The Forex market is where currency pairs are traded. Currencies are critical to nearly everyone in the world, as they need to be exchanged in order to conduct business, trade and travelling. The necessity to exchange currencies is the basic reason why the foreign exchange market is the biggest, most liquid market in the world. The gigantic size of the Forex market dwarfs that of any other, with a daily trading volume of around $5.35 billion, according to the Bank for International Settlements’ triennial survey of 2013.
Want to know more about this exciting market? Then, let’s take a closer look and understand how it works.
What is Forex?
Forex refers to the foreign exchange market, where any person who travels will know this as the currency that you buy when going to another country. For instance, you may sell Euros and buy pounds for your trip to the UK. However, the foreign exchange market is speculative, which means that you do not get the actual currency. Instead, you open and close trades electronically through an online trading account, with the intention to profit from the exchange rate difference.
The foreign exchange market is an over-the-counter market, which means that trading activity takes place directly between two parties, without dealing through a centralised exchange. Traders can effortlessly access the Forex market online from anywhere in the globe. There are two parties involved in an online transaction; the trader and the market maker. A market maker is a company that enables trading by giving an ask or bid price on a currency pair, virtually creating the market for traders to trade in.
Individual investors form the fastest-growing part of the international foreign exchange market. Other participants include the interbank market, which is mainly consisted of major commercial banks, hedge funds and multi-national financial institutions.
When can I trade?
As Forex is a truly global marketplace, a trader can trade 24 hours a day, five days a week. The major trading centres are spread throughout various time zones, abolishing the need to wait for an opening or closing bell. As one region’s trading session comes to an end, the next region’s session commences, so there is never actually a downtime in the 5-day trading week.
Each trading day can be divided into three sessions; the Asian (Tokyo), the European (London) and the US (New York). The Asian session starts operating around 23:00 GMT and closes around 08:00 GMT (summer hours). This overlaps with the EU session which opens around 07:00 GMT and closes around 16:00 GMT. Then, the US session, which overlaps with the EU session, begins around 13:30 GMT and closes around 20:00 GMT. Therefore, a trader can trade non-stop from 21:00 Sunday GMT until 21:00 GMT Friday.
The times when two trading sessions overlap are the most profitable as it is then that there are high volumes traded and maximum volatility, thus boasting greater profit opportunities. The European session has the highest traded volume, as it operates between the Asian and the US session. It is interesting to note that almost 50% of the daily volume occurs during the European session.
How do I make profit?
In order to profit from Forex, you have to correctly determine whether one currency in a currency pair will go up or down in relation to the other currency in the pair. A trader can profit whether the instrument is rising or dropping, due to the fact that currencies are traded in pairs. The general practice is to buy when a currency is low and sell it back when it is high.
Forex traders form their trading strategies based on technical and fundamental analysis. Technical analysis is the use of charts and indicators to predict future price movements based on historical data, while fundamental analysis studies macroeconomic data releases, news announcements and other financial reports in order to determine the changes in market prices.
Do I need a large capital in order to trade Forex?
Forex trading has become so attractive for speculators because of the opportunity of margin trading. Margin trading enables you to deposit a small amount of money into your trading account and control a much larger amount in the real market, through leverage. Online Forex brokers offer traders leverage to give them the ability to place larger trades than they would be able to place otherwise. The standard leverage ratio is 1:100, which means that for every 1$ in an account, a trader can trade $100 in the market. If, let’s say, a trader puts down $3,000 of his own money, then he has access to $300,000 ($3,000 × 100) for his online transactions. Leverage, however, is a double-edged sword, as traders can get large profits when exchange rates make a small move, but they may also face the risk of big losses when rates move against them.
How do you determine the trade size in Forex?
Trading sizes in Forex are measured by lots. A lot signifies the minimum size of a trade, measured in units of the currency. Ordinarily, one standard lot is equal to 100,000 units of the currency, for instant US dollars, with a corresponding pip of 10 units (10 USD). Trades can be placed for any number of lots; 1, 2, 5 and so on. More lots per trade denote higher transaction value and thus higher value of 1 pip. For example, a 2-lot trade will have a value of $200,000 and have a pip equal to $20.
Let us give an example to show how things work. Jack has $3,000 in his trading account and forecasts a rise in the exchange rate of the EUR/USD pair. He is given a quote of 1.3100. He enters a long position to buy 1 lot of the currency pair (standard lot size $100,000). Given the standard leverage of 1:100, Jack will have to place $1,310 of money from his account (required margin) to fund this trade, while opening an order of $131,000 in the market ($1,310 × 100 leverage). Jack pays $1,310 out of his available $3,000, which leaves him with a balance of $1,690 in his trading account.
If Jack forecasted the price change correctly and the EUR/USD rate does rise to, let’s say, 1.3150, the value of his position will increase to $131,500. Jack may decide to close his position and attain the profit. On closing, he will pay the broker back $131,000 – the amount of the original loan – and the difference of $500 (profit), will get deposited into his margin account. His new account balance is $3,500 (previous balance + profit + the original margin of $1,310, which is credited back to his account). Here, you can observe how a 50-pip move is translated into a $500 profit, which represents the pip value of $10 for a 1-lot order.
Why is Forex trading so appealing?
- Increased profit opportunities: Market conditions may change at any time as real-time events occur, bringing constant profit opportunities.
- High leverage: You can use a small investment to control a greater amount and thus get a higher yield.
- Extreme liquidity: You can always find demand to sell or buy, as high volumes being traded worldwide lead to high liquidity.
- Controllable risk: You can use a stop loss order to determine the maximum amount you are willing to risk.