What is Forex Trading and How Does it Work?
The foreign exchange (widely known as FX or forex) is a global marketplace where currencies are traded. National currencies are exchanged against one another worldwide, creating a daily average trading volume of around $5 trillion, making it the largest financial market in the world.
For this reason Forex trading is one of the most actively traded markets in the world since it relates to any conversion of one national currency into another.
The volume of currency forex brokers buy or sell everyday, affects the price movements, and can make some currencies extremely volatile. But this is also affected by several commercial activities, politics, changes in inflation/interest rates or recessions. Unlike stocks and commodities, there is no central exchange. Instead, currencies are converted via a global network of banks, dealers and financial brokers all over the world. The volatile nature of the market attracts many traders as there is an opportunity for high profits alongside the increasing risk.
How does Forex Trading work?
Minor pairs include 42 pairs in total. They have a smaller market share compared to major pairs, but still a very decent level of liquidity. These pairs are made up out of any combination of the following currencies:
- British Pound
- Canadian Dollar
- Australian Dollar
- Japanese Yen
- Swiss Franc
- New Zealand Dollar
Exotic pairs are currencies from emerging economies, which are then paired with major currencies or other exotic currencies and traded. These pairs have the least frequent trades when compared to major and minor pairs.
- USD/HKD - U.S. Dollar/Hong Kong Dollar
- USD/SGD - U.S. Dollar/Singapore Dollar
- USD/ SEK - U.S. Dollar/Swedish Krona
- EUR/TRY - Euro/Turkish Lira
- NOK/SEK - Norwegian krone/Swedish Krone
Major currency pairs
Benefits of Forex Trading
FX trading is one of the most popular financial markets. One reason is because, in particular, the major currency pairs are traded in extremely high volumes giving the market high liquidity. It is because of this size it is thought that forex trading is the most lucrative market out there.
A key advantage of FX trading is Leverage. This means you only need to put up an initial deposit, or margin, to enter a trade. Margins can vary depending on regulations, currency pair and the platform you choose to use. Margin trading can be a more efficient way of using your capital because you only need to present a percentage of the overall value, whilst remaining fully exposed to the fluctuations in the market. This essentially means you can increase your potential profit if the market trends in your favour.
The forex market is traded 24-hours a day. From Sunday night through to Friday night, trading takes place around the world. This means that investors can almost always be ready to respond to currency fluctuations. This is a key benefit as the markets are constantly moving, which places emphasis on monitoring your position and utilising appropriate risk management software.
All trades made on any serious forex platform are authorised and regulated by independent financial institutions, like CySEC or FCA. They enforce rules necessary to offer protection to stop retail investor accounts losing money, and help protect from fraud.
Given the high volatility of the forex trading market, it’s recommended to practice with a demo account as it helps beginners learn and practise trading, before diving into the world of forex.
How does the Forex Market work?
As businesses continue to expand into markets all over the globe, the need to complete transactions in other countries’ currencies is only going to grow. There are constant fluctuations in currency values, and this places businesses at risk when buying goods or services outside of their borders.
The FX market provides a means of hedging that risk by fixing a rate at which the transactions can be completed at a later date. Investors speculate the market when trading forex, in the hopes that the currencies traded will gain or drop in value resulting in a profit.
There are different products available to trade and it is essential to research as much as possible before you start, for example, CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.
Doing your due diligence on key terms, types of products to do forex trading and the differences in currency pairs, will go a long way to helping you make sense of the market, and effectively participating.