Forex trading is something most of us are familiar with – at least on a small scale. When you exchange currency before you go on vacation, you are trading forex. You might look around for the best exchange rate, but that’s as far as it goes.
Forex traders take it a lot more seriously. They buy and sell currencies to make money. Forex trading, also known as FX or currency trading, is a serious business. In 2017, the market was 12 times larger than the futures market, with around $5.1 trillion traded each day. The global forex market is active 24/7 and no matter where you live, there is always a market open.
Currencies are traded as pairs, with one currency ‘pegged’ against another. 85% of global forex transactions take place on seven major currency pairs. These include EURUSD, GBPUSD, USDJPY, USDCHF, USDCAD, USDNZD, and AUDUSD. Other currency pairs, such as BTCUSD, are called ‘exotics’. As you will have spotted, currencies are paired with the USD, as this is the world’s strongest currency.
Currencies are traded as ‘lots’. Traders work with units of currency, typically 100,000 units, which is called a ‘standard lot’. Currency prices move up and down.
A bid price is how much it costs to buy the base currency. The ask price is how much it costs to sell. The difference between these two prices is called a spread.
A price movement is called a pip. So, in a standard lot, a $1 pip is worth $10.
In simple terms, a forex trader must decide whether a price will go up or down. If he thinks the price will rise, he opens a ‘long’ position. If the expectation is that prices will fall, he opens a ‘short’ position. In forex, you simultaneously go long and short on each position because as one currency drops, the other rises.
This is an explanation of what is forex trading, the basic terms, and how it works, but you also need to understand the power of leverage.
Things get complicated when leverage enters the picture. The reason why forex trading can be so profitable is that leverage allows you to trade many times more than the value of your trading account. Forex brokers offer leverage between 50:1 and 200:1, depending on the size of the trade.
For example, if you want to make a trade that’s worth $10,000, using leverage of 50:1 means you only need $200 in your trading account. This increases your profits if the trade goes in the right direction, but it also increases your losses if you get it wrong. The bigger the trade, the more leverage you use, and the higher the risk you will end up burning your trading account.
Open a Demo Account
Reputable forex brokers offer demo accounts. These are a useful tool for inexperienced traders. You can play with fake money, practice your trading strategies risk-free, and get to know the many tools at your disposal. Always begin with a demo account, or you could end up wiping out your trading account in a day.
Forex trading can be risky, so take appropriate steps to protect your hard-earned money.