Forex is short for Foreign Currency Exchange. It basically means buying and selling foreign currency with the aim of making a profit. Foreign Currency Exchange is probably as old as currency itself. Forex trading in its present form started in 1996 when online retail brokers first began trading. Today more than $5 trillion is traded in Forex each day!
If you have ever traveled to a foreign country for a holiday, business trip or even for studies, you already have dabbled in Forex trading. How is that possible, you ask? Well, suppose you are going to a foreign country say ‘F’ country for a holiday. You will be spending money there right, for shopping, sightseeing and the likes. But you can’t pay in your home currency, since that is not the local currency there. You will need ‘F’ country’s currency to pay for goods and services in that country. So, what do you do? Before you start your trip you go to an authorized money changer or to your local bank and ask them to give you ‘F’ currency in exchange for your home currency, say ‘H’ currency. In effect you are purchasing ‘F’ currency with ‘H’ currency. The number of units of ‘F’ currency that you will be able to buy using 1 unit of ‘H’ currency is determined by the exchange rate.
Suppose in this case, 1 unit of ‘H’ currency is equal to 10 units of ‘F’ currency. That is 1 H = 10 F.
So, for 100 H you will be able to purchase 1000 F for spending on your holiday. Let’s assume that you didn’t spend any money on your trip and you still have 1000 units of ‘F’ currency left. (Hypothetically…!) You go back to your bank or money changer and ask them to buy back the ‘F’ currency, since you no longer need it. They tell you that the exchange rate has changed and now 1 H = 9.5 F. So, your 1000 F now fetches you 105 H! You earned a profit by selling ‘F’ currency since the value of ‘F’ currency had decreased in relation to ‘H’ currency.
On the other hand, if the value of ‘F’ currency had increased in comparison to ‘H’ currency, say 1 H = 10.5 F, you would receive only 95 H, suffering a loss of 5 H.
Forex traders essentially take advantage of such price differentials in currency valuations to earn a profit. If you think the value of a currency is going to go up (appreciate), you buy the currency. This is known as going “long”. If you feel the currency is going to go down (depreciate), you sell that currency. This is known as going “short”.
The exchange rate of currencies is determined by demand and supply forces. In the above example, if more and more people were travelling to ‘F’ country, the demand for ‘F currency would increase, consequently driving up the price of the currency and vice versa. Currency prices are also influenced by the economic situation of the countries involved, geopolitical risk and instability, and trade & financial flows, among other factors.
Forex trading is a 24-hour market majorly comprising three sessions; that include the European, Asian and United States trading sessions. The global forex market is the world’s largest and most liquid asset market and is only closed from Friday evening to Sunday evening.
Currency trading is always done in pairs. A currency pair is the quotation of the relative value of a currency unit against the unit of another currency in the foreign exchange market. The currency that is used as the reference is called the counter currency, quote currency or secondary currency and the currency that is quoted in relation is called the base currency or transaction currency. Each currency pair is typically quoted in pips (percentage in points) up to four decimal places. For example, EUR/USD 1.2500 (or EURUSD 1.2500), meaning 1 Euro can be exchanged for 1.2500 US dollars. Here, EUR is the base currency and USD is the quote currency (counter currency).
See also: List of Lowest Currencies in the World
Unlike the stock market, where you can buy or sell a single stock, you have to buy one currency and sell another currency in the forex market. Interestingly, in contrast to the thousands of stocks that are available in the global equity markets, there are only eight currencies that are most often traded in the forex markets viz. U.S. dollar (USD), Canadian dollar (CAD), euro (EUR), British pound (GBP), Swiss franc (CHF), New Zealand dollar (NZD), Australian dollar (AUD) and the Japanese yen (JPY).
The 18 popular currencies pairs are USD/CAD, EUR/USD, USD/CHF, GBP/USD, NZD/USD, AUD/USD, USD/JPY, EUR/CAD, EUR/AUD, EUR/JPY, EUR/CHF, EUR/GBP, AUD/CAD, GBP/CHF, GBP/JPY, CHF/JPY, AUD/JPY, AUD/NZD. Although there are other traded pairs outside of the 18, the bulk of the volume in currency trading is confined mostly to these currency pairs.
Currencies are traded in fixed contract sizes, specifically called lot sizes, or multiples thereof. The standard lot size is 100,000 units. Many retail trading firms also offer 10,000-unit (mini lot) trading accounts and a few even offer 1,000-unit (micro lot).
The officially quoted rate is a spot price. In a trading market however, currencies are offered for sale at an offering price (the ask price), and traders looking to buy a position seek to do so at their bid price, which is always lower than the asking price. This price differential is known as the spread. For example, if the quotation of EUR/USD is 1.3607/1.3609, then the spread is US$0.0002, or 2 pips. In general, markets with high liquidity exhibit smaller spreads than less frequently traded markets.
Now coming to the eponymous question, Is Forex Trading Easy?
Yes and No. Just like any other business which involves buying and selling, Forex trading becomes fairly easy once you get to know the nitty-gritty of the product and the market you are dealing with. Key points to keep in mind while trading in forex include:
- Look for a reputable broker who is duly registered with your country’s regulatory body.
- Use a demo or practice account and do your homework before you go live.
- Keep analysis techniques to a minimum in order for them to be effective.
- Start small when you go live and use proper money management techniques to manage your losses.
- Control the amount of leverage and keep a trading journal.
- Understand the tax implications and treat your trading as a business.
Educating yourself about currency trading is easy but discovering successful trading strategies takes a great amount of practice. The Forex market is fluid and transforming constantly. You cannot just go with the flow. You have to keep learning and updating yourself. Perhaps learning a language is much more arduous than learning to trade in the Forex world, but almost all people manage to do that. To conclude, your success in forex trading ultimately depends on your determination and commitment to master the intriguing world of the Forex market by acquiring the right knowledge and employing the proper tools.
See also: What Affects Exchange Rate?
