Forex, also known as forex or forex trading, is a currency conversion to another currency. It is one of the world's most active traded markets, with an average daily turnover of $5 trillion. Take a closer look at everything you need to know about Forex, including the nature of Forex, how it trades, and how the Forex leverage works.
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| What is Forex and how does it work? |
What is Forex Trading?
Forex or foreign exchange can be defined as a network of buyers and sellers that convert currencies among themselves at an agreed rate. This is the way individuals, companies, and central banks convert one currency into another - if you've already traveled abroad, you've probably made a Forex transaction.
While a lot of foreign currency is converted for practical purposes, the vast majority of currency conversions are made to earn profits. The number of currencies converted daily can lead to significant volatility in the movement of certain currencies' rates. This volatility makes the forex market attractive to traders: it brings great opportunities for great profits, and it also carries increased risks.
How currency markets work
Unlike stocks or commodities, forex is not traded on exchanges but is done directly between two parties in the parallel market (OTC). The forex market is managed through a global network of banks spread across four major forex trading centers in different time zones: London, New York, Sydney, and Tokyo. Since there is no central location, it is possible to trade Forex 24 hours a day.
There are three different types of forex markets:
- Instant Forex Market: is the physical exchange of the currency pair, which occurs at the specific point of trade settlement - i.e. on the spot - or within a short period
- Forex Forward Market: A contract is agreed to buy or sell a certain amount of currency at a fixed rate, to be settled on a specified date in the future or on a set of future dates
- Future Forex Market: A contract is agreed upon to buy or sell a specific amount of a particular currency at a fixed price and a specified date in the future. Unlike futures contracts, futures contracts are legally binding
Most traders who speculate on forex rates do not plan to receive the currency itself, instead making exchange rate forecasts to take advantage of price movements in the market.
What is the base currency?
The base currency is the first currency in the forex pair, while the second currency is called the pricing currency. Forex trading always involves selling a currency to buy another, which is why it is included in the image of a pair - the forex pair price is the value of one unit of the base currency in the pricing currency.
Each currency in the pair is listed as a three-letter symbol, the first two letters usually symbolize the area, and the third for the currency itself. For example, GBP/USD is a pair of currencies that includes buying GBP and selling USD.
GPB | USD
Base currency | Pricing Currency
The currency you buy when trading a forex pair | The currency you sell when trading a forex pair
To maintain the ranking, most providers divide couples into the following categories:
- Main pairs. Seven currencies make up 80% of the world's forex trades. Include: EUR/USD, USD/JPY, GBP/USD, USD/CHF
- Secondary pairs. Less tradable, in which trading of major currencies against each other is utilized instead of the US dollar. Include: EUR/GBP, EUR/CHF, GBP/JPY
- Non-main or unfamiliar pairs. One major currency from a small or emerging economy. Include: USD/PLN, GBP/MXN, EUR/CZK
- Regional or regional pairs. Pairs are classified by regions - such as Scandinavia or Australia. Include: EUR/NOK, AUD/NZD, AUS/SGD
What drives Forex markets?
The forex market consists of currencies from around the world, making it difficult to predict exchange rates relative to the presence of many factors that may contribute to price movements. However, as in most financial markets, forex is primarily influenced by strong supply and demand, and it is important here to understand the effects that lead to price fluctuations.
Central Banks
Supply is controlled by central banks, which can advertise measures that will significantly affect their currency price. Quantitative easing, for example, involves injecting more money into the economy and may cause its currency price to fall.
News Reports
Commercial banks as well as other investors tend to put their capital into economies with strong expectations. Therefore, if there is positive news in the markets about a particular region, that will encourage investment and increase demand for that region's currency.
Unless there is a parallel increase in the currency's supply, the discrepancy between supply and demand will lead to a rise in its price. Similarly, negative news can cause a decline in investment and a reduction in the currency's price. That is why currencies tend to reflect a vision of the health of the region's economy.
Market Tendencies
Also, market tendencies, which are often a reaction to the news, may play a key role in increasing currency rates. If traders believe that the currency is heading in a certain direction, they will trade accordingly and may persuade others to follow the same, leading to an increase or decline in demand.
How does Forex trading work?
There are a variety of different ways you can trade forex, but they all work the same way by buying a currency and selling another at the same time. Traditionally, many forex transactions are made via a forex broker, but as online trading increases you can benefit from forex price movements using derivatives such as CFD trading.
CFDs are leveraged products that enable you to open a position across a fraction of the total value of trading. Unlike products without leverage, you don't get the ownership of the asset, but you get a position depending on what you expect from the rise or decline in market value.
Although leverage products may double your profits, they may also double losses if the market moves against you.
What is the difference in Forex trading?
The difference is the difference between the sale price and the purchase price offered for the Forex pair. Like many financial markets, when you open a forex hub you will be offered two rates. If you want to open a buying position you will trade at the purchase price, which is just over the market price. If you want to open a selling center, you will trade at a sale price - just below the market price.
What is "lots" in Forex?
Currencies are traded as lots - payments of currency used to consolidate forex trading. Because foreign currencies tend to move in small quantities, lots tend to be very large: the standard share is 100,000 units of base currency. Therefore, the great majority of forex trades are leveraged because traded individuals may not necessarily own 100,000 pounds (or any currency they trade) to place in each trade.
What does Forex leverage mean?
Leverage is a way to get exposure to large amounts of currency without having to pay the full trading value in advance. Alternatively, you can place a small deposit, known as a margin. When you close a leveraged position, your profit or loss will depend on the total volume of trading.
Although this may inflate your profits, it may also bring the risk of inflating losses - including losses that can exceed your margin. Therefore, leveraging requires the utmost importance of knowing how to manage your risk.
What is the margin in Forex?
Margin is a key part of leverage trading. It is the term used to describe the initial deposit you place to open and maintain your leverage position. When you trade Forex by margin, remember that your margin requirements will change depending on your broker, and how much you trade.
Margin is often expressed as a percentage of the full position. Therefore, trading on EUR/GBP, for example, may require only 2% of the total value of the center to be opened. So instead of depositing £100,000, you'll need to deposit only £200.
What does pip mean in Forex?
Points are modules used to measure movement in a forex pair. The forex point usually represents the number one move in the fourth decimal place of the currency pair. If the GBP/USD pair moves from $1.35361 to $1.35371, it moves if with one (pip) point. Other decimal places that appear in the price after a pip are known as fractional pips or pipettes.
GBP: $1.35361
USD: $1.35371
The exception to this rule is when the pricing currency is listed as much smaller categories, the most notable example being the Japanese yen. Moving to the second decimal place of this currency is one point (pip). Thus, if the EUR/JPY pair moved from} 106.452 to} 106.462, it moved again by one point (pip).
EUR: 106.452¥
JPY: 106.462¥
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