What is Forex Trading?

Forex trading means the exchange of one currency for another to generate profit from the trade. It is one of the most important parts of the global economy. Let's understand the key elements of forex trading here in detail.

What is Forex Trading Meaning?

Foreign currency trading is the process through which people, businesses, and central banks exchange one currency for another.

While some foreign exchange is done for practical reasons, the great majority of currency conversion is done to make a profit. Because of the volume of money exchanged each day, the price fluctuations of some currencies can be very volatile.

This unpredictability is what makes forex so appealing to traders. 

How Does Forex Trading Work

Unlike stocks or commodities, forex trading takes place directly between two parties in an over-the-counter (OTC) market rather than on exchanges.

The forex market is managed by a global network of institutions based in four major forex trading hubs in various time zones: London, New York, Sydney, and Tokyo. Because there is no central location, you may trade forex 24 hours a day, five days a week.

FX trading market is a market that operates constantly without any breaks across the world. Though the high-operating banks and institutional firms hold the major control over the forex trading market as intermediaries for the respective clients yet, nowadays, the market stands more open to all kinds of retail traders and even investors.

Simply put, forex trading primarily involves the exchange of one currency for another. It consists of the purchase and sale of currency pairs, like EUR/USD, JPY/GBP, etc. In order to earn a profit, an individual would have to sell one currency anticipating it would decrease relative to the currency he/she intends to purchase, which is expected to increase.

Types of Forex Market

1) Spot Forex Market

The actual exchange of a currency pair that occurs at the precise moment the deal is finalized – i.e. "on the spot" – or within a short period of time.

2) Forward Forex Market

A contract is entered into to purchase or sell a specific amount of a currency at a given price, to be settled at a future date or within a range of future dates.

3) Future Forex Market

A contract is an agreement to purchase or sell a predetermined amount of a particular currency at a predetermined price and date in the future. A futures contract, unlike a forward contract, is legally binding.

Forex Trading Terms to Know

Here are the commonly used terms in forex trading. You can use this as a glossary to look for any time you want to learn.

Currency Pair

It is the price quote of the exchange rate for two different currencies traded in Forex markets.

Base Currency

The first currency stated in a forex pair is known as the base currency.

Quote Currency

The second currency in a forex pair is known as the quote currency. Forex trading usually entails selling one currency in order to acquire another, which is why it is quoted in pairs.

Bid-ask spread

Also known as the buy-sell spread, it is the difference between the bid and ask price for a given currency pair.

Pip

It is the smallest unit of measurement for any possible difference between the bid and ask spread in terms of forex trade.

Lot

Lot is the standardized unit of currency in forex trading. A typical lot size size is 100,000 units of currency.

Leverage

Leverage in forex is a technique that enables traders to 'borrow' capital in order to gain a larger exposure to the forex market, with a comparatively small deposit.

Margin

It is the amount of money that a trader needs to put forward in order to open a trade.

Forex Trading Strategies

An individual can make the most of the forex trading strategies to enhance their trading approach and style. The trading strategies are categorised into 4 types on the basis of the number and duration of trades made. They are elucidated here-

  • Scalp Trades

Scalp trades are illustrated by holding positions for minutes/seconds, with profit amounts limited by the no. of Pips.

  • Swing Trades

It concerns with holding positions for a longer period than a day. It can be days or weeks.

  • Day Trades

It is concerned with short-term positions that are held and liquidated within the same day. It usually lasts for a couple of minutes or hours.

  • Position Trades

It involves holding a currency for a long duration. It may last for months and sometimes even years.

What is Foreign Exchange Price Movements and What Causes it

Because the forex market is made up of currencies from all over the world, forecasting exchange rates may be challenging due to the numerous factors that might influence price fluctuations.

However, forex, like other financial markets, is largely controlled by supply and demand dynamics, and it is critical to grasp the variables that drive price changes here.

Central Banks

Central banks regulate supply by announcing actions that have a major impact on the price of their currency.

Quantitative easing, for example, entails pumping more money into an economy, which might cause the value of its currency to fall.

News Reports

Commercial banks and other investors want to invest in economies with a positive outlook. As a result, if favourable news about a certain location enters the markets, it will promote investment and raise demand for that region's currency.

Market Sentiment

Market mood, which is typically influenced by news, may also have a significant impact on currency values.

If traders feel a currency is heading in a particular way, they will trade accordingly and may persuade others to do the same, boosting or reducing demand.

Economic Data

Economic data is critical to currency price movements for two reasons: it indicates how an economy is functioning and provides insight into what its central bank could do next.

Credit Ratings

Investors will want to maximize their profit from a market while minimizing their risk.

So, in addition to interest rates and economic statistics, they may use credit ratings when selecting where to invest.

Providers Split Pairs into the Following Categories

  • Major

Seven currencies account for 80% of worldwide forex trade. EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, and AUD/USD are all included.

  • Minor

Less often traded, they frequently pit major currencies against each other rather than the US dollar. EUR/GBP, EUR/CHF, and GBP/JPY are all included.

  • Exotics

A major currency vs a currency from a minor or developing economy. USD/PLN (US dollar vs. Polish zloty), GBP/MXN (British pound vs. Mexican peso), EUR/CZK.

  • Regional

Pairs that are categorized by areas, such as Scandinavia or Australasia. EUR/NOK (Euro vs. Norwegian krona), AUD/NZD (Australian dollar vs. New Zealand dollar), AUD/SGD (Australian dollar vs. Singapore dollar).

Risks of Forex Trading

  • Forex trading is considered riskier as compared to other types of assets because of higher leverage and margin.

  • There is a constant fluctuation in currency prices, and hence, the traders need to execute large trades (using leverage) to make money.

  • The exchange rates are affected by several factors, thus making it difficult to predict.

  • Trading delays due to lack of liquidity in the market, execution risk, or computer system problems can also affect forex trading.

Pros and Cons of Forex Trading

Pros

Cons

The forex market is a highly liquid market.

Though forex trading online is legalized in India yet it is not regulated completely. This may cause hindrances in searching the trustworthy brokers and making safe investments.

Forex Market operates 24 hours a day and 5 days a week. It enables traders to participate as per their respective geographical location and time zone.

Since the forex market is decentralised, there is not one single exchange where all trades are placed. It may become problematic when finding the correct market price of a currency pair.

Forex trading offers high leverage. Henceforth it allows traders to open positions that are more than their account balance.

Forex trading is a bit risky. The invested capital may witness some losses if the risk is not managed properly.

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