Now that you know what is Forex and how it works, let’s learn about Forex essentials like terminologies. And let's look at the components that you would be dealing with every day.
Forex trading has it's own terminology; much like Futures. With Futures you'll want to know what ticks are. What Forex essentials should we know to trade this sector?If you happen to trade from the United States, the following time frames would apply to you: Europe would open when it is 8:00 a.m. London when it is 9:00 a.m. and New York when it is 4:00 p.m
Some Forex Essentials
- Let’s first dive into these following Forex essentials, catchy words, as a starting point
- Bid – Maximum Exchange rate a trader or broker is willing to pay for an instrument
- Ask – Lowest Exchange rate a trader or broker is willing to sell an instrument
- Liquidity – Financial transaction speed, that is to say, cash
- Trading volume – Amount of money traded
- OTC – over the counter
- Exchange rate – The difference of currency values; for instance, a British Pound is valued at 1.2550 of a US dollar
- Hedge funds –Large mutual funds corporations which control large sums of money and can influence the value of the currency through speculation
- Central bank – National bank of a country, which typically exercises control over the currency's value
Lets now move on to the more elaborated components of the Forex Trading.
1. Currency Pairs
Forex essentials to know are currency pairs. A currency pair is a set of two currency. The first currency in the pair is called the base currency. While the second one is called the counter currency.
EUR/USD is the most traded pair in the Forex world. In this pair, the Euro (EUR) is the base currency while the US dollar (USD) is the counter currency. ]
To understand it further, let's assume that the EUR/USD is quoted at 1.1140, it means you can buy 1 Euro for 1.1140 US dollars.
2. Major Currency Pairs
Know you major currency pairs as apart of Forex essentials. There are seven most dominant currency pairs which are called major currency pairs.
All of these pairs include the US dollar either as a counter or quote currency. The major currency pairs offer high liquidity, tight spreads, and low trading costs.
The seven major currency pairs are EUR/USD, USD/JPY, AUD/USD, NZD/USD, GBP/USD, USD/CHF, and USD/CAD. And you can find the exchange rates online.
3. Cross Currency Pairs
Cross currency pairs ae another thing to add to your Forex essentials list. The pairs that don't involve the US dollar are called Cross Currency Pairs; such as EUR/GBP, NZD/JPY, EUR/JPY, and so forth.
The cross-currency pairs exhibit lower market liquidity and wider dealing spreads than the major currency pairs. However, they also offer the possibility for high probability trading opportunities.
4. Exotic Currency Pairs to Add to Your Forex Essentials List
The exotic currency pairs are the pairs that include a major currency and the currency of a developing economy. For example, USD/ZAR (US dollar vs South African Rand), EUR/TRY (Euro vs Turkish Lira), AUD/MXN ( Australian Dollar Vs Mexican Peso) and so forth.
The exotic pairs have lower liquidity and can be extremely volatile. And the trading costs can be high as well. Knowing this helps answer the question what is Forex trading all about?
What Do You Need for Forex?
- To start trading Forex, you need at least $300 and a knowledge of Forex essentials. The $300 is required to open a trading account. But the more money you can start out with, the better a buffer you have.
1. Lot in Forex
How does a lot tie into Forex essentials? A lot in Forex is a standard term used to describe the size of a trade. For example, a 1000 euro trade is a micro lot. A 10,000 Euro trade is a mini lot. And a 100,000 Euro trade is a standard lot.
Let’s take an example of the EUR/USD pair. If you decide to go long on a mini lot, that means you are trading an amount of 10,000 Euros. Similarly if you go long on a standard lot you'll be trading an amount of 100,000 Euros.
You can trade any number of lots depending on the available investment in your trading account. Remember the actual deposit that you need to make for this mini lot could be from 1 to 400 times smaller depending on the leverage your broker is offering.
2. What Is a Pip in Forex Essentials?
To have all your Forex essentials, you need to know what a pip is. Pip stands for Point in Percentage. It's the unit to express the change in the exchange rate.
For example, a price change in GBP/USD from 1.2555 to 1.2556 is 0.0001 in dollar terms and is called one pip movement. The major currency pairs in Forex are quoted to four decimal places except for the USD/JPY; which is quoted to two decimal places. So in USD/JPY a move from 106.25 to 106.26 is 0.01 in dollars term and is a one pip movement.
