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What is Forex and How does it work?
Forex is a word derived from foreign exchange, and it is indeed the market where currencies are traded. This market has become global with a staggering average daily trading volume of around $5 trillion. The aim is to try to earn a profit as a result of the price changes that currencies go through. Since the amounts of currency that are converted on a daily basis lead to price movements, a trader can make the most out of this volatility.
Unlike shares, forex trading is run by a global network which is spread out across four major trading centres, each in a different time zone. As a result there is the advantage that a trader can trade forex any time of the day or night. Making exchange rate predictions is not that easy as there are numerous factors that could contribute to the movements of prices. So a trader will need to keep an eye on these factors so as to carefully analyse what is going on and predict a best as he can. News reports regarding economies and banks should be considered, as well as the effects of central banks which ultimately control the supply of the currency.
The market sentiment is another important aspect. With a particular piece of news there is bound to be a reaction by the market, and this can greatly affect the currency prices. For instance if most traders believe that the currency is going to head in a certain direction, they will trade according to their prediction, and as a result there could be a tendency for many others to follow suit, thereby affecting the supply and demand. It is also critical to give heed to economic data as they can give key indications of how the economy is doing, as well as hint onto what is likely to take place in the near future. A country’s credit rating should also be considered as a country’s credit rating can affect currency prices whenever it is upgraded or downgraded.
How does forex trading work?
First of all let us outline the three types of forex markets:
- The Spot forex market takes place on the spot, as a physical exchange of a currency pair takes place quickly or within a short period.
- The Forward forex market involves a contract to buy or sell a set amount of a particular currency at a certain price. This will be settled at a set date or in a range of dates in the future.
- The Future forex market refers to a similar process as that of a forward forex market, but the contract will be legally binding.
There are different ways that you can trade forex, but the concept is always the same – there is going to be a currency pair as you will be buying a currency while selling another currency. Many forex transactions take place via a broker.
The broker will have a considerable impact on various aspects of trading and so you need to choose carefully. When choosing a Forex broker make sure that you understand the trade structure that shall be utilised.
A dealing desk broker, also referred to as a market maker is a type of broker that will take the other side of your trades. He will set the bid and ask price. Then he will wait for the trader to take advantage of these terms. The broker will essentially be making a profit by buying at a lower price and then sell at a higher price. He will also be taking advantage of the spreads between the ask price and the bid. If you are a trader who prefers fixed spreads then you will prefer this kind of broker.
On the other hand there is a non-dealing desk broker. Sometimes such a broker is also referred to as electronic communications network broker ECN – or straight through processing STP broker. Basically this broker will not be taking the other side of the client’s trades but rather work with liquidity providers to give the client variable spreads, and then match them up with traders who can take the other side fo the trade.
Currencies are traded in lots, such as a standard lot with 100,000 units of a base currency. This appears a substantial amount and indeed an individual trader is not likely to have 100,000 units to place on a trade. As a result almost all forex trading is said to be leveraged. This means that the trader puts down a margin which is basically a small deposit, and once he closes the leveraged position the profit or the loss that is made will depend on the size of the trade. You may also have heard the term pips. These are the units that are used to measure the movement in a forex pair. A forex pip is equivalent to one digit movement in the fourth decimal place. These fractional pips or pipettes may seem small but they matter.
As a trader you need to take all this into account so as to decide when to buy and when to sell. If you believe that the value of the base currency is going to increase, you will open a buy or long position, and vice versa if you think it will decrease.
Unlike shares, forex trading is run by a global network which is spread out across four major trading centres, each in a different time zone. As a result there is the advantage that a trader can trade forex any time of the day or night. Making exchange rate predictions is not that easy as there are numerous factors that could contribute to the movements of prices. So a trader will need to keep an eye on these factors so as to carefully analyse what is going on and predict a best as he can. News reports regarding economies and banks should be considered, as well as the effects of central banks which ultimately control the supply of the currency.
The market sentiment is another important aspect. With a particular piece of news there is bound to be a reaction by the market, and this can greatly affect the currency prices. For instance if most traders believe that the currency is going to head in a certain direction, they will trade according to their prediction, and as a result there could be a tendency for many others to follow suit, thereby affecting the supply and demand. It is also critical to give heed to economic data as they can give key indications of how the economy is doing, as well as hint onto what is likely to take place in the near future. A country’s credit rating should also be considered as a country’s credit rating can affect currency prices whenever it is upgraded or downgraded.
How does forex trading work?
First of all let us outline the three types of forex markets:
- The Spot forex market takes place on the spot, as a physical exchange of a currency pair takes place quickly or within a short period.
- The Forward forex market involves a contract to buy or sell a set amount of a particular currency at a certain price. This will be settled at a set date or in a range of dates in the future.
- The Future forex market refers to a similar process as that of a forward forex market, but the contract will be legally binding.
There are different ways that you can trade forex, but the concept is always the same – there is going to be a currency pair as you will be buying a currency while selling another currency. Many forex transactions take place via a broker.
The broker will have a considerable impact on various aspects of trading and so you need to choose carefully. When choosing a Forex broker make sure that you understand the trade structure that shall be utilised.
A dealing desk broker, also referred to as a market maker is a type of broker that will take the other side of your trades. He will set the bid and ask price. Then he will wait for the trader to take advantage of these terms. The broker will essentially be making a profit by buying at a lower price and then sell at a higher price. He will also be taking advantage of the spreads between the ask price and the bid. If you are a trader who prefers fixed spreads then you will prefer this kind of broker.
On the other hand there is a non-dealing desk broker. Sometimes such a broker is also referred to as electronic communications network broker ECN – or straight through processing STP broker. Basically this broker will not be taking the other side of the client’s trades but rather work with liquidity providers to give the client variable spreads, and then match them up with traders who can take the other side fo the trade.
Currencies are traded in lots, such as a standard lot with 100,000 units of a base currency. This appears a substantial amount and indeed an individual trader is not likely to have 100,000 units to place on a trade. As a result almost all forex trading is said to be leveraged. This means that the trader puts down a margin which is basically a small deposit, and once he closes the leveraged position the profit or the loss that is made will depend on the size of the trade. You may also have heard the term pips. These are the units that are used to measure the movement in a forex pair. A forex pip is equivalent to one digit movement in the fourth decimal place. These fractional pips or pipettes may seem small but they matter.
As a trader you need to take all this into account so as to decide when to buy and when to sell. If you believe that the value of the base currency is going to increase, you will open a buy or long position, and vice versa if you think it will decrease.