What is Forex Trading?

Forex trading is a type of online trading. If you are interested in investment and you want to invest your money in online trading then with multiple options, forex trading is the most popular type of online trading among the investors nowadays. Before going into details of forex trading and getting into forex trading courses, let us first understand the forex meaning.

What is Forex?

Forex is a global marketplace where different currencies are traded. It is a conversion of one currency into another currency. Forex is also known as Foreign Exchange or FX trading. It is an act of buying and selling currency. Forex is a marketplace where banks, companies and individuals exchange currencies. When you travel abroad and you convert your currency into the currency of your visiting country, it means you are making a forex transaction. Though this is a practical purpose for currency exchange, a lot of currency conversion is done to earn a profit out of it.

If we explain Forex in terms of the investment business, it is a network of sellers and buyers, who transfer currency between each other at a fixed price. The major purpose of this currency exchange is to gain profit. In online trading, Foreign Exchange is the largest, most active and most liquid financial market in the world. The average trading volume of the Forex market is $5 trillion daily. Forex market is an electronic network of institutions, banks, brokers and individual traders. Trading is done over the interbank market that is an online channel through which the currencies are traded. The trading market works 24 hours a day and 5 days a week. The Forex market opens on Monday and closes on Friday.

How does the currency market work?

Forex trading takes place between two parties directly in an OTC (over-the-counter) market. The forex market is run by a global network of banks. These banks are spread across four major forex trading centres in different time zones i.e. New York, London, Tokyo and Sydney. Because there is no central location where you can trade forex 24/7.

Three ways currency markets work

There are three ways forex trading works. These three ways include spot market, forward market and future market. Nowadays the Spot Market in Forex trading is the largest as it is the underlying real asset and provides a base for forwards and futures markets.

The futures market was more famous than the spot market in the past because individual investors had the benefit of its availability for a longer time. But with the rise in electronic trading, the spot market has surpassed the future market and now is the preferred market for individual investors and speculators.

The spot market is preferred by the individual investors whereas the forward and futures markets are preferred by the companies who need to hedge their risks out to a specific date in future.

The Spot Market

In the spot market currencies are sold and bought at the current price. The current price of a currency depends on multiple aspects such as supply and demand, economic performance depending upon the ongoing political situation both nationally and internationally, current interest rate and the future perception of one currency against the other currency. When a deal among the buyer and seller is finalised that is called the spot deal. The transaction occurs when one party delivers an agreed-upon currency amount to the other party and receives counter currency at an agreed-upon exchange value rate. When a position is closed the settlement is in cash.

The Forward Market

Unlike the spot market, the forward market does not trade physical currencies. The forward market deal in contracts. A contract is agreed to buy or sell a set amount of currency at a specific price to be settled at a set date in future. The contract is based on some terms and conditions that are determined by both parties.

The Future Market

In the future market, futures contracts are bought and sold based upon a standard size and a settlement date on public commodities markets. A contract is agreed to buy or sell a set amount of given currency and date in the future. A future contract is legally bound. Futures contracts have specific legal details, including the number of units being traded, delivery and settlement details, and minimum price increments that can not be customized. The exchange acts as a counterpart to the trader, providing clearance and settlement.

Understanding Currency Pairs

Forex trade is an act of purchasing and selling two currencies simultaneously. The currencies work in pairs. All currency pairs include a base currency and a quote currency. If you want to work as a forex trader, you must understand these currency pairs and how they work. Let's understand what is the base currency and what is a quote currency?

Base and Quote Currency

Base Currency: It is a currency that forex traders buy while trading forex pairs.
Quote Currency: It is a currency that forex traders sell while trading forex pairs.

Currencies in the pair are listed using a three-letter code. Two letters stand for the region and one letter stands for the currency. For Example, USD/JPY is a currency pair that involves buying the United States Dollar and Selling Japanese Yen.

In the given example USD is the base currency and JPY is the quote currency. If USD/JPY is trading at 106.020, then one USD is worth 106.020 JPY. If the value of the US dollar rises against the value of the Japanese Yen then a single dollar will be worth more Yen and the pair price will increase. If it drops, the price of the pair will decrease.

If you get the idea that a base currency in a pair is likely to strengthen against the quote currency, you can purchase the pair by going long and if you think it is going to weaken then you can sell it by going short.

Currency Pairs are sorted into different categories such as major pairs, minor pairs, exotics and regional pairs

Major Pairs
Several currencies make up to 80% of global forex trading. These pairs include: EUR/USD, GBP/USD, USD/JPY, USD/CAD, USD/CHF and AUD/USD

Minor Pairs
These pairs are traded less frequently. These pairs include major currencies against each other instead of USD. These pairs include EUR/CHF, EUR/GBP, GBP/JPY.

Exotics
In these pairs, a major currency is set against a currency from a small or emerging economy. These pairs include USD/PLN, GBP/MXN, EUR/CZK.

Regional Pairs
These are the pairs that are classified by the region e.g. Scandinavia or Australia. These pairs include AUD/NZD, AUD/SGD, EUR/NOK.

Now that we have understood what is forex trading, discovering the ways the forex market work, and how the pairs in forex trading work, let's discuss how forex trading works and what forex signals are, and what kind of forex trading strategies you should know if you want to become a successful forex trader.
In a pair of forex trade currency, the currency listed first is known as the base currency and the second currency is called the quote currency. As forex trading involves selling one currency to purchase another currency, so it is quoted in pairs. The price of a forex pair depends on the value of one unit of the base currency in the quote currency. So basically base and quote currencies are defined as follows.

