If the thought of trading foreign currency may seem a little, well, foreign, you’re in the right place. Once you understand the market’s history, a few key terms, and where you can start trading, you’ll be on your way to becoming a full-fledged forex trader.
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History of the Forex Market
The foreign exchange market, usually shortened to “FX” or “forex,” has been around for more than 500 years. Before that, humans bartered goods and traded in copper, silver, and gold.
However, it was not until the first foreign exchange trading market was established in Amsterdam a half-century ago – in the aim of helping to stabilize currency exchange rates – that international forex trades really began.
The forex market is unique in several ways to other markets like the stock market or the real estate market, starting with the fact that it is the most liquid market in business. While stocks of a company are traded in the standard stock market – which can be transformed into capital – the forex market is directly trading the money itself, or better said, its trading government issued currency in its various forms.
Thanks to this aspect alone, the forex market has a whopping $5 trillion in daily turnover, making it the largest market in operation. While most of us think about the standard Monday to Friday working hours when we think of Wall Street operations and traders studying market numbers, the forex market covers currencies in several different time zones. Thus, it’s a 24-hour, 5-day-a-week operation.
The FX market opens starting at 5 pm EST on Sunday (opening hours in Syndey’s market on Monday morning) and closes at 4 pm EST on Friday.
Terms you Need to Know About the Forex Market
Each market has its own lexicon of lingo for traders working within a particular niche. When one talks about the FX market, you’ll commonly hear these terms:
1. Brokerage firm or broker
A broker is synonymous with an intermediary. In the forex market, brokers are firms or individuals that act as a gateway to trading platforms where traders can gain access to buying and selling foreign currencies. Check out Benzinga’s article offering you a variety of options on the Best Forex Broker for Beginners. Here’s a quick look at some of our favorites for beginners.
2. Bid-ask spread
In few words, the bid-ask spread is the commission brokers make for being your intermediary on a foreign exchange platform. Explained in more detail, the bid price is the maximum price that a buyer is willing to pay for a currency, whereas the ask price is the minimum amount at which a broker is willing to sell a currency. This difference in between is called the spread.
As you can imagine, the smaller the spread, the better for the trader. The size of the spread you are offered will depend on a lot of things, including the overall demand for the currency, its volatility, and its liquidity. The more liquid an asset is, the smaller the spread. This is why spreads are usually pretty tight in the forex market, it’s all liquid.
3. Currency pairs
While there are currently 180 government issued currencies used across the world, the majority of forex traders focus on only about a half dozen of them. What’s more, nine times out of ten, the US dollar is one half of the pair, which makes remembering the most commonly traded pairs pretty easy.
- EUR/USD (euro/dollar)
- USD/JPY (U.S. dollar/Japanese yen)
- GBP/USD (British pound/dollar)
- USD/CHF (U.S. dollar/Swiss franc)
These first four are known to many as the “majors” of forex trading, similar to the major league players of baseball. These five currencies are by far the most heavily traded players in the forex market, driving the bulk of activity in foreign exchange. However, there are a few runner-ups who are seen in a substantial amount of trades. Those are:
- AUD/USD (Australian dollar/U.S. dollar)
- USD/CAD (U.S. dollar/Canadian dollar)
- NZD/USD (New Zealand dollar/U.S. dollar)
4. Going Long/Short
There is actually a reason as to why one currency goes in front of the other, i.e., EUR/USD and USD/EUR mean two different things in the forex market. The first currency is the one being purchased by a trader, and the second currency is the one being sold. Here are where the terms “long” and “short” come in.
For example: if you were buying euros and selling dollars, hoping for an increase in the value of the euro, you would be going long EUR/USD. Going short, on the other hand, is betting on the depreciation of a currency, i.e. you are hoping that a currency loses value, which will case you to gain profit. When going short, the first currency is being sold while the second is being bought. To continue with our example, shorting a EUR/USD trade means you would sell euros hoping that the currency loses value.
5. Forex charts
Forex traders rely heavily on charts in order to make educated guesses about how a currency value will change by observing historical fluctuation patterns. Nearly all charts have personalized setting options to allow traders to view a variety of technical indicators like price, volume, etc. in order to analyze price movements.
