• Basic questions about forex

    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 decentralised 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:

    1. buy low, sell high, OR
    2. 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:

    Cash exchange

    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.

     
    Forex trading
    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.

    Figure 1

    The above is an important principle you need to understand: forex trading with leverage can lead to the loss of your investment because you never own the currency; you only trade the price difference.

    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.

    When can you trade forex?

    Forex is open 24 hours a day, five days a week. Some trading pairs may have breaks in the trading sessions, but most can be traded at any time during trading hours. There are three major trading sessions: the Asian, European and US sessions, each with its own level of liquidity. Major currencies like USD, EUR, JPY stay liquid most of the time, but some Crosses and Exotics may suffer from a lack of liquidity. When liquidity becomes low, spreads usually widen, increasing your trading costs. Keep this in mind and adjust your trading strategy accordingly.

    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.