What's Forex Trading?
Updated: Apr 18, 2019
Forex is short for Foreign Exchange, and can also be shortened to Fx. Forex Trading is simply the exchanging of one currency for another in order to make a profit. It is the world's largest platform of trade, trading around $5 trillion per day, and is decentralised. This amount means it dwarfs even the stock exchanges, with an average traded value of around $2 billion per day!
If you have ever been to another country where a different currency is used, then you have been a part of the Forex Market. You would have had to have changed your currency into the currency of the country you were visiting, in order to buy what you needed. For example if you were from the UK, visiting the USA, you would have had to have changed your Pounds into Dollars. If, for example, you received $2 for £1 then the exchange rate is 1:2.
The decentralised nature of the Forex Market, means that the currencies are prone to large fluctuations in value, compared to other currencies. These fluctuations allow individuals, businesses and institutions to speculate on the value of one currency against another, or trade in the Forex Market.
When Trading Forex, the currencies are always expressed in pairs. So, for example, you would trade the Euro vs the US Dollar - expressed as eur/usd - or the Pound Vs the Yen - expressed as GBP/jpy. The first currency in the pair is termed the base and the second currency, the quote currency. When you trade a pair in the Forex Market you are simultaneously buying and selling the base and quote currencies.
For example, if you thought that the value of the Euro was going to rise against the US Dollar you would buy the pair eur/usd - this also known as being bullish or going long. Essentially you would be buying Euros and selling Dollars.
To put this into a physical image, as it sometimes can be confusing: imagine 2 people, one holding Euros and the other holding dollars. In this instance you would be holding the US Dollars and giving (selling) them to the other person in exchange for their Euros, or, buying their Euros.
Let's say now, that the Euro rises in value against the US Dollar, you could now sell your Euros and buy back US Dollars, making a profit!
Back to the visual image. Initially you sold 1 US Dollar for 0.50 Euros. You come back a week later and meet the same person - the value of the Euro has gone up and so, now when you sell 0.50 Euros back to the person, you get 2 US Dollars! You make a 1 Dollar profit for every 0.50 Euros that you sell!
So now, you may well be asking why the person on the other end of the transaction would do that, because they would be losing money?
This is where brokerages, or platforms, come in. What they do is always take the opposite trade to you. So, as in the previous example, if you are buying Euros and selling US Dollars, they will sell Euros and buy US Dollars so that you are able to speculate.
They make money from charging what is known as a spread. The spread is the difference between the buy and the sell price. So, again going back to our example, if you sold your 1 US Dollar for 0.50 Euros and then immediately wanted to buy your dollar back, the brokerage would only give you 0.80 Dollars for your 0.50 Euros - so you have immediately lost 20 cents and they make 20 cents - this is how they are able to offer the service they offer, allowing retail traders to access the Forex Market!
Unfortunately, many beginner traders are unaware of how brokers operate and so they think that they can place loads of transactions and take many small profits. However, the spread will always mean that these small profits are quickly diminished, and sometimes turned into losses - depending on the size of the difference between the buy and sell price, or the spread. On top of this, brokers also charge various commissions on your trades, which will again diminish your profits.
Now, this is not to say you can't make money from Fx Trading, and, indeed, many individuals and institutions make serious money from this medium, you just won't be successful by making lots of trades and taking small profits. There is a huge amount more to learn on this subject alone.
Remember: Always invest in your education, first and foremost!
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