What is Forex Trading?

An Introduction to Forex Trading

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Forex Trading is trading currencies from different countries against each other. Forex is an acronym of Foreign Exchange.

For example, in Europe, the currency in circulation is called the Euro (EUR) and in the United States, the currency in circulation is called the US Dollar (USD). An example of a forex trade is to buy the Euro while simultaneously selling US Dollar. This is called going long on the EUR/USD.

How Does Forex Trading Work?

Forex trading is typically done through a broker or market maker. As a forex trader, you can choose a currency pair that you expect to change in value and place a trade accordingly. For example, if you had purchased 10,000 Euros in December of 2015, it would have cost you around $10,500 USD. Throughout 2016, the EUR or € value vs. the U.S. Dollar's $ value increased. At the end of April, 10,000 Euros was worth $11,600 U.S. Dollars. 

Forex trades can be placed through a broker or market maker. Orders can be placed with just a few clicks and the broker then passes the order along to a partner in the Interbank Market to fill your position. When you close your trade, the broker closes the position on the Interbank Market and credits your account with the loss or gain. This can all happen literally within a few seconds.

Leverage

Trading foreign exchange has many liberties other markets cannot afford.

Easily the most popular liberty is that of leverage, which allows a trader to control a multiple up to 50 times their account balance in the United States (or as high as few hundred times in other less regulated countries).

While such great leverage feels good when a trade works in your favor immediately, very few traders can handle extreme leverage well.

An intensive research report run by DailyFX, a well-known industry research and news analysis site, found that over the span of a year, the traders who were most profitable traded on average with five times leverage, and very often fewer than 10 times leverage.

They also found the least profitable traders traded over 25 times leverage. Unfortunately, many traders learn the hard way that utilizing large amounts of leverage leaves traders unable to act in their best interest if the market aggressively moves against their position. Another key finding of the research report was that traders often used non-favorable risk to reward ratios, with traders losing twice as much on their losing trades as they made on their winning trades. Daily FX went on to recommend traders utilize no less than a one-to-one ratio or preferably a 1 to 2 risk to reward ratio when trading Forex.

 

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