Forex or simply FX means foreign exchange, which refers to the exchange of foreign currencies where you trading a currency for another at a certain price. The forex market has an average turnover of more than $4 trillion (USD) each day. So, just imagine just how big its market is. Take note that the New York Stock exchange only has a daily turnover of around $70 billion (USD). Indeed, the forex market is the largest financial market in the world.
What exactly is forex? Simply put, it is where you simultaneously buy a foreign currency while you sell another, which is primarily for speculation.
Due to different factors that affect the forex market, the value of the different foreign currencies appreciates (increase in value) and depreciates (decrease in value). By speculating or predicting the direction of the foreign currencies, an FX trader can make a profit.
Unlike other financial markets, currencies are also traded in OTC (over-the-counter) markets. As such, they do not have a main exchange platform or physical place; therefore, they are always open 24 hours every day, depending on the trading platform that you are using. They are usually open from Sunday evening up to Friday evening. Since the forex market is almost always open, you can avoid price gapping or the situation where the price changes significantly without any trading in between. The forex is also a leveraged position. This means that you can just place a small percentage of your full value position to set a trade. As such, you can make more profits; however, it can also lead to more losses. Therefore, before you invest any real money, be sure that you first have a good foundation and understanding of what FX trading is about.
Why Trade Foreign Currencies?
Trading foreign currencies are one of the best ways to make money online, especially if you understand what you are doing. The FX market generates trillions of dollars every day, which makes it the most active and biggest financial market around the globe. Of course, trading foreign currencies does not come without risks just like any other worthwhile investment. But, as long as you know what you are doing, if you have a guide that will give you a sense of direction in the FX market, then there is nothing for you to worry about. All that you have to do is to study and practice on a regular basis.
It does not matter whether you are someone who works in an office and is looking for a way to supplement your income or if you intend to become a full-time trader, you are always welcome to join and participate in the forex market. Thanks to the development of technology, it is very easy and convenient to trade foreign currencies nowadays. This is the way to make profits with just a few clicks of a mouse in the comfort of your home.
So many people are now making money by trading currencies. If you are able and willing to invest some money, dedicate time for research and study, then this may be the opportunity that can change your life for the better.
Factors That Affect Forex
Just like the stock market, the FX market is also influenced by a number of factors. Here are the main factors that strongly affect the prices of different currencies:
Inflation
Countries that do not have a high rate of inflation can expect the value of their respective currency to appreciate (increase in value). The reason behind this is that purchasing goods and services in such countries will be more competitive. Many will want to invest in their currency, which will further strengthen it. As a consequence, purchasing goods and services from other countries will tend to have less competition, which results in less investment in their currency, as well as less depreciation. To counteract the increase in value, the high rate of inflation is usually accompanied by higher interest rates.
Government debt
When a country has a large debt, it becomes less attractive to investors. This usually leads to a weakening of its currency and the rising of its inflation rate. When investors and traders notice that the government will not be able to handle its huge debt properly, they are more likely to pull out any investments that they may have in the said country. As you can see, on a bigger scale, the government has an important role to play in the FX market.
Political stability
To lower the risk, traders like to invest their money in countries that show positive economic performance. If the said positive performance has a long line of history, then traders and investors are more encouraged to put money in it, which can significantly strengthen the currency. However, when a country is not politically stable, such instability can reflect on the value of its currency — which tends also to be unstable. As a result, investors become hesitant to make any investment which usually creates a negative impact on the value of its currency.
Speculation
Despite many strategies that have been developed, many still consider the FX market to be highly speculative, where you invest in some currency and hope for it to increase in value. There are simply so many factors that can have a strong influence on the value of foreign currencies. For example, if the news headlines feature something positive about a certain currency, even if it is not good enough but if it manages to draw more attention and interest, then there is a good chance that many will invest in such currency which can significantly boost its price. However, if it fails to draw any attention, there is a good chance that the news will not create any substantial changes.
Interest rate
Interest rate is always related to FX rates. Simply by manipulating the interest rate, banks can manipulate the inflation rate, as well as currency values. In case of a higher rate, then lenders will get a higher return as compared to other countries. This is a good way to attract foreign capital, which leads to an increase in currency value.
Long Term vs. Short Term Vs. Day Trading
As for the duration, FX traders can be categorized as long, short, or even day traders. As their names imply, long-term traders hold their position for a long period. Short-traders hold their position for a short period of time, while day traders are part of short-traders but only hold their positions up to the close of one trading day. Depending on your strategy and how long you intend to hold on to your positions, then you would know what kind of trader you are.
