What is Forex? A Beginner’s Guide to Forex trading
Are you curious about Forex? Forex stands for FOReign EXchange or the exchange of currencies. But what is Forex exactly, and what should you consider when you start investing in Forex? In this beginner’s guide to Fore trading, you’ll read everything you need to know!
What is Forex?
Forex or Foreign exchange is the exchange of one currency for another. The exchange of currencies happens constantly and for various reasons. For example, a company might exchange Euros for Dollars when conducting business abroad. The currency market is the world’s largest market, with a total daily volume of over $5 trillion!
Forex trading: profit is the goal
When you engage in Forex trading, the goal is to make a profit. You do this by predicting the value development of a currency. There are two options when you speculate on Forex:
- Long position: you speculate on an increasing price
- Short position: you speculate on a declining price
When you make the right prediction, you make a profit, and when you make the wrong prediction, you make a loss.
Where can you trade Forex?
Did you know that you can trade Forex currency pairs yourself through an online broker? This allows you to speculate on price increases and decreases of certain currencies.
Do you want to know where you can try out the possibilities of Forex trading completely risk-free? Then check out the overview of the best Forex demo accounts:
What is the Forex market?
The Forex market is the place where currencies are traded. Unlike the stock market, there is not one central place where the currencies are traded. The exchange rates of currencies are determined by the constant flow of international transactions.
When you buy a French cheese in a supermarket in London, the supermarket must have bought it in France. In France, they use the Euro, while in England, they use the British Pound. For a comparable simple transaction, two currencies had to be exchanged.
The Forex market is therefore an over-the-counter (OTC) market. The market is always open because people need to be able to exchange currencies at any time of the day. This means that you can actually trade currency pairs at any time of the day.
The base currency in Forex trading
When you want to engage in Forex trading, it’s important to understand what the base currency is.
In Forex, currencies are always expressed in another currency, which is also called a currency pair. An example of a currency pair is EUR/USD. EUR/USD shows the value of the Euro in Dollars.
In this case, the base currency is the Euro. When the EUR/USD rate is 1.1, you have to pay $1.10 to receive 1 Euro.
As a Forex trader, you try to predict whether the Euro will increase or decrease in value compared to the Dollar.
What moves the Forex market?
- Central Banks: Central banks set interest rates. When the Central Bank increases the interest rate of the Euro, the price is likely to rise, because a higher interest rate makes the currency more valuable.
- News: Many speculators are active in the Forex market. For example, the war in Ukraine in 2023 puts pressure on the Euro, as it reduced the attractiveness of the Eurozone.
- Economy: The economy is ultimately a determining factor in Forex trading. When an economic zone performs well, its currency often becomes stronger.
Useful terms in Forex trading
- Spread: The difference between the buying and selling price of a currency.
- Leverage: In Forex trading, you typically invest with leverage.
- Margin: In Forex trading, you trade on margin, which means you can lose your money quickly.
- Pips: Profit in Forex is expressed in pips.
What Forex markets are there?
There are three Forex markets in which you can trade the price movements of currencies. We’ll briefly discuss these markets on this page.
1. Spot market
The spot market is also called the cash market. In this market, currencies are exchanged directly between parties. You’ve undoubtedly been a part of the spot market: when you exchange your Euros for Dollars on holiday, you are allready an active participant.
2. Forward market
In the forward market, a contract is drawn up in which two parties agree on the terms under which a particular currency can be bought or sold.
3. Futures market
Futures are freely traded on a stock exchange and have fixed characteristics. It’s a binding contract in which you buy a certain amount of a currency at a fixed price on a specific date. Certain elements such as delivery time and minimum capital cannot be adjusted.
Are there any risks associated with Forex trading?
Trading in Forex is certainly not without risk: trading currencies is quite complex. It is important to remember that Forex trading is often not regulated everywhere. Therefore, research whether the broker you want to trade with is reliable.
One advantage of trading in Forex is that there is hardly any price manipulation. The market is simply too large, which makes it very difficult for individuals to influence the exchange rate. However, at a fraudulent broker, you may encounter price manipulation. For example, some brokers may trade against their clients and manipulate prices.
It is therefore recommended to thoroughly research whether a Forex broker is reliable. Do you want to know which brokers are reliable for investments in currency pairs? Have a look at our overview of reliable brokers:
When you invest in Forex, you must understand the risks well. For example, you may experience a loss when the exchange rate moves in the wrong direction.
What are the benefits of investing in Forex?
A major advantage of trading in Forex is high liquidity. You can open a position on a currency pair at any time, and you never have to worry about not being able to close the position. Due to the high liquidity of the Forex market, transaction costs are also relatively low.
Another advantage of the Forex market is the fact that you can trade in currency pairs 24 hours a day. This means that it doesn’t matter where you are in the world, you can always open and close new trading positions.
