political steadiness, geopolitical factors, and more), broad information about financial progress, and retail trading.
Technical analysis
Technical analysis solely concentrates on what the chart shows. This market analysis method essentially considers two features: price and time. Both of these factors are rigidly measured and accounted for.
In today’s fast-growing markets, most dealers use technical analysis to upkeep their trading decisions. This analysis helps you in recognizing key levels, employing technical meters, or analyzing candlestick formations.
Technical analysis is superior to economic research if you want to trade forex for a short period.
However, most traders use an amalgamation of both to generate the most dependable outcomes.
Fortune supports trained traders
Due to the lack of proper training, many ambitious traders experience failure. Trading has always been promoted by forex dealers and other economic establishments as a plan to get rich quickly. They support a fantasy where new traders, with limited or no knowledge, can make loads with little investment and smart judgment.
Many enter the market in anticipation of getting rich, but after incurring a loss, they get disappointed and leave the market. New traders should train themselves about the nitty-gritties of trading and the undercurrents of the foreign exchange market.
Sufficient knowledge and practice will teach you to recognize the top trading opportunities and how you can earn profits from these prospects. Make use of free studying materials, articles, online classes, and webinars that are readily available on the internet.
Spot Market, Forward Market & Future Markets
There are mainly three ways in which corporations, institutions, and individuals buy and sell forex- the spot market, forward market, and future market.
Forex trading in the spot market has perpetually been the largest market. It markets only spot or current transactions in foreign exchange. Back in those days, the futures market was the most sought-after venue for traders as it was available to individual traders for a longer period.
Spot market witnessed a huge rush after the arrival of electronic trading and many forex brokers. It has now surpassed the futures market as the most favored trading market for speculators and individual investors. The spot market has become synonymous with the forex market.
When a deal is settled in the spot market, it is called a “spot deal.” It is a bilateral transaction. An agreed-upon currency amount is exchanged at the agreed-upon exchange rate. After a position is settled, the settlement then takes place in cash. It usually takes two days for settlement.
Unlike the spot market, forward and futures markets are more popular with companies that want to hedge their foreign exchange perils out to a particular future date. These markets do not trade actual currencies. They, instead, deal in contracts. Such contracts represent claims to a specific currency at a definite price per unit, which is meant to be settled on a future date.
In the forward market, sale and purchase of foreign exchange take place for future delivery- which may or may not happen. The exchange rate for purchase or sale of foreign exchange that prevails in a forward contract is called Forward Rate. Thus, the forward rate is the rate at which a futures contract for foreign currency is made.
Though future and forward markets are alike, the future market has regulated organizations in which only members are allowed to trade. This market has its own rules and regulations. The future market offers only regulated contracts, and every such contract requires a security deposit (margin).
Forex trading & your emotions
When trading forex, it is challenging to handle your emotions. The forex market is highly unpredictable. Your decisions should be made smartly. Act consistently without being emotional.
When professional traders sense losses, they close out their trade to limit such losses. On the other hand, a new trader might stay in the trade, in hopes of making future gains. Such an emotional response is not appreciated as novice traders can quickly lose all of their money.
The availability of leverage can be tempting but can weigh you down emotionally if it works against you. By developing a smart trading plan, you can avoid being emotional.
Stick to those methods and strategies that have resulted in gains, at least 50 percent of your time. It is advisable to maintain a forex trading journal. This will help you to keep track of your progress.
Forex Trading Risks
Trading currencies is complex, as well as risky. Forex instruments are not standardized. In some markets in the world, forex trading is entirely unregulated.
The interbank market has varying stages of regulation. Banks have established domestic methods to stay out of huge risks. Such regulations are industry-imposed and are made for protecting the participating banks. The interbank market pricing is mostly based on supply and demand.
Small or semi-unregulated forex brokers can sometimes even trade against their customers. They do so by re-quoting the prices. There are some government and industry-related regulations, but such safeguards are not consistent around the world.
Individual traders should choose reliable forex dealers. Generally, forex dealers in the US and UK have more oversight. You should also find out what kind of protections are available in case of insolvency or market crisis.
A trader must understand when he/she should opt for utilizing leverage. A high amount of leverage introduces a direct proportion of risk in a trading process. Many dealers have become insolvent due to the excess amount of leverage.
If a trader does not have an understanding of the economies of the different countries, economic fundamentals, and other indicators, then there are high chances of low performance.
Even if you take all the precautions, there is still a potential possibility of incurring huge losses. Although it is very rare and nearly impossible, forex traders should be aware that it can still happen.
Trading Forex can be hectic and can be difficult for some traders to manage. It is challenging to keep up with all the information- it is a 24-hour market, after all. Some traders may experience mental stress and other potential problems.
Working on your trading psychology can help you in dealing with the difficulties in forex trading. Trading for the wrong reasons will make you vulnerable and can lead to emotionally-fuelled mistakes.
To Sum Up
The forex market operates very much like any other market that deals with assets- stocks, bonds, or commodities. Your approach to trading in the forex market will dictate whether you will make a profit or not.
Online research can be overwhelming. It may seem like other people are trading forex successfully while you are failing to do so. Don’t let that discourage you. You will find many traders posting on online forums about how well they are trading when, in reality, they might just be struggling like you.
Understanding and winning in the foreign exchange market is an achievable goal. You have to get educated, keep your head focused while you grasp the working of the forex trading.
Use a demo account for practicing forex trading before going for the real thing. You should start small when you eventually start investing your real money.
To avoid pitfalls, you should build relationships with other successful forex traders. Unfortunately, there is no universally accepted strategy that is best for trading forex. However, trading at the right time, keeping volatility at the forefront, making sure to be adequately capitalized, using suitable trade sizing, and limiting financial risk can contribute to your success.
Learn from your mistakes and move on from it when it happens. Be honest with yourself. Always keep a close eye on constantly changing exchange rates to be successful. Learn more about how the market works and what it takes to perform well as a forex currency trader.
