FOREX Trading

What is forex? Quite simply, it’s the global market that allows the exchange of one currency for another.

If you’ve ever traveled to another country, you usually had to find a currency exchange booth at the airport, and then exchange the money you have in your wallet into the currency of the country you are visiting.

You go up to the counter and notice a screen displaying different exchange rates for different currencies.

You find “Japanese yen” and think to yourself, “WOW! My one dollar is worth 100 yen?! And I have ten dollars! I’m going to be rich!!!”

When you do this, you’ve essentially participated in the forex market! You’ve exchanged one currency for another.

Or in forex trading terms, assuming you’re an American visiting Japan, you’ve sold dollars and bought yen.

Before you fly back home, you stop by the currency exchange booth to exchange the yen that you miraculously have left over (Tokyo is expensive!) and notice the exchange rates have changed.

It’s these changes in the exchanges rates that allow you to make money in the foreign exchange market.

The foreign exchange market, which is usually known as “forex” or “FX,” is the largest financial market in the world.

Compared to the “measly” $22.4 billion per day volume of the New York Stock Exchange (NYSE), the foreign exchange market looks absolutely ginormous with its $5 TRILLION a day trade volume.

That’s trillion with a “t”.

Let’s take a moment to put this into perspective using this pie chart.

The largest stock market in the world, the New York Stock Exchange (NYSE), trades a volume of about $22.4 billion each day. If we used a monster to represent the NYSE, it would look like this…

Looks intimidating. Some may even find it sexy.

You hear about the NYSE in the news every day… on CNBC… on Bloomberg…on BBC… heck, you even probably hear about it at your local gym. “The NYSE is up today, blah, blah”.

When people talk about the “market”, they usually mean the stock market. So the NYSE sounds big, it’s loud and likes to make a lot of noise.

But if you actually compare it to the forex market, it would look like this…

That huge $5 trillion number covers the entire global foreign exchange market, BUT daily trading volume from retail traders (that’s us) make up between 5-6% of overall volume, or between $300-400 billion. 

So you see, the forex market is definitely huge, but not as huge as the others would like you to believe. We don’t like to exaggerate.

The forex market is open 24 hours a day and 5 days a week, only closing down during the weekend. (What a bunch of slackers!)

So unlike the stock or bond markets, the forex market does NOT close at the end of each business day.

Instead, trading just shifts to different financial centers around the world.

The day starts when traders wake up in Sydney then moves to Tokyo, London, Frankfurt and finally, New York, before trading starts all over again in Sydney!

What is traded in forex?

The simple answer is MONEY.

Because you’re not buying anything physical, forex trading can be confusing.

Think of buying a currency as buying a share in a particular country, kinda like buying stocks of a company.The price of the currency is usually a direct reflection of the market’s opinion on the current and future health of its respective economy.

In forex trading, when you buy, say, the Japanese yen, you are basically buying a “share” in the Japanese economy.

You are betting that the Japanese economy is doing well, and will even get better as time goes. Once you sell those “shares” back to the market, hopefully, you will end up with a profit.

In general, the exchange rate of a currency versus other currencies is a reflection of the condition of that country’s economy, compared to other countries’ economies.

Major Currencies

While there are potentially lots of currencies you can trade, as a new trader, you will probably start trading with the “major currencies.”

Currency symbols always have three letters, where the first two letters identify the name of the country and the third letter identifies the name of that country’s currency.

Take NZD for instance. NZ stands for New Zealand, while D stands for dollar. Easy enough, right?

Buying And Selling Currency Pairs

Forex trading is the simultaneous buying of one currency and selling another. Currencies are traded through a broker or dealer, and are traded in pairs.

For example the euro and the U.S. dollar (EUR/USD) or the British pound and the Japanese yen (GBP/JPY).When you trade in the forex market, you buy or sell in currency pairs.

Imagine each currency pair constantly in a “tug of war” with each currency on its own side of the rope. Exchange rates fluctuate based on which currency is stronger at the moment.

The majors are the most liquid and widely traded currency pairs in the world.

BRIICS  is the acronym coined for an association of five major emerging national economies: Brazil, Russia, India, Indonesia, China and South Africa.

Originally the first four were grouped as “BRIC” (or “the BRICs”). BRICs was a term coined by Goldman Sachs to name today’s new high-growth emerging economies.

BRIICS is the term used by the OECD, the rich-country think tank adds Indonesia and South Africa.

Unlike other financial markets like the New York Stock Exchange (NYSE) or London Stock Exchange (LSE), the forex market has neither a physical location nor a central exchange.

The forex market is considered an over the counter (OTC), or “interbank” market due to the fact that the entire market is run electronically, within a network of banks, continuously over a 24-hour period.This means that the spot forex market is spread all over the globe with no central location. Trades can take place anywhere as long as you have an Internet connection!

The forex OTC market is by far the biggest and most popular financial market in the world, traded globally by a large number of individuals and organizations.

In an OTC market, participants determine who they want to trade with depending on trading conditions, the attractiveness of prices, and the reputation of the trading counterparty.

The chart below shows the seven most actively traded currencies.

