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Forex Trading for Everyone

Forex Trading - The Basics

Forex trading is the activity of buying a certain amount of a particular currency by selling the convertible equivalent of another currency, borrowed from a broker/ bank. This is done by a trader when he believes that the value of the currency he has bought is going to appreciate compared to the value of the currency he has just sold. When his target is met, he closes the trade by selling back the currency he bought and converting it into the currency he borrowed. If the currency did appreciate as he thought, then he will have received more cash than he borrowed, which is his net profit. On the other hand, if the trade worked against him, then the trade would have closed automatically by his broker once his loss reaches the 'stop loss' value defined by him, which is the maximum amount that he is prepared to risk (or if the he closes the trade by himself if he has reasons to believe that the circumstances have changed). Thus, by using a combination of fundamental and technical analysis, one can do forex trading to get unlimited profits whereas limit the losses of a bad trade.

Forex trading is done on currency pairs, where one currency is sold and the other is bought. The major pairs are

  1. EURUSD (Euro / US Dollars)
  2. GBPUSD (Great Britain Pounds / US Dollars)
  3. USDJPY (US Dollars / Japanese Yen)
  4. USDCHF (US Dollars / Swiss Francs)
  5. AUDUSD (Australian Dollars / US Dollars)

On a day to day basis, the currency rates may or may not fluctuate much, but the volatility is enhanced by dealing in large currency amounts. Until recently, most brokers required a size of at least one currency lot (equivalent of US$100,000) to open a trade. These days, forex trading has become so popular and competition amongst brokers has led to creation of mini-lots (US$10,000) and micro-lots (US$1,000). By using larger amounts, traders can take advantage of the changes in the third and fourth decimal changes in the currency rates. For example, if EURUSD is 1.4215 and then it changes to 1.4220, then the profit on one lot is (1.4220-1.4215) x 100000 = 50 Euros, assuming the trader was long on the Euro (to be 'long' means to buy the first currency of the pair ans to be 'short' means to sell the first currency in the pair).

Here we come across another term, 'pip'. One pip is the lowest value in the currency rate. In the above example, the rate moved 5 pips, and on a lot, each pip is 10 Euros. (On a mini-lot, the 5 pips would correspond to 5 Euros and on a micro-lot, it corresponds to 0.5 Euros).

All retail forex trades work on a leveraged basis. The trader does not have to put up the complete currency equivalent of the lot size he is trading. He only needs to put a comparatively small amount, which is the maximum amount he will risk if he loses the trade. A leverage of 1:50 or 1:100 means the one dollar that the trader puts in is able to control 50 or 100 dollars on a trade. If the trade is profitable, there is no stopping to the profit amount, but if the trade goes the other way, the loss is limited.

Forex trading isn’t a hard endeavor to grasp once you get the hang of how it works. Like any other undertaking you decide to take up, there are some basic terms you need to understand with Forex trading.

As with any subject, the more you study and the more you learn about Forex trading, the more beneficial that knowledge will be to you in the long run. There are places online where you can learn just enough about Forex trading to go ahead and open a demo account and get started right away learning as you go. However most (if not all) of the traders experienced in Forex trading will tell you that’s not a good idea at all. Walking blindly into something you know nothing about can backfire and hit you directly in the wallet.

With Forex trading, the market is a liquid market. This means it has the potential to be easily changed. What does that mean to you? It means that with Forex trading, if you come to the table already knowing what’s being served, you can pick only the best and leave alone the food that might not agree with you. When you see the word Forex in reference to Forex trading, that simply means it’s referring to the Foreign Exchange. You might also see it mentioned as plain Forex, as FX or as Forex market.

While you’re learning about Forex trading, you might come across the term ‘Spot’ or ‘Spot Market.’ In Forex trading, this term is one you want to pay attention to as it means the transactions are wrapped up faster, in a shorter amount of time.

Another important term you should know about when dealing with Forex trading is margin. You may hear it referred to as ‘trading on the margin.’ Margin is the amount of money you have to put up. When you’re trading on the margin, you’re trading with more than you have actually have in your account. When you want to participate in Forex trading, take the time to know as much as you can about the Forex market. That knowledge will reward you in the end.