The Foreign Exchange market, referred to as Forex or the FX market, is the largest financial market in the world and forex trading is very popular.
What is Forex?
The Foreign Exchange market, often referred to as Forex, FX market or spot market for forex, is considered to be the largest and most liquid market in the world. With an average daily trading volume of approximately $5 trillion, trading forex on the currency market dwarves other, more traditional means of investment such as the stock market. The Forex market is decentralised, meaning there is no central location where trades are conducted, rather, forex trading is conducted over the counter (OTC).
Traditionally, trading forex was reserved for major financial institutions and high net worth individuals. However, advances in technology have enabled anyone to invest in the currency market online and over 30% of daily FX trading is now conducted by retail traders.
The exponential growth in the number of retail investors conducting Forex trading has been facilitated by the introduction of derivatives that help in trading forex including Contracts for Difference (CFDs). By investing in these derivatives like EUR/USD, retail forex traders can speculate on whether the value of currencies will rise or fall, without taking ownership of the underlying asset.
How Does Forex Trading Work?
Forex Trading Sessions
The Forex market is open for trading 24 hours per day, 5 days per week and is traditionally separated into three trading forex sessions that overlap throughout the day:
• The Asian or Tokyo Session
Major economic data or economic announcement which may impact the whole trading day is released during this session. Heightened activity is expected in currency pairs featuring the Japanese yen
• The European or London Session
This session overlaps with the closing of the Asian session and sees the release of important data from Europe. Liquidity is highest during this session and increased activity is expected in pairs featuring the Euro and British pound
• The North American or New York Session
Coinciding with the second part of the European session, trading volumes are at their highest during this session. Significant price movements are expected in pairs featuring the U.S. dollar
Forex investing involves trading currencies in pairs, known as a currency pair. It means that investors are concurrently buying one currency while selling another. Currency pairs are separated into three categories:
• Major Forex Pairs
Top traded currency pairs where the USD is partnered with other major currencies. Major currencies include the EUR, GBP, JPY, CHF, CAD, AUD and NZD
• Cross-Currency Pairs
Currency pairs where one of the Major currencies, other than the USD, are partnered with other currencies. Crosses between other major currencies (EUR, GBP, JPY) are known as Minors
• Exotic Forex Pairs
Pairs that feature one of the Major currencies partnered with one from an emerging economy.
Forex market analysis
The price of a currency is a reflection of how positive or negative forex traders deem the future economic health of a country or region to be. So, in essence, when currency trading, investors are using fundamental indicators to effectively speculate on the performance of one country’s economic health against that of another. When they do this, it is called fundamental analysis.
For example, if a trader believes that the economy of the United States is going to outperform that of the Euro area, they would sell the EUR/USD currency pair (selling euros and buying pounds). On the other hand, if Euro area’s economy is likely to grow in comparison to that of the United States, a forex trader would buy EUR/USD (buying euros and selling pounds).
An alternative to fundamental analysis is known as technical analysis. This uses the concept of supply and demand to figure out where forex traders plan to buy and sell currencies. Trading on short-term price charts is known as day trading, while trading on long term charts is known as swing trading or position trading.
Factors That Affect the Currency Market
One of the most challenging aspects of learning how to invest in Forex is knowing when to buy and sell currencies. There are multiple factors that affect currency prices that forex traders looking to make more informed decisions can watch out for. The exchange rate between the United States and other major economies are known as major currencies or major forex pairs. They are affected by the economic calendar from their region.
• Economic Announcements
Economic announcement are released frequently for the countries involved in the top traded currency pairs, economic announcements are important indicators that can provide insights into how market prices may move, allowing traders to take the appropriate position
• Global News and Events
Major news and events including national elections, trade deals, new government policies and geopolitical tensions can all have major effects on the currency market. Staying up-to-date on the latest global bulletins can help investors plan their trading strategies
Trading with Financial Leverage
One of the features of how to trade currencies such as CFDs on Forex is the ability to use financial leverage. This enables investors to control larger market positions than the value of their initial investment. Leverage is expressed as a ratio (1:1, 5:1, 20:1) and in, FX trading, effectively means that an investor is using a small amount of their own funds while borrowing an amount from their Forex Broker to increase the volume of their trade.
For example, if an investor is trading with $1,000 of their own funds, applying leverage of 1:5 would enable them to control positions of up to $5,000. Using financial leverage can help traders increase their potential profits, however, it also involves risks that need to be understood and managed correctly.
Forex trading for Beginners
Through advances in technology, Forex investing for beginners is now easily accessible online via an online trading platform. These online trading platforms have historical charts, price quotes to quote the exchange rate, the spreads of the forex pairs in pips as well as the pace for entering a buy position or entering a sell position. The platform can be thought of as a marketplace for exchanging national currencies that includes all the exchange rate pairs.
Before new day traders starting their journey to trade currencies in the financial markets, beginners should ensure they have a thorough understanding of how to trade Forex and the trading risks involved in using financial leverage.
It is always advised that new traders study the available educational material and begin by opening a demo account, where they can use forex market analysis and test their trading strategies without risking any of their own capital. Additionally, employing a comprehensive risk management strategy which includes using appropriate levels of leverage and utilising Stop Loss and Take Profit levels is of paramount importance.
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