Forex stands for foreign exchange and it is the name given to the currency market/foreign exchange market on which FX traders buy and sell currencies.
What is forex trading?
Forex trading is the way you can trade two currencies against one another. It’s possible to profit in forex if you buy a currency that strengthens versus another currency.
You can think of it like day trading stocks but with currencies on the forex markets instead of shares on the stock market!
A currency rises or falls in value relative to another currency when forex trades happen, so the price is shown as a currency quote. You will have seen these same quotes at the foreign exchange office if traveling overseas.
The change in the quote happens when currency conversion takes place. Foreign currencies converted millions of times (check the average daily trading volume)every day creates the volatility that provides the opportunity for how to profit in forex and creates the risk of loss.
How foreign exchange trading works
Forex trading (FX for short) for most people is done using an online forex trading platform like the one offered by FlowBank. On this trading platform, there is the choice of many exchange rates to trade. Each exchange rate is known as a currency pair or forex pair.
Inside the trading platform, the process of buying a currency pair (or selling) is very easy with simple buy and sell buttons.
Source: FlowBank mobile app
Each currency has a code for how it is written.
The most actively traded forex pair in the world is EUR/USD. EUR stands for euro and USD stands for US dollar. What the currency exchange quote is telling you is the price of one euro in dollars.
What is a base and quote currency?
The first currency in the quotation pricess for forex is known as the base currency and second currency is known as the quote currency.
For example: EUR/USD = 1.35
EUR = Base currency
USD = Quote currency
This means one euro is worth 1.35 dollars.
As a trader, you aim to profit in forex by buying and selling EUR/USD. For example:
If you buy EUR/USD at 1.35 and sell at 1.36 => you make a profit
If you buy EUR/USD at 1.35 and sell at 1.34 => you made a loss
Which currencies can I trade?
The World’s major currencies as well as lesser known currencies can be traded in forex. As a rule of thumb, forex traders target the currencies of the top 10 largest economies. Currency pairs are typically split into three major groupings.
1. Major forex pairs
These include the US dollar and seven currencies from some of the traditionally largest currency markets in the world.
They are: EUR/USD, GBP/USD, USD/CHF, USD/JPY, AUD/USD & AUD/USD.
2. Minor forex pairs
These are typically involve two major currencies excluding the US dollar.
Examples include: EUR/CHF, AUD/NZD or GBP/JPY
3. Exotic forex pairs
These are a major currency set against smaller or emerging market currency.
Examples such as: USD/RUB, GBP/INR, EUR/PLN
The trading of the seven major forex pairs makes up 8 out of every 10 forex trades placed on foreign exchange markets. That’s because the US dollar is the world reserve currency and is used to purchase almost every commodity, including gold and oil.
Given that gold and silver are oldest forms of money, it makes sense that they would be available to trade too. The spot gold price is quoted with the symbol XAU/USD and silver is XAG/USD.
FAQs: How to calculate profit when you trade forex
To understand how to calculate your profit margin when foreign exchange trading, it’s useful for novice traders to understand the answers to the most common questions about forex.
What is a pip in forex?
Pip is short for ‘price interest point’. It is the smallest reference point for the change in price of an exchange rate. Because exchange rates are typically quoted in fractions of a currency, a pip is used to understand those fractional movements more precisely.
For major currencies, the pip is typically the fourth decimal point.
For example: EUR/USD = 1.3001 (The pip is the ‘1’)
But in some cases, typically involving a weaker currency - the pip is valued differently - such as with the Japanese yen, where the pip is the second decimal point).
USD/JPY = 104.32 (The pip is the ‘2’)
What is the spread in forex trading?
The spread is the difference between the buy price and sell price on the currency pair and is measured in pips. With more competition among brokers and as technology improves, forex spreads are generally trending lower. Let’s take a hypothetical example:
GBP/USD = bid 1.4035 / ask 1.4037
The buy price is almost identical to the sell price but there is a small difference of 2 pips (7 - 5 = 2)
The best forex trading platforms will display the amount of the spread before you place the trade, and automatically calculate the exact cost in the currency of the trading account.
What is a lot in forex?
Currencies trade in blocks known as ‘lots’. The standard lot size in the forex market is 100,000. The best forex brokers will offer ‘mini lots’ and even ‘micro lots’ to trade of 10,000 and 1,000 units.
