Forex Trading – Explaining the Concept
Forex trading represents buying or selling a currency with the purpose of generating a profit. More exact, it is buying or selling a currency pair.
Forex comes from the “foreign exchange” and it is the largest market in the world. Every day trillions and trillions of dollars and other currencies are being sold or bought by Forex market participants.
These participants are institutionaml investors, commercial banks through treasury departments, Forex brokers, hedge funds, money managers, retail traders, etc. To have an idea about the size of the Forex market, just imagine that the retail traders represent around five percent 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 the retail traders, suddenly was possible to be accessed.
What exactly is Forex trading and how is the whole trading process functioning? Below there are some considerations 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 needed.
Why Forex Brokers?
Forex brokers are intermediaries or the middleman between the retail trader and the interbank market. The brokerage house is earning a fee or commission for allowing the trader to access the large liquidity Forex market.
Forex brokerage houses have evolved in time as they needed to keep up with the fast technology changes. From basic access to the market, now big brokers offer not only access to the classical currency pairs, but also to other financial instruments like 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 and they are being paired in two. This means a currency pair is formed out of two different currencies.
Such a pair shows the economic differences between the two countries it represents, and it is moving accordingly when these differences are big. In other words, if an economy is doing better than the other, the currency is going to appreciate.
Buying that currency via trading the currency pair means trading the Forex market. To make a profit when trading Forex one needs to be right about the direction the currency pair is going: up or down.
The moment that a currency pair is being bought or sold, the Forex broker charges a commission or a fee for that respective trade. This is correlated with the volume that is traded and on top of that, a spread fee is being paid as well.
These are the two ways a Forex broker earns money, no matter if the Forex trade ends up being a winner or a loser.
Trading the Dashboard
The Forex dashboard is made of all the currency pairs and other financial products that the Forex broker is offering to retail traders. Everything centers around the U.S. dollar.
This is because the U.S. 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, Europe. The Canadian currency is the Canadian dollar (CAD) and Germany’s currency is the Euro, as Germany is a member of the Eurozone.
Let’s assume the house costs 400k CAD. To pay for the house, the buyer cannot pay directly in CAD or Euro.
What he/she does is transferring the money from its bank to the seller’s bank. What the buyer’s bank is doing is selling the Euro from the buyer’s account, buys U.S. dollars, and with those dollars buys the equivalent of 400k CAD to pay the seller.
In doing 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 U.S. dollar, as the world’s reserve currency. These currency pairs are called major pairs and trading multiple majors it is like trading one, as in fact, you’re trading against/in favor of the dollar.
Other currency pairs that do not have the U.S. dollar in their componence from the rest of the dashboard, and based on their fluctuation, spread, volatility, liquidity, etc., they are split into other categories: crosses, minors, exotics, etc. On top of these currency pairs, a Forex broker is offering 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 not only. Geopolitical events, natural phenomena, wars, etc., may make a currency losing or gaining in value.
All the moves attributed to the currency market make the foreign exchange. If traders are right about the direction of a currency, a profit is being made. If not, a loss is realized.
People are attracted to the Forex market because it is easy to understand how things work but few are succeeding and making a career out of it. It has/still is always people’s dream to be on their own, 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 huge winnings and losses can be realized in a blink of an eye. Those swings are being caused by high-frequency trading robots that buy or sell currencies on the same market like the regular retail trader.
The only difference is that the robots are trading faster and more accurately, and there are no emotions when making a trading decision. It is not the same when it comes to humans.
A human touch to 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 make the secret ingredient to trading Forex profitably. Traders strive to excel in these two areas, and those who do, are not necessarily good traders, but they are combining 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!
Recommended Further Readings
- Why Trading Forex?
- What is a Forex Broker and Types of Brokerage houses?
- Financial Products to Trade
- Forex Trading Sessions and Their Importance
- Forex Brokers Types – ECN or STP?
Other Educational Materials
- Foreign Exchange Training Manual. Confidential Treatment Requested By Lehman Brothers Holdings, Inc.
- An Introduction to Forex Trading – A Guide for Beginners. By Matthew Driver, Wells Gray Press Great Britain, 2013.