What is forex?
Demystifying the World of Forex Trading
Forex, or Foreign Exchange trading, involves exchanging one country’s currency for another. It’s a massive global market with a daily trading volume exceeding $5 trillion. Unlike centralized markets, the decentralized Forex market operates 24/5 worldwide, connecting banks, institutions, brokers, and traders.
Initially, Forex was primarily used by banks. However, since the 1970s, when exchange rates floated freely, trading has surged. Now, it’s utilized by a diverse range of participants: importers, exporters, corporations, speculators, and more. This market facilitates currency-related transactions, investments, and risk management across the globe.
History Of Forex
In the past, goods were exchanged using the barter system. The first coins were made from precious metals, and later, paper money emerged as an I.O.U. During the Middle Ages, people began using paper money as a medium of exchange. The foreign exchange market is the newest financial market, experiencing significant changes in the last century.
Before WWI, central banks supported their currencies with gold convertibility. Paper money could be exchanged for gold upon request. To handle normal exchange, banks held gold reserves. However, during crises, confidence dropped, leading to “bank runs” when holders sought more gold than banks had. This relates to how money supply exceeded actual gold, causing potential instability.
What is traded on the Foreign Exchange?
Foreign Exchange (Forex) involves trading currencies, where one currency is bought while another is sold, or money from one country is exchanged for money from another. This occurs through banks, brokers, or dealers, and currencies are traded in pairs. For instance, the Euro and US Dollar (EUR/USD) or the US Dollar and Japanese Yen (USD/JPY) are common pairs. This trading process forms the basis of the Forex market.
Currencies That Are Traded
The US Dollar is the most wildly traded currency globally, being on one side of about 90% of all transactions. The Euro’s share is second at about 35%.while only 3% of all transactions in Forex market do not involve either the Euro or the US Dollar, underlining.
How to Read Forex Quote
As a general rule, each currency has a three letters symbol, which is used in Forex quotes. The first two letters identify the name of the country while the third letter identifies the name of that country’s currency. For example: AUD (Australian dollars), JPY (Japanese yen), CHF (Swiss francs) and CAD (Canadian dollars)
When trading currencies, the trade is always done in pairs and so when you buy one currency, another currency is simultaneously being sold.
The Bid and the Ask
Forex quotes are shown in ‘bid’ and ‘ask’ prices. The Bid is the price at which the market maker is ready to buy a given the market maker currency pair and so at this price the trader (seller) can sell the base currency to the market maker, The Bid is shown on the left side of the quotation. On the other hand, the ask is the price at which the market maker is ready to sell a given currency pair and so at this price the trader (buyer) can buy the base currency from the market maker, The ask is shown on the right side of the quotation. The ask price is also called the offer price.
Symbol Bid Ask
EUR/USD 1.3517 1.3520
As a general rule, each currency has a three letters symbol, which is used in Forex quotes. The first two letters identify the name of the country while the third letter identifies the name of that country’s currency. For example: AUD (Australian dollars), JPY (Japanese yen), CHF (Swiss francs) and CAD (Canadian dollars)
What Is Margin
When referring to margin trading, we are talking about the ability of a trader to trade with more money than what he has in his account. In the forex market, with just a small margin, a trader is able to trade a much larger position than he would when trading on the stock market. This enhanced leveraging factor allows the trader to magnify his profits when the opportunity arises.
Example: Forex brokers offer 200 to 1 leverage, which means that a $100 dollar margin deposit would enable a trader to buy or sell $20,000 worth of currencies. Sim Similarly, with $1000 dollars, one could trade with $200,000 dollars and so on.
The difference between the Stock market and Forex is that margin deposit requirement is much higher for the Stock market than for the Forex market. As such, the dollar value of margin trade goes further in the Forex market.
Margin Call
A margin call occurs when the broker notifies the account holder that its margin deposits have fallen below the required minimum level because an open position has moved against the trader.
Your positions could be partially or totally liquidated if the available margin in your account falls below a predetermined threshold. You may not receive a margin call before your positions are liquidated.
What is a Pip?
A Pip is the acronym for “Percentage in Point”. A pip was typically defined as the smallest price change that a currency can move, however recent pricing developments have extended the granularity another decimal place further to the right so traders can see fractions of pips now also called “pipettes”. For example if you saw a EUR/USD quote of 1.1750, a price change to 1.1751 would equal 1 pip. Now that same quote shown using pipettes or fractions of pips would be.2 would be; 1.17500 with a price change to 1.17512 which would equal 1.2 pips. The easiest way to determine if your broker is showing standard pips or fractional pips is to look at the Euro and see how many decimal places are shown to the right of the decimal point.
What is Spreads?
Forex broker spreads can be “fixed”, where they do not move (i.e. stay at 3 pips wide during all market conditions) and tend to be generally wider overall, or “variable” where they fluctuate based on the current market conditions (i.e. may be 1 pip wide, 2 pips or 5 pips wide at different times) and tend to be tighter overall.
Rollover Adjustments -Carry trade (Swap)
Rollover is an interest adjustment that occurs on any open position that you hold and keep from one day to the next (or overnight position). A position is said to be “rolled over”
When it is being held overnight. In this case, a trader pays or receives what is called a rollover rate based on the difference between the interest rates of the countries that have a position in. In most cases when short term trading any major currency, these rollover fees are negligible, but they can add up in the long term so be careful.
Example: If you bought the EUR/USD then you are technically Long EUR and Short USD. If your broker is paying 1.75% for Long Euro positions and charge 2% on Short USD positions, then you would own the difference of 0.25% for that day