What is Forex trading, exactly? Well, Forex trading is the trading of currencies from different countries against each other, and is acronym for Foreign Exchange. One example of this would be that in Europe – the currency is called the Euro, and here in the U.S., it’s called the U.S. Dollar. Well, if you buy the Euro while simultaneously selling the U.S. Dollar, it’s called Forex trade. When this happens, it’s called going long on the EUR/USD. The NASDAQ tells us,
Forex (FX) is the foreign exchange market where currency trading takes place. This market is unique due to its trading volumes, extreme liquidity, geographical dispersion, long trading hours, and a variety of factors affecting exchange rates.
How Does Forex Trading Work?
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Typically, this kind of trading is done through a broker or market maker, and as a Forex trader, you have the ability to choose a currency pair that you think will change in value, and place a trade accordingly. Say you had purchased 1,000 in Euros back in January of 2005, you would have spent about $1,200 U.S.D. to get it. All throughout the year, the value if the Euro as compared with the U.S.D. increased, and at the end of the year, that 1,000 Euros was now worth around $1,300 U.S.D. That’s a profit of $100 if you chose to cash out after that year.
You can place an order online with just a few clicks, and then the broker will pass your order along to a partner in the Interbank Market to fill the position. After your trade is closed, the broker will close the Interbank Market position and will credit your account with the loss or gain. All this takes place within a few seconds. We learn from Investopedia that,
While it is possible to buy or sell currencies directly through banks and other institutions, brokers offer services that typically benefit traders such as charting platforms, analysis tools, and access to leverage.
Foreign Exchange Pricing
When Forex trading is conducted, a broker receives prices from various banks in private networks. This network is commonly referred to as The Interbank, and is not actually a single network, but more like individual networks that trade with each other. Prices between the banks are not set, and can vary greatly at any given moment. These days, foreign exchange trading is considered to be a common investment activity, and traders have the ability to trade against not only Euros and U.S. Dollars, but also British Pounds, the Japanese Yen, the Australian Dollar, and many others. Once reserved for banks and the very rich, this type of trading can now be used by virtually anyone, and a Forex trading account can be opened with as little as $10, and a bit of paperwork.
Forex Traders
Generally speaking, a Forex trader is anyone that practices the art of trading on the foreign exchange market, and these traders trade currencies with the intent of purchasing currencies when they are low, and selling them when they are high. This is how they, and you, make money. One advantage of this kind of trading is that traders are not limited to trading during only the week days, and can actually buy and sell currencies any time of day. Real-forex.com says,
The fact that it is one continuous session for all over the week allows the traders to immediately respond to global developments with an economic effect, unlike traders from other markets that are forced to wait for the opening of the market to respond to developments.
Because the Forex trading market is worldwide, trading is continuous as long as there is a market open somewhere in the world. Trading begins when the markets open in Australia on Sunday night, and ends after markets close in New York on Friday.
High Liquidity & Low Transaction Cost
The ability of an asset to be turned into cash quickly and without a drop in price is called liquidity. In Forex trading, this means that you can transfer large sums of money into and out of foreign currency with a marginal movement in price. Usually, the price for a transaction is built into the cost, and is called the spread. The spread is the difference between the buying and selling price.
Leverage
Brokers give traders the ability to trade the market using leverage, or the capability to trade more money than is actually in the trader’s account on the market. If you were to trade at 50:1 leverage, you could trade $50 on the market for every $1 that was in your account. This means you could control a trade of $50,000 using only $1000 of capital. There are no restrictions for directional trading on the Forex market, and this means if you believe a currency pair will rise in value, you can purchase it, or go long. Likewise, if you think the price would drop, you can sell it, or go short.
Using Too Much Leverage
The greatest advantage to this type of trading is the ability to use leverage or trading on margin, but you should avoid the mistake of using too much leverage. This common mistake is made when you have a small account balance, but make a big trade. This can result in a large loss if the market moves against your position, and many new traders will become emotional and nervous, closing the trade for a sizable loss.
Over Trading
Another common mistake is over trading. This is when traders search for trading opportunities that aren’t really there, and many newbies fall victim because they are just so eager to trade. What happens is a poorly executed trade resulting in eventual loss. Over trading can also cause traders to make too many trades at once, using too much margin.
Many new traders attempt to try to pinpoint where a currency pair will turn around and start moving the opposite direction, but this is something that is hard even for professional traders. Some traders search diligently on the internet trying to locate that perfect system, but it simply doesn’t exist.
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