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What is Forex?

What is Forex?

In this article, we will look at the history of the Forex market and figure out how it works. We will also study the main market participants and analyze the reasons Forex is so popular among ordinary traders.

Forex, also known as FX or Foreign Exchange, is a currency market where traders buy or sell foreign currencies at current or established prices. Forex is the largest market in the world in terms of the trading volume.

How does the Forex market work?

How does the Forex market work

Unlike the securities market, where each exchange holds their trading separately, Forex is divided into trading sessions that overlap in time. In other words, traders from Japan will be able to continue to open and close trades even after the Tokyo Stock Exchange closes because at that moment European markets are already open.

The Forex market itself is not some specific place or building. All the trading takes place online on weekdays around the clock worldwide. Special electronic networks were created for this reason. They are known under the abbreviation ECN - Electronic Communication Network. These networks analyze all current market offers and identify the most appropriate price level for opening a position to sell or buy currency. The resulting information is sent to all traders.

Forex currencies are designated in the form of currency pairs, for example, EUR/USD. In a standard Forex transaction, a trader buys a set amount of one currency by selling a certain amount of another currency. For example, a trader can buy dollars for euros or sell dollars and get euros in return. Since currencies are traded in pairs, the foreign exchange market does not determine the exact price of a currency. Rather it uses the comparative value of the exchange rate of one currency in a pair in relation to the second currency. Exchange rates are constantly changing, thus determining the current market price of a currency pair.

The Forex market as we know it now developed quite recently. Until the 1970s, the so-called Bretton Woods system of monetary management was used. In accordance with this system, the rates of the state currencies of many countries were tied to the exchange rate of the US dollar. The dollar exchange rate was backed by gold - the so-called "gold standard". Then countries gradually adopted floating exchange rates instead of a fixed rate.

Why should you trade on Forex?

There are several main reasons the Forex market is popular among traders:

  • large trading volumes provide a high level of supply and demand for assets, or liquidity in other words;
  • the market is decentralized and therefore independent of local economic restrictions that apply to a particular country;
  • the market works around the clock every day, except Saturday and Sunday;
  • exchange rates are constantly changing due to numerous factors affecting the market;
  • trading on the Forex market is accessible to almost anyone thanks to leverage.

How do you learn to trade Forex?

Since Forex is wildly popular, it’s easy to find a wide selection of Forex trading materials online. There are several ways to get the basic knowledge about trading:

  • Forex-themed forums and chat rooms;
  • textbooks on Forex trading:
  • video and audio lessons;
  • podcasts by experienced traders;
  • educational articles;
  • analytical materials and tools.

It is important to understand that success in Forex trading comes with experience. Don't count on instant profits. The more you engage in trading and devote time to training, the faster you will be able to achieve your goals.

When is the best time to trade on Forex? What are trading sessions?

Forex trading is available to any trader 24 hours on any weekday. It is impossible to enter the foreign exchange market on weekends and holidays. Working hours are directly connected to the schedule of trading sessions. The main trading sessions are the American, Asian and European sessions.

The American trading session starts at 12:00 and closes at 22:00 GMT. The European Forex session opens at 06:00 and closes at 16:00, while the Asian session is open from 23:00 to 09:00. There is also a Pacific trading session from 19:00 to 05:00. It is considered the most volatile session. The European session is considered optimal for entering the market, since it overlaps with the end of the Asian session and the beginning of the American session, which means high liquidity for many currency pairs.

It should also be noted that for each trading session holidays fall on different dates, and the number of non-working days is different. It depends on the specific dates of national holidays of different countries. This is why trading can be suspended on certain days for the duration of one of the sessions. The main dates are Catholic Christmas (December 24-25) and New Year's (January 1-2). For more information on non-working days and holidays, see the holiday calendar.

What is financial news?

Financial news is political and economic events that have a significant impact on the trading process on the financial market. Such news can be forecasts of various organizations about the current economic situation in the largest countries of the world, reports showing an increase or decrease in natural resources, or changes in the level of inflation or unemployment.

In order to keep track of the news, traders use the economic news calendar provided by most brokers.

Novice traders are advised not to enter the market during major macroeconomic news releases as it is difficult to predict sharp market movements at this time. It is also not recommended to start trading during the opening and closing of trading sessions due to the uncertainty in the trend movement.

Who trades on Forex?

The main players on the Forex market are the central banks, large international commercial banks, investment and hedge funds, as well as various financial companies and insurance organizations.

The above institutions trade on the so-called "interbank Forex market". This system was created specifically to facilitate currency exchange at a favorable rate. Professional traders representing banks and other financial institutions trade directly with other professional counterparties. The volume of such trading operations at the interbank level can reach several hundred million US dollars.

Although the main participants on the Forex market are large banks, trading is also available for individuals (traders) who seek to capitalize on changes in the exchange rate. Retail traders usually use Forex brokers as intermediaries to enter interbank trading. Transactions are made using specialized electronic trading platforms, through which they are brought to the interbank level.

