Forex is the portmanteau of two words: foreign and exchange. It is the process of conversion of one currency into another for commerce and trading.
About Forex Marketplace
Do keep in mind that there is no central marketplace for forex. Currency trading takes place over computer networks among traders across the world. The marketplace is open for 24 hours for five and a half days a week.
Major financial centres for forex trading include Frankfurt, Hong Kong, New York, Singapore, Sydney, London, Tokyo and Zurich. These centres cover most time zones in a manner when the trading ends in one zone, it starts in another.
Earlier this market was predominant with banks and institutional firms. Over the recent years, the market has seen a shift in the traders. It has started to become retail oriented.
How Does Forex Trading Work?
Forex trading is also similar to trading in other securities such as stocks. However, this trading is conducted in pairs such as EUR/USD. This means that you buy a different currency such as the Japanese yen when you sell another currency such as the dollar.
The profit or loss depends on the value of the currency that you are selling against the currency that you are buying.
Investors can earn profit from the difference between interest rates in the two different economies. They can buy currency with a higher rate of interest and then short the currency which has the lower rate of interest.
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Unlike shares, forex trading does not take place directly between two parties. There are 4 major forex trading centres across the world in different time zones including London, Sydney New York and Tokyo. There is no central location and you can trade forex all day long.
There are three types of forex market:
Spot forex market: Here, the exchange of a currency pair takes place at the exact point when the trade is settled within a short time period.
Forward forex market: In this market, a contract is agreed to trade a fixed amount of currency at a specified price that must be settled at a set date in the future.
Future forex market: It is a legally binding contract which is agreed to trade a fixed amount of currency at set price and future date.
Learn How To Trade Forex
Forex trading is similar to trading in equity. As a beginner, you can follow this simple forex trading guide to kick start your trading journey.
1. Learning basics: If you plan to trade in this market, you need specialised knowledge since it is a risky market. Here, the leverage ratio for trades is higher than for equities.
The drivers for the currency price movement are also different from that for the equity markets.
2. Setting up the brokerage account: You should have a forex trading account at a brokerage for forex trading. Here, brokers do not charge commission but make money through spreads between buying and selling prices.
As a beginner, you can set up a micro forex trading account since it has low capital requirements. These accounts have variable trading limits and allow limiting the trades as low as 1,000 units of the currency.
A standard account lot is equivalent to 100,000 currency units. Through a micro forex account, you will become more comfortable with forex trading.
You will also be able to identify your trading style.
3. Develop a strategy: You cannot always predict and time the market movement. Therefore, it is important to have a trading strategy so that you can set broad guidelines for trading.
You should base your trading strategy according to your finances. You should also consider the amount of cash that you can invest in trading and assess your risk tolerance.
4. Keep a track of your numbers: Always check your positions as the trading day ends. Trading software provides daily accounting of forex trades. Do not leave any pending positions that need to be filled out. Also, ensure that you have enough cash in your account for future trades.
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Uses of Forex Trading
Hedging: Companies doing business in foreign markets often face fluctuations in currency values while trading goods and services outside their domestic markets.
Foreign exchange markets hedge currency risk by fixing a rate at which transaction will be completed. Traders can trade currencies in forward or swap markets in advance. This locks in an exchange rate.
Speculation: Factors such as interest rates, trade flows, economic strength and geopolitical risk impact supply and demand for currencies. This can create frequent volatility in forex markets.
Trader can profit from these changes that impact one currency’s value in comparison with another. If one currency weakens, then the other currency in the trade pair will automatically strengthen.