Forex Trading: We always strive to earn more and get something extra to sustain our lives smoothly. In this context, the Forex market has always tempted us and remained the cornerstone of the global financial market. It revolves around the buying and selling of international currencies driven by constant price fluctuation. The market operates 24 hours a working day, five days a week, with financial centres across the globe, from London, Sydney, and Tokyo to New York.
The foreign exchange market works in a decentralised way, and unlike other financial markets, it doesn’t have a centralised exchange. It allows traders to speculate on currency movement and earn profit from it. There are various financial tools through which a trader can get involved in the forex trade.
- Spot transaction
- Forwards
- Future
- Option
It is very important to understand various features and basics of the forex market before a trader thinks to invest and gain profit.
Basics of Forex Trading
To understand the basics of forex trading, we shed some light on what exactly forex trading is and how it works.
1. Forex Trading
Foreign exchange, which is also known as Forex, involves the buying and selling of international currencies. The sole aim of this transaction is to make a profit from the fluctuating currency prices. It is a very big market, with over $7 trillion being invested daily. The market has attracted more customers worldwide, making it an ultra-aggressive tool surpassing the global stock market.
The exchange rate plays an important part during a Forex trade. In this market, the currencies trade against each other as exchange rate pairs. For example, EUR/USD is a currency pair for trading Euros against Dollars. The trader makes a bet in an attempt to see if a particular currency rises as compared to others.
2. How it Works
The working principle of the forex market is simple: it works by speculating on fluctuating exchange rates. Every trade aims to gain profit from the changing values of currencies relative to each other. It majorly operates by.
Currency Pairs
It is a quotation of two different currencies. Where one currency acts as a base currency, and the other is the quote currency. Traders buy or sell the base currency in exchange for the quoted currency.
For example, USD/INR- The value of 1 dollar in terms of Indian rupees.
Bid and Ask Price
The bid price is the price at which a currency pair can be sold. Similarly, the asking price is the price at which it can be bought. The difference between them is spread, which represents profit.
Leverage and Margin
In the foreign exchange market, leverage and margin are very important concepts. This allows traders to open and maintain positions beyond their cash balance.
For example, with 100:1 leverage, you can control up to $100,000 in the market with $1,000. It may look good, but it increases risk way too much.
Pips
In the forex trade market, pips mean percentage in points. Traders aim to earn pips through price movements.
Market Analysis
There are two types of market analysis used by traders in the forex market.
Fundamental Analysis
It can involve the economic indicators like,
- Political events
- Inflation
- Interest rates
- Employment data
Technical Analysis
This can involve studying charts, patterns, and historical data to predict future movements.
Risk Management
Like any other money market, foreign exchange trade also involves risks which are majorly caused by a global event, market volatility, and leverage. Traders can use various tools to minimise the risk involved in forex trade markets. Like,
Stop-loss orders
It is a risk management tool used in the Forex trade market. It automatically buys or sells the asset when it reaches the predetermined price. This tool is very helpful in protecting traders during adverse market movements by limiting losses.
Take profit orders
It is a predefined instruction that automatically closes a position when a specified profit level is reached. It usually works when a trader sets a take profit (TP) order and executes automatically without constant market monitoring.
Risk reward strategy
It is the measure of the ratio between potential profit to potential loss. For example, if a trade has a risk-reward ratio of 1:2, the potential profit can be twice the potential loss.
Long and Short Positions
Buying a long or short position can be a good strategy for earning profits in the forex trade market.
- Going long means that the trader has anticipated an increase in the price of the bought currency pair.
- Going short means selling a currency pair by expecting its value to drop.
Market Orders and Execution
A market order is an instruction to buy or sell a currency pair at the current market price. The main aim is immediate execution.
Forex Market and Key Participants
A trader can easily be tempted by the number of daily transactions and the size of a forex market. The daily turnover of the market is estimated to be well over $6 trillion, and its global presence adds to its glory. By its global presence, we mean it operates through different time zones involving various banks, brokers, traders and financial institutions. It may include:
- Central banks
- Commercial banks
- Investment funds
- Traders
Pip in Forex Trade
In a foreign exchange market, pip stands for “percentage in points” or “price interest point.” It is the smallest movement of currency pairs in terms of price. Normally, it is the fourth decimal place for almost all currencies 0.0001, except for currency pairs, which involve Japanese yen, where pip is the second decimal place, i.e. 0.01.
Importance of Pips
It plays an important role in measures of profit and loss. Let us understand how
Profit or Loss
Let me quote an example so that you will better understand. If the USD/INR pair moves from 1.2000 to 1.2010, it means there is a moment of 10 pips. If a trader had bought the pair, then the pair price went ahead by ten pips, which means profit (depending on the position size)
Standardisation
Pip provides standardisation to measure price change across currencies.
Understanding Pip with Example
Suppose the pair moves from 1.2000 to 1.2005. This means there is a 5-point movement in the pip.
