What is forex trading?
Forex or foreign exchange can be defined as a network of buyers and sellers who transfer currencies among themselves at an agreed rate. This is the means by which individuals, companies, and central banks convert one currency into another - if you have traveled abroad, you have likely made a forex transaction.
While a lot of foreign currency is converted for business purposes, the vast majority of currency conversions are for profit. The amount of currencies converted daily can result in significant fluctuations in the price movement of some currencies. This volatility is what makes the forex market so attractive to traders: it brings great opportunities for big profits, and it also involves increased risks.
How do the currency markets work?
Unlike stocks or commodities, foreign currencies are not traded on exchanges, but rather traded directly between two parties in an over-the-counter (OTC) market. The forex market is managed by a global network of banks spread over four major forex trading centers in different time zones: London, New York, Sydney and Tokyo. Since there is no central location, it is possible to trade forex 24 hours a day.
There are three different types of forex markets:
- The spot forex market is the physical exchange of a currency pair, which takes place at the specified settlement point of the trade - that is, immediately - or within a short period of time
- Forex futures market A contract is agreed to buy or sell a certain amount of currency at a specified price, to be settled on a specified future date or within a set of future dates.
- The forex future market is a market in which a contract is agreed to buy or sell a specified amount of currency at a specified price and a specified date in the future. Unlike futures contracts, futures contracts are legally binding
Most traders who speculate on foreign exchange rates do not plan to take delivery of the currency itself, but instead make exchange rate predictions to take advantage of price movements in the market.
What is the base currency?
The base currency is the first currency in the forex pair, while the second currency is called the quote currency. Forex trading always involves selling one currency in order to buy another, which is why it is included in pairs - the price of a forex pair is the value of one unit of the base currency in the quote currency.
Each currency in the pair is listed as a three-letter code, the first two letters usually representing the region, and the third for the currency itself. For example, GBP/USD is a currency pair that involves buying the British pound and selling the US dollar.
To maintain order, most providers divide pairs into the following categories:
- major pairs. Seven currencies make up 80% of global forex trade. They include: EUR/USD, USD/JPY, GBP/USD and USD/CHF
- secondary pairs. Less traded, as major currencies are traded against each other rather than the US dollar. They include: EUR/GBP, EUR/CHF, and GBP/JPY
- Non-major or non-major pairs. Major currency versus currency from a small or emerging economy. Include: USD/PLN, GBP/MXN, EUR/CZK
- Regional pairs. Couples arranged by region - eg Scandinavia or Australia. They include: EUR/NOK, AUD/NZD, and AUS/SGD
What moves the forex markets?
The forex market is made up of currencies from all over the world, which makes it difficult to predict exchange rates since there are many factors that may contribute to price movements. However, like most financial markets, forex is primarily influenced by the strength of supply and the strength of demand. It is important here to understand the effects that lead to price fluctuations.
Supply is controlled by central banks, which can announce measures that will significantly affect the price of their currency. Quantitative easing, for example, involves pumping more money into the economy and may cause its currency to fall.
Commercial banks as well as other investors tend to put their capital in economies with strong prospects. Therefore, if there is positive news about a particular region in the markets, it will encourage investment and increase the demand for the currency of that region.
Unless there is a parallel increase in the supply of a currency, the discrepancy between supply and demand will cause its price to rise. Likewise, negative news can cause investment to fall and the price of a currency to fall. For this reason, currencies tend to reflect a view of the health of the economy of the region they represent.
Also, market sentiment, which is often a reaction to the news, may play a major role in increasing currency rates. If traders believe that a currency is headed in a certain direction, they will trade accordingly and may persuade others to do the same, causing demand to increase or decrease.
How does forex trading work?
There are a variety of different ways you can trade forex, but they all work the same way by buying one currency and selling another at the same time. Traditionally, many forex transactions are conducted through a forex broker, but with the advent of online trading, you can take advantage of forex price movements using derivatives such as CFD trading.
CFDs are leveraged products that enable you to open a position for a fraction of the total value of the trade. Unlike non- الرافعة المالية products , you cannot take ownership of the asset, but rather take a position based on what you expect to see as the market value goes up or down.
Although leverage products may double your profits, they may also double your losses if the market moves against you.
What is the spread in forex trading?
The spread is the difference between the bid and sell price quoted for a forex pair. Like many financial markets, when you open a forex position, you will be shown two prices. If you want to open a long position, you will trade at the buy price, which is slightly higher than the market price. If you want to open a short position, you will trade at the sell price - just below the market price.
What is meant by a lot in forex?
Currencies are traded in the form of contracts - payments of currencies used to standardize forex trading. Since forex tends to move in small amounts, the contracts tend to be quite large: a standard lot is 100,000 units of the base currency. Therefore, the vast majority of forex trades are leveraged because individual traders may not necessarily have 100,000 pounds (or whatever currency they are trading) to put into each trade.
What is meant by leverage in forex?
Leverage is a way to be exposed to large amounts of currency without having to pay the full value of the trade up front. Alternatively, you can place a small deposit, known as a margin. When you close a position with leverage, your profit or loss will depend on the total trading volume. Although this can magnify your profits, it can also lead to the risk of inflating losses - including losses that can exceed your margin. Therefore, trading with leverage is very important to know how to manage your risk.
Margin is a major part of leveraged trading. This term is used to describe the initial deposit you make to open and maintain a leveraged position. When you trade forex on margin, remember that your margin requirements will change based on your broker and your trading volume.
Margin is often expressed as a percentage of the full position. Therefore, trading on EUR/GBP, for example, may require paying only 2% of the total value of the position to be opened. So instead of depositing £100,000, you will need to deposit only £200.
What is the point in forex?
Pips are the units used to measure movement in a foreign currency pair. A forex pip usually represents the movement of one digit in the fourth decimal place of a currency pair. If the GBP/USD moves from 1.35361 USD to 1.35371 USD, this means that it has moved by 1 pip. The other decimal places that appear in the price after the point are known as fractional points.
The exception to this rule is when the pricing currency is listed in much smaller denominations, the most prominent example being the Japanese yen. The movement in the second decimal place of this currency is 1 pip. Therefore, if the EUR/JPY moves from 106,452 yen to 106,462 yen, it moves again by 1 pip.
Frequently Asked Questions
Despite the large size of the forex market, there are very few regulations due to the lack of regulators to monitor the market 24 hours a day, 7 days a week. On the other hand, there are many national trading bodies around the world that monitor local forex trading as well as other markets to ensure that forex providers adhere to certain standards. For example, in Dubai, the regulatory authority is the Dubai Financial Services Authority (DFSA).
Nearly $5 trillion of forex transactions are traded daily, at a rate of $220 billion per hour. The market is generally made up of institutions, companies, governments and currency speculators - speculation accounts for about 90% of the trading volume and most of the trading is centered on the US dollar, the euro and the yen.
Gaps are points in the market when there is a sharp up or down movement with little or no trading, resulting in a "gap" in the normal price pattern. Gaps do occur in the forex market, but they are less common than in other markets because forex trading takes place 24 hours a day, five days a week.
But gaps can occur when surprising economic data is revealed to the markets, or when trading resumes after the weekend or holidays. Although the forex market is closed to speculative trading during the weekend (Saturday and Sunday), the market is still open to central banks and related institutions. So it is possible that the opening price on Sunday evening differs from the closing price on the previous Friday night (London time) - creating a gap.