Forex stands for foreign exchange and is a decentralized platform through which you can buy and sell currencies. These transactions are carried out through the interbank market rather than a centralized exchange.
Even if you have little idea about forex, you may be surprised to know that you may have likely participated in it when buying imported items.
Forex trading is immensely popular due to numerous reasons that attract traders to the forex market. These factors include the following:
- A wide range of currencies for trading
- Large of the market
- Low transaction costs
- Varying volatility levels
- Trading at all times during the day
The basic principal of forex trading lies in demand and supply. Let’s understand this better with the help of an example. Suppose that EU citizens are showing a high demand for US dollars. They will thus exchange euros for US dollars. As a result, the value of US dollar will rise, while the value of the euro will go down. Such a transaction will affect the value of the dollar vs. euro only. It will not affect the value of the US dollar against any other currency, such as the Japanese yen.
The forex market can witness a of ups and downs due to several factors. These include political events, changes in interest rates, inflation, among others.
What Is Traded?
Simply put, different currencies are traded in the forex market. Forex trading might appear confusing to some as nothing physical is actually being bought in the market. And the idea of buying cash with another kind of cash may seem perplexing to newcomers.
If you know something about stock trading, then that can be help you understand forex. Stock trading involves the purchase of stocks whose value is likely to increase. The same principal applies to forex trading. For instance, if you think that the yen will appreciate, then you need to buy the currency to sell it at a profit later on.
The kind of currency you are looking at is not too different from stocks. Think of a currency as the ‘stock’ of its national economy. So you can consider the Japanese yen to be the stock of the Japanese economy. This is not the reality, but it will give you an idea of how currencies work.
Thus, if the Japanese economy is doing well, the yen will appreciate. This is much like how the value of a particular stock rises when the company behind it is doing well.
Currencies also happen to have nicknames as well. For instance, the Canadian dollar is called the loonie. This is because the country’s dollar coin shows the loon, which is a common bird in Canada.
In the forex world, the broker acts as the intermediary between the interbank system and you. Interbank refers to the network of banks that trade with one another.
Forex brokers have access to currencies and lines of credit from banks that they deal with. Thus, they can offer you values for various currencies. Since they usually deal with different banks, they can offer you the best available prices.
For forex trading, you can open an account with a forex broker. It’s somewhat like opening a bank account. Just like banks, you will need to go through paperwork, file an application and reveal your identification to get your account opened. This process can take a few days.
But if you are in a hurry to begin honing your skills, you can always go for the demo accounts. You can open one quickly with minimal information. The demo account can help you enhance and augment your trading skills so that you can start dealing profitably with real currencies later on.
You can gain leverage with forex brokers. It can vary from 10:1 to 100:1. Thus, with a 10:1 leverage, you have $10 to trade for every dollar that you have in your account.
What Is a Pip?
A pip basically shows small increments in currency values. It is an abbreviation for a point in percentage. The forex pip is usually measured in the form of the currency it represents or the quote.
The pip represents the smallest increment by which a particular currency can change. For instance, dollar currency pairs have a pip of $0.0001. This is also referred to as one basis point, or 1/100 of 1 percent. The small size of the pip protects traders from incurring massive losses. So if one pip was equal to 10 basis points, then a change of pip could spell much bigger changes in currency values. This can translate into much bigger losses for traders.
The pip helps you to understand currency value movement. For instance, suppose that the USD/EUR direct quote is 0.7746. If there is one pip change, the quote will now be 0.7747. Since you can now buy more euros with US dollars, it means that the dollar is now more valuable. Thus, the pip can show you how much more (or less) you can purchase of another currency.
Currencies are usually quoted up to the 4th decimal digit. The pip is the 4th that is, the last digit.
What Are Currency Pairs?
A currency pair shows how two different currencies are trading. That is, it shows the relative values of two currencies. Among the most well-known is the euro/dollar currency pair, also designated as EUR/USD. Since this currency pair is traded so heavily, it also has the greatest liquidity.
So a quotation of EUR/USD = 1.2500 shows that one euro currently costs 1.2500 US dollars. The euro here is the base currency, while the US dollar is the quote/counter currency. So you can spend 1.2500 US dollars to buy 1 euro. Or you can sell 1 euro to purchase 1.2500 US dollars.
Since there are so many currencies used throughout the world, the number of currency pairs is tremendous. Those currencies that are used the most for trading with the US dollar are called the major currencies. On this basis, the USD/CAD, AUD/USD, USD/CHF, GBP/USD, USD/JPY, EUR/USD are the most important currency pairs due to their enormous trading volumes. The abbreviations stand for, EUR = Euro, JPY = Japanese Yen, GBP = Great Britain Pound, CHF = Swiss Franc, AUD = Australian Dollar and CAD = Canadian Dollar.
The final USD/CAD and AUD/USD currency pairs are known as commodity pairs because Australia and Canada are rich in commodities. Hence, these two exchange rates affect the economies of the 2 countries very strongly.
Forex binary options are an advanced form of forex trading. In comparison to leveraged spot forex trading, binary options can be a better way of trading forex for beginners. The big advantage of binary options is that there is a limit on losses, which is known in advance.
There are two outcomes for binary options. You can get either nil or the predetermined value, which is 70% of the trade value in most cases. This final amount depends on price of the underlying asset. Here is an example.
If you enter a buy trade of the currency pair EUR/USD for $10 and the price has increased by the time your time limit expires you will earn $17 dollars.
The strategies and process is simple too learn and implement. I highly recommend you check out the IM Mastery Academy if you want to maximize your gains and minimize your losses from the beginning.