Let us suppose you’re trading with a standard of 100,000 units; each pip would be worth $10. A gain of 5 points means $10*5= $50 profit.
For a mini lot of 10,000 units, each pip is worth $1. In this case, a gain of 5 points means $1*5= $5 profit.
Pipettes
Now you will say, is it even a thing? In this case, some broker quotes prices with an additional decimal point, which we call a pipette. So, the movement will be measured to five decimal points instead of four. E.g. 0.00001 instead of 0.0001.
Margin in Forex Trading
Margin is the amount of money a trade has to deposit to their broker to open and maintain a leveraged position. The deposited money is like a security deposit that ensures the trader can cover the potential loss that can happen while trading. Below are a few points to remember on margin.
1. Margin v Leverage
- Leverage can allow traders to control large positions with a smaller capital. For example, in 100:1 leverage, a trader can control $100,000 in the market with just $1,000.
- Margin is usually the portion of your account that is kept aside to open the leveraged trade. In case a trader is using 100:1 leverage, the margin required would be 1% of the position you create.
2. How Margin Works
A margin is a security or guarantee that a broker sets aside while a trader opens a trade. This margin will be held until the order is complete or closed.
For example, in the case of a standard lot, which is 100,000 units of EUR/USD with 100:1 leverage, the margin requirement is 1%, which means a trader needs $1,000 in margin to open the trade.
3. Free and Used Margin
- Used margin can be defined as the portion of the fund which is currently used to maintain the open trades in the market. In simpler words, whenever you buy a forex trade, some money in your account is kept as the margin.
- All the remaining funds that are not being used as a margin for an open trade are free margins.
4. Margin Call
During the execution of an open trade, whenever your account balance falls below the required margin level, a margin call is generated. This happens when your open trade is losing money, and your account equity is balanced, plus or minus any profit or loss. At this point, the broker asks you to deposit more funds or automatically close your position to prevent further losses.
5. Maintenance Margin
To keep the position open, the trader maintains a minimum amount of equity, known as the maintenance margin. If equity falls below this level, the broker may start liquidating the open positions.
Popularity of Forex Trading
We all strive to earn, and that, too, is risk-free. Forex trading is an option in which, if we have in-depth knowledge and experience, then we can make money. Other reasons why forex trading is popular.
1. High Liquidity
With an estimated value of over $6 trillion traded daily, the forex market is the most liquid finance market globally. High liquidity ensures traders can execute the buying and selling of currency pairs smoothly without significant price slippage.
2. Leverage
- Forex brokers offer high leverage, which will allow investors to hold a large position in the market at a considerably small amount.
- With a 100:1 leverage, an investor can control a position of $100,000 with just $1,000.
Note: High-leverage positions increase potential profit, but it also increases the risk of loss.
3. 24 Hours Accessibility
This can be the most tempting thing for forex traders. Unlike stock markets, the forex market works 24 hours, five days a week. Regardless of time zones, investors can make a trade anytime and cash in on their opportunities for any event or news.
4. Low Transaction Cost
Most forex brokers charge a small spread between bid and ask price. The cost associated with a forex trade is low.
5. Trading Opportunities
The market offers a variety of opportunities. A wide variety of currency pairs can be traded. Like from major pairs like EUR/USD to minor pairs USD/TRY. It allows the investor to find different market trends, diversify the portfolio and take advantage of market movements.
6. Volatility
Forex markets are highly volatile during geopolitical events or economic announcements. Greater volatility in the market means higher risk, but it also allows traders to capitalise on price movements.
7. Low Barrier to Entry
The Forex market offers low barriers to investors. Many brokers allow individuals to start with low capital by offering micro and mini lots.
8. Availability of Education Resources and Tools
Traders can easily access free educational resources and tools. These can help them learn and understand the basics of the market and broker platforms by offering webinars, guides, etc. The ease of availability of educational material will encourage more investors.
Risks and Challenges in Forex Trading
Like any other form of trading or investment, forex trading also comes with unique risks and challenges. As investors, we must pay attention to them. Some of them are,
1. High Market Volatility
The Forex market can be highly volatile. It may depend on numerous factors like geo-political changes, economic data and market sentiments. High volatility brings greater risk as it can affect price fluctuations, which means higher losses or gains.
2. Interest Rate and Country-Based Risk
A forex trade may involve a pair of currencies from different currencies like the American Dollar and European Euro, among others. Changes in interest rates, political stability and other economic changes in a particular country can influence the market to a greater extent.
3. Leverage Risk
Many forex traders utilise leverage to amplify their returns from the market. They can hold a large position even with a small account. Leverage not only amplifies the chances to make more money but also increases risk in many ways. I am not saying this is a good strategy to make money, but you may need to be extra cautious about price movements and have in-depth knowledge and experience.
4. Broker Risk
Traders should choose a reputable forex broker and do thorough research before choosing one. Broker risk is very common in this market, as it includes broker insolvency, poor trade execution, or conflict of interest.
