Forex Trading, the trading exchange of foreign currencies, has become an increasingly popular method of investing in the global market. With the advent of technology, one can invest in currencies at any time, as the forex market is open at any time of the day.
But before investing your hard-earned cash in the global economy, it is very crucial for you to at least learn the basics of Forex Trading. Therefore, in today’s article, we will learn what exactly is forex trading, and how it works. So, if you want to create wealth by investing in the world economy, read on!
What is Forex Trading?
If you have ever traveled abroad on holiday or for business, you probably have engaged in a foreign exchange transaction. But Forex trading involves more than just exchanging your currencies into a currency of your choice – it is much more than that.
The foreign exchange market describes the entire global market for buying and selling currencies. Forex Trading is basically the process of exchanging one currency for another. By exchanging currency, a trader speculates whether one currency will rise or fall in value against the other. While most forex exchanges occur for practical purposes, like traveling abroad, a vast majority of the transactions are made as a part of forex trading, i.e. to earn profit.
So how do you make a profit? It is very simple – due to the high amount of currency conversion every day, there is extreme volatility in the price of currencies. This very volatility makes Forex a beautiful trading business; it also comes with certain risks. That’s why most big companies trading turn to experts that handle FX risk management for corporates.
The Prime Benefit of Forex Trading
Talking about the benefits of Forex Trading, well, there are plenty of them. First is, of course, it earns the traders a great number of profits. Due to very few transaction costs (commissions and brokerages), and hence a high return value, Forex trading has become an apple in the eyes of traders.
That’s not all; traders also have the leverage to jump on volatility whenever and wherever it happens. The forex market is a global decentralized trading platform with no central exchange like a stock market. You can trade 24 hours of the day and seven days of the week – that is every day.
Forex trading is one of the simplest yet most effective ways to make money in the financial markets. It’s a dynamic and highly liquid market, with 24-hour trading. As a currency trader, you can trade currencies anywhere and anytime, on your own or via a managed account.
Other Benefits of Forex Trading include:
- Transparent Trading: Even though Forex Trading is a huge market, there still is high transparency in comparison to other trading markets. The information is easily available to everyone, and no nation or one particular central bank can rig the Forex market.
- Variety of Trading Options: Forex markets provide you with various trading options, including trading in hundreds of currency pairs. Besides, individuals can also choose to enter into spot trade or a future agreement.
How Does Forex Trading Work?
Forex is the market that offers currency pairs based on the dominant currencies of each country. These currency pairs are traded on an open market and the values can fluctuate to reflect world events and economic conditions.
If a fluctuation occurs in the value of one currency against another, you could make a profit or loss by buying or selling its pair. Sounds simple, right? But in reality, it is much more complex than that.
When trading currencies, you are actually trading two currencies at once: a base currency and a quote currency. Base currency is the first currency listed in a forex pair, while Quote currency is the second currency of a forex pair.
Currency Pair in Forex Trading
As mentioned above, Forex trading always involves selling one currency to buy another which is why it is quoted in pairs, known as “currency pairs”. The price of a forex pair is how much one unit of the base currency is worth in the quote currency.
All currencies are assigned a three-letter code, similar to the company’s tickers in the stock market. For example, AUD is the Australian dollar symbol, EUR is the Euro, and GBP is the symbol for the Great Britain pound.
While there are more than 170 currencies around the world, the most traded currency is of course the United States USD, which is involved in the majority of Forex trading. Euro then follow it, the currency accepted in 19 countries of the European Union.
The Exchange Rates
Exchange Rate is the most common term used in forex trading; you might have heard the term in your daily life as well. The exchange rate of two currencies represents how much of the 2nd currency (the Quote currency) is required to purchase a unit of the base currency.
If the EUR/USD exchange rate is 1.2, that means €1 will buy $1.20. In other words, each Euro equals a dollar and 20 cents worth of U.S. dollars. Here, the rise in the exchange rate means a rise in the value of the base currency against the quote currency. This is because traders get to purchase more quote currency with 1 unit of the base currency.
Contrary to the rise, if the exchange rate is dipping down, it means that the value of the base currency has fallen. The direction you trade will depend on your views on whether one currency will likely rise or fall relative to another. If you believe that the exchange rate is going to increase, you purchase the currency pair. Similarly, if you think that the exchange rate will fall, you should sell the pair.
The Bottom Line
To conclude, these are just the basics of Forex Trading – you can of course begin your trading journey with these simple lessons. But you will need a deeper knowledge of Forex Trading in order to forecast the rise and fall in the exchange rates of the currency pair, and earn a decent amount of profit from your trading.