Let’s take an example:
USD/CHF = 0.9325
One lot of $100,000 in Swiss francs is 100,000 * 0.9325 = 93,250 CHF
We can also understand the value of a pip once we know the lot size.
E.g. a spread of 2 pips = 0.0002 * $100,000 = $20
What is leverage in forex?
Not everybody has the ability to start making forex investments worth hundreds of thousands of dollars. Fortunately, there is a way to trade with lower available capital by trading on margin using leverage. Spot forex pairs are a form of financial derivative and leveraged products.
Leverage is expressed as a ratio. It is a ratio between the funds you need in your account to place a trade and the value of the trade.
What is margin in forex?
The margin requirement is the amount of funds needed in your account to place a trade.
If the leverage is 30:1, then you need $1 in your account to trade $30. However, $30 is too small to trade.
To trade three standard lots worth $300,000 you need ($300,000 / 30) = $10,000
Making a forex trade
With the understanding about pips, spreads lots, leverage and margin - we can now better understand how to calculate profit in forex and execute orders. In order to do this let’s set out an example forex trade.
EUR/CHF trades with a price of 1.1103 / 1.1106 (3-pip spread)
You place a trade to go long (buy) €20,000 at the ask price of 1.1106
The leverage ratio is 30:1 (margin rate of 3.34%)
Therefore the margin requirement is (0.34% x 20,000) = 668 EUR (or 741 CHF)
Example winning forex trade:
The trade idea was right and the prices rises to 1.1153 / 1.1156
You close the trade at the bid price of 1.1153
The difference between your entry and exit is 47 pips.
That means a profit of 47 pips, including all fees.
Example losing forex trade:
The idea was wrong this time, and the price falls to 1.1053 / 1.1056
You close the trade at the bid price of 1.1053
The difference between your entry and exit is 53 pips
That makes a loss of 53 pips including all fees
*in both instances, the forex market moved 50 pips but a spread of 3 pips was taken away from the profit and added to the loss.
How to make money in trading forex
To find the best opportunities in forex - smart traders learn how to trade the forex market, including how to read charts, manage risk and stay disciplined. By this point we have understood how to buy and sell currency trading on margin with leverage.
Forex trading for beginners should begin with some form of forex training to learn the best practises of successful traders. Flowbank offers training in forex through numerous blogs and videos on FlowBank.com.
Checkout our blog: What is MACD? A MACD Trading Strategy Example
There are also many free online forex courses and some top trading books written by smart traders and well-known trading mentors, as well as many free forex ebooks.
From a very birds eye perspective there are 7 majors steps in learning how to make money forex trading:
- Learn how the forex market works (you just got started with this blog! Well done!!)
- Open a demo trading account (you can click here to open a FlowBank trading account)
- Get familiar with the trading platform
- Learn technical analysis to be able to read the market price action
- Learn the principles of risk management.
- Develop a trading strategy and backtest the results
- Start trading in a live forex account
A simple forex trading strategy for beginners in the forex market
Don’t worry - we won’t leave you hanging without an example of how to put all that knowledge together when you trade currencies.
Bear in mind this is intended as an easy trading strategy to get started with some price action signals and some proper money management. It is a simple example to get you started using and improving your forex trading skills, not a path to fortunes in itself!
Trend following forex strategy with trendlines
The idea behind this strategy is to trade in the direction of the overall trend in the market but buying when there is temporary weakness in the price. Therefore, you can check on patterns such as the daily average trading volume to get an idea of what to expect in the market.
Steps to trade setup
- Find a market that is trending up on a 4-hour or daily chart timeframe (H4 or D1)
- Draw a trendline connecting two or more ‘lows’ (see below)
- Enter with a market order to buy when the price has bounced more than 20 pips after touching the trendline. **
- Set the order as GTC (good til cancelled)
- Set a stop loss 30 pips under the trendline = (50 pips slop loss)
- Set a take profit order of 100 pips (2:1 risk to rewards ratio)
- Cut your losses if the stop loss is reached
- Take your profits if your TP order is reached.
- If the price drops straight below the trendline, cancel the trade
- If the price never reaches the trendline, cancel the trade
** Optional extra would be to wait for a Japanese candlestick pattern at the trendline
Thank you for reading and be sure to check out our next article on: How the forex market works