The Foreign Exchange (FX) or forex market is the largest market in the world. It is not bound to any one location, like an exchange. You can trade on the forex market 24/7, from the comfort of your home. For those of you that don’t know, the foreign exchange market is where monetary currencies are traded. And just to give you an idea of the enormous amounts of money that goes around on the FX… More than five billion USD is traded on the FX every day! That is a staggering amount of money!
We figured that you might want to take a swing at trading forex, seeing as it is such a massive market. That is why we decided to make a series of blog posts to enable you to start trading FX. In today’s post, we will discuss the basic principles behind trading forex and then in future posts, we will go into more detail about risk management and trading strategies.
The basic premise of trading forex
In its simplest form, trading FX is when you go to your local bank or money exchange to buy Euros for your upcoming Euro trip. You are exchanging one currency (the Rand) for another currency (the Euro). But we just said that FX is not bound to a specific location, so why do you have to go to the bank to trade currencies? Well, that is just the basic premise of trading forex. And you need the actual Euro notes before you fly to Amsterdam, right?
Currency Pairs
So, how does it work? The first thing you should know is that you always trade in pairs – call it a currency pair. In other words, you will trade one currency against another one. For instance, if you want to trade Euro (EUR) against the Great British Pound (GBP), you will be trading the EUR/GBP currency pair. The first currency in the pair, in this case, the Euro, is called the base pair. This is the one that you think will go up or down against the second currency, which is known as the quote. So when trading FX you will always have a base/quote currency pair. Now remember, when you trade, you will be speculating on how the base will perform against the quote.
If you think that the base currency will rise against the quote, you place what is called a buying trade. Let’s make it simple by using our EUR/GBP example. If you are of a mind that the Euro will rise against the British Pound, you place a buying trade. And then, if the Euro does indeed rise, you make money on that trade! On the other hand, if the Euro falls against the Pound you lose money. But! And this is a big but ladies and gentlemen. When you trade forex, you can also predict that the base currency will go down against the quote. This is called going short. So if the Euro from our example falls against the Pound, you start earning money.
Leveraging
What makes trading forex so appealing to some people is the fact that you can trade using only a portion of the overall value of the trade. So you can place a deposit, also known as margin, on the trade and use the remaining money on other trades. This is known as leveraging. To leverage trade can have great benefits because you can run simultaneous trades at the same time with only a fraction of the full value of each trade. And if your predictions were accurate, you’ll make a lot of money! But on the other hand, if you run simultaneous trades like this and your predictions are off, you won’t only lose the deposits you had to put down to start a trade, you’ll have to pay in the full amount of what you lost.
So as you can see, leveraging goes both ways.
Risk Factor
Currencies can rise and fall rapidly, depending on political and economic factors in a country. Thus you can make money quickly through trading forex. Especially if you follow what is going on in the specific countries where the currencies that you are trading comes from. If you can see that a political situation might spiral out of control, you can start trading accordingly. But on the other hand, if your prediction was wrong and that country’s political situation stabilises, you can lose out on money because that currency stayed strong or even strengthened against the quote currency in your pair. So you have to be extremely careful when you trade forex. Things can change in moments, which can play out in your favour or ruin you.
Until Next Time
And there you have it, ladies and gentlemen. The basics of trading forex. In the next blog post, we will go into more detail about how to get started. We’ll talk about how to set up a trading account, how the trade transactions work and so on.
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