There are certain pros and cons when you trade for a short or long-term period, or even just for a day. Long-term trading will allow you to encounter more significant volatility, which is your key to making a huge profit. Also, when you trade for the long term, you would not have to make as many trades as short-term traders. In fact, many long-term traders only make less than ten trades in a year. Long-term trading is also not affected by the day-to-day fluctuations that are normally experienced in the FX market.
For short-term trading, you can expect a more active form of trading. Usually, long-term trades are for investors willing to hold on to their positions for a long period, while short-term trades are for an active trader who makes trades every week or month. There are also what are called day traders. These are the people who open their positions on one trading day and close them all down at the end of the trading day. For short-term traders, including day trading, you can expect to deal with the day-to-day fluctuations in the FX market. You will also have to trade on a regular basis.
Whether you intend to trade for a long or short term, or even just for a day, what matters is how effective you deal with it, and how much profit that you make, if any.
Is It Gambling?
“Is forex gambling?” Many people still wonder about this question, despite the fact that this has been clearly answered many times already. The reason is that the answer can be either: It be can be considered as gambling. However, it can also be considered as not gambling. It all depends on how you approach the FX market. If you exchange currencies and aim to make a profit just by relying on luck or mere guesswork, then you can consider yourself as a gambler. The good news is that you can still make money when you gamble. The bad news is that you cannot expect to make a continuous stream of profit simply by relying on mere guesswork.
If you want to make real money as a trader and have a regular flow of positive income, then you need to approach the FX market as a professional trader. A successful and professional trader spends serious time and effort to study and analyze different currencies to allow him to identify the best trading decision. With patience and perseverance, it is possible for you to make regular profits by trading foreign currencies.
Risks and Benefits
The key to profit in the FX market is similar to investing in stocks: You need to buy low and sell high. Unlike the stock market where you need to deal with so many stocks and options, you only have to study a handful of currencies in the FX market.
However, take note that just because the number of currencies is quite limited, it does not mean that it requires less study. In fact, this is all the more reason for you to study and specialize in all currencies that are available for trading. To give you a better idea of what forex is like, you need to know the risks and benefits associated with this kind of venture.
Leverage Risks
In FX trading, you need a small investment to leverage, which is usually referred to as a margin, which will allow you to access significant currency trades. In case of fluctuations in price which is normal, you will be required to pay for an additional margin. Hence, if the forex market becomes highly volatile, you can encounter a big loss worth higher than your initial investment.
Interest Rate Risks
Currencies are strongly affected by the interest rate. If a country’s interest rate increases, it usually creates an influx of investments which tends to also increase the value of its currency. However, in case the interest rate drops, then it can also cause the value of a currency to decline. This is because, in such instances, investors would tend to pull out their positions. It is this difference that can be found between currency values that can cause substantial changes in forex prices.
Transaction Risks
Transaction risks are correlated with time differences. Take note that the prices of the different foreign currencies continuously fluctuate. The greater the time differential is at different times, the higher will be the transaction risk. You may also have to consider the transaction cost.
Counterparty Risk
In a financial transaction, this refers to the company that provides assets to the trader or investor, it refers to any risk of default on the part of the broker or dealer. In FX trades, no clearinghouse or exchange guarantees spot and forward contracts. Therefore, in case the FX market becomes highly volatile, you cannot always expect a counterparty to adhere to the contract.
Country Risk
Before you even invest in any currency, you should first assess the stability of the country issuing the said currency. In developing countries, their exchange rates are usually matched against a primary currency like the US dollar. In such cases, it becomes important for their central bank to keep reserves to have a stable exchange rate. A currency crisis may take place in case of frequent payment deficits, which can cause the value of a currency to fall. Of course, this can have a serious impact on FX price and trading.
Speculative risk
The FX market has a highly speculative nature. When investors and traders think that a currency will decline in value, then they start to pull out their assets, which will further devalue its currency, while those who continue to trade the said currency will find their assets to become illiquid or even face insolvency. In forex trading, you will also have to worry about liquidity dangers, as well as credit risks.
The FX is so speculative that the behavior and feelings of the investors and traders have a strong influence on the price fluctuations and changes in the forex market.
Loss of investment
Of course, just like any other investment, there is a chance that you will lose your money when you trade foreign currencies. Like any investment, it goes either of two ways: you make money, or you lose it. Therefore, it is important for you to observe the basic advice given to all gamblers and investors: only spend the money that you can afford to lose.
