What is Foreign Exchange?
Foreign exchange, also referred to as Forex or FX, relates to the buying and selling of currencies to profit off the changes in exchange rates. Forex is by far the biggest financial market in the world and it enjoys massive liquidity that continuously attracts both new and experienced investors and traders worldwide.
The Forex Market
With a daily turnover of over A$7 trillion, the forex market eclipses the entire global equities market and enjoys high liquidity as well as high trading volumes at practically all times. The opportunities available in forex trading are immense, with the market open round the clock. From Monday to Friday, the forex market literally follows the sun around the world, opening in Australia, followed by Asia, and then Europe, and finally, this is followed by the US market until the markets close on the weekend. The only market open on the weekend is the cryptocurrency market.
The start time of the forex market is on Mondays at 07:00 AM AEST and it then closes at 4:00 PM AEST on Fridays.
Currencies are the primary commodity traded in the forex market. A typical forex trade will involve the simultaneous buying of one currency and the selling of another. There are numerous currencies in the world, and each one of them is distinguished by its own unique three-letter currency code. For instance, the American dollar is represented as the USD, the euro as EUR, and the Australian dollar as AUD.
Currencies are categorized into two broad groups – major currencies and minor currencies. The major currencies are derived from the most powerful economies around the globe – the US, Japan, the UK, the Eurozone, Canada, Australia, Switzerland, and New Zealand. Their respective 8 currencies are called major currencies, and most remaining currencies are considered minor currencies.
Currencies are traded in pairs. For instance, the AUDUSD currency pair represents the Australian dollar (AUD) against the US dollar (USD). When you buy the AUDUSD pair, you expect the value of the Australian dollar to strengthen relative to the US dollar; and when you sell, you expect the USD to strengthen relative to the AUD.
There are 3 types of currency pairs available for trading in the forex market: Majors, Minors, and Exotics.
- Major Pairs – When any of the major currencies is combined with the US dollar, a major currency pair is formed. This is because the USD is considered the most widely used currency in the world, both in reserves and circulation. Examples of major currency pairs include the EURUSD, AUDUSD, and USDJPY.
- Minor Pairs – A minor currency pair is when two major currencies are combined but the USD is not one of them. They are also known as cross-currency pairs. Examples of minor currency pairs include the AUDJPY, AUDNZD, and EURGBP.
- Exotics Pairs – An exotic currency pair is one that combines a major currency with a minor currency. Exotic currency pairs include local currencies of emerging economies such as Turkey, Singapore, and South Africa. Examples of exotic currency pairs include the AUDSGD, USDZAR, and EURTRY.
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Forex Trading Basic Terms
Understanding basic forex terms will help you to get started in online forex trading.
- Base Currency and Secondary Currency
One of the major currency pairs that are traded in the Australian dollar vs the American dollar or the AUDUSD pair. In this case, the AUD (the currency on the left) is called the base currency and is the one we wish to buy or sell; whereas the USD (the currency on the right) is the secondary currency and is the one we use to make the transaction.
- Bid and Ask Prices
When trading any currency pair, there will always be two price quotes (or exchange rates) – the bid and ask prices. The Bid price is the price for buying the base currency, whereas the Ask price is the price for selling the base currency.
The difference between the bid and ask prices is called a spread, and it represents the trading fees charged by a broker to open a trade position in the market. Usually, major currency pairs, such as the AUDUSD, have high liquidity and their spreads are narrower, whereas illiquid currency pairs, such as exotics, mostly have wider spreads.
On most platforms, a currency pair exchange rate will be quoted to the fourth decimal place. For instance, the price of the AUDUSD pair can be expressed as 0.8010. This means that you will need 0.8010 US dollars to buy 1 Australian dollar. Price changes in forex are measured in terms of A pip is the smallest change in the exchange rate of currencies. For instance, if the AUDUSD moves from 0.8010 to 0.8011, it is said to have moved by 1 pip.
- Going Long and Going Short
Some other important terms to understand include ‘Going Long’ and ‘Going Short’. Going long simply means buying an asset in anticipation of higher prices in the future. Going long is also known as being ‘bullish’. On the other hand, going short simply means selling an asset in anticipation of lower prices in the future. Going short is also known as being ‘bearish’
- Bulls and Bears
A bullish trader is optimistic that the prices of an underlying asset will rise. As well, a bullish market is when the underlying sentiment is of higher prices. In contrast, a bear (or bearish) market is one that is typically falling. Traders should always develop strategies to help them effectively identify and take advantage of the underlying market conditions when trading.
- Trading Platform
Traditionally, forex traders would call their brokers to deliver instructions on actions they wish to perform in the market. However, today, everything is conducted by traders directly using software known as the Trading Platform. A trading platform is your portal to the forex market, and in addition to allowing you to open, manage and close trades, you can also access charts as well as other trading tools and resources to help you enhance your trading activities. A good broker will allow traders to access the trading platform with a desktop computer, web browser, and even a mobile device.
