While a lot of foreign exchange is done for practical purposes, the vast majority of currency conversion is undertaken with the aim of earning a profit. The amount of currency converted every day can make price movements of some currencies extremely volatile. It is this volatility that can make forex so attractive to traders: bringing about a greater chance of high profits, while also increasing the risk.
SO HOW DOES TRADING WORKS?
Paired currencies are the focus of every trade and each currency’s value is dependent on its pair. For example, as a currency pair, the EUR/USD has been set against each other. This means that their market behavior will determine their profitability. When the price of the first currency (Euro in this case) surges, the price of the other (USD) will decrease and vice versa. So, the ability of traders to predict their price movements accurately will determine who profits or losses in the Forex market.
Unlike shares or commodities, forex trading does not take place on exchanges but directly between two parties, in an over-the-counter (OTC) market. The forex market is run by a global network of banks, spread across four major forex trading centres in different time zones: London, New York, Sydney and Tokyo. Because there is no central location, you can trade forex 24 hours a day.
There are three different types of forex market:
- Spot forex market: the physical exchange of a currency pair, which takes place at the exact point the trade is settled – ie ‘on the spot’ – or within a short period of time
- Forward forex market: a contract is agreed to buy or sell a set amount of a currency at a specified price, to be settled at a set date in the future or within a range of future dates
- Future forex market: a contract is agreed to buy or sell a set amount of a given currency at a set price and date in the future. Unlike forwards, a futures contract is legally binding
Most traders speculating on forex prices will not plan to take delivery of the currency itself; instead they make exchange rate predictions to take advantage of price movements in the market.
WHICH PAIRS TO TRADE?
To keep things ordered, most providers split pairs into the following categories:
- Major pairs. Seven currencies that make up 80% of global forex trading. Includes EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD and AUD/USD
- Minor pairs. Less frequently traded, these often feature major currencies against each other instead of the US dollar. Includes: EUR/GBP, EUR/CHF, GBP/JPY
- Exotics. A major currency against one from a small or emerging economy. Includes: USD/PLN (US dollar vs Polish zloty) , GBP/MXN (Sterling vs Mexican peso), EUR/CZK
- Regional pairs. Pairs classified by region – such as Scandinavia or Australasia. Includes: EUR/NOK (Euro vs Norwegian krona), AUD/NZD (Australian dollar vs New Zealand dollar), AUD/SGD
HOW TO SELECT TRADING PAIRS?
The process of selecting trading pairs should not be started without adequate market analysis and information at the fingertips of the trader. The purpose of this precaution is to have an educated guess on the possible behavior of the currency pair within a specific period. A trader must know the conditions responsible for price changes, volatility and also the way a currency can be detrimental to another.
As a result of all this, some traders are avoiding major currency pairs and no longer consider them as the best option. In their replacement, they go for pairs that are familiar to them because they understand the factors that can influence them as well as have deeper knowledge about their value.
One important principle traders must adhere to is to never get involved with currency pairs with high spreads. Instead, they should go for those with 0 – 3 pips. This is because the more a trader goes high, the more risky and expensive it gets. The average trader may not afford the consequences of anything above six pips.
WHAT MOVES THE FOREX MARKET?
The forex market is made up of currencies from all over the world, which can make exchange rate predictions difficult as there are many factors that could contribute to price movements. However, like most financial markets, forex is primarily driven by the forces of supply and demand, and it is important to gain an understanding of the influences that drives price fluctuations here.
WHY CHOOSE TO TRADE IN THE FOREX MARKET?
The main reasons are: it is a large market and it operates 24/5. The volume trades per day is larger than any of the stock exchange. That means you will have multiple opportunities all day long.
For a student or a working adult, it is very difficult to find free time during work hours to login to your stock trading platform. But the forex market is different, you can find trade opportunity before and after your working hours.
You also don’t need to be afraid of low volume, because the market volume is large enough that your orders will be filled within seconds or milliseconds. And it is one of the industry that is recession proof.
Forex is a profitable business for those who are willing to let go of the wrong perception of the market and are ready to put in the required work. Both the traders with little funds and those with lots of it have good opportunities to make money in the Forex market but they must understand what works best for the resources they have.
Traders with little capital are advised to adopt day trading in little amounts, while those with more capital can go for long-term fundamentals-based trading. New Forex traders should invest in the knowledge of macroeconomic fundamentals which influences currency values as well as in technical analysis in order to make the most of the Forex market. It takes years of practice, patience, and discipline to become a skilled forex trader. So practice, practice and practice!