Forex Trading Strategies

There are multiple ways to forex trade, but all of them work in the same way i.e. simultaneously purchasing a currency and selling the other. Traditionally forex transactions are made through a forex broker, but nowadays with the rise of online trading, you can take advantage of forex price movements using derivatives such as CFD trading. One thing that is consistent about forex are the consistent and essential forex daily tasks every trader must discipline themselves in to better their odds.

CFD Trading

CFDs are leveraged products. This enables you to open a position for just a fraction of the full value of the trade. You do not have to take the ownership of the asset but you take a position on whether you think the market will fall or rise in value. Leveraged products have both the chance of magnifying your profits or magnifying your losses if the things go against you. If you are wondering what is leverage and how you can use it strategically here is the answer.

What is Leverage in Forex Trading?

Leverage is not only a strategy to use in forex trading but it works as a tool as well. It is a key feature of CFD trading. If handled wisely a trader can use it as a powerful tool to gain lucrative trades. Leverage is defined as a facility that enables you to get a larger exposure to the market you are trading than the amount you deposited to open the position for trade. Leverage in forex trading provides a means to gain exposure to large amounts of currency without paying the full value of trade upfront. A trader puts down a small deposit, that is known as margin. When a trader closes a leveraged position, their profit or loss is based on the full size of a trade.

Leverage indeed increases the chance of amplifying profit, however, there are chances of huge loss as well. There are chances of great loss that can even exceed your margin. Therefore it is crucial to learn how to manage the risk.

How does leverage work?

Leverage works by making a small deposit that is called margin. It provides the forex trader with large exposure to an underlying asset. A trader puts down a fraction of the full value of an asset, and the provider of that trader loans them the rest. The total exposure in comparison to margin is called the leverage ratio.

Here is an example to explain it. Let us suppose a trader wants to buy 1000 shares of a company at the share price of 100p ("p" here denotes pip - which is a unit used to measure movements in a forex pair.

To open a traditional trade with a broker the trader is required to pay 1000 x 100p for exposure of $1000. If the price of share increases by 20p, the trader's 1000 shares will be worth 120p each. If the trader closes their position at this point, they will make a $200 profit from their original $1000.

But one the other hand, if the share price goes down by 20p, the trader will lose $200 or a fifth of their original payment. To avoid any kind of mishaps like this a trader needs to know how to manage risk and strategically make trades. Here is when a forex signal comes in handy.

Forex Signals

Forex Signal is a trading recommendation on a specific financial asset, to be executed at a fixed or pre-decided price and time. It does not matter how much trading experience you have, forex signals help you enhance your trading activities.

Forex signals are very helpful and beneficial for beginners. With the help of forex signals, as a new forex trader, you can make money while still learning about the market and how you can earn profit from your trades.

Forex signal systems give you a full insight to which trading options the signal is based upon that helps you understand the logic behind any trading recommendation. It is a set of analyses that forex traders use to decide whether to purchase or sell a currency pair at a specific time.

Manual and Automated Forex Signals

Forex trading strategies can be manual or automated methods to generate forex signals. In Manual system, a trader sits in front of a computer and looks for signals to interpret whether or not to make a trade, whether it is a good time to purchase or sell. On the other hand in the Automated system, the trader develops an algorithm that finds trading signals and executes trades on its own. The automated system leaves the element of human emotion out of the algorithm that can be a factor for improved performance.

Creating Forex Trading Strategies

Most of the time, forex traders start with a simple strategy. For example, they notice that a currency pair is likely to rebound from a particular resistance or support level. They can decide to add other elements that improve the accuracy of these trading signals over time.

Multiple elements form an effective forex trading strategy.

Market Selection

It is important to learn and decide the currency pairs for trade and then become an expert at reading those currency pairs.

Sizing the Position

Traders must understand and learn how large each position is to control the amount of risk taken in each trade.

When to Enter

The trader must learn and make rules for when to enter a long position or when to enter a short position for a specific currency pair.

When to Exit

It is necessary to layout rules so that you know exactly when to exit a long or short position. It is also very crucial to learn when to get out of a losing position.

Trading Tactics

To become a successful forex trader you must have set rules laid out on how to purchase and sell currency pairs. And you should know how to select the right execution technology.

How can Forex Trading Strategies be changed?

If you follow all the rules then a forex trading strategy can be very useful and works very well. But you must keep in mind that these strategies are not life long. One must not think that if one particular strategy has worked well for you today will work exceptionally for tomorrow as well. If a strategy is not giving you profit or you are unable to achieve the desired result you should adopt another strategy. If you plan to change your strategy, when is the right time to change your strategy? Here are some of the points that will help you determine whether you should go for a new strategy or not.

Match risk management with your trading style. If the risk vs reward ratio is not suitable, it can be a cause to change strategy

Understand the Change in market conditions. A trading strategy depends on specific market trends if the market trends change then your existing strategy may be of no use in the new market trend. It is a sign that you should modify your technique

Understand the strategy fully and thoroughly. If you are unable to comprehend the strategy and you do not completely understand how it works then you won't be able to work with it. You will not be able to understand the problems of it which means you should work on another strategy.

Changing the strategy can be good, but do keep in mind that changing a forex trading strategy too often can be costly. If you modify your strategy too often, you could lose out. However, one thing that is essential in forex strategies is understanding that having the right mindset and the importance of psychology in trading are essential to avoid the temptations of bias, fear, and greed.