Forex Trading 101: What is FX Trading?
You’ve heard that you can make money with forex trading, but you’re not really sure where to start. You know forex trading has something to do with currencies, but that’s about all. You certainly don’t know how people can make money through trading, but you want to learn. Well, you’ve come to the right place.
Our forex guide will teach you the basics you need to understand how the forex market works. Concepts like currency pairs, price fluctuations, and bulls and bears will no longer seem quite as complicated.
This page will help you understand how the forex market works, how currencies interact with each other and what drives price. You’ll also discover why the US dollar is so important in global trading. More importantly, you’ll learn how forex traders make money.
Understanding these concepts will help you build the vital foundation you need to become a profitable forex trader in your own right.
However, in forex trading, the most effective way to learn is to put the theory into practice. So, once you’ve finished reading this page, make sure to sign up with one of our top forex broker sites. This way, you can start practicing what you’ve learnt, which will help you become a better trader much faster.
Video Transcription: What is Forex Trading?
Hello there, we start today a series of video courses here on Top rated forex brokers, with the beginner’s part. The aim is to create also intermediate and advanced trading training courses, both from a technical analysis point of view and a fundamental analysis point of view, but we have to start from somewhere. And here we are with explaining ‘what is Forex trading?’, and moreover why traders are attracted to Forex trading.
(0.35) Forex trading means that you come to a place where you buy or sell a currency, but currencies are arranged in currency pairs. You can not only buy a currency, you can buy a currency or sell a currency based on the way a currency pair moves, and against another currency. For example, this is the Euro/USD that you see here listed on the trading platform and it is under ‘four hours’ chart. What does it mean?
(1.05) It means that every candle that you see here, green candles or red candles on the screen, they represent four hours as a timeframe. If we want to buy the Euro/USD or to sell, for example, let’s buy at market the Euro/USD, now trading at 1.19180 – 1.19184. This is the quotation. If you want to buy you always buy it from the right side, this is called the ‘ask’ price. You buy from the ‘ask’. If you want to sell, you always sell from the left side, from the bid price.
(1.45) When you do that, you can take a trade either based on bullishness – being bullish on the Euro means that you expect the Euro to move to the upside – or you can take a trade being bearish on the dollar – namely, you expect the dollar to move to the downside and hence the Euro/USD pair will move to the upside.
(2.14) When it comes to Forex trading, everything relates to the number of pips that you make. A pip is the difference between the bid and the ask price. For example, now the price is 1.1918, therefore if we buy it here at 1.1918, and the market moves to the upside to 1.1980 or 1.20, the difference between the higher price and the entry price, or the exit price and the entry price, represents the profit.
(2.54) Or, if the market moves to the downside, it represents the loss. That’s Forex trading, Ladies and Gentlemen, nothing else.
Now imagine how this world functions, or not how it functions, but how it is organised. Imagine that this is the world. Now, every country that we have here in the world has a currency.
(3.23) We have the USD in the United States, let’s put it here, we have the Euro in the Eurozone and so on. So, let’s actually put the Euro here as well – this will be the Euro. We also have the Japanese Yen and so on and so forth, all the currencies in the world. Now if you combine them two by two you will have currency pairs.
(3.58) So this will be the Euro and the USD, or the Euro and the Japanese Yen, or the Japanese Yen and the Australian dollar, the Australian dollar and New Zealand dollar, the New Zealand dollar and the Euro, the Euro and Australian dollar, and so on, you get the picture.
When buying and selling a currency pair it means that effectively you have an opinion about how the economies – the two economies in a currency pair – evolve.
(4.29) Because if you look at the currency pairs and how they are part of the Forex ledge board, the way it moves represents the imbalances between those two economies. The Australian and New Zealand dollar pair, for example, this one shows the weakness and the strength of an economy. As long as the AUS/NZD pair moved from 1.06 to 1.14 this can happen only in two instances.
(5.01) Either the Australian economy outperformed the New Zealand dollar economy, or the monetary policy in New Zealand is easiest, if you want, or is not that tight like the one in Australia. The differences between the two economies, the differences between the two monetary policies, are seen in a currency and in a currency pair.
(5.28) Traders strive to have a competitive edge or to have an educated guess about fundamental, or about technical parts, in order to interpret how the market will move. That’s what makes a successful trader.
