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What is Forex trading?

An abbreviation of Foreign Exchange trading, ‘Forex’ trading is the buying and selling of one currency in exchange for another. This exchange takes place in an online marketplace called the Forex market.


About the Forex market

The Forex market is an exchange in which currencies are traded. Daily, trillions of dollars are exchanged on it, making it the world's largest and most liquid market.

The Forex market is not centralised or owned by any single individual or entity. Instead, it is made up of the many participants who contribute to it. These include central and retail banks, hedge funds, investors, corporations, and retail, or individual, traders.

No single entity is influential enough to manipulate prices in the market, and all participants play a part in contributing to the liquidity of the market simply by executing trades and circulating currencies.

 

Who trades Forex?

 

People may participate in Forex trading as long as they have capital and are compliant with local laws and broker regulations. As the launch of trading apps and digital platforms have made trading even more accessible, and more and more people have taken up trading with the aim of making a profit from market price fluctuations.

However, not everybody who participates in Forex trading does so for profit.

At its core, Forex trading is the exchange of one currency for another. Large corporations with overseas offices exchange currencies to pay their employees in their local money, and companies that do business with foreign ones also exchange currencies in billing processes.

Even tourists who go abroad and exchange money at the airports participate in the Forex market.


 
How Forex trading works?

 

Forex traders buy and sell currencies depending on whether they think their market price will increase or decrease.

To break down currency trading for beginners, traders should be familiar with basic Forex terminolo and understand currency pairings before participating in trading.

 

Currency types

 

Currencies are sorted into two categories—major and exotic.

There are eight major currencies, and they are derived from the eight most powerful economies in the world. These are the US dollar, the British pound,  the  Euro,  the Japanese yen, the Canadian dollar,  the  Australian  dollar, the  New Zealand  dollar,  and the Swiss franc.

These currencies are considered the most tradable, with the US dollar being the most traded in the world. This is followed by the British pound and the Euro, as the UK and Eurozone have substantial relationships with the United States and frequently participate in trades with the United States.

All other countries are considered emerging or developing markets in the context of Forex trading, and their currencies are exotic.

Commonly traded exotic currencies are the South Korean won, the Russian ruble, the South African rand, the Singaporean dollar, and the Hong Kong dollar.

Traders will find that exotic currencies may be less liquid than major currencies, but they
are still frequently traded, usually against a major currency.

 

Currency pairs


Currencies are traded in pairs, and they are represented by two currency codes with a slash in between. The first currency listed on the left is the base currency, and the second one on the right is the quote currency.

A currency pair's exchange rate is the price of one unit of the quote currency relative to that of the base currency. For example, if the exchange rate of GBP/USD is 1.3529, it requires 1.3529 US dollars to buy 1 British pound.

The exchange rate increases when the pound (base currency) strengthens against the dollar (quote currency). It decreases when the reverse happens.


Currency pair types

Imagine a financial market where $5,3 Trillion changes hands. Every. Single. Day. You are intrigued, we can tell! Because we have been doing this for a decade! Let’s talk about how to trade Forex!

Forex (or FX) is short for Foreign Exchange market. You may also have heard of it called currency trading. The fundamental idea is to exchange one currency for another and gain profit.

If you have physically exchanged currencies before, you know that as a result of the exchange you either gain or lose money. It depends on how one currency gained more value than the other since your purchase.

There are three types of currency pairs: major, minor, and exotic.

Major currency pairs consist of the US dollar and one other major currency, such as GBP/USD and EUR/USD. Major pairs account for 80% of the trades in the Forex market.

Minor currency pairs consist of pairings between the rest of the major currencies, excluding the US dollar. This could be EUR/GBP or EUR/JPY. Minor currency pairs are also referred to as cross currency pairs or crosses.

Exotic currency pairs are made up of one major currency and one exotic currency.

Examples include USD/SGD and USD/HKD.

Pairings between two exotic currencies are much less common, as currencies from emerging markets are not as liquid, meaning their market prices do not fluctuate too much for traders to be interested in trading.


Spreads


All currency pairs carry two prices—the bid price and the ask price.

