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Forex Trading Basics
The Forex marketplace is an international trading hub of various world currencies. On Forex, investors are able to buy and sell currency pairs, speculating on the value of them relative to each other.
Forex was established in 1971 and has since grown into the largest trading marketplace in the world. In fact, over $4 trillion on average is traded on Forex every single day. All Forex trades are made via the telephone or the Internet and the market stays open 24 hours a day, Monday to Friday.
The Forex is the most popular marketplace in the world for a variety of reasons:
- It is a volatile currency market providing plenty of opportunities for short-term profits.
- Long-term trades on currency can provide solid gains and the opportunity to hedge against other risks in your portfolio.
- Forex currency pairs are sold on leverage, so you can control much more capital than you actually invest. This lets you grow your bankroll grow quickly if you are able to profit.
- The convenience of trading anywhere in the world.
- There aren't any traditional fees charged by Forex; you only need to cover the spread that's set by your trading firm.
Currency Pairs Explained
Forex trading involves only one type of investment, known as currency pairs. A currency pair is a quote that is set when you use one currency to purchase a fixed amount of another.
Reading a quote is easy. The first currency quoted is known as the base currency, which is the one you are using to make a purchase. The base currency always equals 1. The second currency is known as the quote currency and is the one you are purchasing. The number after the quote is simply the amount of the quote currency you are purchasing. AUD/JPY 2.52, for example, means you would get 2.52 Japanese yen for every Australian dollar spent.
Whenever you read a currency pair quote, you need to pay close attention to the spread. Because Forex doesn't charge any fees, trading firms implement a spread in order to make money. A spread is the difference between the price they will sell a currency for and the price they will buy it. The spread is usually only several decimal places, but spreads can eat into short-term trades very quickly.
Common Currency Pairs
Forex is a worldwide marketplace that allows trading of a wide variety of currencies, but investors usually stick to what they know. Most of the $4 trillion in daily trades is confined to only 18 currency pairs.
In fact, the majority of trades only include eight separate currencies, including the Australian dollar, Japanese yen, New Zealand dollar, Swiss franc, and the Canadian dollar. Not surprisingly, the British pound, euro and US dollar round out the most popular currencies.
You can trade other currencies and currency pairs if you wish, but the small volume of trades can make it difficult to buy and sell at times. Less volume also makes them much more volatile, and a much riskier proposition than the more established currencies listed above.
Why Currency Prices Fluctuate
Currency behaves like many other tradeable assets, such as stocks and commodities. The prices are set by simple supply and demand. This is one of the reasons that stock traders are beginning to get serious about the Forex market. If you're good at trading stocks, you'll probably also be good at trading currency pairs.
Here are some of the key indicators that will affect a currency's price:
- Interest rates. Interest rates are vital because they directly affect the strength of a country's economy and currency. You can also earn the difference between a currency pair's interest rate if the currency you purchase has a higher interest rate than the one you sold.
- Economic indicators. The best indicator of a currency's future value is the economic state of its country. Economic indicators such as GPD, CPI, retail sales, and industrial production are strong indicators of where a currency is headed.
- Employment. A country's employment numbers are also a good indicator of currency value. The better the employment numbers, the more spending and investing can occur and the less inflation will rise, all pointing to a stronger currency.
Now that you know the basics of Forex trading, you're ready to get started with some small transactions. Dip your toe in the water by creating an account with us today.