Forex trading, also known as the currency market, forex, foreign exchange, and FX trading is the buying and selling of currencies. The market has grown in popularity in recent years, following an increase in the number of online brokers and enhanced technological advancements. As such, FX trading is the world’s most liquid market with an average daily trading volume of $5 trillion. You must be wondering how the market runs; read on and explore more about Forex trading.
Liquidity of Forex Trading
As mentioned above, FX Trading market is popularly known for its liquidity nature. The following are factors that contribute to this:
- Interbank Settlement
Banks are one of the key players in Foreign exchange. The activity of FX Trading markets remains vibrant since most banks are consistent movers in the market. In addition, large corporations involved in exports and imports are part of FX trading also. The corporations utilize the market for currency hedging to minimize their losses due to the fluctuating value of currencies.
- International Trade
If you have been in a different country with a different currency, you have probably had to convert your currency to that of your host country. This is known as foreign exchange. It is very important for the continuity of international trade across the globe. The continuous use of foreign exchange impacts the value of a currency pair. An example is the EUR/USD pair. Although the impact is minimal per pair, its collective effect has contributed to the high activity of markets.
Forex market is a host of different users and participants. They include brokers, traders, banks, and speculators to mention but few. As such, activities of the market are not confined to one thing. While brokers may be dormant, there is a possibility that traders are still active. Therefore, the Forex market continues to be vibrant hence its liquidity.
- Easy to Understand
If you are a beginner at trading, and you are wondering where to start, here is the good news. FX trading is one of the easiest markets to navigate. With the use of a demo account, you can open up your own account easily and quickly. Running a forex account is easier than running a stock market account.
Currency Conversion VS FX Trading
First, the two concepts are different. In currency conversion, there is physical handling of money. For example, if you have 20 pounds and you need to purchase an item that is being sold in dollars, you have to convert the pounds to dollars. At the end of the transaction, you will have dollars and not pounds.
On the other side, for FX trading, the transactions are done online. It does not use physical money. In this case, if your online broker deals in pounds and you bet on either the rising or falling value of the pound per dollar, the transaction remains in pounds for both profits and losses.
So, how does The Currency Market Work?
Firstly, the Currency market is open and runs for 24 hours for 5 days. It opens at 11.00PM Sunday and closes at 11.00PM Friday, London Time. As mentioned earlier, FX Trading market does not have a specific location where it is based. A network of global banks spread out in London, New York, Sydney, and Tokyo runs it.
Secondly, Forex is an Over the Counter Market (OTC Market). Therefore, it is unregulated and exposed to frauds that pose as brokers. As such, before investing with any broker, verify that they are reliable as counterparty. This reduces the risks of losses.
Thirdly, trading in currency is done using currency pairs. That is, for example, while trading in EUR/USD, buying will mean you are purchasing EUR and selling USD. On the other hand, selling the pair will mean you are buying USD and selling EUR. Forex pairs are grouped into three, that is Major groups, Minor groups, and Exotics.
- Major Groups
Major currencies are the most traded pairs in FX markets. They make up to 80% of trading in the market. Each of the pair has a US dollar. They include USD/CAD, AUD/USD, GBP/UAD, and USD/ CHF.
- Minor Groups
Minor currencies are less traded as compared to major pairs. They consist of two major currencies comparing against each other like GBP/JPY, EUR/\GBP and EUR/CHF.
This group of currencies includes one major currency against a small economy currency. Examples are USD/PLN, (us dollar VS Polish zloty) and EUR/CZK.
Types of Contracts in Forex Trading
There are three different types of contracts in FX Trading markets: The spot contract, Forward Forex contract, and Future Forex Contract.
Spot Forex Contract
As the name suggests, this is the exchange of currencies physically within a short period usually 2 days. Within the two days, the two parties settle the trade with the price agreed on, two days ago.
However, most Spot Forex Contracts are not settled because they are rolled over before settlement. In this case, settlement refers to the physical exchange of currencies. The rollover happens because when dealing in a Spot Forex contract, the counterparty is not usually ready to exchange currency but just betting on the price movement. The result is a rollover, which prevents settlement.
When your position is rolled over, you are subject to a rollover fee. If the currency moves in your favor, your online broker will pay you the fee, but if you lose in the betting, you have to pay a rollover fee to your broker.
Forward Forex Contract
Forward forex contract is where a pair of currencies is set to buy or sell at a given agreed price. The price is to be settled within a given range of dates or in the future depending on the agreement.
Future Forex Contract
To start, this is one of the safest modes to trade in FX trading since it is traded on regulated markets. When trading in this contract, you do not have to verify your counterparty for risk minimization.
In addition, when you trade in future forex contract, your counterparty is the exchange. The exchange sets pre-defined specifics for settlement that have to be met.
However, although Future Forex Contract is enticing, it requires a high initial amount of money to invest and trade. Therefore, it cuts off a number of traders who cannot afford the cost of starting.
What is Leveraging in Forex?
Leveraging in Currency Markets allows traders to hold bigger positions than their initial capital would allow them. With leveraging, you can earn more than your investment. However, leveraging has its drawbacks. While else it can earn you bigger positions, when used in the wrong way, your account can read 0.00 in just a few seconds. Therefore, before using this feature, make sure you are well skilled at trading and you understand both the risks and advantages it bears.
FX trading markets do not only engage in the exchange of currency but also in the prediction of the price movement of currencies. This is known as CFD trading. It does not require you to own any financial assets. If you have been holding back due to lack of assets, it is time to get started in FX Trading. This is possible with CFD trading which is allowed in Foreign Trading Markets.
Terms Used in FX Trading Markets
- The quote– this is the buy and the selling price.
- Spread- this is the difference between the buy and the sell price quoted for a currency pair.
- Pip – a pip is a unit used to measure movement in currencies. That is either a rise or a fall. A pip is the smallest currency in FX Trading. It is usually measured when there is a one-digit movement in the fourth decimal place of a pair of currency. Example USD/CHF move from 1.47362 to 1.47372, the pair has moved by one pip. The decimal places after a pip are known as pipettes or fraction pips.
- A long position– this is when you predict the price of currencies to increase.
- A short position– predicting the price to decrease
What Drives the FX Market?
If you are considering investing in FX trading, you must have knowledge of the forces behind the market. Forex Markets are among the most unpredictable markets due to a number of underlying driving forces. The following are a few factors that affect Currency Market performance.
- Central Banks
Central banks control the supply of currencies in the market. When the Central Bank releases more money to the economy, the price of the currency is likely to decrease affecting currency markets.
- Political Stability
Investors and banks like to put their money in politically stable countries. When a country is stable, the demand for its currencies increases. This has a direct impact on trading markets.
- Market Sentiments
In Currency Markets, everyone has an opinion. Most opinions are influenced by the news. Therefore, if a certain economy is predicted to collapse in the near future, investors tend to withdraw their investments. In return, the value of the currency of the given economy will decrease indefinitely.
As we wrap up, it is important to highlight some of the cons of Forex Trading. First, leveraging works in two ways, it can maximize your profits but it can also be the cause of a drained account. Second, before investing in FX Trading, read widely to understand some of the driving forces of the Market. This will save you many regrets in the future. Overall, investing in a forex market is not a guarantee of financial success. Invest what you can afford to lose.