The bid price is the best price currency buyers are willing to pay to buy an amount of a currency, while the ask price is the best price currency owners are willing to sell an amount of currency they possess.
 
The difference between them is called a spread.

Generally, a smaller spread is desired by traders, as it indicates that a currency pair is more liquid and less volatile.


Pips


‘Pip’ stands for Point in Percentage, and it is a unit of measurement in price market movements. In most currency pairings, 1 pip is 0.001 and refers to the fourth decimal place of a pair’s market price.

If GBP/USD moves from 1.3245 to 1.3248, it has moved 3 pips.

In currency pairings that involve the Japanese yen, 1 pip is 0.01 and refers to the second decimal place of the pair’s market price.

If GBP/JPY moves from 151.080 to 151.100, it has moved 2 pips.


Lots


Market movements are small, and a large number of units of currencies have to be exchanged for traders to make significant profits. Therefore, traders trade in lots, which contain a specific number of units of a base currency.

A micro-lot contains 1,000 units of a currency, a mini lot 10,000, a standard lot 100,000.

Traders can purchase a fraction of a lot, called an odd lot, if their broker permits. However, many brokers impose restrictions on odd lot trading, such as not issuing odd lots during certain times of the day.


Leverage


Leverage is a way for traders to increase their investment in an underlying currency by increasing their trade exposure.

With the use of leverage, traders only have to provide a fraction of their total position, while their broker loans them the rest of the money as a supplement. If a trader predicts GBP/USD will increase and it does indeed, they can close their position and reap the profits of the full size of the trade.

Leverage is expressed in ratios. A leverage of 100:1 in a position of £100,000 means that a trader only has to supply a 1% margin, or £1,000, to open their position and begin trading.


Going long and short


Forex traders take advantage of price fluctuations and buy and sell currency pairs according to price predictions.
 
When they predict the market price of a currency pair will increase, they buy it or go long. When they have the opposite prediction, they sell the currency pair or go short.

For example, a trader who predicts the British pound will appreciate against the US dollar will buy GBP/USD to sell later at a higher price. If he predicts the pound will depreciate against the dollar, he will sell GBP/USD to buy it back later at a lower price.


What influences exchange rates in the Forex market?


Due to a large number of participants in the Forex market, no single individual or corporation exerts enough dominance to manipulate market prices on their own.

What moves Forex market prices are government fiscal policies such as tax and inflation rates, terms of trade, political economy, and market sentiment—the general attitude of investors and traders who participate in it.

 

Trading Forex

 

On Forex markets, you do not physically purchase a currency. You simply make a prediction and take your position in the market: X currency will gain value over Y currency in a given time.

Traders do not simply guess which currency will gain or lose value over another. They rely on analyzing the economy, past trends and upcoming major events before making that decision. This whole process is called ‘trading forex’. The more technical term is trading Contracts for Difference (CFDs). We will learn more about CFDs later in this section.

Trading Forex is all about observing the markets, the currency pairs and their respective values over one another. If you can predict the direction of the market, you profit. It’s simple as that.

You open either a long (buy) or short (sell) position, assuming the currency’s value will either go up or down. As millions of other Forex traders open positions just like you, the price is set as a collective result of everyone’s positions.

Think of it as a ‘tug of war’ where millions of traders are holding a rope. One side is buying, the other side is selling. When a trader opens a position, they join a team and grab one end of the rope. When happy with the current price, they close the position and thus ‘let go’ off the rope. Their current positions define the live price of the currency.

Without an official regulator or state involved, this is pretty much how the pricing is determined. But not everyone has the same amount of investment, or as in our analogy, the same muscle strength! Larger investors will definitely impact the direction and the pricing of markets slightly more than others. Still, the market is so deep that even the largest players can never shape or corner it.


Ready to trade Forex?


Here at GKFX, we are a fully European Union regulated broker, and we offer 42 Forex pairs for trading. Our spreads are as low as 0.6 for our Standard traders and as low as 0.1 for our Premium traders.

GKFX traders can also access daily and weekly market analysis as a supplement to our trading guides. Open a free trading account to test out a demo or trade live today.