What is Forex Trading?
Forex exchange is the biggest financial market in the world with trillions and trillions of dollars changing hands on a daily basis. The Forex market consists of speculating on different currencies that represent world economies in order to gain from their rapid movement. As a trader, one looks to buy or sell currencies with the idea of making a profit if the direction of the currency is the correct one. For example, let’s assume that a trader believes that things are going to go wrong for the European Union now that the United Kingdom voted for Brexit, or to exit the Union. Such a belief will lead automatically to a lower currency, so the Euro as a currency should weaken. Naturally, in order to speculate on this belief, the trader will turn to the Forex market and sell the European currency.
The Importance of the U.S. Dollar
The whole global financial system is built based on one reserve currency, and that one is the US dollar. Therefore, it is being said that the US dollar is the word’s reserve currency for all transactions, in the end, are being cleared in dollars. Let’s assume you are from Europe and want to buy a home in Canada. For that, you need to have Canadian dollars to pay for the new home. Therefore, you go to your bank, exchange the Euros into Canadian dollars and the bank transfers the money oversea. While you see this transaction being made, in reality, the bank is going to buy US dollars with your Euros, and will use those US dollars to pay for the Canadian dollars needed for the transaction. This means the transaction is cleared and clearings are happening around the clock at specific times in major financial centers like London, New York, Shanghai, Hong Kong, Tokyo, etc.
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What Makes a Currency Pair Moving
In the foreign exchange market, currencies are paired with one another in such a way that they are forming currency pairs. There is a currency pair for every currency in the world as such a pair is moving based on the economic differences between the economies they represent. For example, the economic differences between New Zealand and Australia are being seen through the fluctuations of the currency pair that represents those economies: AUD/NZD. If the Australian economy is performing better than its New Zealand counterpart, the AUD/NZD currency pair is going to move to the upside. If on the other hand, the New Zealand economy is outperforming the Australian one, the pair will move to the downside. To speculate on the example above means to take a position or to trade the AUD/NZD pair. If one believes the Australian economy is going to strengthen, will buy the AUD/NZD with the purpose of profiting from this economic analysis and if indeed the pair is moving to the upside, the position can be closed. The difference between the opening price and the closing one being a positive one, it means a profit has been made.
The great thing about the Forex market is that a currency pair can also be sold, with the idea that if indeed it is going to move to the downside, a profit can be made as well. In order to access this huge currency market, one needs a broker. Such a Forex broker is an intermediary or a middle man that based on a commission allows the trader to place trades on the foreign exchange market. The Forex brokerage business is an extremely competitive one with plenty of brokers out there and this is great from a trader’s point of view as it has many possibilities to find the right broker for his needs. Some Forex brokers are offering other financial products that can be traded on the same principle as well, like stock indexes, CFD’s (Contracts For Difference), commodities (gold, silver, oil, platinum, cotton, palladium, copper, and the list can go on). This may appeal to Forex traders as well as again, the principle is the same. In order to trade on the Forex market, one needs to open a Forex trading account with a Forex broker. In such an account all the currency pairs are listed, charts can be opened in order to make a forecast and see how prices fluctuated in the past, and a clear list of open trades and historical transactions can be found as well.
Forex Market Participants
When trading, it is important to know what moves the currency market overall and who is trading such a market? The biggest chunk of the market consists of central banks (yes, they do have trading desks of their own) and commercial banks (through their treasury departments they are effectively buying and selling currencies for the day to day operations), large investment houses and institutional players, and retail traders. The latest Internet developments changed the face of Forex trading for good in the sense that online trading spread worldwide and now with a secure Internet connection one can trade these markets. To have an idea about the size of the retail market when it comes to Forex trading, it represents a “staggering” 5% of the whole market, so what moves a currency pair is definitely not the action of a retail trader. Robots or expert advisors or trading algorithms are part of this market as well as they are instructed to buy or sell specific currency pairs based on economic events that are about to be released or based on what a specific central bank will do. Violent moves that happen in a blink of an eye are the result of HFT (High-Frequency Trading) as algorithmic trading is called. Finally, Forex market is moving based on fundamental analysis (interpreting economic news in different economies in order to speculate on the future direction of a currency) and technical analysis (forecasting future price direction based on patterns that formed on the past or on historical prices) and both of them are part of Forex trading and are used by traders when speculating. To sum up, Forex trading is the speculation on the future move of a currency/currency pair with the purpose of making a profit.
More educational materials
- What is a Currency Pair?
- Majors and Crosses – How to Trade Them?
- Leverage and Margin Requirements
- Forex Trading Platforms – Metatrader 4 and 5
- What is a Margin Call?
- Setting Up a Chart in Metatrader 4