What is Forex Trading? How does it Work?
BY Chris Andreou
|diciembre 13, 2021Forex Trading is the activity of buying and selling currencies through online platforms, to try and profit from exchange rate fluctuations. Forex is an abbreviation of the two words, Foreign Exchange.
The forex market is made up of a global network of banks, spread across the four major financial centers. As one financial center is closing, another is just opening so the Forex market is open 24 hours a day, five days a week.
Trading in the Forex market is much simpler than most people imagine. The barriers and costs to enter are very low and the potential exists to profit from your very first deal.
You can Start trading by registering your account, depositing funds and downloading the platform to your computer or smartphone.
How Does Forex Trading Work?
Forex trading is the simultaneous buying and selling of two currencies. The first currency in the symbol is referred to as the base currency. The second currency in the symbol is the quote or counter currency. The price indicates how much of the quote currency one unit of the base currency buys.
Let’s look at an example between the euro and the US Dollar, which is represented with the EURUSD symbol. In this case, the base currency is the euro, while the quote or counter currency is the US Dollar.
If the EURUSD exchange rate is 1.2000, it means that one euro (base currency) is equivalent to 1.2000 US Dollars (quote currency).
Our trading platforms stream the current prices of many currency pairs, plus you can check what the rates of exchange are with our currency conversion calculator.
When trading Forex, you have the choice between buying and selling a currency pair.
The financial instrument offered by online brokers to trade in the forex market is known as a contract for difference (CFD). The CFD’s value tracks the rate of exchange and allows you to trade currencies without having to make conversions and transfers between bank accounts.
If you think the price of a currency pair is likely to rise, then you will open a buy trade. For example, if you believe the euro is going to appreciate against the US Dollar, then you will buy the EURUSD.
On the other hand, if you think the price of the EURUSD is likely to go down, then you will sell the currency pair.
Forex Trading Terminology
The financial industry and trading specifically has many terms that you should know. You will come across these often and it’s imperative to understand the basic and common ones.
What is a PIP in forex trading
Price movements in the forex market are measured in PIP’s. This is an acronym for Percentage In Points. For example, if the price of the EURUSD moves up from 1.2000 to 1.2001, the price has increased by 1 pip. A PIP is equal to the fourth decimal place in the price quote (0.0001). Except for currency pairs that involved the Japanese Yen (JPY), where the PIP is measured from the second decimal place (0.01).
The BID and ASK price
Currencies are quoted with two prices, a price to buy the currency pair and a price to sell the currency pair. The BID price is the lower price and this is the price that you will sell at. The ASK price is the higher price and this is the price that you will Buy at.
What is the spread in Forex trading
The spread is the price difference between the buy (ASK) and sell (BID) prices for the currency pair. When the price for the EURUSD is 1.2000/01, the difference between 1.2000 and 1.2001 is one pip. The price needs to move by the distance of the spread to break even and move beyond it before your trades become profitable.
This excludes any broker commission associated with your trade.
Lots
Currencies are traded in lots, this refers to the volume that is being bought or sold. One lot is the equivalent to trading $100,000. You can also trade in mini lots, which is the equivalent to $10,000 of currency and micro lots which is $1,000.
The lot size or volume of trade determines the value of each pip. So when you trade one lot, a one pip move up or down in the price would approximately be worth $10.
Check our pip value calculator for more information.
Leverage
Leverage provides you with buying power, so you can buy currency that is of greater value than the amount of money in your trading account. For example, a trader might leverage their $100 to buy $1,000 worth of currency. In this example, they have leveraged their funds by a factor of 10 or 10:1. If this same trader buys $2,000 worth of currency with the same $100, the leverage is now 20:1.
Using leverage speeds up your potential to profit or lose, because you are trading with much larger amounts.
Margin
This is the amount necessary to open or maintain trades. When trading using leverage, you need to deposit margin as a form of collateral against the trade. Margin requirements are far less than the value of your trade and this is what makes Forex trading affordable.
For example, a trader might want to buy $1,000 worth of currency. Using leverage, they would only need $100, which is ten times less as a margin requirement to open the trade.
The trading platform will show you what is available as free margin and what is being used as margin. Any open trades are maintained with used margin, while new trades can only be opened from available free margin.
Use our margin calculator to learn more about how much you need to open trades.
Going long or short
This means buying the currency pair but more specifically, buying the base currency and selling the quote or counter currency. When a trader goes “long” on the EURUSD, it means they have sold the US Dollar to buy euro. Long positions in the market benefit from rising prices.
A short position is simply the reverse of the long position. When a trader is “short”, they have sold the base currency in the pair to buy the quote or counter currency. Short positions in the market benefit from falling prices.
What does bullish and bearish mean?
In a bull market, the price trend has been or is expected to continue on an upward trajectory. When a Forex trader is “bullish”, it implies that they are confident the price of a currency pair will rise.
Bear markets involve falling prices. So when a trader is “bearish”, they are confident that prices will continue to fall.
What does it mean to get “filled”?
An order is “filled” once it is executed and a deal is opened or it has been closed. This is the basic act of buying and selling and undertaking a market transaction.
Why is Liquidity important for trading?
The liquidity refers to an assets ability to be bought and sold and converted into cash. The Forex market is very liquid, so you can buy or sell currencies instantly, practically whenever you like. Other assets might not be as liquid, especially if the volume of trade is low or people trade it infrequently.
How does volatility affect returns?
