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Getting involved in the forex trading market can be a lucrative prospect for many people. However, there are lots of things to learn – some of them are a true headache to internalize, while others feel as natural as going putting on a pair of pants. If you are considering becoming a forex trader, then this article is dedicated to you. Here is what every rookie needs to know about the forex market before initiating their first trade.
What is Forex?
The foreign exchange market, more widely known as forex or simply FX is a global decentralized market for trading currency. The forex market includes all matters related to currency, from buying, selling and exchanging currencies at predetermined rates. This is the most basic definition of this activity. But, as you might have already guessed, there is more to it than that.
In the past, the market was open solely to those belonging to corporations, hedge funds, big financial institutions, and people who had a lot of wealth to spare and invest. But the advent of the internet has opened the market to countless everyday individuals who wanted to try their luck at forex.
The Basics of Forex Trading
Here is something that not many people think about – you are already unknowingly participating in the forex market. How? Essentially, every time you order something online from another country, the money you use to buy the product (which is usually the local currency) is exchanged to the regional equivalent from said state.
Since there is no central marketplace in the traditional sense of the word that conducts these exchanges, they are finalized electronically. This means that all of these transactions go through the computers of traders all over the world.
The difference between you, the person who bought said product, and the trader is that the trader oversees the effects of these transactions on a macro level, and reacts accordingly by betting for or against a currency pair (more on that later). This is forex broken down to its most essential components.
Currency Pairs and Types
A currency pair describes the quotation and pricing structure of the currencies traded through the market. The value of the currency is set by comparing it to another. As such, forex trading involves purchasing one currency and selling another. But when it comes to currency pairs, you can think of them as a single unit that can be traded.
To put things into perspective, if you decide to buy a particular currency pair, you are essentially purchasing the base currency and selling the quoted currency. When selling, you will be selling the base currency and receiving the quote currency. The price of a currency is called ‘’bid’’, whereas the selling price is called the ‘’ask’’.
As for the currency types, there are three types:
- Minor currency packs – every pack that contains the U.S. dollars.
- Major Currency Packs – those that do not contain the U.S. dollar.
- Exotic currency packs – packs made out of currencies from emerging markets, such as Singapore, Mexico or Hong Kong.
Types of Risks
Every trader assumes some manner of risk. However, learning the types of risks and how to manage them can give you a significant edge over other traders:
- Transaction risk. It involves the time differences between a certain number of countries, meaning that the rates can change and render your trade obsolete. This type of risk is directly proportional to the time-zone gap.
- Interest rate In short, when the interest rates are high due to investments in the country’s assets, the currency becomes stronger. When interest rates fall, investors withdraw their investments, causing the currency to suffer a sharp drop.
- Leverage risk. This is a double-edged sword – the higher the risk, the bigger the profit margin. However, it is worth mentioning that the same thing applies in reverse.
There are several strategies that traders can employ to full effect. Some of them have been known to be effective in most cases, while others are highly situational. But for starters, here are the ones that are the easiest to understand:
- Swing trading strategy – like the name suggests this strategy is used for short-term trades that last between a day or a week.
- Trend trading strategy – this one deserves an entire article of its own. But to summarize, as a trader, you will be following trends (meaning the price evolution) even without applying a strategy built specifically for this purpose. From a strategic perspective, a trend trader will follow the price of a particular currency to determine if it is worth investing based on past patterns, or if it is a fluke.
- Day Trading Strategy – it is exactly what the name suggests. Trading by day will decrease the likelihood of inferring loses due to any negative events that occurred overnight.
These are the basic things that you need to know in order to kick-start a fruitful forex career. Learning the types of risk, a few simple strategies, as well as how currency pairs work is enough to get you going. As for the aspects that we did not have the time nor the space to talk about – technical and fundamental analysis, studying the industry, and so on and so forth – we highly recommend checking out this article, as it covers all facets of these issues.