It should be said that the total trade volumes of private traders are usually small in comparison with banks and do not affect exchange rate changes. However, experienced traders are able to generate significant profits by using various tools to analyze the market and predict its changes.

Who are brokers and traders?

Brokers are companies through which private investors can access the interbank Forex market to make buy and sell trades. They act as intermediaries between individuals and large financial institutions. Brokers are organizations providing individual traders with access to the foreign exchange market.

Forex brokers work based on the A-book (NDD - non-dealing deck) and B-book (DD - dealing desk) systems. You can read more about what brokers are and how their operation principles differ in the article “Types of Forex Brokers”.

A trader is a private investor, an individual who concludes trades on the foreign exchange market. They can trade for themselves or represent the interests of other individuals / legal entities. The main goal of a trader on the Forex market is to make a profit using their preferred trading strategies.

How does Forex trading work?

Trading volumes on Forex are calculated in lots. A lot is a standardized unit. 1 lot is 100,000 units of the base currency. This means that if you open a GBP/USD buy position with a volume of 1 lot, you’re buying 100,000 pounds for the corresponding amount of US dollars. At the rate of 1.31891, in order to buy 100,000 pounds you will need 131,891 US dollars. If you set the volume to 2 lots, then all the amounts are doubled.

But amounts like this are usually out of reach for most private traders. To ensure that trading is still accessible, Forex brokers provide additional services such as leverage or trading accounts with special conditions.

What is leverage?

As we said earlier, quite often traders do not have enough money to trade on Forex. In order to enable them to make trades, the broker can provide financial leverage. With its help, retail investors can open positions for amounts exceeding their own funds.

Leverage is the ratio of the private investor's (trader's) own funds and the funds provided by the broker to make transactions on the trading account. For example, the leverage can be 1:200 (one to two hundred). This means that with a $50 deposit, you will be able to manage an amount of $10,000 (50 x 200 = 10,000). Thanks to leverage traders can use less of their own funds than is necessary, for example, to implement a specific trading strategy. The lower the leverage, the more own funds the client needs to open positions. As a rule, the leverage cannot exceed 1:1,000.

However, it must be remembered that leverage is provided as a loan and is the property of the broker. This means you cannot withdraw these funds. What you can do is make more profitable trades and withdraw your own funds. When using leverage, a trader should always remember that they can only lose their own funds in the total balance. If the balance is reduced by the amount deposited to the trading account by the trader, the losing positions are automatically closed and the leverage is revoked. For more details on closing positions, see the article on Margin Call and Stop Out.

When creating an account and choosing leverage, keep in mind that its size can be different and depends on the trading conditions provided by the broker. You can get a leverage of 1:20 or 1:500.

What trading instruments can you trade on Forex?

Currency pairs

All transactions on the foreign exchange market include currency exchange. Therefore, rates of currencies are set relative to other currencies. In other words, each transaction is based on the exchange rates of the two currencies. For this reason, all currencies traded on the foreign exchange market are grouped into currency pairs, such as USDJPY. It is customary to divide currency pairs by popularity, namely by how often positions are opened for the pair. The so-called “major” pairs are the most popular currency pairs. “Minors” or cross pairs are less popular and exotic pairs are used even less frequently.For more details, see the article "What is currency pair?"

Metals

Precious metals have always been an integral part of world trade and commerce. Before the collapse of the Bretton Woods Agreement in 1971, main world currencies were pegged to the value of gold. Although precious metals are no longer used as the basis for monetary transactions, they still have a close relationship with currencies.

Precious metals are assets denominated worldwide in US dollars. Since the early 1970s, these metals have shown an inverse relationship with the value of the dollar. When the US dollar strengthens, the value of these precious metals falls, and when it weakens, the prices of metals rise. Metal prices also have a large impact on the currencies of the countries that import and export these metals.

Metals on Forex are also designated as quotes. Quotes reflect the current price of a certain volume of this metal called troy ounce in relation to US dollars. For example, gold is designated as XAUUSD, which includes the troy ounce of gold (XAU) and the US dollar (USD). Traders try to make a profit by using the fluctuations of this price.

Trading in precious metals is a reliable option for diversifying investment portfolios during the fall of the currency pair rates.

Oil

Historically, oil prices and exchange rates have always been closely related. Oil is an important source of energy and its price affects the global economy. Changes in world oil prices are communicated to financial markets and displayed through fluctuations in exchange rates. This is especially true for the currencies of the major oil importing and exporting countries. Many of the world's major currency pairs go up or down in response to fluctuations in oil prices.

Oil is represented on Forex by two brands - USCrude and UKBrent. Oil is priced in US dollars. Oil quotes represent the current price of 1 barrel of oil of the corresponding brand in US dollars. The US dollar is the settlement currency on the international oil market. When the dollar rises, you need less to buy barrels of oil. Likewise, when the USD rate falls, more currency is required to buy oil. Oil price surges lead to a depreciation of the US dollar and vice versa. By analogy with metals, the trader's goal is to make a profit using changes in the rate of oil against the dollar.

