Forex trading, put simply, is the buying and selling of foreign currency - and the foreign exchange market is where these currencies are traded.
The forex market is open for 24 hours a day and five days a week - starting the day in Australia and ending in New York. Trading takes place in the major financial centres across the globe, including London, New York, Tokyo, Singapore, Sydney, and Hong Kong.
BluFX subscriptions are open to traders of all levels - so if you’re new to trading, this blog is designed to cover everything you need to know about trading for beginners!
What is forex trading and how does it work?
Forex trading (‘forex’ being a portmanteau of ‘foreign exchange’) works by buying one currency and simultaneously selling another, the aim being to make a profit by predicting the value currencies are likely to have in the future.
So - how does forex trading work?
If you’ve ever travelled abroad, you will have exchanged one currency for another. For example, if you have travelled to the US from the UK, you will have bought US dollars. How many US dollars you will get for your pounds depends on the exchange rate between the two currencies.
This exchange rate is reliant on supply and demand and shifts constantly - and this feeds into how we trade forex.
What is supply and demand?
Supply and demand is the idea that if more people are interested in buying a product, then the price of that product will increase (with the aim of making more profit). If less people are interested in buying a product, then the price will decrease (with the aim of encouraging people to keep buying). This principle underpins forex.
As we discussed above, trading relies on forecasting the value currencies are likely to have in the future - so each trader will buy or sell a currency based on what they think its value is, or what they think it will be in the near future.
Put simply: if you think a currency will increase in value, you can buy it - and if you think its value is likely to decrease, you can sell it.
For example, let’s say you think the value of the Euro will increase. You’ll buy it and then sell it later, making a profit on its increased value. If you believe the value of the Euro will decrease, you’ll sell it and then buy it back at a later date, making a gain on its devaluation.
Forex trading explained: the basics
►►What are currency pairs?
This is a forex trading explained: a basic overview of how it works.
As we’ve seen, forex trading involves, essentially, betting on the value of one currency against another. For example, EUR/USD (this is what we call a currency pair) is comparing the value of the euro against the dollar.
The first currency (in this case, EUR) is referred to as the base currency, and the second (in this case, USD) is the quote currency.
It will read like this: EUR/USD = 1.0997 - but this is what it means: 1 EUR = 1.0997 USD. So, for every Euro you have, you can get 1.0997 US dollars.
When we see a price quoted, this shows us how much one euro is worth in dollars. The two prices reflected the buy price and the sell price - and the difference between them is referred to as the ‘spread’ - and this moves according to supply and demand.
When you click ‘buy’ or ‘sell’, remember that you are buying/selling the first currency in the pair (in this instance, euros).
►►What are pips?
A pip stands for a percentage point.
For example, if EUR/USD goes from 1.2788 to 1.2798, this is a gain of 10 pips.
Forex trading for beginners: to buy or to sell?
Let’s say you think the euro will increase in value compared to the dollar. If this is the case, you will buy EUR/USD. If you think it will decrease, you will sell EUR/USD.
This is also referred to as ‘going long’ (buying) or ‘going short’ (selling).
While making this trade you might read in the news that several European countries are devaluing their currency to encourage more foreign business. If you think this is likely to continue, you could sell EUR/USD. The more the euro devalues against the dollar, the more profit you will make.
If, however, the euro increases in value while you still have your sell position open, then your losses increase and it’s a good idea to get out of the trade.
Forex trading for beginners: key facts
Here are some key facts to know if you’re new to trading…
- Forex trading is 24/7! The forex market is open for 24 hours a day, five days a week - starting in Australia and ending in New York.
- The average forex daily trading volume exceeds $5 trillion - more than the volume on the New York Stock Exchange.
- EUR/USD is the most-traded currency pair in the world.
- The usual rule of thumb is that traders should never risk more than 1.5-2.5% of their capital on any given trade.
What is margin in forex? Stay tuned for the next step of our trading guide: margin requirements and calculations…