So, you think forex trading is for you? Well, you certainly wouldn’t be alone. The forex market is the largest in the world by volume, valued at more than $6.6 trillion a day. It’s bigger than the stock market and reaches virtually every corner of the world, meaning that, with all time zones considered, it’s open five days a week, 24 hours a day. And with the abundance of online forex trading platforms popping up left and right nowadays, its popularity is bigger than ever, but that doesn’t mean it’s easy to understand. In fact, like all forms of trading, forex trading is both risky and complex, but done with the right knowledge and experience, could be an interesting route for certain investors. Let’s take a closer look at what forex trading is, how it works, and how to enter this fast-paced, exciting market.
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What is forex?
In case you haven’t already figured it out, the word ‘forex’ is a combination of two words: foreign (currency) and exchange, which is the act of changing one country’s currency into another. Sound familiar? Many of you reading this may have already dabbled in forex trading without realizing it. For example, pretend you took a vacation to Europe and beforehand, you went to the bank or bureau de change with $500 to turn your currency into euros. Now, thanks to the universality of credit cards, let’s say you didn’t spend any of those euros, so that once you return from vacation you go to the bank to sell them back to get your original $500 back. But instead, you get $510 back because, while you were away, the exchange rate between USD and EUR changed, thus earning you a profit of $10. That, in a nutshell, is the basis of forex trading, however when done on a larger scale using a trading platform, you’re able to speculate on price changes in both directions—increases and decreases—without the need to buy any actual fiat currency.
Which currencies can I trade?
Currency trading can be done using a variety of foreign currencies, not necessarily your national currency. The currencies you can invest in come down to three different categories:
- Major currencies: These are the most-traded in the world and include the US dollar, such as: EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF, NZD/USD and USD/CAD.
- Cross pairs: Although they contain popular currencies, these currency pairs do not include the USD, such as: GBP/JPY and JPY/CAD.
- Exotic currencies: These pairs comprise one major currency and one from an emerging economy, such as: USD/ZAR, USD/HKD.
You’ll also notice that forex trading is done in pairs, such as EUR/USD, the price of which fluctuates. That price represents how much of the second currency it would take to purchase one unit of the first currency. So, if the price of EUR/USD were 1.25, that means it would take $1.25 to purchase one euro.
How to start forex trading
Below, we’ll break the concept of forex trading down into four simple steps, but before you even think of opening a deal, you must learn more about how the markets work and what can affect the price of foreign currencies.
- Choose your currency pair: Using EUR/USD as an example, let’s say the price is $1.1500, meaning with a €100 investment you could buy $115 worth of USD.
- Choose your deal size using leverage: Leverage is a trading tool that allows you to magnify your trading power by opening deals worth up to 400 times your investment. Here, 400:1 leverage would let you open a deal worth €40,000 with a €100 investment. Note that leverage can also magnify your losses, so it’s best to use with knowledge and experience.
- Choose your direction: Like we said above, you can open a forex trading deal whether you think prices will go up or down. If you think the price of EUR/USD will increase, you’d open a ‘Buy’ deal or ‘Go long,’ however, if you think it will decrease, you’d open a ‘Sell’ deal or ‘Go short.’
- Close your deal and take your profit: Let’s say in this example the euro’s price went up by 0.01 and you decided that was enough to close your deal. With a price change of 0.01 on a €40,000 deal, you would’ve made a $400 profit.
What next?
These are the bare basics of how forex trading works, but like we said, you’ll still need to read up on the many fundamental factors which affect currency prices including a country’s interest rates, governmental policies, geopolitical conflict, and inflation—all of which have been in heavy supply lately. The more you become acquainted with the world of forex trading, the more you’ll be able to develop your own trading strategy using both fundamentals and technical elements to conduct a thorough analysis that could shed light on how prices may behave next. Therefore, it’s best you choose a forex broker with a robust educational section so you’ll find all the info you need to begin trading with knowledge and confidence.
