Basic questions about forex
What is forex?
There are many different definitions of forex, but from a trading perspective, you only need one: Forex is a decentralized global marketplace where traders agree to exchange one currency to another at specified prices.
According to the Bank for International Settlements, the daily trading volume of the forex market exceeds USD 5 trillion. So how can you benefit from this enormous market? You can trade price fluctuations and pocket the difference. The concept is simple. You need to:
- buy low, sell high, OR
- sell high, buy low.
Number 2 can be confusing because it sounds like you have to own the currency first to sell it, but you don’t. In forex, when you buy a currency, you are selling another simultaneously, as currencies are quoted in pairs. The result of the simultaneous buy and sell is the price difference between the two. You only trade the price difference and speculate which direction the price will go.
Let’s take a look at how cash exchange differs from forex trading:
|When you exchange cash, YOU OWN that money. The price may fluctuate, but your cash doesn’t disappear (unless it’s spent). You can still trade it back: maybe for more, maybe for less.
|When you trade forex, YOU DO NOT OWN that currency and only speculate on the price difference. If you speculate wrongly, you can lose all of your investment.
Why trade forex?
Most think of forex as a way to earn money. Being a successful forex trader is no harder than on any other financial market where the key to success is the same: to predict the future price direction of an asset. But forex does have some distinct advantages over other markets:
- Trade 24 hours a day, five days a week.
- Choose the currencies suitable for you, your location, time zone, and risk tolerance.
- Trade anywhere. All you need is a device connected to the internet—even your smartphone.
- Forex has massive liquidity vs other markets.
- Currencies are regularly discussed in the media, providing free analysis to aid your trading.
- Forex has the highest leverage with the lowest margin. You don’t need thousands of dollars to start trading, but you need to use leverage wisely — it is a double-edged sword.
- Forex is a very competitive market, which keeps trading costs low.
Who trades forex?
There are many different types of forex trader, from national banks to individuals. The market is divided into two major parts: institutional and retail. The institutional sector is where large financial institutions trade with each other – this where most of the liquidity comes from. The retail market is where individuals trade with companies like FXChoice, who, in turn, work with larger institutions (known as ‘liquidity providers’). Brought together, all this creates the global decentralised network we know as forex.
What is traded in forex?Forex is a global marketplace to exchange currency, but the answer is different from a retail trader’s perspective. As mentioned previously, you don’t buy anything; you only speculate on the price difference between currencies – this is so important to keep it in mind. Forex currencies are traded in pairs (like EURUSD) which can be classified into different groups: Majors, Crosses (or Minors) and Exotics. Majors are the most liquid and traded currencies and belong to the most developed nations. They always contain USD plus one other to form the pair. Ticker or currency symbols contain three letters, where the first two letters identify the country’s name and the third letter identifies the name of that country’s currency. There are some exceptions to this rule, like EUR, RUB and CHF. Major pairs consist of USD plus one other of the currencies below.
Quotes for majors can be direct or indirect. Direct quotes are when USD is the base currency (the first symbol, like USDJPY) in a quote. Indirect quotes are when USD is the quote currency (the second symbol, like GBPUSD). There are some exceptions to these rules, but they are an established ‘rule of thumb’ in the forex world. Let’s take a look at some examples: Direct: USDJPY 108.722. Here, we are looking at a direct quote. USD is the base currency, and JPY is the quote currency. The number is the quote itself. It is telling us how many JPY we need to buy one unit of USD. So we can see that $1 = ¥109 (approx.). If you want to know how many JPY you can buy with $100, you need to multiply (100 x 108.722 = ¥10872.2). Indirect: GBPUSD 1.27787. Here, USD is not the base currency, so we are looking at an indirect quote. We can see that £1 = $1.28 (approx.). If you want to know how many GBP you can get for $100, you need to divide (100 ÷ 1.27787= £78.26).
How to trade forex?
As we mentioned under the question ‘What is Forex?’, the main idea is to exchange one currency for another at two points in time (when you open the trade and when you close it) in the expectation that the price will move in your favour. You can then pocket the difference in price as profit. When you open the trade, you predict whether the price will go up or down. This direction is more commonly known as Buy and Sell, or Long and Short in forex parlance. Let’s use two examples:
Sell (short): You believe that EUR will decrease in value vs USD. The pair you want to trade then is EURUSD. You need to open a Sell trade (also known as ‘shorting’) on this currency pair because you believe the base currency will decrease in value vs the quote currency.
Buy (long): You believe that EUR will increase in value vs USD. Again, you want to trade the same pair as in the previous example, but you need to open a Buy trade (also known as ‘longing’) because you believe the base currency will increase in value vs the quote currency.