Beginner’s Guide to Forex Trading: How It Works and Some of the Risks

Forex Trading

Forex trading, also known as Foreign Exchange, is a form of investing that involves the conversion of one currency into another. The Forex market has grown exponentially in the last decade and now handles over $5 trillion per day in trades. It’s an attractive way to invest because it can be easily done from anywhere with internet access.

However, like any other form of investing, there are risks associated with Forex trading. In this article we will discuss how Forex trading works, what currencies are traded in Forex markets and how beginning investors can get started in Forex trading.

What is the Forex trading market?

Forex is the trading of one currency for another. In Forex, traders invest in a certain type of asset and then sell it when its value rises to make a profit. The most popular form of investing with Forex involves buying one currency and selling it at an increased price after converting it into another more stable or higher valued currency.

A Forex trader can invest in many different types of currencies, depending on the country they live in. The most popular are American dollars or Euros because these two make up a large percentage of all Forex transactions.

Forex traders also trade with other less common currencies and this is called “diversification” when investing in a variety of currencies.

A brief history of Forex trading

Forex trading began in the 1970s when foreign markets were deregulated. In 1973, there was a global recession and the United States dollar fell against other currencies including the British pound. This caused Forex rates to fall from $0.30 per British pound down to $0.20, which gave traders a chance of making money by purchasing the pound and selling it at a higher price.

Forex trading soon became popular as traders could make a lot of money in just one transaction. As the trading market became more popular, banks started to offer Forex traders opportunities for leverage (borrowing) so that they could purchase larger quantities of currency with less capital.

An overview of Forex markets

The Forex market is the largest, most liquid financial market in the world. It consists of transactions for 180 different currencies that are traded 24 hours a day and five days a week, with trading volume exceeding $200 trillion every year. The currency exchange rates fluctuate constantly due to supply and demand of each country’s economy as well as news events and political happenings.

The Forex market is a decentralized network of dealers that trade with each other in various countries to match buy and sell orders from investors for the purpose of making money on the difference between demand, or “buying power,” and supply, or “selling pressure.” Currency trading can be highly speculative because it relies largely on the expertise of one’s personal judgment.

What currencies are traded in Forex?

The currencies that are traded in Forex can be classified into two categories: major and minor. Major currencies include the US dollar, euro, pound sterling, Swiss francs (or simply “Swissies”), Japanese yen and Australian dollar among others. Minor or emerging market currencies typically have lower trade volumes than those of major countries but offer greater opportunity for profit.

Forex terminology

Forex traders use a number of terms to describe the nature and conditions of their trades. Some of the common terms used by traders are:

  • Spot trade: Forex spot trades are made within one day of the transaction. The Forex market is open 24 hours a day, five days a week on Sunday through Friday; however, traders can only execute orders during these times. A trader who wants to sell USD/CAD and buy GBP/USD in order to exchange US and Canadian dollars for British pounds would do so during the Forex spot market.
  • Forward: Forward trades are deals that take place on one day but settle at a later date for an agreed upon price in the future. The Forex market is closed only two days per week (Saturday and Sunday) so traders can execute a forward trade during these times when they’re unable to trade in the spot market.
  • Futures: Futures are a type of forward contract traded on an exchange that locks in an agreed price for future delivery, at which point it can be exchanged for cash with the seller and delivered or used as collateral by buying parties prior to settlement date.
  • Options: Options contracts give buyers the right, but not the obligation to purchase or sell an asset at a predetermined price on (or before) the contract’s expiration date.
  • Swaps: This is when two parties exchange interest rates for different currencies with each other  — this type of Forex trade often takes place between commercial banks and corporations who are looking to hedge against currency risk.
  • Spread: This is the difference between a bid and an ask price, which can also be called a “quote.” Forex brokers put together quotes based on their own level of information about what market participants are willing to buy or sell at  — in other words, broker’s bids for currencies they want to get, and offers for currencies they want to sell.
  • Markets: There are two major types of Forex markets, the interbank market which is an over-the-counter (OTC) market with no central exchange or clearing house  — this type of trading tends to be lower volume but generally has more competitive spreads than on an exchange  — and the spot market, which is an electronic trading system where buyers and sellers trade on a centralised marketplace with competitive spreads.
  • Currency Pairs: The most popular types of currencies are those that represent regional markets or major economies like EUR/USD for the Euro vs US Dollar pairing. Currencies can also be paired with precious metals like Gold, which creates the USD/XAU and EUR/XAU pairings.
pros of Forex trading

What are the pros of Forex trading?

The pros of Forex trading are that it offers a high level of liquidity with low spreads, and is easy to get started. The cons include the increased risk in leverage because you only need to put down a small percentage of the total investment. Forex trading offers a high degree of liquidity with low spreads, and is easy to get started.

What are the risks of Forex trading?

The main risk to Forex trading is leverage. The increased risk in leverage means that you only need put down a small percentage of the total investment, but it also means your losses can be higher on any given trade.

Unlike other types of trading, the price movement in currencies can be unpredictable because they are affected by global macroeconomic events. For this reason, it is important to carefully plan your Forex trades and only invest in a currency if you have done the research on that particular market.

What is margin in Forex trading?

A margin is the amount of money that you put down for a Forex trade. Margin requirements vary depending on the type and location of your account, but they generally range from .01% to 20%.

For example, let’s say you are opening an online Forex trading account with Vanguard Brokerage Services LLC in US Dollars. Vanguard requires a margin of at least $25,000 to open an account and trade in US Dollars with no leverage.

What is a pip in Forex trading?

A pip is the smallest unit of change in Forex trading. The value of a pip changes depending on how you trade:

  • Spot (cash) currency pairs have up to four pips with price quotes being quoted as “123.4500 USD/CAD”. If your margin requirement was at 20% and the rate for this currency pair was 123.50 USD/CAD, then the pip would be .01 (one) or 25 cents per share traded.
  • Contract for Difference pairs have up to eight pips with price quotes being quoted as “123.4500 GBP/USD”. If your margin requirement was at 20% and the rate for this currency pair was 123.50 GBP/USD, then the pip would be .01 (one) or 25 cents per contract traded.
  • Exchange Rate pairs have up to 12 pips with price quotes being quoted as “123.4500 EUR/GBP”. If your margin requirement was at 20% and the rate for this currency pair was 123.50 EUR/GBP, then the pip would be .01 (one) or 25 cents per contract traded.
  • Some brokers will only accept trades to go “long” on a trade and not require you to have an exit strategy before opening such as when trading Forex pairs with 12 pips.”

How to get started in Forex trading

The first step for beginners who are starting to trade Forex is to open a trading account with an online broker. There are many different brokers out there and most of them offer only “pathetic” rates on the currencies they allow you to trade in, so it’s worth shopping around for one that has competitive rates.”

The next step would be opening your brokerage account. This is typically done through the trading platform, which will be where you’ll perform your trades.

The last step in getting started is understanding your risks and exposure, which can be summed up with one word: leverage.

ready to get started

Are you ready to get started in Forex trading?

Trading in Forex can be highly profitable if done right, but it is also riskier than investing in stocks or other standard investments because there are many factors that go into deciding which currency to invest in and when to buy or sell them.

Beginners should take advantage of all resources available to them, including free tutorials and videos from finance websites, financial professionals or brokers.

Several online training programs claim they will teach you to become a professional at Forex, including one offered by iMarketsLive. Check out I Buy I Review's comprehensive iMarketsLive review here.

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