WHAT IS FOREX?
Forex, also known as Foreign exchange, FX, or forex trading, is a decentralized global market for all currencies that are traded around the world. It is the largest and most liquid market in the world, with a daily volume of trades exceeding $5 trillion. The other stock markets in the world as a whole do not come close to this.
If you have ever traveled abroad, you have made a forex transaction converting your pounds into euros. When you do this, the exchange rate between the two currencies - based on supply and demand - determines how many euros you will get for your pounds. And the exchange rate fluctuates continuously.
On Monday a pound could give you 1.19 Euros. Tuesday 1.20 Euros. This little change may not seem like a big deal. But think about it on a larger scale. A large international company may have to pay foreign employees. Imagine what you could do to the bottom line if, as in the example above, does changing one currency for another cost you more depending on when you do it? These few cents add up quickly. In both cases, you as a traveler or business owner may want to withhold your money until the exchange rate is more favorable.
Just like on the stock market, you can exchange the currency based on what you think it's worth. (or where it's headed). The big difference with Forex is that you can trade up or down just as easily. If you think a coin will increase its value, you can buy it. If you think it will decrease the value, you can sell it. With such a large market, finding a buyer when you are selling and a seller when you are buying, is much easier than in other markets. Perhaps you hear on the news that China is devaluing its currency to attract more foreign business to its country.If you think the trend will continue, you could make a currency trade, selling the Chinese currency against another currency, for example, the US dollar. The more the Chinese currency devalued against the dollar, the greater its profits. If the Chinese currency increases in value while it has its sell position open, then your losses will increase and you will want to exit the trade.
Past Results: Past results are not indicators of future results.
All Forex trades involve two currencies because you are betting on the value of one currency against another. Think EUR/USD, the most traded currency pair in the world. The EUR, the first currency in the pair, is the basis, and the USD is the counterpart. When you see a quoted price on your platform, it's what a euro in dollars costs. You will always see two prices, one is the one for the purchase and the other is the one for the sale. The difference between the two is the spread. When you click buy or sell you are buying or selling the first currency of the pair.
Let's say you think the EUR will increase the value against the USD. Its torque is EUR/USD. As the euro is the first, and you think it will go up, you buy EUR/USD. If you think the euro will fall in value against the US dollar, you sell EUR/USD.
If the buy price of EUR/USD is 0.70644 and the selling price is 0.70640, then the spread is 0.4 pips. If the trade moves in your favor (or against) then once you cover the spread, it could be a gain or a loss on your trade.
Fractions of a penny
If prices are quoted at one hundredths of a cent how can you see a significant return on your investment when trading Forex? The answer is leverage.
When you trade forex, you are effectively lending the first currency in the pair to buy or sell the second currency. With a market of US$5 trillion a day, liquidity is so deep that liquidity providers, the big banks, basically allow you to trade with leverage. To trade with leverage, simply set aside the margin required for your trade. If you are trading with leverage of 200:1, for example, you can trade $2,000 in the market by holding only $10 in the margin of your trading account. For a leverage of 50:1, the same trading size would only require about $40 margin. This gives you much more exposure while keeping your capital investment low.
But leverage not only increases your earning potential. You can also increase your losses, which can exceed deposited funds. When you are new to the forex market, you should always start trading with small leverage ratios, until you feel comfortable in the market.