What is Forex trading all about? Ever wondered what you called the exchange of one currency for the other? The exchange of foreign currencies is commonly known and referred to as Forex. The Forex industry has developed itself to become a million-dollar industry.
Table of Contents
- Why Is Forex So Successful?
- What is Forex Hedging?
Why Is Forex So Successful?
The reasons for the success of the forex industry are multifold. Users can enter and exit the market very easily. The markets are open all the time. Meaning that you can trade currencies on your own time. In fact, the market is also easily the most advanced technological markets in the globe.
Perhaps the unique aspect of this market is that there’s no single central marketplace for foreign exchange. Currency trading is often conducted electronically over the counter.
This means all transactions occur over the counter with computer networks and robots. But before you start your forex trade, there are a few things you need to know.
What Is Forex Trading All About With Currency Pairs?
In the forex market, currencies are always traded in pairs. The most common currency pair is the US dollar and Euro in which one currency is exchanged or traded with for another. The EUR/USD price is the exchange rate where you find the amount it takes to buy the other currency.
To denominate different currencies, the forex market often uses symbols. For example, the EUR symbolizes the Euro. The Australian dollar is represented by the AUD. And CAD symbolizes the Canadian dollar.
Each Forex pair will also have a market price associated with it; which indicates how much of the first currency will be required to buy the second currency. The first currency is also always considered to be the directional currency.
Did you know that the GBP/USD currency pair is often referred to as the cable in the forex industry? There’s a reason why this currency pair is called the cable.
Before the advent of fiber optics and satellites, the London and New York stock exchange were connected through a giant steel cable that ran under the Atlantic.
Forex Speculation, Rumors, Supply & Demand
Currency rates can be defined in two ways; fixed rates or floating rates. The market determines the floating rate as a supply and demand rate.
If the demand for a particular currency is high, then the price will increase. If the demand for that currency is low, then its value will fall.
A fixed-rate of a currency is determined by the central bank of the respective government. The fixed-rate is set against a major currency.
To maintain its exchange rate, the government will buy its currency against the currency at which it’s fixed.
Most currencies are now allowed to float freely following the Bretton Woods system. Therefore, most exchange rates are not set but determined by ongoing trading activities in the world’s currency markets.
What Is Forex Trading All About With Leverage Explained
In the Forex market, short-term currency value movements are termed speculation where rumors and everyday supply and demand situations reflect the currency. If the supply is less than demand, then the currency value will decline. Whereas if the demand is more than the supply, then the currency value will rise. Rumors about government actions can also play an instrumental part in currency fluctuations
One reason why individuals are so attracted to Forex trading is that you enjoy much higher leverage with Forex than you would enjoy trading on other platforms.
Forex trading allows its users a high amount of leverage, and people can control a large amount of money with an initial margin requirement.
Leverage works uniquely. Suppose you have $20,000 in your account and you use it to open a position that’s worth $200,000. You’ll be trading with leverage that’s ten times your initial deposit.
If you trade $400,000, that means that you’ve taken leverage that’s 20 times your initial deposit. In most forex markets, leverage is often 100:1, which means that you can trade up to $100 for every $1 in your account.
However, leverage is a double-edged sword. Leverage can enlarge your profits and also at the same time, enlarge your losses as well. Only take on as much leverage as your appetite can afford
What is Forex Hedging?
In Forex, hedging is a strategy used to protect your money from losing its value via currency depreciation. Hedging limits the losses you could potentially make on a trade. Many people use options to hedge themselves against risks.
Consider that you buy a currency in hopes that its value will increase. You, however, also want to protect yourself from it, decreasing in value.
What you can do now is hedge the risk with a put option; in the put option, you will be required to pay a small fee to sell the currency at the previously agreed value.
Another way through which you can hedge your risk is by diversifying your portfolio. It’s difficult for all your assets to decrease or increase value with a diverse portfolio, simultaneously making your investments secure. As another example, traders often buy bonds to offset the risk of stock ownership. Learn more on how to hedge.
The Money Supply Effect
Most central banks control the value of their currency, and if the central bank prints too much money, it can also adversely affect exchange rates by causing the currency to depreciate.
Governmental expenditure is supported by taxes, loans, or simply by printing more money. But printing more money isn’t as easy as it sounds, and it may have some adverse effects attached to it as well. Printing too much money can give rise to inflation; in some rare cases, it can also give rise to hyperinflation.
Governments usually avoid printing excess money because it results in more harm than good. China, however, prints more money to keep its currency value low.
If the Chinese currency value is depreciated, then it means that China has a competitive edge over product exports; which is its primary industry and primary source of revenues.
Chinas strong export sector allows them to run a current account surplus and a weak currency keeps Chinese exports very competitive in the global market.
At the same time, it also makes imports very expensive. Therefore a weak currency supports local businesses. Chinese exports have also previously helped shape the economy. They’ve also created better jobs for traditionally paid workers.
The US has criticized this strategy as currency manipulation because a devalued Chinese currency results in an overvalued US dollar; which results in large numbers of people losing their jobs in the US.
Spot Markets And Futures Markets
Forex trading is also popularly known as the spot market because transactions are all settled on the spot. Stocks and currencies are the most well-known spot market instruments. Therefore, Forex in the exchange of currencies is also a global spot market.
The futures market is the opposite of a spot market, and it was created to settle the transactions made at a future date. The market was created to make a place where banks and corporations could hedge against potential risks or potential losses when trading.
Long And Short Positions
Selling long and buying short or vice versa are common trading terms used in the forex market. New traders might confuse these terms.
However, these terms aren’t as difficult as they seem. A long trade is when the first currency is bought while the other currency is sold.
To go long means that traders buy the currency in hopes that the currency pair rises in value so that they can sell it and make a profit.
Buying long is commonly used for stock purchases, investments in bonds or stocks where traders rely solely on their assets increasing in value.
Traders can also sell their currency or go short in the hopes that their currency pair decreases in value so that they can re-buy it at a lower rate. Buying short means selling the currency at a higher rate and buying it at a low rate.
What Is The Forex Spread?
The forex spread is the difference in the bid and the ask price of the currency pair i.e., if the asking price of a currency is 1.00002-1.00003, the spread is 0.00001 or 1 pip.
Currency pairs that have too large a spread will take more time to become profitable. Low spread trading ends up earning a quick profit, which is why many Forex traders often prefer it.
Pips is a commonly used term in forex trading, and it refers to 1/10th of a pip or the fifth decimal in the currencies value.
Many people prefer making multiple smaller trades than making large trades for this reason. Numerous forex trading strategies trade in small amounts of currencies rapidly.
Forex trading is risky, complicated, and unpredictable. However, the risks make the industry profitable to those who know how to do so.
Traders often have to overcome mental battles and resist the urge to take shortcuts to make profits. Forex trading is also ideal for new traders because it allows you to trade in small amounts compared to other trading markets. It’s also incredibly easy to enter into this market. And the market itself is very transparent.
We hope our post answered what forex trading is all about for you. If it did, and if you’re looking to learn the technicals the right way, you can always start with our free trading courses. We provide more than enough learning resources to get you going! Enjoy!