Benefits
If you think you can handle the aforementioned risks, if your entrepreneurial spirit remains strong despite knowing the dangers of trading FX, then it is time for you to know the benefits of engaging in forex:
Profitability
Of course, the main highlight of why you would want to trade currencies is that you can make lots of profits with them. There are more chances for you to earn a higher percentage of profit than keeping your money in a bank or investing in stocks. Also, with forex trading, you can exercise leveraging which will allow you to trade more and earn more. There is so much profit that you can make by trading currencies. In fact, there are those who can abandon their office work and simply make a living trading foreign currencies in the comfort of their home.
Accessibility
If you are of legal age, and if you have Internet access, then it is most likely that you can start trading currencies in a real FX market. The FX market is also available 24 hours a day. With trillions of turnover per trading day, this market is highly liquid. This means that under normal market conditions, you are free to trade currencies as much as you want and as many times as you please.
Four Major Currency Pairs
When trading foreign currencies, you should know the four major currency market players:
- EUR/USD: Euro/U.S. dollar
- USD/JPY: U.S. dollar/Japanese yen
- GBP/USD: British pound sterling/U.S. dollar
- USD/CHF: U.S. dollar/Swiss franc
Why should you take note of the major forex currencies? The reason is that there are certain advantages of trading them. A good advantage that you can take advantage of is their popularity. Since they are popular, you can easily find news and information about them. As you may already know, information is the key to success in forex trading. What you know and the quality of the information that you know is important since such information is what you will analyze, and from which you will come up with a trading decision. You can easily get updates regarding these major currencies, and since they are the top choice of most forex traders, they followed by the market and other trades, which leads to sharp price changes that you can make money from.
Buying and Selling Simultaneously
Many traders find it hard to grasp the idea that in trading currencies, you buy and sell at the same time. If you are familiar with the stock market, the logic is simple: For example, you can buy ten shares of a company and hope for their value to increase in the future. To exit, you simply sell them for a profit (if the price goes up).
However, in the FX market, whenever you buy a currency, there is a simultaneous sale that is made to another currency. Do not be confused; this simply refers to the exchange in the foreign currency exchange. To put it simply, if you are looking for the euro to increase and have a higher value, the question that you should ask is: higher than what currency? When its price goes up, then the value of the other currency goes down, and vice versa. From the perspective of a stock market trader, this is like buying a stock. When you purchase a stock, you need to sell cash; and when you sell stocks, you exchange it for cash.
The thing is that every time the value of certain currency increases, there is a corresponding decrease in another currency. You can see this simply by looking at the exchange rate. Pay attention to the relationship between the base currency and the quote currency. As you can see, the idea of simultaneous buying and selling is not really hard to understand.
Rollovers and Interest
Rates When you deal with currencies, you need to understand how rollovers and interest rates work. A rollover applies when you hold an open position from one value date to another. Take note that your account is always divided into two currencies with interest rates of their corresponding countries. The difference between the two rates is referred to as the interest-rate differential.
Of course, the bigger is the said differential, the bigger impact it will have on the rollover. Do not worry; the cost of rollovers is automatically handled by a broker, but it is good that you are aware of it so that you understand everything that goes on with your money. Other brokers apply the rollover rate directly to your margin balance. As for interest rates, you need to check your broker’s guidelines as such may vary from broker to broker. Take note that small amounts can pile up easily and turn into a substantial amount in the long run.
Terminology
When you trade foreign currencies, there are certain terms that you should take note of. The FX market has its own set of jargon that you will surely encounter on your journey as a forex trader. Before you dig deeper into how you can trade successfully, you first need to learn the basic forex terminology.
Exchange rate
Perhaps the most common term in the forex, the exchange rate simply refers to the rate or value of a currency when expressed in another currency. For example: EUR/USD or 1 EUR / 1.1844 USD. This means that 1 EUR is equivalent to 1.1844 USD.
Cross rate
This refers to the rate given to two currencies where both currencies are not the official currency in which the quoted rate is given. For example, the quoted rate between the Japanese yen and the British pounds if given in U.S. newspaper. Take note that neither yen nor pounds are the official currency in the U.S. Hence, there is a cross rate.
Pip
A pip refers to the smallest change or movement that a currency makes. It is also referred to as a point or point. For example, 1 pip is a change of 0.0001. currencies usually have four decimal places. The exception is in the case of the Japanese yen which only has two decimal places. The best way to illustrate this is by example: Let us use the currency pair EUR/USD. If the current exchange is 1 EUR / 1.1844 USD, and there is a 2 pip movement, then it will be 1 EUR / 1.1846 USD.
