Forex is a term that is used to represent the combination of foreign currency and exchange. It can simply be described as a network of buyers and sellers who transfer money between each other at an agreed price and for several reasons, including tourism, commerce, or trading, among others.
Foreign exchange trading, which is frequently called FX, is the largest market on a global scale, and as such, the trades that happen in it leave a mark on almost all industries one might think of. Additionally, it is the most liquid market as the worth of the currencies that are traded globally every day exceeds $5 trillion.
While a considerable share of foreign exchange is done for practical purposes, most people undertake currency exchange because they are looking to earn a profit. For the most part, the trade activity in the market occurs between institutional traders, and such trades do not necessarily aim at taking physical possession of the currency.
Currencies are traded against each other as exchange rate pairs that are used to measure the value of one currency against another currency. While placing a trade in the forex market, traders can choose between a great number of currency pairs, including major, minor, exotic, and regional. Currency pairs can be regarded as a single unit, an instrument that can be sold or bought.
What Is Forex Trading
At its simplest, the foreign exchange market, which is also known as the currency market, has a lot in common with the currency exchange one does while traveling abroad. Forex is always traded in pairs, and it cannot be otherwise since forex trading involves simultaneously buying one currency and selling another. The exchange rate constantly fluctuates as a result of supply and demand.
Currencies are traded in the foreign exchange market, which is open around the clock, Monday through Friday. Unlike stocks, all forex trades are executed over the counter, which is to say that there is no physical exchange. Instead of a central exchange that oversees the market, this is done by a global network of banks and other financial institutions.
As a result of the large trade flows, the price movements of some currencies are rather volatile. One way to stay abreast of all developments in the forex market is to check TradingPedia’s currency news.
The appeal of forex lies exactly in that volatility, as the chances of getting greater profits are exceptionally high. So is the risk, which makes forex trading exceptionally risky for total novices. If traders want to learn more about the intricacies of forex trading, they should visit TradingPedia’s Forex Academy.
Forex Terms to Know
Each market has its own language, and if traders want to properly understand forex, they should know what these words mean.
- Pip – is short for percentage in points and is a measurement of movement in forex trading. It describes the smallest move each currency can undergo. Forex prices are quoted out to at least four decimal places, and for this reason, a pip is equal to 0,0001.
- Lot – forex is traded as a lot, or in other words, as a standardized unit of currency. Typically, the lot size is 100,000 units, but micro and mini lots are featured for trading too.
- Leverage – as you can see, lot sizes can be rather large, and some traders might not be willing to put up that much money in order to execute a trade, and this is where leverage comes in. Leverage makes it possible for traders to participate in the forex market without using the amount of money that is required. In simple terms, leverage is another term for borrowing money.
- Margin – trading with leverage is not free of charge, and traders are required to make an upfront deposit of some money that is also known as margin.
- Spread – is used to measure the difference between buy or bid and sell or offer prices quoted for a specific asset.
Intricacies of Currency Markets
As we mentioned earlier, forex trades are placed directly between two parties in an over-the-counter manner, which is not the case when trading commodities or shares. There is no central location, but the market is run by a global network of banks that are based in Tokyo, Sydney, London, and New York. As a result, trading forex is possible around the clock.
- Spot forex market – this is the primary forex market in which the physical exchange of currency pairs takes place. The exchange is executed in real-time, and it happens immediately after the trade is settled or shortly after this.
- Forward forex market – executing trades is not the only alternative traders have as they can also enter a bidding or a private contract with other traders to buy or sell a currency at a predetermined price. In addition to the price, the future date or the range of future dates within which the trade will be settled is also preset.
- Future forex market – likewise, traders can also go for contracts to buy or sell a preset amount of a currency at a specific rate at a later date. Like the forward markets, such contracts are done on exchanges, rather than privately.
The futures and forward markets are preferred by traders when they want to hedge against future price movements in a currency. The spot market is the largest of all forex markets, and most of the forex trades are executed precisely on it. The exchange rates in the futures and forward markets are determined by the changes in the spot market.
In addition to learning the ins and outs of forex trading, our team of experts at TradingPedia provides reviews of some of the best forex trading brokers.
Understanding Base and Quote Currency
Currency pairs are used to indicate the current exchange rate for the two currencies and are divided into two parts. Each currency in the pair is written using a unique three-letter code, in which the first two letters indicate the region, while the last one indicates the currency itself.
The first currency that forms the forex pair is referred to as a base currency, while the second one is the quote currency. The first currency in the currency pair is the one traders think will go up or down against the second currency, which is also known as the counter currency.
The exchange rate indicates what amount of the quote or counter currency is required in order to obtain 1 unit of the base currency. Therefore, the base currency will always be indicated as a 1 unit, while the quote currency varies. Its value is determined by the current market, as well as how much traders need in order to buy 1 unit of the base currency.
Thus, if we use as an example the GBP/USD pair and suppose that the base currency increases against the quoted currency, a single pound will be worth more dollars. Thus, the currency pair’s exchange rate will increase whenever the value of the base currency increases. If the base currency falls in value, the exchange rate will fall too.
Types of Currency Pairs
The number of currencies available out there is well over 170, and traders need to know that the USD is involved in a considerable share of the forex trading. The EUR is accepted in 19 countries in the EU, and it makes sense that it is the second-most popular currency in the forex market. Other major currencies are the Japanese yen, Australian dollar, New Zealand dollar, British pound, Swiss franc, and the Canadian dollar, among others.
While placing a trade, traders can pick from multiple currency pairs, and to make things easier for traders, most brokers divide them into several categories.
- Major Currency Pairs – the majors among the currency pairs account for approximately 75% of the trading in the forex market and these include EUR/USD, USD/JPY, GBP/USD, USD/CHF, AUD/USD, USD/CAD, and NZD/USD.
- Minor Currency Pairs – unlike major currency pairs, minor ones are traded less frequently, and most of the time, such pairs consist of two major currencies, and do not necessarily feature the USD. Minor currency pairs are EUR/CHF, GBP/JPY, and EUR/GBP.
- Exotic Currency Pairs – exotic currency pairs feature a major currency against a currency from a smaller economy or emerging one. Such are EUR/CZK, USD/PLN, and GBP/MXN, for example.
- Regional Currency Pairs – such pairs are classified by regions like Australasia and Scandinavia, for example. Exotic pairs are AUD/SGD, EUR/NOK, and AUD/NZD.
If traders are looking for more in-depth information about currency trading, they should take a look at the strategies our experts have approached more profoundly.