General

Quick Guide: What is Forex Trading and How Does it Work?

The Foreign Exchange, or Forex, is a global market that operates 24 hours a day around the world. It’s a decentralized or over-the-counter market for the trading of different currencies, whether fiat or crypto. During the past few years, Forex trading has become an increasingly popular way of investing, especially as it’s become more accessible to people, outside of finance and the stock exchange, in particular. 

You can trade on the Forex market at any time of the day or night, making it ideal, as a side hustle, to gain a little extra income or for your retirement. So if you’re new to the world of Forex Trading, and want to know how it works, here’s a quick guide for you.

Brief Forex Background

Forex is run by a large network of banks around the globe, enabling it to operate 24 hours a day. As we said in our introduction, anyone can trade in Forex, including banks, corporations, retail traders, and the public. It can roughly be divided into three types of market.

  1. Spot Market

This is the exchange of the currency pair, which occurs at the point when the trade is settled.

  1. Forward Market

There is a contract to buy or sell an amount of currency at an agreed price. This has to be settled on a predetermined date or range of dates in the future.

  1. Future Market

There is a contract to buy or sell an amount of currency at an agreed price and date. These contracts are legally binding, unlike the Forward Forex contracts.

Some people trade themselves via Forex, whereas others prefer to use brokers. For instance, contract for difference, or CFD, traders, will trade over-the-counter (OTC). Brokers organize market demand and supply, setting prices, accordingly. If you choose to use a broker, ensure you have done your research and have a group of registered cfd brokers to contact. Think about what you want to ask them and write your questions down. This way, you’ll get to know which one you’ll prefer to work with when it comes to your trading. 

How Does Forex Work?

The Forex exchange market is known as a spot market because when trading occurs, assets are immediately exchanged from buyer to seller. Usually, one currency is exchanged for another, at an already agreed price, which is called the spot price, or even a future-based one. There are usually two currencies trading, and these are known as currency pairs.

Currencies will be bought or sold according to whether one in the currency pair will increase (long) or decrease (short) against the other. This exchange rate determines which one will be bought and sold. However, Forex isn’t exchanging because the exchange of currency occurs between two parties in an over-the-counter market.

Aside from supply and demand, there are various reasons for price movements to occur in the Forex market. It’s these that traders use to help them decide what to keep an eye on and how to trade. Some major driving forces include central banks, news reports, and market sentiments.

Central banks get to control supply. They also could have an impact on their country’s currency by announcing measures that may affect it. News reports could encourage banks and investors to place their money in strong economies. This then increases demand for the currency in that economy. Therefore, current affairs, especially when it comes to financial news, are always worth keeping abreast of. In respect of news, market sentiment, which is the reaction to it could cause demand to increase or decrease, if traders believe a currency is going to go a certain way.

Currency Pairs

We’ve already mentioned one currency is bought by another, and that this is usually done when one is long and the other is short. The two currencies that are used in this exchange are known as currency pairs

Currencies are always quoted in pairs. The first currency in a pair is known as the base currency, whereas the second is known as the quote currency. The price of a currency pair is what one unit of the base currency is worth in the quote currency.

Currency pairs can be divided into major pairs, minor pairs, exotic pairs, and regional pairs. Major pairs are made of the seven predominant currencies around the world, whereas minor pairs have major currencies against each other, and not the United States Dollar (USD). 

An exotic pair is one major currency against an emergent or smaller one, and a regional pair, as the name suggests, is classified according to regions like Australasia.

Basic Terminology

  • Spread

The spread is the difference between the buying and selling prices quoted in a currency pair.

  • Pips

This is the smallest amount a price can move, which are one-digit movements in the fourth decimal place in a currency pair. Decimal places after a pip are referred to as decimal pips or pipettes.

  • Lots

Forex is traded in lots. Lots are batches of currencies, with a standard lot usually consisting of 100,000 units of the base currency.

  • Leverage

This allows a trader to gain exposure to a certain amount of currency without having to pay the full value of their trade upfront. Traders can put down a margin, which is a small deposit, as collateral. 

  • Risks

As with anything to do with trading, there is some element of risk you need to be aware of, especially as a beginner, and more so if you’re not planning to use a trader. There is a political risk involved, with this impacting economies, and how trading is done. It’s important to keep an eye on pre-election news in any country you’re thinking of using its currency to trade-in. Using an economic calendar is a good way to do this.

Interest and exchange rates can also impact how trading is done. Currency interest rates and exchange rates are often interlinked, so it’s worth you being aware of what’s happening in countries and how businesses could be affected.

So now you have the basics about Forex trading, you’ll have a good starting point. Once you’re comfortable with this information, you’ll have a good idea of what to research further into so that you’re ready to trade online. Remember, trading isn’t just about the Forex exchange, it’s also about what’s going on around the world. Current affairs can impact Forex, so knowing what’s going on around the world will help you make a move before it’s too late, and you’ve made a loss on it.

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