In the first place we will see what Forex is, how it works and its most important characteristics. And then we will explain step by step how to trade in the forex market.
What is Forex?
FOREX is the global currency exchange market and corresponds to the abbreviation of the English term Foreing Exchange, which could be translated as “exchange of foreign currencies”.
It is also known by some different names such as FX, currency market or foreign exchange market.
What is done in the Forex Market is to exchange one currency for another, such as Euros (EUR) for Dollars (USD) .
Next we are going to see some practical example of the foreign exchange market:
Suppose we are going to travel to any other country in the world that has a different currency than ours. Before starting our trip we will go to our bank and exchange our currency (for example euros) for the currency of the country to which we are going to travel (Dollars, Yens, Pounds…)
Another example would be when we buy from an online store that sells products in a currency other than our own. When paying with our bank card, a currency exchange is automatically carried out electronically.
In both cases it can be said that we have participated in the Forex market exchanging one currency for another.
Foreign exchange operations are carried out constantly by the different participants of the FX market, for very different reasons.
The Forex market is the largest in the world which makes it highly liquid. According to the Bank for International Settlements, it has a daily trading volume of more than 6 Trillion Dollars.
How does the Forex market work?
The Forex market works through a global network of banks, companies and individuals who constantly buy and sell currencies with each other.
Unlike most financial assets, such as stocks or commodities, the foreign exchange market does not have a physical location and operates 24 hours a day.
The negotiation is carried out electronically between both parties, which is called the over-the-counter market (known as OTC for its acronym in English). Currency prices constantly fluctuate in value relative to each other, potentially offering a greater number of trading opportunities.
There are four main forex trading centers: London, Tokyo, New York and Sydney.
When trading stops at one, it starts at another. However, the foreign exchange market is also traded in other cities such as Frankfurt, Hong Kong, Singapore or Paris.
Before going into Forex Trading in detail, it is important that you understand what a currency pair is and how they move.
What is a Currency Pair?
A currency is any foreign currency, that is, official currencies other than that of our own country.
Each country or region has its own currency and one way to determine its value is by comparing it to other countries. For example, if we want to know what a Euro is worth, we can compare it with the Dollar.
It is what is known as currency pairs or crosses .
For example, the Euro/Dollar pair (EUR/USD) means that we are comparing the value of a Euro with the value of a Dollar.
There are a large number of currency pairs or crosses and they are usually classified into major, minor and exotic currency pairs.
The major pairs are the most frequently traded and have the most liquidity:
- EUR/USD: Euro vs US Dollar
- GBP/USD: British Pound vs US Dollar
- AUD/USD: Australian Dollar vs US Dollar
- NZD/USD: New Zealand Dollar vs US Dollar
- USD/CAD: US Dollar vs Canadian Dollar
- USD/JPY: US Dollar vs Yen
Minor pairs trade less frequently and have less liquidity. Some examples are:
- EUR/JPY: Euro vs Yen
- AUD/NZD: Australian Dollar vs New Zealand Dollar
- EUR/GBP: Euro vs British Pound
- EUR/CHF: Euro vs Swiss Franc
And finally there are the exotic pairs that are crosses between a major currency and another of a small or emerging country. They are rarely traded, some examples being USD/MXN (Dollar vs Mexican Dollar) or EUR/TRY (Euro vs Turka Lira).
Who participates in the Forex Market?
Taking into account how extremely large the Forex market is, you may ask yourself, but who are the participants in the foreign exchange market?
We could summarize it in three large blocks:
- Banks: whether they are Central Banks, Commercial Banks and Investment Banks.
- Large corporations: they can participate to invest directly in currencies or to hedge investment portfolios, to name a few examples.
- Small agents: any person, to trade or to pay when we buy in an online store in another country, among other reasons. Also small shops, Brokers…
Why does the Forex Market move? (3 factors)
An important question about Forex trading is to know what makes the price of currencies vary.
The first thing is to keep in mind that FX pairs move according to the relative strength of both currencies, that is, one with respect to the other. Therefore, we must be attentive to the movements of the base currency and the traded currency when we are operating.
On the other hand, there are several factors that make the forex market move:
- Economic Data: Currencies backed by strong economies are in high demand. Some key economic data that can have an impact on the price of currencies are inflation or unemployment figures.
- Central banks: set interest rates and influence the flow of money circulation.
- Political reasons: political uncertainty in some countries lowers the demand for some currencies and money is directed to safer markets such as the Swiss franc or the US dollar.
Forex Trading Guide
Once we have seen what Forex is and how it works, we are going to focus on currency trading as a way to make a profit in the financial markets.
1. What is Forex Trading?
Forex Trading consists of speculating on the variations in the price of currency pairs to obtain a profit for the difference that occurs between the price of entry and exit to the market.
In Forex it is possible to make money both with the rise and the fall of currencies. It is what is known respectively as opening trades “Long” or “Short”.
- Trading Long or “Long” consists of buying a currency pair if you think that the base currency will increase in value and therefore you will sell more expensive.
Here is a long trade on the USD/JPY (US Dollar/Yen) pair:
- Trading Short or «Short», consists of speculating that the price of a currency pair is going to fall. To do this we first sell and repurchase when the price has fallen.
In the following example we see a Short operation in the pair USD/CAD (American Dollar / Canadian Dollar):
It can be a bit confusing to trade short, but just think that we make a profit if there is a difference between the entry price (where I sell) and the price where I close the trade (buy).
How much is earned with each operation?
It depends on many factors, but the idea that you have to stay with is the following:
The difference between the purchase price and the sale price is measured in PIPs (it is the unit of measurement in FX, we will explain it later). Therefore, when making a trade, we will know that we have earned a certain amount of PIPs.