When it comes to Forex trading or to entering a market, you can enter a market either from a fundamental point of view – there are a lot of macro traders that look at different economic aspects around the world’s regions, around the different countries and so on, and they buy or sell a specific currency pair or a specific currency like the Euro against everything else, or the dollar against everything else.
(6.14) Or you can be a technical trader – if you are a technical trader then you have any trading platform, like this one, that offers a bunch of technical indicators to use. If you go here to ‘add indicator’, you have indicators for everything. You have indicators for the Bill Williams indicators, you have math transform, you have momentum, which are more or less oscillators, you have trend indicators, and so on, statistical, volatility indicators, you name it, everything you need to have from a technical point of view exists in a trading platform today.
(6.52) If it doesn’t exist it can be imported as long as you have your own indicator, or technical approach.
There are also trading theories that we will cover in these courses, like the Elliott Wave theory, the Gartley theory, the Gunn theory and so on, but in the end what matters is to answer a very simple question – which by its simplicity makes Forex trading so complicated…
(7.24) – is the market, any market, moving to the upside or to the downside?
(7.36) Or will it range? Because if it ranges you may have some problems, because if the market ranges and takes its time on the daily chart or on the bigger timeframes and you play a negative swap – you will learn later what a negative swap is – then the balance of your trading account will decrease, which is not something that you actually want.
(7.58) To sum up, Forex trading, or the foreign exchange market, is the biggest financial market in the world. There is no lack of liquidity here, you can sell and buy whatever you want. You will always find someone willing to take the other side of the trade. And every day over five trillion dollars exchange hands. This makes it not an impossible, but a difficult trading environment.
(8:31) This makes it mandatory to understand how the market moves and what are the best approaches to technical analysis, and this is why we have created a trading academy destined to help everyone. We’ll start from scratch with explaining various concepts, technical analysis concepts, explaining a trading account, pros and cons of different brokers and trading platforms, and so on.
(9.01) Then we will move slowly but surely into fundamental approaches. into central banking, into basic technical analysis concepts, and then to advanced stuff to see how to trade the Forex market to make a profit.
Thank you for being here and let’s move on.
The Forex exchange is the biggest financial market in the world, with trillions of dollars changing hands on a daily basis. The Forex market consists of traders 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 (to exit the Union). Such a belief will lead automatically to a lower-value 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 US Dollar
The whole global financial system is built based on one reserve currency, and that is the US dollar. It is said, therefore, that the US dollar is the word’s reserve currency, because all transactions at the are finally 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. So you go to your bank and exchange the Euros for Canadian Dollars, and the bank transfers the money overseas. While you see this transaction being made between the two currencies, 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 happen around the clock at specific times in major financial centers such as London, New York, Shanghai, Hong Kong, Tokyo, etc.
What Makes a Currency Pair Move?
In the foreign exchange market, currencies are paired with one another in such a way that they form currency pairs. There is a currency pair for every currency in the world, as such a pair moves based on the economic differences between the economies they represent. For example, the economic differences between New Zealand and Australia are seen through the fluctuations of the currency pair that represents those economies: AUD/NZD. If the Australian economy performs 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 outperforms the Australian one, the pair will move to the downside.
To speculate on the example above means taking a position, or trading the AUD/NZD pair. If a trader believes the Australian economy is going to strengthen, they will buy the AUD/NZD with the purpose of profiting from this economic analysis, and if indeed the pair moves 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 who, 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, which is great from a trader’s point of view as it offers him many possibilities of finding the right broker for his needs. Some Forex brokers offer other financial products that can be traded on the same principle as well, such as stock indexes, contracts for difference (CFDs), commodities (gold, silver, oil, platinum, cotton, palladium, copper, etc.). This may also appeal to Forex traders, 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 have 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 their day to day operations), large investment houses and institutional players, and retail traders. The latest Internet developments have changed the face of Forex trading for good, in the sense that online trading has spread worldwide, so that now with a secure Internet connection anyone can trade these markets. To get 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 retail traders. 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 happen or information or about to be released, or on what a specific central bank will do. Violent moves that happen in the blink of an eye are the result of high-frequency trading (HFT) as algorithmic trading is called.
Finally, the Forex market moves 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 directions based on patterns that have formed in the past, or on historical prices). Both of these are part of Forex trading, and are used by traders when speculating. To sum up, Forex trading involves 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?
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- Leverage and Margin Requirements
- What is a Margin Call?
- Setting Up a Chart in Metatrader 4