What is Forex Trading?

An Introduction to Forex Trading

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Forex trading involves trading currencies from different countries against each other. The name is a hybrid term derived from the term foreign exchange market.

The euro (EUR) is the currency in circulation in Europe. The U.S. currency is the dollar (USD). A forex trade might involve buying the euro while simultaneously selling the dollar. This is referred to as "going long" on the EUR/USD.

How Does Forex Trading Work?

Forex trading is typically done through a broker or a market maker.

You can choose a currency pair that you expect to change in value and place a trade accordingly. For example, if you purchase 10,000 euros in March 2017, it would cost you about $10,800 USD. If the EUR or € value versus the U.S. dollar's value increases, you'll make money.

Ten thousand euros might be worth $11,600 U.S. dollars months later. Value depends on and can be influenced by several factors that might change suddenly, such as volatile political circumstances, or that may shift more slowly and over time, such as interest rates. 

How Forex Orders Are Placed 

Forex orders can be placed with just a few clicks of your mouse. 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 within a few seconds.

It's called a "spot deal." One party receives currency and another surrenders currency at the current exchange rate a virtually the same time.

Leverage

Trading on the foreign exchange offers many liberties that other markets cannot afford. The most popular is that of leverage, which allows a trader to control a multiple of up to 50 times his account balance in the U.S., or even as high as few hundred times in less regulated countries.

 

Although such great leverage feels good when a trade immediately works in your favor, very few traders can handle extreme leverage well. An intensive research report by DailyFX, a well-known industry research and news analysis site, found that the traders who were most profitable over the span of a year were those who traded on average with five times leverage, and very often fewer than 10 times leverage.

They also found that the least profitable traders traded over 25 times leverage. Unfortunately, many traders learn the hard way that utilizing large amounts of leverage leaves them unable to act in their own 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. DailyFX went on to recommend that traders utilize no less than a one-to-one ratio, or preferably a 1-to-2 risk-to-reward ratio when trading Forex.