Volatility measures how quickly prices change or the price range currencies move over a given period of time. A highly volatile currency pair has rapid price fluctuations and large price ranges. Some currency pairs are more volatile than others, so you can profit or lose money faster or slower depending on what you trade.
What is slippage?
When the price you see or want to execute at differs to the price your order gets filled at. The difference is referred to as Slippage. It is possible to experience price slippage in the market during highly volatile times or when liquidity is low.
How to start Forex trading
Getting started with Forex trading is very simple and affordable; all you need is a brokerage account, a computer or smartphone, an internet connection and some funds.
Here’s how.
How to open a trade in the Forex market
Just follow these 5 simple steps; you could be trading within a matter of minutes.
1) Choose a forex broker and register
There are many brokers online to choose from but we recommend that you trade with us. You will receive very competitive trading conditions, excellent customer support and hassle free withdrawals.
2) Make the first deposit
The registration process only takes a few minutes. Once you have registered, you can choose a convenient deposit method to fund your account. Your funds will then appear in your TIO Markets wallet within your secure client portal.
3) Create your trading account
This is done through your secure client area. You can create a demo or live trading account and choose to trade on two of the world’s most popular trading platforms. Then you can transfer your funds from your TIO Markets wallet to your trading account.
4) Download the trading platform and log in
The trading platform provides you with live streaming prices, charts and analytical tools to help you make your trading decisions.
5) Start trading
Once you have selected what currency pair to trade, click the new order button, select the lot size, and then click “Buy” or “Sell”. Now you have established a position in the Forex market.
If your prediction is correct, you will see your deals accruing profit. Once you have reached your target, you can close the deal to take that profit and the funds will be credited to your account. Also, it is important to understand that Forex trading carries risk, adverse price movements can result in your deals being closed with a loss.
Use our profit calculator to get a better idea about the potential profit or loss for different currency pairs and account base currencies.
What currencies are traded in Forex trading?
The forex market is made up of currencies originating from many different countries. If you are new and just starting with forex trading, you may be confused by their symbols. However, there aren’t that many and you can learn them very easily and quickly.
In the Forex market, currencies are divided into three main categories, which are:
- The majors
- The minors or cross currencies
- Exotics
Let’s take a look at each of them in detail.
The major currencies
The majors are seven currency pairs that cover 80% of the volume of global trade. These currency pairs are the main currencies that trade against the U.S. dollar.
The majors are widely traded and are very popular among novice and experienced traders. Because they are the most liquid currency pairs and they have lower spreads. Unlike the other currency pairs, the majors are also generally more stable.
The currencies originating from these nations have developed economies and their political institutions are much more consistent and established than other countries.
The following currency pairs make up the majors:
- Euro (EURUSD)
- Japanese Yen (USDJPY)
- Great British Pound (GBPUSD)
- Swiss Franc (USDCHF)
Many also believe that these currencies should also be included to make up the majors, because they fit the criteria mentioned above.
- Canadian Dollar (USDCAD)
- Australian Dollar (AUDUSD)
- New Zealand Dollar (NZDUSD)
They could have a point, but the values of these currencies are significantly influenced by commodity prices. So they are commonly referred to as the “commodity currencies”.
The minors or cross currencies
The minor currency pairs refer to exchange rates between the major currencies that do not include or cross the US Dollar. Some of the most popular ones are:
- EURGBP (Euro vs Great British Pound)
- EURJPY (Euro vs Japanese Yen)
- GBPJPY (Great British Pound vs Japanese Yen)
- EURAUD (Euro vs Australian Dollar)
- AUDCAD (Australian Dollar vs Canadian Dollar)
- NZDJPY (New Zealand Dollar vs Japanese Yen)
- CADJPY (Canadian Dollar vs Japanese Yen)
The exotic currencies
The Exotics are currencies or currency pairs that are traded less often than the others. They typically have higher spreads and they are more volatile. Usually, these currencies belong to nations with emerging economies. The Mexican Peso (MXN) and the South African Rand (ZAR) would be included in that list, as an example.
Why Trade Forex?
The Forex market is the largest market in the world, with a global daily volume of about $5 trillion, which translates in to a huge opportunity.
It’s also easy to get started; education is widely available and easy to access. The only thing required from you is the effort to learn, dedication to practice and some funds to deposit to your trading account.
Another advantage to Forex trading is that you can trade around your existing commitments and start from as little as $50.
You can trade from anywhere and at any time!
Is Forex trading worth it?
Forex trading is a very popular form of trading and the potential does exist to make substantial profit (and loss).
Furthermore, Forex is a major financial market, towering above all the global stock markets combined. This presents you with a huge opportunity but you have to be willing to accept some risk!
It is also an essential marketplace that facilitates international trade of goods and services between countries. For as long as the need exists for countries to trade with each other, currencies will continue to be bought and sold.
As a trader, you can buy or sell currencies as well to benefit from the imbalances in supply and demand. But unlike other markets, you can benefit from both rising and falling prices.
You can try Forex trading with a demo account or go live from as little as $50. Then make up your own mind. Click here to register
Risk disclaimer: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Never deposit more than you are prepared to lose. Professional client’s losses can exceed their deposit. Please see our risk warning policy and seek independent professional advice if you do not fully understand. This information is not directed or intended for distribution to or use by residents of certain countries/jurisdictions including, but not limited to, USA & OFAC. The Company holds the right to alter the aforementioned list of countries at its own discretion.
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