What is Forex Trading and How Does It Work | Trading Forex for Beginners
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Why Trade Forex? About Forex
Trading Forex for Beginners – before we begin, here are some of the benefits of trading Forex which make it very popular among a wide variety of investors.
Today, the foreign exchange market is the biggest financial market in the world with a daily turnover equivalent to USD4. The higher the degree of liquidity, the tighter the spreads.
You can trade Forex 24 hours a day, five days a week. You can trade pretty much whenever you want, from anywhere in the world.
Low Transaction Costs
No commission* or other fees are involved with Forex, except on the spread.
Leverage can work for you or against you. Nevertheless, it is a powerful tool. Rapid rate fluctuations combined with high leverage make this market highly lucrative but at the same time also very risky.
Enjoy Both the Rising and Falling Markets
Trade the market both up and down. The opportunities are waiting for you whether the markets are going up or down.
What is Foreign Exchange / Forex / Spot FX/ FX?
The word FOREX is derived from Foreign Exchange and it is the largest financial market in the world.
Foreign exchange is the simultaneous purchase of one currency and sale of another. Currencies are always traded in pairs. Unlike many markets, the FX market is open 24 hours per day and has an estimated $3.5 in turnover every day.
This tremendous turnover is more than the combination of all the worlds’ stock markets on any given day. This tends to lead to a very liquid market and thus a desirable market to trade.
Is There a Central Location for the Forex Market?
Unlike many other securities (any financial instrument that can be traded), the FX market does not have a fixed exchange. It is primarily traded through banks, brokers, dealers, financial institutions, and private individuals.
Since transactions are conducted between two counterparts, the Forex market is an “interbank,” or over the counter (OTC) market. Transactions are conducted between two counterparts over the telephone or via an electronic network.
Who are The Participants in the Forex Market?
Central, commercial, and investment banks have traditionally dominated the FOREX market. Other market participation is rapidly increasing, and now includes international money managers and brokers, multinational corporations, registered dealers, options and futures traders, and private investors.
Who are The Major Players in Forex Trading?
A survey by Wall Street Journal Europe found that over 70% of the trade volume is covered by Deutsche Bank, who covered 17% of the total currency trades; followed by UBS, Citi Group, HSBC, Barclays, Merril Lynch, J. P. Morgan Chase, Goldman Sachs, ABN Amro, and Morgan Stanley.
Forex vs Traditional Stocks/ Mutual Funds Trading
Forex and conventional stocks are different types of trading. When trading Forex, most traders’ objectives are to predict short term movement in the currency exchange values.
Most Forex tradings are done in a day-trading style where traders will buy and sell on the same day. Different from Forex, stocks, and mutual funds trading is more to medium to long term styles where trades may last for years!
for more information about Forex Market versus the Stock Market, click here.
When is the Forex Market Open for Trading?
Forex is a true global 24-hour marketplace. The trading day begins in Sydney and moves around the globe as each financial Center comes to life. Tokyo follows, then London, and
finally New York. Investors can respond in real-time to any fluctuations caused by current economic, social, and political events.
How is Pricing Determined for Certain Currencies?
A full range of economic and political conditions impact currency pricing. It is generally held that interest rates, inflation rates, and political stability are top among important factors. At times, governments participate in the Forex market in order to influence the traded value of their currencies.
Which Currencies Are Traded?
The most popular currencies along with their symbols are shown below:
Forex currency symbols are always three letters, where the first two letters identify the name of the country and the third letter identifies the name of that country’s currency.
When Can Currencies Be Traded?
The spot FX market is unique within the world markets. It’s like a Super Wal-Mart where the market is open 24-hours a day. At any time, somewhere around the world, a financial center is open for business, and banks and other institutions exchange currencies every hour of the day and night with only minor gaps on the weekend.
The foreign exchange markets follow the sun around the world, so you can trade late at night (if you’re a vampire) or in the morning (if you’re an early bird).
What are The Best Forex Trading Hours?
The best time to trade the Forex markets is basically the hours of the London market with the last 5 hours being in overlap with the US market. This is the time when most traders and biggest banks are in the markets making their trades. It is widely considered the most profitable time to trade.
How often are Trades Made?
Market conditions dictate trading activity on any given day. As a reference, the average small to medium trader might trade as often as 10 times a day.
What is Leverage?
In Forex trading, a small margin deposit can control a much larger total contract value. Leverage gives the trader the ability to make nice profits, while at the same time keeping risk capital to a minimum.
For example, Forex brokers offer 200 to 1 leverage, which means that a $50 dollar margin deposit would enable a trader to buy or sell $10,000 worth of currencies. Similarly, with $500 dollars, one could trade with $100,000 dollars and so on. But leverage is a double-edged sword. Without proper risk management, this high degree of leverage can lead to large losses as well.
