As the world continues to evolve, forex trading has become more popular over the recent years. As such, for those looking to learn more about FX trading, we have compiled a guide on all things related to forex, so you can better understand what it entails. Keep reading below to learn more about this topic.
What is forex trading?
Forex trading is simply the conversion of one currency into another, usually done for various purposes, but mainly for potentially making a profit. That said, there are plenty of currency conversions happening in the forex market that are for practical reasons, not just to simply make a profit. Traders can even speculate on forex price movements, with the aim of potentially benefiting from correctly predicting these specific movements.
What is the forex market?
Forex trading takes place on the forex market, which is the largest and most active financial market in the world. One thing that makes it unique is that it does not have a central marketplace. Instead, all trades are done electronically and over-the-counter (OTC). This means transactions take place on computer networks via traders worldwide, instead of on one centralised exchange.
The forex market is open 24 hours a day, five days a week. Trading typically takes place in major financial districts around the world, such as Sydney, Hong Kong, London, New York, Zurich, Paris, and more. As this covers various time zones, the forex market is extremely volatile and dynamic, with price quotes changing all the time.
How does the forex market work?
The FX market prides itself on being the only truly nonstop and continuous trading market in the entire world. While in the past the forex market was mainly made up of institutional firms and large banks, which acted on behalf of their clients, nowadays it has become more friendly to retail and individual traders and investors.
There are three main ways one can trade forex. That said, when most people talk about the forex market, they are actually referring to the spot market. Here they are explained more below:
Spot market: This is the primary place forex trading happens. It is where currencies are sold and purchased based on their current trading price. This price is determined by the forces of supply and demand, as well as some other factors, such as economic performance, current sentiment, price speculation and current interest rates. A finalised deal done here is known as a spot deal.
Forwards market: A forward contract refers to a private agreement between two separate parties to purchase a currency at a future date and predetermined price. This is done in the OTC market. Here, forward contracts are bought and sold OTC between the two parties, and they are the ones who determine the details and terms of the agreement.
Futures market: While similar to a forward contract, a futures contract is instead a standardised agreement between two parties. Again, it is an agreement to purchase a currency at a future date and predetermined price. Here, the futures contracts are traded on exchanges, not OTC. As such, the contracts are bought and sold based on a settlement date and standardised size.
Forex for speculation
Traders can get into forex trading to speculate on the price of currency pairs. There are plenty of factors that can influence a currency’s price, such as trade flows, interest rates, economic strength, tourism, current events and more. All of these affect the supply and demand of a currency, making the forex market incredibly volatile. This volatility is what makes the forex market so attractive, as traders can find opportunities to take advantage of, and potentially profit from price changes that may decrease or increase the value of a currency in relation to another.
Forex for hedging
Another thing traders can do in the forex market is to hedge against price movements. For instance, companies that have business in foreign regions are at risk in case the price of a currency fluctuates, especially if they have to sell or buy services and goods. Fortunately, the forex market provides traders and businesses with a way to hedge currency risk. This is done by fixing a rate at which a particular transaction will be completed. Traders can either sell or buy currencies in the forward or swap markets in advice, which helps them lock in an exchange rate.
Forex trading terminology
Those looking to get started on their forex trading journey should start to learn the terminologies and technical jargon associated with forex trading. Here are a few popular terms to know below:
Ask: An ask (also known as an offer) is the lowest price at which a trader is willing to purchase a currency.
Bid: A bid is the price at which a trader is willing to sell a currency.
Leverage: Leverage refers to the use of borrowed funds so traders can open a larger position than what they initially paid for. The forex market is mainly characterised by high leverages, with traders mainly using them to increase their trading positions.
Forex vs stocks
Surprisingly, the forex and stock market are similar to each other, as a result of their historical volume and volatility. In fact, these two markets are currently very popular with traders today. That said, there are still a few differences between them.
Market trading hours
Trading hours are different between the forex and stock market. As mentioned above, the forex market is open 24 hours a day, five days a week. This is a major advantage that forex trading has over stocks. On the other hand, with stocks, there is a set daily timetable for stock trading hours. The times will depend on the specific region and exchange a trader picks.
Liquidity and volatility
Market volatility refers to the measure of price fluctuations that happen within the market. Forex traders typically focus on high-volume activities in the span of a short time. This makes liquidity very effective for forex traders. On the other hand, stock traders generally use the buy-and-hold method, so they may be less comfortable in a volatile environment, especially if they are looking to gain potential returns in the long term.
For forex trading, there are plenty of forex trading strategies that aim to potentially make a return in the short term. This means traders are likely to use strategies such as swing trading, day trading, and scalping. On the other hand, focused strategies for stock trading tend to be less common, as stocks are typically traded through long-term positions. That said, stock traders can still use strategies such as day trading to help them with their trades.
Overall, forex trading can be a potentially lucrative endeavour if a trader manages their risk correctly, monitors the market, and understands how forex trading works. Additionally, a focus on understanding the factors that influence the price of a currency, and experience with certain trading strategies, can help a forex trader do well in the market.