Join the over A$7 trillion a day market by opening an account with AvaTrade today!
Leverage is one of the biggest attractions of the retail forex market. By definition, leverage trading involves a broker allowing traders to control trade positions in the market that are much larger than their available capital. For instance, AvaTrade offers leverage of up to 400:1. This means that you only need $250 to control a $100,000 trade position in the market. But leverage should always be used carefully because it is a double-edged sword. Leverage boosts profits of your winning trades but it also magnifies the losses of trades that go against you.
What Affects the Forex Market?
Like every other market, prices in the forex market are determined by demand and supply. The principle is simple: if a currency is in high demand, its value will increase relative to other currencies, and vice versa.
Numerous factors can affect the demand and supply of any currency. The major catalysts for price changes in the forex markets are:
- Macroeconomic statistics, such as interest rates and inflation. Higher interest rates limit the supply of local currencies, which consequently raises their demand and overall value. Countries with higher inflation generally see their local currencies decrease in value, whereas countries with low inflation will see their currencies increase in value over time. Some other important macroeconomic statistics include trade balance, employment numbers, and consumer spending.
- Economic Events – To understand the value of a currency, many traders usually track economic news releases and events when trading relevant currencies. Positive releases (relative to expected numbers) usually increase the demand for the underlying currency, whereas negative releases (relative to expected numbers) will reduce the demand for the underlying currency.
- Major political events and government headlines such as elections and the state of public debt can also impact the supply and demand of various currencies. Therefore, traders need to stay on top of relevant news and events using the Economic Calendar
A Sample Forex Trade
Consider this: You log into your trading platform and the AUDUSD rate is displayed as follows 0.8015/0.8019. Those are the bid/ask prices and in this case, the spread is 4 pips (the difference between the bid and ask prices).
If you believe the price will go up, you will buy at 0.8019. If you believe the price will go down, you will sell at 0.8015. The amount of profit or loss you incur will depend on the number of pips the price has covered by the time you close the trade. If after some time the rate moves to 0.8039, it will mean that the price has moved up by 20 pips. If you bought the AUDUSD pair, you will have earned a profit equivalent to 20 pips. If, for instance, you had bought a standard lot size of AUDUSD (1 pip = A$8), will have earned a profit of A$160 (20pips*A$8).
Why Trade Forex with AvaTrade?
Forex trading is as lucrative as it is risky. There is a very real possibility of making huge amounts of money, but you are also in perpetual danger of losing your trading capital as well.
- Regulation – With the risks of trading, it is important to walk this journey with a reliable and trustworthy brokerage partner. For your safety and security, AvaTrade has secured regulatory approval in various jurisdictions across 6 continents. Such high regulation gives our traders the peace of mind that they are dealing with a globally reputable broker that offers fair and transparent trading services, and never compromises their safety of funds or personal information.
- Trading Environment – Beyond regulation, AvaTrade offers an outstanding trading environment to ensure that traders can trade their preferred financial assets with confidence. We have the most advanced and user-friendly trading platforms and also boast a comprehensive educational section where traders can access a wide selection of relevant eBooks as well as video tutorials. Furthermore, we have made available handy trading tools and resources such as the Economic Calendar, AvaProtect (our exclusive risk management feature), and AvaSocial.
- Customer Support – In case you ever need any help or assistance, the responsive, friendly, and professional AvaTrade team will always be available to offer you multi-lingual support round the clock.
How does forex work?
Forex trading is conducted peer-to-peer in the over the counter (OTC)market. This means there is no centralized location for forex trading, with the market operated by global bank networks located in four major centers: Sydney, Tokyo, London, and New York. This has made forex a true 24-hour financial market, where money literally never sleeps. Forex trading is mainly done in derivative form, with participants simply speculating on price changes and not actually buying or selling physical currencies.
What are the three different types of forex markets?
There are three ways you can trade in the forex markets. The first is in the spot forex market, where settlement is done at current market prices (on the spot). The second is the forward forex market, where settlement is done at a set price and set date in the future. The third is the future forex market, where like the forward forex market, the settlement is done at a set date and set price in the future. But unlike forwards, futures are legally binding contracts.
Is forex a good idea?
Many traders around the world will believe that forex is a great idea. In this day and age, the forex market has opened up opportunities that were previously only accessible to a minority of elite investors. The power of leverage also makes trading forex an idea that can change your life, with not much capital to start with. But while the allure of forex is real, it is always important to understand the risks involved. If you can build a solid trading strategy to earn profits in the market consistently, as well as a practical risk management plan to mitigate the risks involved, forex might be the best idea for you!
Join AvaTrade today and enjoy the best trading experience you can get!