We would only need to know the value of each PIP and we would know the amount of money earned. However, in the Trading platforms it tells us in real time what the profit or loss of the operations is. The following example is from the Metatrader4 platform:
2. How to trade Forex
You can trade forex using different financial products. Some examples are:
- Spot Forex
- futures contracts
- ETFs and ETNs
The easiest way to trade in the foreign exchange market is through a Spot Forex or CFDs broker, which are the usual ones in which the retail public operates.
Simplifying a lot, the steps to trade FX are:
- Open an account in a Broker: intermediary that allows us to operate with existing currency pairs.
- Select a platform to view charts and submit orders. The most common in Forex is Metatrader4.
- Develop a strategy and a trading plan with the rules on how we are going to operate.
- Analyze the market to look for opportunities.
3. How to read a currency pair
A currency pair is divided into the base currency and the quote currency.
- EUR (Euro) is the base currency or first currency that is the one we exchange for Dollars.
- USD (Dollar) is the so-called quote currency or second currency.
- Price: it is the price of the currency cross
The price of a currency pair is usually expressed in a way similar to this:
The number on the right is the exchange rate that expresses how many units of one currency are needed to obtain one unit of the other.
What does all this mean according to the above example EUR/USD 1.22? Well, for 1 EURO they would give us 1.22 DOLLARS.
4. Forex Trading Strategies
Trading strategies involve analyzing the market to determine the best entry and exit points, as well as the size of the position and how long it will remain open.
Strategies often include elements of different types of analysis and a wide variety of tools to attempt to forecast future market movement.
The strategy will vary depending on our trading style. The main types of trading are: scalping, day trading, swing trading and positional trading.
5. Analyzing the Forex Market: Technical Analysis and Fundamental Analysis
When analyzing a currency pair to know when to buy or sell, the two most used methods are:
Technical analysis focuses on analyzing price and volume using charts. From this analysis it is a question of determining what will be the possible movement of the price to obtain a profit.
The fundamental analysis in Forex focuses on analyzing economic, social and political information to determine if this information weakens or strengthens a currency and therefore if its price will rise or shuffle.
6. News and events: their importance when trading in FX
Macroeconomic news and events such as central bank meetings, interest rate decisions or country unemployment data greatly influence currency pairs, creating situations of sharp price movement.
We must keep track of all the economic events that can influence us and have a strategy in our trading plan on how to deal with them and what decisions to make (reduce positions, not operate, etc.)
An easy way to keep up to date with all the news is through the Forex Factory website , which has a calendar of economic events and a news section updated in real time.
7. When to Trade: Forex Sessions
The Forex market hours are very wide. It works 5 days a week and 24 hours a day. The opening is on Monday morning according to Australian time and closes on Friday night with the closing of the American market.
It is important to know what
Each day there are 4 sessions corresponding to each of the world's largest markets.
- New York
During those sessions, the price of the currencies that correspond to these countries tend to have more activity. For example, the USD/JPY pair will move more during the American session and during the Japanese one.
8. Forex Dictionary: Terms You Should Know
ASK Price and BID Price
When you look at the price of a currency pair in the broker, you will see two different prices: the ASK price and the BID price. The ASK price is the price you have to pay when you buy and the BID price is the price you have to pay when you sell.
What is the spread?
The BID price is always less than the ASK price and the difference is known as SPREAD which represents the cost to trade.
Simplifying a lot, let's say that the spread in Forex is the money that a broker charges for executing our operations.
What is a PIP?
Currency pairs move in small increments. The minimum value of these increases is what we know as PIP in Forex.
Let's take an example:
GBP/USD is trading at 1.5233. If it rises to 1.5234 it has increased its value by one pip (0.0001).
A lot in Forex is the unit of measurement used when buying or selling a pair and corresponds to one hundred thousand units of the base currency.
Then there are smaller units such as the mini-lot and the micro-lot.
Leverage and Margin
When operating in the Forex market we have the possibility of leveraging and
borrowing money. This allows you to trade with more money and make higher profits (but also more losses).
The advantage is that it allows you to start trading Forex with little starting capital.
Margin is related to leverage as it is the amount of initial deposit you have to put down to open and hold a leveraged position.
9. How to get started in Forex Trading: first steps
Trading Forex is similar to trading in other markets such as stocks or cryptocurrencies. If you want to get started in Forex Trading follow this short roadmap:
- Learn trading : learn everything related to technical analysis, risk management and the peculiarities of the Forex market.
- Make a first contact with charts and trading platforms: a good idea is to open a demo account with a broker. They are free and allow you to use their platform to practice.
- Create a trading plan: as you increase your knowledge you will be able to develop strategies in which you specify exactly how you are going to trade.
- Start trading with real money, but always with little capital. Trading psychology is a very important factor to master and there is a big difference between trading with a play money account and a real money account.
- Create a trading journal in which you write down all your operations to analyze them later in a process of continuous improvement.
10. Advantages and disadvantages of Forex Trading
To end this beginner's guide, we are going to explain the advantages and disadvantages of trading in the forex market:
- It is a very liquid market so it is easy to enter and exit a position in most currencies.
- The Forex market is traded 24 hours a day and 5 days a week. The long hours make it easy to adjust the operation according to our lifestyle. If, for example, we have an 8-hour job, we can adapt our strategy to it.
- It allows us to start with little capital and increase it as we have more solid results.
- It requires us to be very attentive to the different news and events since they usually produce sudden increases in volatility.
- The leverage that brokers allow can play tricks on us if we don't have a lot of experience.
- The foreign exchange market is much more volatile than other markets such as the stock market.
- International Bank for Settlements. « Foreign Exchange Turnover in April 2019 «
- BBC NEWS. ” Brexit: Sterling Falls to Lowest Levels Since 1985 as Stocks Plunge “.