• September 7, 2021

The Basic Guide to Forex Trading for Beginners

Forex trading is becoming more popular and is currently one of the largest financial markets. The forex market has a very high potential for fast returns and high profits. This kind of trade involves trading large volumes of currency hence more opportunities for liquidity.

However, the potential for high and fast returns comes with a downside; very high risk. Forex trading is a high-risk market that requires the right strategy to succeed. If you are new to forex trading, then this is the guide for you.

What is Forex Trading?

Forex trading, also known as FX trading or foreign exchange, is exchanging one currency against another. It is a network of sellers and buyers who trade currencies at an agreed price between each other. Forex trading enables central banks, individuals, and companies to convert a currency into another. The exchange rates frequently change based on the demand and supply.

There are many reasons for converting a currency into another, such as trade, tourism, and commerce. However, a majority of forex traders convert currencies with the sole aim of making a profit. Forex trading involves a lot of currency conversion, which can cause some currencies to be highly volatile.

How Does the Forex Market Work?

The forex market is an over-the-counter (OTC) market where currencies are exchanged directly between two parties. There are no physical exchange markets for currencies like there are for stocks and commodities. The lack of a central location makes it possible to trade currencies for 24 hours a day.

Types of Forex Markets

  • Spot Market: This is a physical exchange of two currencies and takes place when the actual trade is settled and within a short time. I.e., on the spot. Spot market forms the primary forex market, and currency exchange rates are determined based on demand and supply in real-time.
  • Forward Market: An agreement is made to sell or buy a set amount of currency, to be settled at a specific future date at a stated price. The Forward market locks in an exchange rate on a future date for a specified amount of currency.
  • Futures Market: Future markets are similar to forward markets. The only difference is that futures are done on an exchange while forwards are done privately. Futures are done on a standardized contract and are legally binding.

Forex traders use futures and forward markets to hedge or speculate against currency price changes. Futures and forward exchange rates are based on the spot market. Traders are therefore able to take advantage of price movements.

How are Currencies Traded?

All currencies are allocated a three-letter code, used to identify each currency. The table below shows a list of the major currencies and their codes:

CURRENCY CODE
U.S Dollar USD
British Pound GBP
Euro EUR
Canadian Dollar CAD
Japanese Yen JPY
New Zealand Dollar NZD
Swiss Franc CHF
Australian Dollar AUD

A combination of two currency codes is used to quote the currencies being traded. For example, EUR/USD.

Understanding a Currency Quote

A currency pair represents the exchange rate between two currencies. It is essential to know how to interpret a currency quote.

Understanding the euro to U.S dollar EUR/USD exchange rate:

  • The EUR (euro) is the base currency. It is the currency you will buy when you trade the pair.
  • The USD (U.S dollar) is the quote currency, which you will sell when you trade the pair.
  • The currency exchange rate is the amount of the quote currency, in this case, the U.S dollar (USD) needed to buy one base currency, i.e., euro (EUR). The quote currency varies depending on the demand and supply of the currency.
  • Assuming the EUR/USD currency exchange rate is 1.5, you will need 1.5 USD to buy 1 EUR.
  • If the EUR/USD exchange rate rises, it means that the base currency EUR has increased in value. On the contrary, if the exchange rate falls, the base currency has decreased in value.

Currency pairs will always have the base currency on the left and the quote currency on the right.

Conclusion

It is the duty of every investor to do due diligence before investing in a particular market. Every investment with a profit potential has a risk factor involved. This article will provide you with the information you need to begin forex trading.