The three most commonly used forex charts are bar charts, line charts, and candlestick charts. Best of all, the top charts on the market on free! Check out Benzinga’s article on Best Forex Charts for a more detailed breakdown of chart options. Most any broker you work with will also provide you with access to charts, so you’ll have a host to choose from. The key is narrowing in on which charts will help you make your best market readings and carry out your most lucrative trades.
While skilled forex trading requires knowledge of macroeconomic changes and politics, as well as careful consideration of how these factors will impact the value of various currencies, this aspect is not the biggest one that has traders losing money – it’s leveraging. Leveraging is used in the forex market to increase the potential profits (or losses) a trader can make from fluctuations in exchange rates between two currencies.
Why is it necessary? Because without leveraging, which can increase your profits by 50:1, 100:1, or even 200:1, traders of the forex market would be making pennies. This is because currency prices usually change by less than one percent within one trading day, so leveraging allows traders to make it big from a relatively small actual change.
Remember that the forex market is volatile and highly-liquid, thus leveraging levels are on a whole different plane to other markets like equities or futures, which offer leverages of 2:1 and 15:1, respectively.
7. Margin and margin account
A margin is the amount represented in the “1” of the leveraging ratios mentioned above, i.e., 50:1, 200:1, etc. It is a small percentage of money put into your margin account as an act of good faith towards your broker, who will either pay you or charge you up to 50, 100, or 200 times what you placed in your account, depending on how your chosen currency pair performed.
Remember when learning about leveraging we noted that currency prices usually change by less than one percent within one trading day? This means traders are constantly looking at menial changes that occur several numbers after the percentage point.
These are PIPs, an acronym for “price interest point”, which is almost always referring in forex trading to the fourth number after the decimal point, the standard decimal place in forex trading. Here’s an example: Today’s EUR/USD exchange rate is roughly 1.1534 – here 4 is the pip. If several hours later the value of the euro increases to 1.1537, that means an increase of three pips and profit for the trader who bought euros.
As you go deeper down the rabbit hole into forex trading, you will learn how exactly to calculate the value of one pip, based on the current exchange rate and the amount of leverage you agreed upon with your broker. This will allow you to calculate how much a movement of one pip will increase or decrease your portfolio value.
9. Spot market
This term refers to the time at which trades take place. In a spot market, trades are made immediately. Conversely, in a non-spot market, also known as futures, or a future transaction, both parties agree to buy/sell currencies at the current price, but make the actual swap down the line.
This is done for several reasons, but an easy example can be seen in the commodities market when an airline company needs to secure that it has enough fuel six months from now. If oil prices are low, they may sign a futures contract, committing to pay today’s oil price 6 months down the line. If the price goes up over time, they made a smart move.
If the price continues to go lower, they realize they could have saved more, however, the security of ensuring a supply of their necessary resource at a low price was most important to them. In terms of the forex market specifically, most people, especially newer traders, shoul stick to operating in the spot market, which is quite volatile on its own without adding lengthened time periods and diverse exchange rates. As a beginner, get very familiar with the spot market before moving onto futures.
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Understand the Risks Associated with Forex Trading
Currencies are specifically susceptible to swings based on major events as planned as the announcement of the unemployment rate, or as unplanned as a hurricane. Information like this can quickly cause investors to lose faith in a currency and jump ship. Small fluctuations in pips can lead to big wins or losses for traders, chiefly due to the size of your leverage.
Make sure to talk to your broker about implementing a stop-loss in your portfolio, in order to automatically close out of trading if you ever reach a predetermined amount of losses. You can also put a stop-limit on a single currency you’re holding, preemptively telling your trader to sell if the currency ever reaches below X price. As a general rule of thumb, do not bid with more than you can afford to pay back.
You’ve just learned about the ABC’s of forex trading, but make sure to continue familiarizing yourself with the fundamentals of this heavily traded market before you put a significant amount of money on the line. If you would like to try your hand at the forex market, take advantage of a few risk-free trials with trading platforms like MetaTrader 4, which will give you 30 days to test out trading forex using virtual money.
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