The foreign exchange market or forex market is a global decentralized financial market that specializes in over-the-counter trading in different currencies. Because of the speculative exposure of this market, it is important to understand how trading and transactions are conducted in order to know how to go about trading in currency.
The currency exchange rate is a critical aspect when pairing currencies, this rate is the level at which one currency is exchanged against the other. It is also important to understand that the currency exchange rates (buying and selling) can fluctuate based on economic indicators such as geopolitical happenings, inflation and industrial output.
Some of the advantages of forex trading is that most forex trading firms do not charge commissions on trade, they instead charge only for fees paid on bid or ask spreads. Currency traders are also run on 24-hour basis, which means that as a trader you can decide how and when to trade, the other advantage is that the Forex-C markets are always accessible to investors as such traders do not have to possess huge amounts of money to start trading. As a trader you may also decide to trade on leverage, although this instrument can expose you to higher gains or losses. Traders also have a choice to select what currencies they want to trade-in, rather than let themselves to be exposed to a large number of stock trades.
- Currency Pairs: This is one of the most critical instruments for trading in foreign exchange markets. Currency pairs can be described as the rate of currency exchange relative to another currency. Some of the most traded pair of currencies in the entire Forex-C market are; GBP/USD – Pound, EUR/USD – Euro, USD/JPY – Yen, USD/CAD – Canadian Dollar, USD/CHF – Swiss Franc and the AUD/USD – Aussie. It is estimated that these currency pairs constitutes up to 85% of the entire global foreign exchange market volumes.
- Bid/Ask Spread: Most currencies are quoted with a bid price and an ask price. The bid price, is usually quoted lower compared to the ask price, this is because the ask price is the price at which the broker is willing to buy; it is also the price that the trader should quote as the sell price. On the other hand, the ask price is the price at which the broker is willing to sell; this price should entice the trader to jump at the marked-price and buy. For example EUR/USD 1.2546/49 or 1.2546/9, means that the bidding price is set for 1.2546 while the corresponding ask price is set to 1.2549.
- Pip: This is the slight incremental move that is made possible through currency pairing. The term also stands for the price interest point. For example a change in EUR/USD currency pairing from 1.2747 to 1.2762 would be equivalent to 15 pips.
- Margin Calls: In case the balance available in the trading account falls short of the maintenance margin, which is the required capital for opening a position, a margin call will occur. When the margin call situation arises, the broker will either buy back in the event where a short position occurs or sell-off the entire trades. This predicament will leave the trader with the maintenance margin, which is a stable low risk holding position. Margin calls can also occur in situations where there is an occurrence of improper money management.
- Margin Leverage: In most financial markets trading, it is usually a requirement to have full deposit paid-up during trading. However, in a forex trading market, all which is required for you to trade is the margin deposit, with the remaining amount being offered through the brokerage. For example a broker may offer a leverage that will rise to 500:1. This means that only 1/500 in-balance or 0.20% of value will be required to open a trading position.
Forex Exchange Market Dynamics
To demonstrate the market mechanics of a foreign exchange market trade, a situation may arise where a trader advances that the British Pound is likely to rise in price value. The trader then decides to move along and put to risk 30 pips, thereafter in an event that sees the market move in the opposite direction to the trader’s position, the trader will end up losing 30 pips. On the other hand, if the trade moves according to the trader’s whims, the trader will gain 60 pips.
Recent development in technology has seen a rise in accessibility of the forex market trading. This factor has resulted into the growth in trading opportunities such as on-line trades. Another huge benefit today concerning currency trading is that players do not have to be big money hotshots or money managers to begin trading. What this means is that, any willing investor can enter and trade in this huge market.
Currency Trading Precautions
Traders and investors willing to invest into the forex trading market should understand that trading in foreign exchange on the basis of margin calls carries with it a high risk level. This essentially means that the forex trading market is not meant for every interested investor. Potential forex currency traders should carefully consider their investment options, risk appetite and level of trading experience before taking up currency trading. It is always critical before you decide to indulge into the currency trading market to have a good grasp of the foreign currency trading basics, beginning with the basic concepts to the complex ones.
Some of the pertinent issues that you need to focus on prior to opening a live currency trading account includes; risk management, trading psychology as well as any other related financial aspect. Forex trading may expose you to a gain or loss of part or entire investment portfolio, this means that traders should be careful not to invest money they believe should not be risked in forex trading. In case you are in doubt about any trading move, it is advisable to seek an opinion from qualified independent financial advisor or an investment authority for directions.