What is Margin?
Margin is the amount of cash or other eligible collateral that a broker requires in a customer account to open or to maintain an open Foreign Exchange position. If the customer’s open position worsens and his or her account does not have funds equal to or more than the required margin amount, the broker will initiate a margin call.
When this occurs, the customer must either deposit more money into the account or close out the position. The broker trading system will automatically calculate margin requirements for current open positions and check for margin availability before allowing the execution of a new trade.
What is a Margin Call?
In the event that money in your account falls below margin requirements (usable margin), your broker will close some or all open positions. This prevents your account from falling into a negative balance, even in a highly volatile, fast-moving market.
Let’s say you open a regular Forex account with $2,000 (not a smart idea). You open 1 standard lot (100,000 units) of the EUR/USD, with a margin requirement of $1000. Usable Margin is the money available to open new positions or sustain trading losses. Since you started with $2,000, your usable margin is $2,000. But when you opened 1 lot, which requires a margin requirement of $1,000, your usable margin is now $1,000. If your losses exceed your usable margin of $1,000 you will get a margin call.
What is a Pip?
PRICE INTEREST POINT. The smallest price increment a currency can make. Also known as points. For example, 1 pip = 0.0001 for EUR/USD or 0.01 for USD/JPY.
What is Pip Value?
The value of a pip. Pip value can be either fixed or variable depending on the currency pair. e.g. The pip value for EUR/USD is always $10 for standard lots, $1 for mini lots, and $0.10 for micro-lots.
What is Spread?
It is the difference between the sell quote and the buy quote or the bid and offer price.
For example, if EUR/USD quotes read 1.3200/03, the spread is the difference between 1.3200 and 1.3203, or 3 pips. In order to break even on a trade, a position must move in the direction of the trade by an amount equal to the spread.
What is Rollover?
A spot transaction is generally due for settlement within two business days (the value date).
The cost of rolling over a transaction is based on the interest rate differential between the two currencies in a transaction. If you are long (bought) on the currency with a higher rate of interest, you will earn interest. If you are short (sold) on the currency with a higher rate of interest, you will pay interest. Most brokers will automatically roll over your open positions allowing you to hold your position indefinitely.
What is a Swap?
A currency swap is the simultaneous sale and purchase of the same amount of a given currency at a forward exchange rate.
What Does it Mean to Have a Long or Short Position?
Long Position – A position in which the trader attempts to profit from an increase in price. I.e. Buy low, sell high.
Short Position – A position in which the trader attempts to profit from a decrease in price. I.e. Sell high, buy low.
What is the difference between an intra-day and an overnight position quote?
Intraday positions are all positions opened anytime during the 24 hour period AFTER the close of the broker normal trading hours at 4:30pm EST.
Overnight positions are positions that are still on at the end of normal trading hours (4:30 pm EST), which are automatically rolled over by the broker at competitive rates (based on the currencies interest rate differentials) to the next day’s prices.
What is a Lot?
Spot Forex is traded in lots. The standard size for a lot is 100,000 units. There is also a mini lot size and that is 10,000 units. As you already know, currencies are measured in pips, which is the smallest increment of that currency. To take advantage of these tiny increments, you need to trade large amounts of a particular currency in order to see any significant profit or loss.
Let’s assume we will be using a 100,000 unit (standard) lot size. We will now recalculate some examples to see how it affects the pip value. USD/JPY at an exchange rate of 119.80 (.01 / 119.80) x 100,000 = $8.34 per pip USD/CHF at an exchange rate of 1.4555 (.0001 / 1.4555) x 100,000 = $6.87 per pip In cases where the US Dollar is not quoted first, the formula is slightly different. EUR/USD at an exchange rate of 1.1930 (.0001 / 1.1930) X 100,000 = 8.38 x 1.1930 = $9.99734 rounded up will be $10 per pip GBP/USD at an exchange rate or 1.8040 (.0001 / 1.8040) x 100,000 = 5.54 x 1.8040 = 9.99416 rounded up will be $10 per pip.
What is a Risk-Reward Ratio?
The risk-reward ratio is simply a calculation of how much you are willing to risk in a trade versus how much you plan to aim for as a profit target. To keep it simple, if you were making a trade and you only wanted to set your stop loss at 5 pips and set your take profit at 20 pips, your risk-reward ratio would be 5:20 or 1:4. You are risking 5 pips for the chance to gain 20 pips.
Trading Forex for Beginners the Bottom Line
It’s not easy to become a successful Forex trader but on The5ers blog You can find lots of articles on how to become one. A great trading plan, risk management strategy, trading strategy, etc…, take your time to learn, and don’t rush yourself. Be patient, disciplined, and you will be on the right path in your Forex training career.
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