Forex Trading – Explaining the Concept

Forex trading represents buying or selling a currency with the intention of generating a profit; or more exactly, it is buying or selling a currency pair.

Forex comes from the term “foreign exchange” and it is the largest market in the world today. Every day trillions and trillions of dollars and other currencies are sold or bought by Forex market participants.

These participants are institutional investors, commercial banks through treasury departments, Forex brokers, hedge funds, money managers, retail traders, etc. To get an idea about the size of the Forex market, consider that retail traders represent around 5% of the whole daily Forex volume.

This market was not available to retail traders for quite some time. However, by the time the Internet exploded, and with more and more people having access to it, online retail trading started to get popular.

Nowadays, anyone with an Internet connection can open a Forex trading account and start buying or selling currencies online. Basically, a market that wasn’t available to retail traders suddenly became accessible.

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What exactly is Forex trading, and how does the whole trading process function? Below are some points you need to consider.

What is Forex?

To trade a currency pair, or to be part of the foreign exchange market, a trader needs to be able to access it in the first place. For that, a Forex broker is required.

Why Forex Brokers?

Forex brokers are intermediaries, or the middleman between the retail trader and the interbank market. The brokerage house earns a fee or commission for allowing the trader to access the high-liquidity Forex market.

Forex brokerage houses evolved over time, in response to the need to keep up with the fast-changing technology. From basic access to the market, now big brokers offer not only access to the classical currency pairs, but also to other financial instruments such as commodities (gold, silver, oil, etc.), indexes (DJIA/Dow Jones Industrial Average and SP500 in the United States, Xetra Dax in Germany, Cac40 in France, Nikkei in Japan, etc.) and even contracts for difference (CFD).

The broker offers currency pairs to be traded; each currency pair being formed out of two different currencies.

Such a pair shows the economic differences between the two countries it represents, and it moves accordingly when the difference is large. In other words, if one economy of the pair is doing better than the other, the currency is going to appreciate.

Buying that currency via trading the currency pair entails trading the Forex market. To make a profit when trading Forex one needs to be right about the direction the currency pair is going in: up or down.

The moment that a currency pair is bought or sold, the Forex broker charges a commission or a fee for that particular trade. This is correlated with the volume that is traded, and on top of that, a spread fee is paid as well.

These are the two ways a Forex broker earns money, regardless of whether the Forex trader ends up being a winner or a loser.

Trading the Dashboard

Forex Trading - Explaining the ConceptThe Forex dashboard is made up of all the currency pairs and other financial products that the Forex broker offers to retail traders. Everything centres around the US dollar. This is because the US dollar is the world’s reserve currency, and everything that moves in the world’s financial system will be cleared in dollars. Let me give you one simple example…

Say you want to buy a house in Canada, and you’re from Germany, in Europe. The Canadian currency is the Canadian dollar (CAD) and Germany’s currency is the euro (EUR), as Germany is a member of the Eurozone.

Let’s assume the house costs 400,000 CAD. To pay for the house, the buyer cannot pay directly in either CAD or euro. What they has to do is to transfer the money from their own bank to the seller’s bank. What the buyer’s bank is doing is selling the euro from the buyer’s account, buying US dollars, and with those dollars buying the equivalent of 400,000 CAD to pay the seller.

In carrying out all these transactions, the commercial bank is actively involved in the Forex market, buying and selling different currencies on behalf of its client. For that, it charges a commission in the form of a bank account charge.

The dashboard has the currencies fluctuating against the US dollar, as the world’s reserve currency. These currency pairs are called major pairs, and trading multiple majors it is like just trading one, as in fact you’re trading against or in favour of the dollar.

Other currency pairs that do not have the US dollar in their componence form the rest of the dashboard, and based on their fluctuation, spread, volatility, liquidity, etc., they are split into other categories: crosses, minors, exotics, etc. As well as these currency pairs, a Forex broker offers access to other markets, and those instruments are to be found on the Forex dashboard.

Currency pairs fluctuate based on the economic factors, also called fundamental factors, but these are not the only ones. Geopolitical events, natural phenomena, wars, etc., may all make a currency lose or gain in value.

All the moves attributed to the currency market make the foreign exchange market. If traders are right about the direction of a currency, a profit is being made. If not, a loss is suffered.

People are attracted to the Forex market because it is easy to understand how things work, but few succeed and make a career out of it. It has always been, and still is, people’s dream to be on their own, to be their own boss, to have financial independence, etc.

Forex can give all that, but it comes with a cost. To be consistently right and make a profit, traders need to put in “screen hours”, meaning they need to constantly monitor markets for new opportunities.

The Forex market is known best for its huge swings, meaning that huge winnings and losses can be realised in a blink of an eye. Those swings are caused by high-frequency trading robots that buy or sell currencies on the same market just like the regular retail trader.

The only difference is that the robots trade much faster and more accurately, and there are no emotions involved when making the trading decisions. It is not the same when it comes to humans.

The human touch in Forex means that every trade will be second-guessed, and knowing yourself as a person is more important than knowing all the trading rules in the world combined. No one can prepare a trader for the last mile when it comes to pulling the plug on a losing trade, or staying for a take profit to be reached.

Patience and discipline are key, and they are the secret ingredients to trading Forex profitably. Traders strive to excel in these two areas, and those who do are not necessarily good traders, but they combine knowledge with market psychology.

This is what Forex trading represents: the opportunity of a lifetime, if you do your homework correctly. Future articles in the Trading Academy project aim to show you how!

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