Cryptocurrencies

Cryptocurrencies are referred to as digital currencies. Despite that, they are different in many ways from conventional currencies such as the US dollar or the Japanese yen. Cryptocurrency trading is like Forex trading in that it involves exchanging one currency for another. However, the factors that influence the cryptocurrency market and the Forex market are quite different.

Unlike cryptocurrencies, real (fiat) currencies are backed by central banks of different countries. Cryptocurrencies, on the other hand, are maintained online by a decentralized authentication process (blockchain), which does not allow the cryptocurrency to be used more than once.

This system also generates new cryptocurrency in exchange for the efforts of people working on network security and verifying transactions. These people are called miners, and they receive a certain amount of newly issued cryptocurrency for their work.

The first cryptocurrencies appeared quite recently and immediately became popular instruments for Forex trading. The list of cryptocurrencies is extensive. The main cryptocurrencies include Bitcoin, Ethereum, and Bitcoin Cash. Most brokers provide quotes as the current rate of the cryptocurrency against the US dollar, for example BTCUSD. However, some brokers provide pairs with other currencies.

The cryptocurrency market is much more unpredictable and volatile than the Forex market. This is why cryptocurrency trading can be attractive for high-risk trading strategies.

Contracts for Difference (CFD)

A Contract for Difference (CFD) is an agreement between a buyer and a seller that provides for the exchange of the difference in the value of an asset between the opening and closing prices of a trade. Contracts for Difference allow traders to speculate on the prices of large companies' stocks.

It is important to understand that when trading CFDs, a trader does not become a shareholder of the company for which they purchased this contract. CFDs allow traders to profit from price movements without owning the asset itself. When buying a CFD, a trader buys an agreement or contract for the difference between the asset's opening and the closing prices.

For example, when opening a position to buy Disney stock CFDs (#DIS), the trader expects that the company's stock price will increase. The size of the difference between the opening and closing prices will be the size of the trader's profit or loss.

CFDs are advanced trading tools used by experienced traders. CFD trading is associated with a high level of risk and requires large financial investments.

Stock indices

A stock index is a generalized index calculated using the prices of a group of securities - the "index basket". The change in the stock index corresponds to the current changes in the prices of securities or other assets in the basket. When trading indices, traders can speculate on the price movements of those indices. A stock index can represent macroeconomic changes in the whole geographical region or in a selected economic sector.

For example, the NASDAQ100 index includes the 100 largest US companies by market capitalization listed on the NASDAQ stock exchange. The change in the index allows us to judge the dynamics of price changes on a larger scale than the stock price of a single company. Stock indices are popular market analysis tools. Indices are traded using derivatives such as Contracts for Difference (CFDs), futures, or options. Forex brokers mostly provide their clients with the opportunity to speculate on the prices of stock indices using CFDs.

Mini-FAQ

Is forex good for beginners?

Yes, the Forex market is attractive to beginners for several reasons. To start trading on Forex, it is enough to have a small deposit. Forex trading is available 24 hours a day, 5 days a week. You can trade from almost any place where a stable internet connection is available.

How do you learn forex?

To summarize, these are the main steps in learning Forex trading the beginner traders have to follow:

  1. Learn the basic concepts of Forex trading
  2. Study the interface of the trading terminal
  3. Choose the proper Forex broker
  4. Use demo accounts to study the process of trading
  5. Study different trading strategies and choose a suitable strategy for your own trading (develop your own strategy)

Can you live off Forex trading?

Yes, successful Forex trading can provide a stable living and even make you rich, but it also carries the risk of you losing your own funds. Only experienced traders with a proven trading strategy can afford to use Forex as their main source of income.

How difficult is Forex?

Forex trading is not easy. In order for Forex trading to be successful and profitable, you should be patient. First, you need to carefully study all aspects of Forex trading. This will take time and a good deal of persistence. The better you learn the basics of Forex, the easier it will be for you to trade in the long run.

Is Forex trading illegal?

Forex trading is completely legal and most large banks and other financial institutions participate in it. Unfortunately, not all Forex brokers remain honest with their clients and provide transparent trading conditions. Every novice trader should be familiar with the most common methods unscrupulous brokers use in order to deceive their clients and be aware of the associated risks.

Can I trade on Forex without a broker?

Yes, it is possible to trade on Forex without intermediaries, but for this you need to have a large amount of your own funds. One of the main advantages of brokers and Forex in general is the existence of credit leverage, which makes it possible for traders to enter the market even with a small initial deposit.

How much do Forex traders make a day?

It is impossible to specify the exact amount of how much the average Forex trader earns on average on a daily basis. The daily profit of traders depends on many factors, such as the number of profitable and unprofitable trades, the amount of funds on the account balance, the trade volume of closed trades, etc. By using a competent trading strategy and limiting the level of risks, a trader can earn from 5% to 15% per month from the amount of his initial deposit.

It is also worth noting that the amount of possible profit earned on Forex is practically unlimited. At the same time, the amount of incurred losses can not exceed the amount that the trader deposited on the trading account balance.

Article last updated: 2022-05-11

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