One of the larger areas of the trading sphere, and in fact the largest type of market by traded volume is the forex (short for ‘foreign exchange’) market. The forex markets allows traders and speculators to trade off the back of different currencies and their fluctuating valuations in much the same way as a share speculator might buy and sell shares. It is a marketplace that is driven by supply and demand in the same way as every other financial market, and presents opportunities for traders to capitalize on macro-economic triggers that shift currency values in both directions.
Forex markets can be a profitable place to play, but only if you understand what you’re doing, and there is a lot of information to take in and digest before you’re even ready to place your first trade. As you move off alone into the forex trading wilderness, it might be wise to continue to read and learn about different areas, and even to revisit some elements of currency trading theory along the way in order to ensure you have the most comprehensive basis of knowledge and skills.
Key Characteristics Of Forex
What Are Forex Markets And How Do They Work?
The forex markets trade around the clock, traders generally place their orders in the markets directly, with the broker facilitating their move. What forex does have in common with other derivatives is that traders can deploy massive amounts of leverage to increase the size of the position, and make more money from smaller incremental price increases. However, the degrees of leverage afforded by forex are often many times greater than of other markets, often as much as a ratio of 500:1, which means that forex is both potentially more profitable while also potentially much more risky.
The forex markets’ real point of distinction lies in the volatility of the traded currencies as compared to the volatility of the stock markets, and indeed many other different types of financial market. Currencies trade up and down on the basis of two major factors: economic indicators and geopolitical current affairs. This means that while currency valuations do have the ability to move heavily in either direction, they tend to be less volatile on the whole than share markets. This is a significant part of the reason that leverage plays such an important role in forex markets – by inflating the transaction size, leverage effectively mimics the effects of volatility by making much smaller movements up and down more severe.
On a similar vein, forex markets are substantially more liquid than all other types of financial markets, because currency is the most liquid asset there is. Rather than a share purchase, which must then be kept for a dividend or sold for cash, currency is already cash, and therefore positions are traded with much more speed and order filled much more quickly than in other financial markets.
Foreign exchange trading, hereinafter referred to as forex, can be a fantastic way to make money trading off the back of a potentially narrower field of research than many other financial markets. For those that want to be successful, the trick lies in understanding how the markets work, how they might respond to different triggers, and how you can manage the potentially massive risks that are posed to you by exposure to the market. In the coming sections, we’re going to look at how you can achieve these objectives, with a view to delivering the best return on your capital from the forex markets.
How Is Forex Traded?
So we’ve established already that forex is the platform through which investors and traders from across the globe buy and sell currency on a daily basis. A massive market in its own right, the forex markets turn over trillions every single day, with governments, banks and funds being amongst the biggest contributors to market price setting. But what is actually traded through forex, and how is the anatomy of a forex deal structured?
Currency Pairings
The first and perhaps most crucial thing to understand about forex is that currencies are quoted in and traded as pairs. So, you don’t strictly just buy dollars or sell sterling – you are instead buying dollars in sterling, or buying Euros in dollars. Without currency pairs, it would be hard to breed in any kind of standardisation for traders and limits the flexibility of the transaction – those that happen to live in the UK would always have to trade currencies in pounds, while those that lived in Spain would always have to trade in Euros. By creating currency pairs that may or may not involve the local base currency of the trader, the forex markets have essentially levelled the playing field and allowed easier transacting to take hold.
Currency pairings also mean that there are more variables and additional factors that must be considered during the research process. Instead of just looking at how the markets will view a particular currency in light of external goings on, the question then becomes how will a particular currency move in relation to another, which makes the calculation a little more complicated.
What Does It Mean For Traders?
When you start to trade forex for the first time, you will notice that you are taking positions on pairs expressed as EUR/USD, or GBP/USD. Fairly obviously, these pairings are read as Euros/US dollars, and pounds sterling/US dollars respectively. When you see a price point of 1.200 EUR/USD, what does this actually mean? The best way to think about it is that it takes 1.200 dollars to buy one euro. The currency pairing is effectively a ratio of 1:x, with x being the figure quoted as the price. So, if the figure rises to 1.400, it takes 1.400 dollars to buy a euro, in which case the value of your Euros in dollars will have increased.
In a nutshell, this is the best way to think about forex transactions and the way in which they are priced. Generally, if you’re going long on a currency pair and the number goes up, you make money, and vice versa on the downside. But by getting your head around exactly how the currency pairings are structured, you can start to think about likely price movements in the currency pairings you’re considering.
The idea of currency pairings and how they work can seem slightly complicated when explained, but in practice it’s fairly straightforward for most traders to get their heads around. So long as you appreciate the implications of currency pairings and what that means for your required research input and decision-making, it is unlikely that the structure of forex positions will pose many problems as you move into the markets for real.
FX Trading Journey
From choosing an FX broker and running a demo account through to the finer points of currency trading strategy, we cover the full scope of everything you need to trade forex successfully. Bear in mind that this doesn’t make the markets any less risky, and merely by having the tools at your disposal you don’t necessarily have the skills to avoid losing from time to time. What’s really important is that you remember as you go to keep a lid on your risk and downside exposure at all times, to avoid the ravages of leverage turning against an unguarded position.
As parting advice, if you had to remember one technique from this tutorial, it would be leaving profits to run and cutting out losses as soon as they become obvious. So fundamental when it’s written down, it should become your mantra as you trade forex, and on its own has the capacity to both earn and save you significant amounts over your trading career. It takes a long time for most FX traders to become comfortable with this concept fully, but trading otherwise is akin to leaving money on the table, and in a risky game like forex you really need to be in a position to maximise your returns whenever you can.
Most of all, remember that much of the mystery of forex trading lies in research. Assuming you’ve gleaned a basic understanding of the underpinning concepts, realising the true value in solid, ongoing research should set you well on the way to success as a forex trader long term.