Trading Basics
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What Is Forex Trading? A Beginners Guide
Forex (FX) is a portmanteau of the words foreign currency and exchange. Foreign exchange is the process of changing one currency into another for various reasons, usually for commerce, trading, or tourism. According to a 2022 triennial report from the Bank for International Settlements (a global bank for national central banks), the daily global volume for forex trading reached $7.5 trillion in 2022. Read on to learn about the forex markets, what they’re used for, and how to start trading.
The foreign exchange market is where currencies are traded. This international market’s most unique aspect is that it lacks a central marketplace. Instead, currency trading is conducted electronically over the counter (OTC). This means that all transactions occur via computer networks among traders worldwide rather than on one centralized exchange. The market is open 24 hours a day, five and a half days a week. Currencies are traded worldwide in the major financial centers of Frankfurt, Hong Kong, London, New York, Paris, Singapore, Sydney, Tokyo, and Zurich across almost every time zone. This means the forex market begins in Tokyo and Hong Kong when the U.S. trading day ends. As such, the forex market can be highly active at any time, with price quotes changing constantly.
The FX market is the only truly continuous and nonstop trading market in the world. In the past, the forex market was dominated by institutional firms and large banks, which acted on behalf of clients. But it has become more retail-oriented in recent years, traders and investors of all sizes participate in it.
An interesting aspect of world forex markets is that no physical buildings function as trading venues. Instead, it is a series of connected trading terminals and computer networks. Market participants are institutions, investment banks, commercial banks, and retail investors from around the world.
Who Trades On It?
Currency trading was very difficult for individual investors until it made its way onto the internet. Most currency traders were large multinational corporations, hedge funds, or high-net-worth individuals (HNWIs) because forex trading required a lot of capital. Commercial and investment banks still conduct most of the trading in forex markets on behalf of their clients. But there are also opportunities for professional and individual investors to trade one currency against another.
Types of Market
Forex is traded primarily via spot, forwards, and futures markets. The spot market is the largest of all three markets because it is the “underlying” asset on which forwards and futures markets are based. When people talk about the forex market, they are usually referring to the spot market. The forwards and futures markets tend to be more popular with companies or financial firms that need to hedge their foreign exchange risks out to a specific future date.
Spot Market
The spot market is where currencies are bought and sold based on their trading price. That price is determined by supply and demand and is calculated based on several factors, such as: Current interest rates, economic performance, geopolitical sentiment & Price speculation.
A finalized deal on the spot market is known as a spot deal. It is a bilateral transaction in which one party delivers an agreed-upon currency amount to the counterparty and receives a specified amount of another currency at the agreed-upon exchange rate value. After a position is closed, it is settled in cash. Although the spot market is commonly known as one that deals with transactions in the present (rather than in the future), these trades take two days to settle.
Forward Market
A forward contract is a private agreement between two parties to buy a currency at a future date and a predetermined price in the OTC markets. In the forwards market, contracts are bought and sold OTC between two parties, who determine the terms of the agreement between themselves.
A futures contract is a standardized agreement between two parties to take delivery of a currency at a future date and a predetermined price. Futures trade on exchanges and not OTC. In the futures market, futures contracts are bought and sold based on a standard size and settlement date on public commodities markets, such as the Chicago Mercantile Exchange (CME). Futures contracts have specific details, including the number of units being traded, delivery and settlement dates, and minimum price increments that cannot be customized.
The exchange acts as a counterparty to the trader, providing clearance and settlement services. Unlike the spot, forwards, and futures markets, the options market does not trade actual currencies. Instead, it deals in contracts that represent claims to a certain currency type, a specific price per unit, and a future date for settlement. Both types of contracts are binding and are typically settled for cash at the exchange in question upon expiry, although contracts can also be bought and sold before they expire.
These markets can offer protection against risk when trading currencies. In addition to forwards and futures, options contracts are traded on specific currency pairs. Forex options give holders the right, but not the obligation, to enter into a forex trade at a future date.
How To start Trading Forex
Trading forex is similar to equity trading. Here are some steps to get yourself started on the forex trading journey. Learn about forex, while it is not complicated, forex trading is an undertaking that requires specialized knowledge and a commitment to learning.
You will need a forex trading demo account with us to get started with forex trading. Develop a trading strategy, while it is not always possible to predict and time market movement, having a trading strategy will help you set broad guidelines and a road map for trading.
Always be on top of your numbers. Once you begin trading, check your positions at the end of the day. Most trading software already provides a daily accounting of trades. Make sure that you do not have any pending positions to be filled and that you have sufficient cash in your account to make future trades. Cultivate emotional equilibrium: Beginner forex trading is fraught with emotional roller coasters and unanswered questions. Discipline yourself to close out your positions when necessary.
Forex Terminology
The best way to get started on the forex journey is to learn its language. Here are a few terms to get you started: Forex account: A forex account is used to make currency trades. Depending on the lot size, there can be three types of forex accounts: Micro forex accounts: Accounts that allow you to trade up to $1,000 worth of currencies in one lot. Mini forex accounts: Accounts that allow you to trade up to $10,000 worth of currencies in one lot. Standard forex accounts: Accounts that allow you to trade up to $100,000 worth of currencies in one lot. Ask: An ask (or offer) is the lowest price at which you are willing to buy a currency. Bid: A bid is the price at which you are willing to sell a currency.
Contract for difference: A contract for difference (CFD) is a derivative that lets traders speculate on price movements for currencies without owning the underlying asset. Leverage: Leverage is using borrowed capital to multiply returns. The forex market is characterized by high leverages, and traders often use it to boost their positions.
Volatility and Regulation
Forex markets are among the most liquid markets in the world. So, they can be less volatile than other markets, such as real estate. The volatility of a particular currency is a function of multiple factors, such as the politics and economics of its country. Therefore, events like economic instability in the form of a payment default or imbalance in trading relationships with another currency can result in significant volatility.
Are Forex Markets Regulated? Forex trade regulation depends on the jurisdiction. Countries like the United States have sophisticated infrastructure and markets for forex trades. Forex trades are tightly regulated in the U.S. by the National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC). However, due to the heavy use of leverage in forex trades, developing countries like India and China have restrictions on the firms and capital to be used in forex trading. Europe is the largest market for forex trades. The Financial Conduct Authority (FCA) monitors and regulates forex trades in the United Kingdom.
The Bottom Line
Currencies with high liquidity have a ready market and exhibit smooth and predictable price action in response to external events. The U.S. dollar is the most traded currency in the world. It is paired up in six of the market’s seven most liquid currency pairs. Currencies with low liquidity, however, cannot be traded in large lot sizes without significant market movement being associated with the price.
For traders especially those with limited funds day trading or swing trading in small amounts is easier in the forex market than in other markets. For those with longer-term horizons and more funds, long-term fundamentals-based trading or a carry trade can be profitable. A focus on understanding the macroeconomic fundamentals that drive currency values, as well as experience with technical analysis, may help new forex traders become more profitable.
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