Forex – a brief A to Z guide
Wondered what Forex is and how it works? Find out in our brief A to guide.
The term ‘Forex’ designates the market on which foreign currencies are traded. There is no central marketplace for exchanging currencies. Forex trading is entirely paperless and decentralized. It, therefore, allows traders to execute currency transactions almost 24 hours a day, every day of the week. Forex is the world’s largest financial market with a daily trading volume valued at nearly $ 5.3 trillion.
Forex has long been reserved for wealthy people only, but in recent years, a private individual can get started with a stake of only a few tens of dollars, thanks to many online Forex brokerage platforms. It’s a viable option for earning extra money and at some point, if you reach a professional level of trading, replace your nine to five job.
How Forex trading works
The Forex brokers and banks make financial instruments available to retail traders for hedging or speculating on currency rate changes. It is possible to access the market through an exchange platform and real-time quotes with online trading sites.
The broker’s profit comes from the spread. This corresponds to the difference between the purchase price (the bid price) and the sale price (the ask price).
If you do some research, you will notice that most brokers offer attractive Forex bonuses to encourage trading, such as double deposit amounts or other bonuses. Check out broker reviews to compare their offers. Make sure they are licensed and have customer support in your language.
Forex trading basics
In Forex, currencies are always sold and bought in pairs. You can, for example, exchange euros for US dollars. A simple way to do this is to trade in EUR / USD. When the EUR / USD pair has a quote of 1.3105, you can:
- Either buy 1 euro against 1.3105 dollars (we say that we buy the pair)
- Either sell 1 euro against 1.3105 dollars (we say that we sell the pair)
The fourth decimal place of the quote is called the pip. So when the quote goes from 1.3105 to 1.3107, we have two pips gained. Conversely, when the quote goes from 1.3105 to 1.3103, two pips have been lost. The currency pairs can be unstable and evolve constantly. It’s called volatility. Most day traders benefit from this market’s features.
It allows you to make profits in two ways:
- Either by buying the pair, then selling it sometime later when its price has risen;
- Either by selling the pair, then buying it back some time later when its price has fallen.
Forex leverage explained
Brokerage companies allow their clients to invest more money than they have in their trading accounts. It’s called leverage.
Thus, the leverage effect makes it possible to invest an amount up to a thousand times greater than the client has but with a high risk-taking. There are several leverage levels, ranging from 1: 100 (the investment in a currency pair is multiplied by 100 to 1: 400.
Due to price fluctuations, currency pairs are often very weak, and it would be very difficult to make a profit without this effect. In that case, traders usually use leverage in Forex trading.
For instance, if your broker allows you leverage of × 100, this means that for 100 dollars deposited, you can invest 100 × 100 = 10,000 dollars.
This technique makes it possible to increase your earnings significantly if you have followed the right market trend. But beware that it can also speed up your losses if you don’t and can even lead to losing more than your initial investment.
As Forex is the world’s largest financial market, you can expect a high degree of volatility. While high volatility is great for traders, high volatility combined with high leverage can lead to huge losses. Sometimes, this can result in a loss that exceeds your deposit. That is why you should take a close look at Forex trading or seek expert advice before committing.
The importance of education and practicing
As a beginner, look up the free trading material online or, even better, enroll in some of the Forex trading courses or look up for Forex trading tutorials to learn trading strategies. Before even depositing money on the account, trading in a virtual account, also called a demo account, could give you a better insight into trading and the market itself.