Forex trading basics

Forex trading - also referred to as FX, currency trading, or currency trade - is the buying, selling and exchanging of currencies in the foreign exchange market.

This article will cover the key Forex trading basics, including essential Forex vocabulary, and the basic standards of currency trade.

Before we plunge into the basic elements of trading Forex, let's briefly recap the origins of the Forex market.

Birth of the Forex market

In the 1950s, the world's financial forces understood that global exchange was becoming vital to maintaining various economies and carrying out world trade activities. Over the next few decades, advancements in technology meant that universal exchanges could run much smoother, which encouraged the development of the foreign exchange market.

One of the greatest accomplishments of the computerised period is digitising our currencies. Internet advancements have made the buying and selling of currencies as simple as clicking a button. The world wide web has connected more than three billion individuals. When this technology first emerged in the 1990s, organisations were built to utilise it, subsequently developing the frameworks of today's Forex trading industry. These organisations are known as Forex brokers.

Forex is at present the most famous of the financial markets due to its trading volume and liquidity. Today, more than 80% of Forex trading is speculative.

The basics of Forex trading for 2018

Knowing brokers' language alone won't make you a decent trader, yet it will help you process the data needed to turn into one.

Forex, or Forex trade, is a decentralised global marketplace for exchanging currencies. The Forex business is actually a blend of the spot market, forward and futures market. The spot market is the greatest bit of the Forex pie, as it manages the currency costs and prompt trades on the spot. The two others are less known, yet are still worth mentioning. Both the forwards market and the futures market manage trades that will be settled on a set date, perhaps one or eighteen months ahead. The forward market is utilised for tweaked trades, while the future markets includes standard contracts.

The currency pair is a key idea among the rudiments of Forex trading. For the purpose of simplicity, and in connection to the Forex market, think about the pair as a solitary money related instrument - for instance EUR/USD. The euro is called the base currency. The US dollar is called the quoted currency. Assessing the base currency against the quoted currency makes a Forex quote.

When taking a look at EUR/USD or other currency pairs in your trading terminal, you'll see two numbers - the bid and ask price. They will look similar to this: EUR/USD 1.1234/1.1240. This quote implies that you can purchase one euro for 1.1240 US dollars, because that is how much the bank is requesting - the ask price. Alternatively, you can sell one euro by for 1.1234 US dollars - the bid price. You'll notice that a bank will generally purchase cash from you for a somewhat lower value and offer it to you at a marginally higher cost. Banks can do that, since they have more influence than a broker does.

To be totally objective, you can't just buy or bid EUR/USD, as you would for instance purchase or offer shares in an organisation. This is because there is no such thing as the EUR/USD currency pair. Currency exists alone, not as a couple or a pairing. Traders are merely speculating on future price movements, not physically buying currency.

Profit is made in Forex by currency appreciating or depreciating in value relative to one another. Let's say you are buying euros and selling US dollars (using the currency pair EUR/USD). In order to make a profit, you would need to sell US dollars once the euro has appreciated in value against the dollar.

Let's reverse the situation and say you want to sell euros and buy US dollars. To make a profit, you would need to buy US dollars once they had appreciated in value against the euro.

There are two points to consider here. First, that traders never actually buy or sell physical currency. Second, both buying and selling happens in every single trade transaction.

These are the essential mechanics of Forex trading.

Forex essential terms

A pip is a base unit of progress in the price assessment of currency pairs. At the point when the bid price for EUR/USD pair goes from 1.1234 to 1.1235, that is a one pip change.

Pips are a straightforward concept to understand. But in order to make significant gains, much depends on trading volume. Trading volume is the size of a trading position available, measured in units known as lots. A standard lot refers to a 100k unit trade; a mini lot refers to a 10k unit trade; while a micro lot refers to a 1k unit trade.

Spread is the difference between a currency pair's bid and ask price. As you have read before, a currency quote has two costs - the bid price and the ask price. The ask price is constantly higher than the bid price. Spread is what causes trades to start in a slight negative P&L.

Spreads also come in two kinds - fixed or, as they are with most contemporary brokers, floating. A floating spread is a more accurate reflection of what actually happens on the market. Prices float because the currency is liquid. Supply and demand change.

Margin, in the simplest terms, is the actual money in a trader's account. However, an average retail Forex trader simply lacks the margin to be trading Forex with enough trading volume. This is where leverage, if applied cautiously and properly, can be helpful.

Leverage is essentially capital provided by a Forex broker to bolster their client's trading volume. For example, a trader could use a 1:10 rate of leverage to place $10,000, despite only having $1,000 in their trading account. If their trade is successful, leverage maximises that trader's profits by a factor of 10. However, please note that leverage comes with a risk warning, as it can also amplify losses if the market moves against a taken position. In some cases, should the margin in a trader's account run too low to maintain an open position safely, a broker can action a margin call and liquidate it with a loss - effectively wiping out all capital in a trader's account.

What currencies are traded in Forex?

This guide on Forex currency trading basics would be incomplete without highlighting the the most popular assets available to a trader.

Combinations of the five most popular world currencies - the US dollar, the euro, the pound sterling, the Japanese yen and the Swiss franc, make a group of Forex major currency pairs, also known as Forex majors: EUR/USD, GBP/USD, USD/JPY and USD/CHF.

Notice how they all pair with the US dollar.

Currency pairs comprised of major currencies that do not pair with the US dollar are called 'cross pairs': EUR/GBP, GBP/JPY, CHF/GBP and so on.

Three more national currencies are common in Forex trading - the New Zealand dollar, the Canadian dollar and the Australian dollar. Pair them with the US dollar and you have a group of Forex minors: NZD/USD, CAD/USD and AUD/USD.

All other currency pairs in Forex trading are generally referred to as 'exotic pairs' and account for less than 10% of all foreign exchange transactions.

To conclude, if this article is your first step to learn Forex basics, do not stop here. A successful trader is one constantly on the lookout for more information. When you have finished with the basics of Forex trading, move on immediately to the material written for advanced traders.

Read also:

How does Forex work?

Why trade Forex?

How to start Forex trading?