What is Forex Trading and How Does It work?

Forex, sometimes just FX, is the process of changing one currency to another. Short for Foreign Exchange, Forex is the largest financial market in the world. You can buy and sell national currencies against each other.

To have a better understanding of how Forex works, let’s put it this way: an American tourist is traveling to London and has to convert US dollars into British pounds. As doing so, the exchange rate between the two currencies (based on supply and demand) will determine how many pounds will be given for the dollars.

Another example is when you shop in an online shop that sells products in a currency other than your own. When you pay with your bank card, you automatically exchange your currency electronically.

Therefore, in both cases we can say that we have done a Forex transaction by exchanging one currency for another.

How to trade Forex?

The Forex market is the largest market in the world and has a daily turnover of approximately $6.6 Trillion. Currency exchange transactions are carried out on an ongoing basis by the various participants in the FX market for a variety of reasons.

The first thing you should know is that currencies are traded in pairs. Just like in the stock market, you can exchange currency based on what you think it’s worth (or where you think it is going). If you think a certain currency will increase in value, you can buy it. If you think it will decrease in value, you can sell it.

The Forex market operates through a global network of banks, companies and individuals who constantly buy and sell currencies from each other. Unlike most financial assets, such as equities or commodities, the foreign exchange market has no physical location and operates 24 hours a day.

Trading is done electronically between the two parties, which is called the over the counter (OTC) market. Currency prices constantly fluctuate in value with each other, potentially offering a greater number of trading opportunities. There are four main centres of foreign exchange trading: London, Tokyo, New York, and Sydney.

When trading stops in one, it starts in another. However, the Forex market also trades in other cities such as Frankfurt, Hong Kong, Singapore or Paris.

Before we go into detail on Forex Trading, it is important that you understand what a currency pair is and how they move.

Currency pairs

Each country or region has its own currency and one way to determine its value is to compare it with that of other countries. For example, if we want to know what a Euro is worth, we can compare it with the Dollar. This is what we know as currency pairs. For example, the Euro/Dollar (EUR/USD) means we are comparing the value of 1 EUR to the value of 1 USD.

There is a wide number of currency pairs, and they are classified into major, minor, and exotic currency pairs.

Majors

The major pairs are the most frequently traded and have a higher liquidity. Most major Forex pairs include USD as their base or quote currency, as it is the most commonly traded currency across the globe. These are some examples:

• EUR/USD: Euro vs US Dollar

• GBP/USD: Pound Sterling vs US Dollar

• AUD/USD: Australian Dollar vs US Dollar

• NZD/USD: New Zealand Dollar vs US Dollar

• USD/CAD: US Dollar vs Canadian Dollar

• USD/JPY: US Dollar vs Yen

Minors

Minor pairs are less traded and have a lower liquidity, such as:

• EUR/JPY: Euro vs Yen

• AUD/NZD: Australian dollar vs New Zealand dollar

• EUR/GBP: Euro vs British Pound Sterling

• EUR/CHF: Euro vs Swiss Franc

Exotic

And finally,theexotic pairs, which are crosses between a major currency and another currency of a small or emerging country. They are rarely traded, examples being USD/MXN (Dollar vs Mexican Dollar) or EUR/TRY (Euro vs Turkish Lira).

Who trades Forex?

Traders commonly may take two different types of positions: a long position or a short position. A long position can be classified when a trader/investor is speculating that prices will increase. A short position can be described when a trader/investor is betting that prices will decrease. It is important to note that traders/investors can make money in both directions.

Depending on the duration and numbers involved in forex trading, the strategies can be classified into four types:

- Scalping: when a position is held for no more than 2 minutes.

- Day trading: when positions are opened and closed by the end of day.

- Swing trade: when a position is held for a longer period of time, typically for days or weeks.

- Position trade: when a position is held for a long duration that can last up to several weeks, months or even years.

How to read charts for beginners

Candlestick charts are easy to interpret and considered to be the most popular chart types in Forex trading. Candlesticks are a visual representation of price movements across different periods of time.

Candlesticks show the opening, closing, lowest and highest prices OHLC during the trading session.

They can be bullish when the closing price is above the opening price, and bearish when the closing price is below the opening price.

The following graphic shows how candlesticks are formed:

What moves foreign exchange markets?

An important question about Forex trading is to know what causes currency prices to move.

The first thing to know is that FX pairs move according to the relative strength of the two currencies, i.e. one relative to the other. Therefore, you need to be aware of the movements of the base currency and the traded currency when you are trading.

On the other hand, there are several factors that cause the currency market to move:

- Economy: currencies backed by strong economies are in high demand. Key economic data that can have an impact on the price of currencies are inflation or unemployment figures.

- Central banks: they set interest rates and influence the flow of money.

- Political reasons: political uncertainty in some countries causes demand for some currencies to fall and money to flow to safer markets such as the Swiss Franc or the US Dollar.

Source: multibankfx