What are the disadvantages of Forex trading?
A challenge for trading in Forex is the high leverage. Leverages can be attractive: if you use a leverage wisely, you can improve the profitability of your investment position. However, it is important to pay attention: if you take too much risk, you may experience a margin call. You then risk losing the entire amount in your account.
Another challenge is that you need sufficient knowledge to trade in Forex. For example, pay attention to the economic indicators that can affect currency pairs and study how to apply technical analysis.
Do you want to speculate on Forex?
The demand for currencies worldwide is constantly fluctuating. Factors that positively influence the demand for a currency can cause the exchange rate to rise, while factors that negatively influence the demand for a currency can cause it to fall.
When the interest rate on the euro rises, it can increase demand for the euro. This is because the euro offers a higher return. When a monetary zone performs better socio-economically, this can also attract more interest. By looking at these kinds of factors, you can determine whether it is wise to speculate on a price increase or decrease in a specific currency.
Do you want to know exactly how investing in foreign currencies works? Then read our guide to trading currencies:
Hedging on the currency market
Large companies use the forward & futures market to hedge against large risks. A multinational can easily see a large part of its profits evaporate when a currency moves in the wrong direction.
Companies therefore buy a contract that allows them to lock in an exchange rate. This way they know for sure that they can sell their European products for a fixed amount, despite possible fluctuations in the exchange rate. Do you want to know more about these kinds of contracts? Then read the article about swaps.
Conclusion about Forex trading
Forex trading is simply trading in currencies. When you engage in Forex trading, you try to predict whether a currency will increase or decrease in value relative to another currency.
Frequently asked questions about Forex
An exchange rate indicates the relative price of one currency against another currency. Reading the exchange rate is essential when you want to invest in Forex yourself. Do you want to know how exchange rates work when trading Forex? Then read this article.
Forex literally stands for Foreign Exchange. On this market, you can trade all currencies, but the vast majority of people trade in the euro, dollar, pound and Japanese yen. Forex trading always happens in a currency pair: you then measure the value of one currency against the value of another currency. Forex trading mainly takes place in major economic centres located in London, New York, Sydney, and Tokyo.
When you go on holiday, you can exchange your currencies at a currency exchange office at any time. When you invest in currencies yourself, there are some more restrictions. With most brokers, you can trade Forex from Sunday night 23:10 to Friday night 23:00. Every day there is a short break between 23:00 and 23:15 during which trading is suspended.
The dollar plays a dominant role and is involved in most currency transactions. When we look at the pairs, EUR/USD is the most traded: 25% of all transactions are carried out on this pair. In addition to the euro dollar, USD JPY and GBP USD are also popular currency pairs.
The value of a currency is not stable and is expressed compared to another currency. In Forex, for example, you can trade in EUR/USD, where you buy euros to then buy dollars. You then earn money when the value of the euro compared to the US dollar rises.
It is also possible to short a currency pair like EUR/USD. You earn money when the value of the euro compared to the dollar falls. The value of currencies is determined by various external factors, including Central Bank interest rate decisions, transactions executed by large companies, and the monetary policies of the respective governments.
With Forex, you can make high profits by making predictions based on the available data. It is never possible to predict the exchange rate with certainty, but professionals do have a higher success rate.
Personally, I like to predict the exchange rate by studying the charts. By identifying levels where the price does not move any further, you can build a good strategy by placing orders. Managing your maximum risk versus your profit plays an important role in becoming successful.
Starting with Forex trading is not difficult: all you need is a computer and to be at least 18 years old. However, trading Forex consistently is a different story and is achieved by only a few investors. Therefore, work on developing a good strategy and practice with a demo account.
Forex itself is reliable since it is the global market where currencies are traded. To trade on this market, you require access to it through a reliable Forex broker. Conduct thorough research into the available options, since not all brokers are equally reliable.
The Forex market, as we know it today, only came into existence relatively recently in 1967 after the Bretton Woods Agreement. This agreement determined that major currencies were allowed to move freely against each other, making it possible to actively trade currencies.
There are two methods to make money with currencies. The first method is to take advantage of the interest rate difference between two currencies. By buying the currency with the higher interest rate, you can earn a positive return; this is also known as a carry trade. It is important to note that there must be a strong interest rate difference between the currencies.
Another option is to speculate on a currency’s price increase. If the currency you bought becomes more valuable, you can earn a significant profit.
Ready to start with Forex?
Auteur
Over Alex Mostert
When I was 16, I secretly bought my first stock. Since that ‘proud moment’ I have been managing trading.info for over 10 years. It is my goal to educate people about financial freedom. After my studies business administration and psychology, I decided to put all my time in developing this website. Since I love to travel, I work from all over the world. Click here to read more about trading.info! Don’t hesitate to leave a comment under this article.
