Foreign Exchange Trading

What Is Foreign Exchange Trading?

Foreign Exchange

Foreign exchange trading, commonly called forex trading, is the buying, selling and exchanging of currencies from different countries. The worldwide forex market is the largest trading market in the world, with daily trading volume of more than $4 trillion. Below are the basic facts about forex trading markets.

Forex Leverage

The forex is the most highly-leveraged trading market in the world. In the U.S. stock market, for instance, if you invest $5,000, you can then buy and sell $10,000 in equities.

In the U.S. housing market, in most instances for every dollar, you invest you can borrow another four. But in the forex, for every dollar you invest, in some circumstances you can trade as much as $200 --a leverage of 200:1. In most circumstances, leverage of either 50:1 or 100:1 is available. This presents unique investment profit opportunities -- and equal opportunities for losses. 

Forex Trading Hours

Another unique feature of the forex market is its trading schedule. Trades can occur whenever a particular market is open anywhere in the world. The Forex market opens Sunday at 10 pm GMT and closes Friday at 10 pm GMT. Because of the international dateline (Sunday on the Western side of the dateline is already Monday on the Eastern side) and continuously varying time zones, technically speaking, a forex market is open somewhere in the world 24 hours a day, 7 days a week. 

Forex Brokers

There are thousands of Forex brokers all over the world.

However, not all are equally reputable. Moreover, the forex market is lightly regulated. Transactions knew as "spot transactions," the most common kind of transaction on the forex, aren't regulated all. Fraud isn't unknown. Therefore, it's prudent to open a brokerage account either at an SEC-regulated stock market broker with a forex capability or at a forex brokerage affiliated with a major U.S. brokerage, such as think or swim, a division of TD Ameritrade.

 A few forex traders without an affiliation with an SEC-regulated brokerage that are also well known and reputable are FXCM, Forex.com, and Oanda. FXCM has particularly attractive transaction costs. 

How Does a Forex Trade Work?

The first thing to know about the mechanics of a forex trade is that it always involves two currencies, known as a currency pair. Here's what a trading pair looks like:

                                         EUR/USD = 1.17000

This trading pair consists of Euros (EUR) and US Dollars (USD. The currency on the left is the "base currency" and the currency on the right is the "counter currency." The numbers to the right of the equal sign tell you the quantity of counter currency, here Dollars, needed to buy one unit of the base currency, here the Euro. $1.17000 dollars buys 1 Euro.

Note that because forex trades are always executed with a pair of currencies, when you are buying one currency, here EUR, you are selling the other currency, USD. If you're selling EUR, you're buying USD.

 

In all cases, if you believe the value of the base currency will rise against the counter currency, you'll buy the base currency. If you believe the base currency will fall in value against the counter currency, you'll sell the base currency. In this instance, if you believe the value of the Euro will rise, you'll buy Euros; if you think it will fall against the Dollar, you'll sell Euros. 

One last thing to know about a forex trade is the significance of the three trailing zeros in the example. In most trading instances, the gains and losses per unit value are very small. If you bought any quantity of Euros at the 1.17000, you might close out the position when the value rose to 1.17005. However, a common trade size, in fact, one often referred to as a "standard trade," is 100,000 units. So if the value of the Euro rose to 1.17112, your profit from a single trade unit would be $112.   

A Cautionary Word

At this point, you have a very basic understanding of the forex market and in theory, you could open an account and execute a real-world trade without knowing more. But it would be a very bad idea. A good way to begin is to carefully read at least one book about forex trading,such as Matthew Driver's "Introduction to Forex Trading -- A Guide for Beginners,"  available on Amazon. Reading several is even better. After you've thoroughly digested what you've read, start with a practice account. If you start making (theoretical) money in your practice account, that's wonderful. If not, you haven't lost real money and you can continue reading and practice-trading until your results are consistently positive. When you begin real-world trading, however, start small. What often happens to new investors who've begun winning in their practice accounts is they begin trading too confidently with real-world trades that quickly rack up real losses. When that starts to happen, many novice traders throw everything they've learned out the window and begin panic trading. Which is one of the reasons the average length of a forex trading account is four months?  

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