5. Technical Risk
Yes! This can be a problem, too. Software glitches, connectivity issues or delays in trade execution can occur when the trader is in an electronic trading environment.
Need: Traders need a stable internet and robust trading platform to minimise this risk.
6. Market Manipulation
Forex markets are susceptible to manipulation, such as insider trading and price fixation. However, the market strives to maintain fairness. The traders should be aware of such risks.
7. No Central Exchange
Forex market operates globally but is decentralized, which means it has no central exchange. This can lead to problems like liquidity issues during a trading session.
8. Psychological Risk
Like stock market trading, forex trading also requires self-discipline, the ability to make decisions in chaotic situations and emotional control. Commonly, traders may face some psychological risks while trading, such as over-trading and emotional trading. A trader must control these psychological factors to be successful in the forex market.
3 Best Forex Trading Platforms
Choosing a forex trading platform can depend on various factors like individual preferences, trading style, etc. Based on that, I have tried to make a list of 5 best forex trading platforms.
1. Exness
- Exness is a well-known forex trading platform with a user-friendly interface. It is suitable for both beginners and experienced traders.
- It is available on multiple devices, including desktops (MetaTrader 4/5), web trading and mobile apps.
- It is regulated by authorities like FCA (UK)and FSA (Seychelles).
- Exness supports both MetaTrader 4/5, which offers a wide range of technical analysis and charting. It also offers automated training with expert advice.
- Exness offers the highest leverage option up to 1:2000 or more. This depends on account type and jurisdiction.
- It charges no withdrawal fees for most methods.
2. cTrader
- The cTrader user interface is user-friendly and easy to navigate. The platform comes with customizable capability, which allows the trader to tailor their workspace accordingly.
- It is an ECN platform that provides traders with direct market access. This helps traders to execute trades at the best available prices.
- The platform has advanced charting capabilities, over 60 technical indicators, and a wide range of drawing tools.
- The platform has a powerful algorithm known as cAlgo or cTrader Automate that allows traders to develop their strategies and custom indicators.
3. PrimeXBT
- It is a cryptocurrency-based trading platform that offers forex trading and CFD (Contracts for differences).
- It provides access to more than 50 currency pairs, including major, minor, and exotic pairs.
- Traders can keep a check on forex markets along with cryptocurrencies, commodities and indices from a single account.
- It offers high security to forex accounts. To create an account, a trader needs to provide a minimum amount of information that provides a degree of privacy. It uses cryptocurrency deposits, which can provide an extra layer of security for crypto-savvy traders.
Conclusion
Forex trading plays a very important role in strengthening the global economy. It not only helps governments worldwide but also different traders and business houses to exchange currencies to facilitate international trade. As discussed in the blog, the forex trade attracts investors for various reasons, such as a high liquidity rate and the flexible market, which remains open for 24 hours on working days, which can be some of the chief reasons. It is one of the largest financial markets, with $7 trillion being traded per day. However, despite being such an attractive market, it can be complex and needs a deep understanding of market dynamics, currency pairs and economic indicators.
The market’s unique characteristics are leverage and high liquidity, which attract lots of investors worldwide. Leverage can allow traders to control large positions with relatively small accounts. This can amplify the risk as well as the reward. High liquidity ensures trade can be executed quickly and efficiently. Thanks for reading journalistfx.com
Frequently Asked Questions
Yes! Forex trading is a good idea. It can depend on several factors like knowledge, risk tolerance, experience and financial goals. High liquidity, easy accessibility and leverage opportunities can be pros of forex trading. High risk, emotional stress and complexity can be some cons.
Beginners can learn from various methods. First, they need to understand the basics, and for that, they need to get familiar with different terminologies and understand how the market works. Refer to some forex trading books or search for some online courses. They can also get the market feeling through a demo account. Beginners must learn and master fundamental and technical analysis. Finally, they can join some trading communities and develop their trading plan.
Foreign exchange is a global financial market that is mainly designed to exchange national currencies. The Forex market has a global reach and is perhaps one of the most liquid markets in the world.
For most of the currency pairs, pip is equal to 0.0001. For example, if the USD/EUR pair moves from 1.1000 to 1.1001, it represents a change of 1 pip. The concept has a special case with the Japanese Yen. If the USD/JPY pair moves from 110.00 to 110.01, this is also a change of 1 pip.
It all depends on the number of lots traded at a time. Some forex pairs move 100 pips per day on average. If a trader makes ten pips per day, they may get a significant profit. Again, it all depends on the number of lots being traded.
It may all depend on the experience level of a trader. Generally, a good margin level in forex is 100%. It can be much higher.
A 1 to 500 leverage means traders can control a position which is 500 times the amount of money they have in the margin. In simpler words, if a trader has $1000 in their account and uses 500:1, they will be able to control the position worth $500,000.
There can be various challenges associated with forex trading. They can be volatility, leverage, transparency, emotions, operational risks and many more.