To calculate the pip value of GBP/USD or any other pair that's quoted to four decimal places you need to divide 0.0001 by the current market price. Then multiply the value with your lot size.
So in our example of GBP/USD above if we divide the 0.0001 by 1.2256 it equals 0.00008159. Now you need to multiply this number with your lot size. Let's assume the lot size is 100,000 so the one pip value would be $8.159.
Similarly to calculate the pip value of USD/JPY you need to divide 0.01 by current market price and then and multiply it with your lot size.
3. Spread in Forex Essentials
A spread is the gap between the asking price and the bid price. For example, if the EUR/USD is trading with an ask price of 1.1420 and a bid price of 1.1422 then the spread will be the ask minus the bid price which is 0.0002. And that equals to two pip.
For yen based currencies like USD/JPY the spread is again the gap between the ask and the bid price. So if the USD/JPY is trading with an ask price of 107.20 and a bid price of 107.21 then the spread will be 0.01; which equals to two pips.
Remember that the higher the spread the higher your trading cost would be. Like in the above example of EUR/USD, if you buy the pair at 1.1420 you will have to wait for the price to come up to 1.1422 to actually break even.
Many brokers these days are offering two different types of accounts; which are fixed spread account and variable spread account. In the fixed spread account, the spread remains the same regardless of market volatility.
Whereas the variable spread can change based on market volatility. Both types of spread have their advantages and disadvantages. Trading with a fixed spread often results in requotes from the brokers.
Trading with variable spread may not bring frequent requotes but the widening spread increases your trading cost. All in all, you should prefer trading with a low spread so that your trading cost can remain lower.
Which Day Is Best for Forex?
- Tuesday, Wednesday and Thursday are the best days to trade Forex. So note that in your Forex essentials list. Monday and Friday are unpredictable and somewhat flat. The most trading action happens in the middle of the week.
1. Short Selling With Forex Essentials
The Forex market offers the opportunity to benefit from both the rising and the falling markets. Usually, when the market price is trending higher, you want to buy the instrument at a lower price and sell later at a higher price to make a profit.
But the market isn't always trending up. So the Forex market also lets you take advantage of the falling market. This is called short selling. In this form of trading, you aim to sell an instrument first at a higher price and then buy it later at a low price. This difference between selling and buying would be your profit.
It sounds really weird, especially to the new Forex traders. However, to understand short selling you can relate it to borrowing. So basically you borrow from someone who owns and immediately sell at the market price.
Then you wait for the market price to go down so that you can buy it back at a cheaper price and return the product to the lender. In this transaction, the difference between selling and buying price would be your profit. Finally, in this example, the broker is the lender.
In Forex, you can use leverage to make large trades without having to deposit the full amount of trade. To understand how leverage works, let's assume that you believe that the euro will become stronger than the US dollar.
You are so sure about this that you would even trade a hundred thousand Euros but you don’t have this amount of money. So, to trade more than the amount you have in your trading account, the brokerage firms offer you leverage.
You can borrow a hundred, two hundred, or even four hundred times of your deposit. In simple words, using leverage you can place a trade between more the value of the deposit in your account.
Always remember that the leverage is a dual-edge sword. It increases your profit but at the same time, it also increases your risk exposure. You can always control the leverage.
For example, if your deposit is just one thousand euros and your trade is also one thousand then you are not exercising the leverage. You can simply say your leverage ratio is 1:1. But if you decide to trade more, for instance, 50,000 Euros with just 1000 Euros then you are using a leverage of 50:1.
3. Trading Hours
The Foreign exchange market operates 24 hours a day and goes by the trading sessions. Knowing about the Forex trading session will help to determine your trading hours.
These trading sessions are London Session, New York Session, Sydney session, and Tokyo session. The sessions vary in trading volume, the most active trading session in terms of volume is the London session which is followed by the New York session. The trading activity reaches its peaks when the timing of London and New York sessions overlap.
Forex Essentials Bottom Line
Forex essentials give you the means to successfully trade Forex. It's a market a lot of people are into learning. Just make sure you're not taken by someone promising the moon. If it sounds to good to be true, it usually is.