Leverage
This is the key to make large sums of profit in the FX market. However, this can also lead to big losses, so you need to be careful how you leverage your account positions. For example, if you only have a $100 margin in your account to trade, by leveraging, you can open a position worth $1,000. in fact, you can even leverage it even as high as 100 times, and even higher. Take note that leveraging can magnify your potential profit but, at the same time, it also magnifies your potential loss.
Leverage refers to a loan that is given to a trader by a broker. When you decide to trade in the FX market, you should register and open a margin account with a broker. The amount of leverage may vary, but is usually either 50:1, 100:1, or even as high as 200:1. This depends on the preference of your broker, as well as the size that you intend to trade. So, what does this leverage ratio mean? For example, in the case of the 50:1 ratio, it means that the minimum margin that is required for a trader is 2% (1/50).
Hence, a 100:1 leverage ratio signifies that the trader has to have at least 1% (1/100) of the total value, and so on. For leverage as high as 200:1, usually, the required position would be around $50,000 or less. To clarify further, you can trade $100,000 value of the currency even if you only deposit $1,000 (1% margin with a leverage ratio of 100:1).
Of course, leveraging does not come without a catch. Although it can enlarge your profit potential, it also increases your risk. The higher is your leverage, the higher will also be your risk. Of course, there is no problem if you hit a successful trade. However, if the pips do not move enough to cover the amount of leverage involved, then you will lose your investment.
Margin
This is the amount of deposit that is needed to maintain or open a trading position. It can be either a “free” or “used” margin. A used margin refers to the amount used to maintain an open position, while a free margin is an available amount to open a trading position. For example, if you have $1,000 as a margin balance, and there is only a 1% margin requirement in order to open a position, you can buy and sell a position for up to around $100,000 with leverage of a 100:1 ratio. In case the money in your account drops below the minimum amount to maintain a position open, then you will get a margin call where you can choose between two options:
- Add more money to your account or,
- Close the open position.
Normally, brokers will automatically close down a position once your account drops below the minimum requirement. But, how much does it cost to maintain an open position? This depends upon your broker. It can be as high as 50% of the margin to open a certain trade.
Spread
This refers to the difference between:
- Buy vs. Sell, or
- Bid price vs. Offer price
Take note that this refers to the difference in price. Hence, if a quote says 1.4204 and 1.42000, or simply 4 pips. Then there is a spread of 4 pips. This means that one currency is higher than the other by 4 pips. To break even, the lower currency must increase by 4 pips. This usually refers to the cost of trading charged as charged by your broker.
Bid price
This is the price where a currency is bought by the market or a broker from a trader (you). Therefore, the base currency is sold at its bid price.
Ask price
This refers to the amount at which a currency is sold to you. It is at this price where you buy a currency from the market (or more specifically, from your broker).
Bid/Ask spread
This simply refers to the difference between the bid price and the asking price. Take note that this spread may vary from broker to broker.
Currency pair quotes
Before you even start trading, you need to learn how to read a currency pair. What is a currency pair? A currency pair simply refers to the exchange rate between two quoted currencies in a pair. For example, EUR/USD. The reason is that in forex, you buy and sell currencies at the same time.
Let us use a sample currency pair: EUR/USD. The first currency in our example, (EUR) is known as the base currency. The second currency in a pair, in this case, the USD, is the quote currency. The quote currency tells you how much you need to buy one unit of the base currency. Think of it this way: the base currency is what you buy for selling the quote currency. For example, if the pair expresses 1 EUR / 1.1844 USD, then it means that you need to sell 1.1844 USD to buy 1 EUR in exchange.
So, how do you make money with forex? Simply put, the way to make money is to buy a currency pair if you predict that its base currency will appreciate (increase) in value. Take note that such an increase in value is relative to the pair’s quote currency. However, if you predict that the value of the base currency will depreciate relative to the value of the quote currency, then the best option that you have is to sell the pair. Take note that forex is about buying and selling currency pairs.
On Cryptocurrencies
You may also encounter a trading platform that also trades cryptocurrencies. They are digital currencies that are not regulated by any government or central authority. Although they are also “currencies” in the sense that they are cryptocurrencies, they are not considered legal tender. Common cryptocurrencies are bitcoins and etherium, among others. It is worth noting that it is easy to get tempted to buy and trade cryptocurrencies, especially if you see just how much they grow. It is not uncommon for the value of cryptocurrencies to increase by 100% in a week’s time.
However, it is worth noting that their value can also drop just as fast. Indeed, cryptocurrencies are highly volatile. They are more volatile than the major currencies. Take note that cryptocurrencies are not normally part of forex because they have a different category. For forex trading, it is advised that you stick to the major currency pairs.
