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What is Forex Trading ?

April 6, 2016
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  What is Forex?

Forex market is a financial marketplace where currencies are traded. The countries, top financial institutions and banks trade currencies throughout the day, which continuously results in changing exchange rates. The total volume of daily transactions exceeds $5.3 trillion per day, making forex market the most liquid market. Unlike stock trading, there is no central exchange for the forex trading. The market is always open for 5 days so that you can trade currencies during any time of the day. The market stays open to allow traders to trade multiple currencies from all over the world.

Forex market is unique

Even if you are an experienced trader with the stocks, the forex market will surprise you due to its uniqueness. Until recently, the participants were mainly large international banks. The forex market is now open for individuals  too who are interested in trading currencies. You can buy one currency in terms of another and sell it accordingly. You have to participate in the trade depending on the rise or fall of exchange rates of the currencies you trade.

  • Highest liquidity in the forex market promotes great opportunities for trading.
  • Geographic dispersion allows you to trade during any time of the day. Even if one of the forex markets close down, another one remains open, influencing in fluctuating currency values.
  • Except for weekends, you can trade during any time of the day from any time zone without worrying about closing down of the market. This provides ultimate flexibility for traders to check on their trades.
  • The exchange rates are affected by numerous political factors, economical changes, monetary policies, natural disasters and other influential factors. There is simply no foolproof way to predict the changes in exchange rates.
  • Compared to other trading markets, the margin is very low for relative profit.
  • The huge leverage makes the actual deposit irrelevant in the forex market. With respect to account size, the profit or loss is magnified several times because of the leverage.

Trading currencies in pairs

In the forex market, you simply buy and sell currencies. Compared to other types of market, the technical jargon is minimal. However, you have to relearn the trading skills if you want to be successful in the forex market. While trading currencies, they are always quoted in pairs. The value of one currency is always stated in terms of another currency. This implies that a currency’s value is reflected only through another currency. To trade two currencies, for example, US dollar (USD) and Japanese Yen (JPY), the forex quote will be like USD/JPY = 120.60. The USD and JPY are called the currency pair. The left currency, USD is called the base currency. The right currency JPY is the quote currency. The base currency always corresponds to 1 unit and the quote currency indicates the value of quote currency equal to 1 unit of base currency. In the previous example, 1USD = 120.60 JPY. This essentially means that when you pay $1, you will get 120.60 Japanese Yen.

In most of the trades, USD is used as a base currency. Other stronger currencies such as British Pounds (GBP), Australian dollars (AUD) and New Zealand dollars (NZD) are also used as base currencies. In the currency pair EUR/USD, the Euros (EUR) is almost always used as the base currency. In the currency pairs, the exchange rates are quoted with four digits after the decimal place. However, when the Japanese Yen is present in the currency pair, only two digits are quoted after the decimal place.

In the forex market, it is theoretically possible to trade any pair of currencies of your choice. However, only a few common pairs gain a lot of attention. You always have to trade currencies through a forex broker. Essentially, the currency pairs you get to trade depend on the currency pairs that the forex broker offers.

Benefits of forex trading

Due to the large liquidity, the forex market is definitely profitable for traders. Investors can also benefit from trading currencies because there is an option to go long or short depending on the preference of the traders.

Huge market size

The huge market size makes it impossible for a single group of players to influence the market price. This means that there is no unique factor that can affect the exchange rates. You can enter and exit trading positions without worrying about holding the position too long. There is no need to wait for a  major increase in price because if you can predict the market trend, you can generate huge profits with a small movement.

Easy to enter

Often, the other trading markets make it impossible for traders with a small risk capital to start trading. In the forex market, you can start trading with as little as $250. Even with a small investment, you can enjoy a greater profit margin.

Potential for profit

Unlike the stock market, the forex market won’t follow the bear or bull trend. There is no possibility of complete loss with this market. When the value of one currency increases, the value of another decreases. You can enjoy profits even if the currency value increases or decreases.

High leverage

By investing a small amount of money in your forex account, you can control more with a leverage as high as 100:1. This makes it possible to risk a portion of your own money and realize a huge profit.

Commission free trading

The forex brokers don’t charge commissions on the trades. They make their profit with the difference between the bid and ask price.

Risks of forex trading

The benefits of forex trading are riddled with risks. The volatility of the forex market makes it impossible for even an experienced trader to predict the rise and fall of currencies. The time difference and fast changing exchange rates may not bring you the profit you had hoped for. The huge leverage can easily turn out to be a disadvantage when you have to deal with a huge loss, wiping out your investment with a single trade.