12/08/2020
What is forex trading?
Forex trading is THE largest trading market in the world right now. To put it in the simplest of terms, it is an act between two individuals who trade currencies.
So for example, if you are a US citizen and travel to Italy, you’d have to exchange all of your dollars to euros. The act of making that exchange is Forex trading, but it doesn’t have to happen with you flying halfway across the world. You can just do it from home.
But Forex trading cannot be described in just a small amount of words, but I preferred to give you the simplest answer from the very beginning.
In order to understand what Forex trading is, we need to look at what Forex is, simple as that.
What is Forex?
Forex, as already mentioned above is the act of trading one currency for another. But Forex trading and the Forex market itself are slightly different and you’ll soon find out why.
Forex is an abbreviation for Foreign Exchange, words that you may have seen or heard many many times. It is currently rumored to be around $5 trillion daily traded volume, but that amount of money is very hard to track so I wouldn’t believe it wholeheartedly in the statistics if I were you.
When trading Forex you’ll very often hear the terms, “Retail” and “Institutional”, and it’s quite common to get confused as to what these terms mean.
To put it as simply as possible, you and me as individual traders are referred to as “Retail traders”, while banks, hedge funds, and corporations are referred to as “Institutional traders”, or market makers as they’re the ones that can make really big changes in the market thanks to the sheer amount of volume they can trade within a day.
Institutional Forex
Institutional Forex is quite simple actually. To be honest, most of the trading on the institutional level happens inadvertently, very few institutions have a deliberate trading test in their offices. here’s why.
Imagine a company that is located in Russia, let’s call company X, and a company that is located in Poland, let’s call it Y.
X is a construction company that has just run out of concrete, but the local supply is either very low or very expensive. Therefore they contact Y and ask for a shipment. They agree that it will come down to 1 million euros, but there’s a catch. You see, company Y will only accept payments through the Polish zloty. So now X and Y need to find a bank as an intermediary to make the exchange.
X pays its Russian bank in rubles, the bank then converts these rubles into euros, sends it to the Polish bank, then the Polish bank converts it into zloty and Y withdraws it. Simple as that, 1 million’s worth of exchange was made very easily.
But why did they have to convert to euros first? Why not just convert directly into zloty?
Well, there’s a catch. You see, most countries have repositories of foreign currency, but since neither zloty or they rubble is a major currency, they had to find an intermediary.
Due to the fact that the transaction was happening in Europe, the euro was chosen. Had it been literally anywhere else it would have been the US dollar. It all comes down to how much reserves the country has of a particular currency. And in most cases, you’d find countries holding on to USD or EUR.
Retail Forex
Retail Forex trading is, as already mentioned, tailored towards individual traders, like you and I. It is direct trades of currency pairs on a specific platform.
In order for you and me to participate in Forex trades, we need some type of intermediary. Due to the fact that banks usually ask for a large spread, we tend to ignore bank-controlled trading desks and go for third-party service providers.
In most cases, you’d find people trading Forex with Forex brokers, which are companies designed for this industry. What it usually takes is that people register on the platform, deposit a small number of funds, and start opening positions for a specific currency pair.
These people are also subject to promotional material, but some areas have started to ban it.
For example, European traders are not able to utilize anything from this Forex no deposit bonus 2019 list, due to ESMA (an EU-wide regulator) forbidding it due to security issues.
How trading works
Ok, so you’ve registered on a Forex broker’s platform, now what?
The very first step is to deposit some funds if you weren’t given any bonus. Usually, the minimum amount you need to deposit ranges from $200 to $250, but there are brokers that offer minimum deposits as low as $1.
Once the deposit is made, you will need to choose a currency pair that you’d like to trade. Since you’re a beginner I’d suggest going for major currencies, such as USD, EUR, GBP, AUD, CAD and etc.
Pick a pair and open your first position. Let’s bring in an example. Let’s say I just opened a “Buy” position for EUR/USD, what exactly happened? What happened was that I purchased EUR with the USD on my account. If I want to make some profit, I will need to wait until the EUR increases in price, after which I will sell it again for dollars.
So for example, if the exchange rate was 1/1, meaning 1 euro = 1 dollar, I’d have to wait until 1 euro = 2 dollars.
On the other hand, I also had the option to open a “Sell position”. Meaning that instead of buying EUR, I’d be selling it for USD. Rinse and repeat, if I open a sell position I will need to wait until EUR falls to a profitable price point until I can close my position.
Here are some very important details about Forex trading, and terms that you absolutely need to know:
Spread
Spread is the difference between the bid and ask price. Have you ever seen a Foreign exchange offer the exact same price on buying and selling a currency? No right?
Let’s say that the official exchange rate for EUR/USD is 1 euro = 2 dollars. Nearly every single foreign exchange will offer different prices. So they would as for something like 1.9 dollars as a means to buy euros from you while offering 2.1 dollars as a means to sell euros to you.
The difference between these prices is the spread. So 2.1 – 1.9 = 0.2(spread).
Leverage
Leverage is also a handy dandy tool used by Forex traders, but only use it if you’re experienced enough.
To put it as simply as possible, leverage is the opportunity to borrow funds from your Forex broker and use it in your trades.
So when you see Forex brokers offering 1:100 that means that if you open a trade with $100, you’ll be trading with $10,000 instead, $9,900 of which was given to you by the broker.
Naturally, the larger your trade, the bigger the profits. Therefore, at the end of your trade, the broker will be expecting those $9,900 back, with a little bit extra. You’d be able to score some nice profits but would have to give the broker its cut as well.
Nearly everybody uses leverage as it’s the only way to truly scale your profits without risking too much of your own money. But, if your trade decision was wrong, you’d not only lose all of the invested amounts you had but may actually lose some of the leverage as well (brokers usually force the position to close if this happens), which will put you into debt with the broker.
So I’d suggest avoiding it in the beginning.
There’s so much more I can tell you but I can see that it’s turning into an essay. You can find out pretty much everything by visiting websites, reading the news on various sources like Bloomberg or CNBC, and trying out Forex brokers by reading reviews.