Forex is also known as foreign exchange or Forex trading is a decentralized global market where all the world's currencies trade. The forex market is the largest , most liquid market in the world with an average daily trading volume exceeding $5 trillion. Forex trading allows you to speculate on price movements in the global currency market.
If you've ever traveled
overseas, you've made a forex transaction. Take a trip to USA and you convert
your Euros into USD. When you do this, the forex exchange rate between the two
currencies based on supply and demand-determines how many USD you get for your
Euros. And the exchange rate fluctuates continuously.
A single euro on Wednesday
could get you 1.10 USD. On Friday 1.15 USD. This tiny change may not seem like
a big deal. But think of it on a bigger scale. A large international company
may need to pay overseas employees. Imagine what that could do to the bottom
line if, like in the example above, simply exchanging one currency for another
costs you more depending on when you do it? These few pennies add up quickly.
In both cases, you-as a traveler or a business owner-may want to hold your
money until the forex exchange rate is more favorable.
Forex is always quoted in pairs, in terms of one currency versus
another. Take for example EUR/USD (sterling vs US dollar) - the fluctuations in
the exchange rate between these two is where a trader looks to make their
profit. The first currency, also known as the base is the one that you think
will go up or down against the second currency, which is known as the quote. When
trading currencies, you can speculate on the future direction of the market,
taking either a long (buy) or short (sell) position depending on whether you
think the currency’s value will go up or down. Forex price movements are
triggered by currencies either appreciating in value (strengthening) or
depreciating in value (weakening).
Like any other trading
price, the spread for a forex pair consists of a bid price at which you can
sell (the lower end of the spread) and an offer price at which you can buy (the
higher end of the spread). It is important to note, however, for each forex
pair, which way round you are trading.When buying, the spread always reflects
the price for buying the first currency of the forex pair with the second. So
an offer price of 1.2000 for EUR/USD means that it will cost you $1.20 to buy
€1. You would buy if you think that the price of the euro against the dollar is
going to rise, that is, if you think you will later be able to sell your €1 for
more than $1.20.When selling, the spread gives you the price for selling the
first currency for the second. So a bid price of 1.2000 for EUR/USD means that
you can sell €1 for $1.20. You would sell if you think that the price of the
euro is going to fall against the dollar, so you can buy back your €1 for less
than the $1.20 you originally paid for it.
If prices are quoted to the
hundredths of cents, how can you see any significant return on your investment
when you trade forex? The answer is leverage. When you trade forex, you're
effectively borrowing the first currency in the pair to buy or sell the second
currency. With a US$5-trillion-a-day market, the liquidity is so deep that
liquidity providers—the big banks, basically—allow you to trade with leverage.
To trade with leverage, you simply set aside the required margin for your trade
size. If you're trading 200:1 leverage, for example, you can trade £2,000 in
the market while only setting aside £10 in margin in your trading account. For
50:1 leverage, the same trade size would still only require about £40 in
margin. This gives you much more exposure, while keeping your capital
investment down. But leverage doesn't just increase your profit potential. It
can also increase your losses, which can exceed deposited funds. When you're
new to forex, you should always start trading small with lower leverage ratios,
until you feel comfortable in the market.
Now take an example.
Suppose the spread for EUR/GBP is 0.8414-0.8415. If you think the price of the
euro is going to rise against the pound you would buy euros at the offer price
of 0.8415 per euro. Say in this case you buy €10,000 at a cost to you of
£8415.The spread for EUR/GBP rises to 0.8532-0.8533 and you decide to sell your
euros back into pounds at the bid price of 0.8532. The €10,000 you previously
bought is now therefore sold for £8532. Your profit on this transaction is
£8532 minus the original cost of buying the euros (£8415) which is £117. Note
that your profit is always determined in the second currency of the forex pair.
Alternatively, suppose in the first instance you think the price of the euro is
going to fall, and you decide to sell €10,000 at the original bid price of
0.8414, for £8414.In this case you are right and the spread for EUR/GBP falls
to 0.8312-0.8313. You decide to buy back your €10,000 at the offer price of
0.8313, a cost of £8313. The cost of buying back the euros is £111 less than
you originally sold the euros for, so this is your profit on the transaction.
Again your profit is determined in the second currency of the forex pair.
Forex trading is ideal for investors who want the
opportunity to trade on a market that is open 24 hours a day, while at the same
time minimizing trading costs and potentially profitting from markets that are
rising or falling. However, it contains significant risks to your money and is
not suitable for everyone. We strongly suggest trading on a demo account before
you try it with your own money.
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