Currency Distribution in Forex Market

*Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%

The dollar is the most traded currency, taking up 84.9% of all transactions.

The euro’s share is second at 39.1%, while that of the yen is third at 19.0%.

As you can see, most of the major currencies are hogging the top spots on this list!

You’ve probably noticed how often we keep mentioning the U.S. dollar (USD).If the USD is one-half of every major currency pair, and the majors comprise 75% of all trades, then it’s a must to pay attention to the U.S. dollar. The USD is king!

In fact, according to the International Monetary Fund (IMF), the U.S. dollar comprises roughly 64% of the world’s official foreign exchange reserves! Because almost every investor, business, and central bank own it, they pay attention to the U.S. dollar.

There are also other significant reasons why the U.S. dollar plays a central role in the forex market:

Speculation in the Forex Market

One important thing to note about the forex market is that while commercial and financial transactions are part of the trading volume, most currency trading is based on speculation.

In other words, most of the trading volume comes from traders that buy and sell based on intraday price movements.

The trading volume brought about by speculators is estimated to be more than 90%!

The scale of the forex market means that liquidity – the amount of buying and selling volume happening at any given time – is extremely high.

This makes it very easy for anyone to buy and sell currencies.

From the perspective of a trader, liquidity is very important because it determines how easily price can change over a given time period.A liquid market environment like forex enables huge trading volumes to happen with very little effect on price, or price action.

While the forex market is relatively very liquid, the market depth could change depending on the currency pair and time of day.

In our forex trading sessions part of the school, we’ll tell you how the time of your trades can affect the pair you’re trading.

In the meantime, here are a few tricks on how you can trade currencies.

The objective of forex trading is to exchange one currency for another in the expectation that the price will change.

More specifically, that the currency you bought will increase in value compared to the one you sold.

Trader’s ActionEURUSD
You purchase 10,000 euros at the EUR/USD exchange rate of 1.1800+10,000-11,800*
Two weeks later, you exchange your 10,000 euros back into U.S. dollar at the exchange rate of 1.2500-10,000+12,500**
You earn a profit of $7000+700

*EUR 10,000 x 1.18 = US $11,800
** EUR 10,000 x 1.25 = US $12,500

An exchange rate is simply the ratio of one currency valued against another currency.

For example, the USD/CHF exchange rate indicates how many U.S. dollars can purchase one Swiss franc, or how many Swiss francs you need to buy one U.S. dollar.

Currencies are always quoted in pairs, such as GBP/USD or USD/JPY. The reason they are quoted in pairs is that, in every foreign exchange transaction, you are simultaneously buying one currency and selling another.

Here is an example of a foreign exchange rate for the British pound versus the U.S. dollar:GBP/USD forex quoteThe first listed currency to the left of the slash (“/”) is known as the base currency (in this example, the British pound), while the second one on the right is called the counter or quote currency (in this example, the U.S. dollar).

When buying, the exchange rate tells you how much you have to pay in units of the quote currency to buy ONE unit of the base currency. In the example above, you have to pay 1.51258 U.S. dollars to buy 1 British pound.

When selling, the exchange rate tells you how many units of the quote currency you get for selling ONE unit of the base currency.

In the example above, you will receive 1.51258 U.S. dollars when you sell 1 British pound.

The base currency is the “basis” for the buy or the sell.

If you buy EUR/USD this simply means that you are buying the base currency and simultaneously selling the quote currency.

In caveman talk, “buy EUR, sell USD.”

  • You would buy the pair if you believe the base currency will appreciate (gain value) relative to the quote currency.
  • You would sell the pair if you think the base currency will depreciate (lose value) relative to the quote currency.

Long/Short

First, you should determine whether you want to buy or sell.

If you want to buy (which actually means buy the base currency and sell the quote currency), you want the base currency to rise in value and then you would sell it back at a higher price.

In trader talk, this is called “going long” or taking a “long position.” Just remember: long = buy.

If you want to sell (which actually means sell the base currency and buy the quote currency), you want the base currency to fall in value and then you would buy it back at a lower price.

This is called “going short” or taking a “short position”. Just remember: short = sell.

The Bid, Ask and Spread

All forex quotes are quoted with two prices: the bid and ask.

In general, the bid is lower than the ask price.

EUR/USD forex quote

The bid is the price at which your broker is willing to buy the base currency in exchange for the quote currency.

This means the bid is the best available price at which you (the trader) will sell to the market.

If you want to sell something, the broker will buy it from you at the bid price.

The ask is the price at which your broker will sell the base currency in exchange for the quote currency.

This means the ask price is the best available price at which you will buy from the market.

Another word for ask is the offer price.

If you want to buy something, the broker will sell (or offer) it to you at the ask price.

The difference between the bid and the ask price is known as the SPREAD.

On the EUR/USD quote above, the bid price is 1.34568 and the ask price is 1.34588. Look at how this broker makes it so easy for you to trade away your money.

  • If you want to sell EUR, you click “Sell” and you will sell euros at 1.34568.
  • If you want to buy EUR, you click “Buy” and you will buy euros at 1.34588.

Here’s an illustration that puts together everything we’ve covered in this lesson:

Bid, Ask and Spread Example in Forex Trading

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