What is Forex Trading and How does it Work?

Before beginning the procedure, it is crucial to understand what is forex trading. The foreign exchange market can indeed be defined as the network of sellers and buyers who exchange currencies amongst each other at a predetermined rate. The term refers to the process by which people, businesses, and federal reserve convert currency into another. If you’ve ever travelled outside of your country, it is possible that you have participated in a currency exchange transaction.

To put it another way, if a trader makes a reasonable prediction that a certain currency would appreciate in value relative to the home currency, they will be compensated a predetermined sum. If the currency does indeed drop, the trader will lose the money he or she has staked.

However, while a significant amount of foreign exchange is carried out for practical reasons, the overwhelming bulk of conversion is carried out with the intention of making a profit. Because of the large volume of cash that is converted each day, the price swings of particular currencies can become quite erratic. It is this unpredictability that really makes forex trading so appealing to traders: it increases the likelihood of making large profits while simultaneously increasing the likelihood of losing money.

What Is Currency Trading?

What Is Currency Trading?

All currencies are issued a three-letter identifier, similar to the ticker symbol of a stock. As there are as many as 169 currencies globally, the US dollar is engaged in the great bulk of forex trading, therefore knowing its code is very useful: USD. The Euro, which is recognised in 19 European Union nations, is the 2nd most used currency in the foreign exchange market (code: EUR).

JPY, GBP, AUD, CAD, CHF, and NZD are the other main currencies in order of popularity. Every forex transaction is stated as a fusion of two currencies getting exchanged. These 7 currency pairings, termed as the giants, account for around 75 percent of forex trading:

  • USD/CAD 

How are Forex Trades Quoted?

Every currency pair indicates the two currencies’ official exchange rate. This is how one can analyse the data, using the EUR/USD transaction:

  • The base currency (the Euro) is on the left, and the quote currency (the US dollar) is on the right. 
  • The exchange rate represents how much of the quote currency is required in the base currency to purchase one unit of the base currency. As an effect, quote currency varies according to the market trends and the amount of money necessary to purchase one unit of the base currency. In contrast, one branch of the base currency is always represented as one unit.
  • If the exchange rate of EUR/USD is 1.2, it means that $1.20 will see for €1 (or, in other words, it will cost €1 will buy $1.20). 
  • If there is a rise in the exchange rates, the base currency’s value has risen relative to its quote currency (because €1 will buy more US dollars). When there is a fall in the exchange, it means that the base currency’s value has fallen.

Just a brief note: Currency pairings are typically presented with the quote currency after the base currency. In contrast, specific currency pairs have a historical standard for how they are stated. For example, conversions from USD to EUR are reported as EUR/USD rather than USD/EUR.

What Explains the Versatility?

The forex market allows giant corporations, retail dealers, governments, and individuals to swap between one currency to another. The interbank market, where liquidity providers deal with one another, is the ‘heart’ of the FX market.

The benefit of forex trading between worldwide banks and liquidity providers is that currency may be exchanged 24 hours a day, seven days a week (during the week).

As the Asian trading day comes to an end, European and UK banks go online before the US. The trading day ends when the US session transitions into the Asian session for the following day.

The availability of round-the-clock liquidity adds to the allure of this market for traders. Because there are so many buyers and sellers of foreign currency, traders may join and leave positions fast.

How To Read A Foreign Exchange Market?

Every trader must understand how to comprehend a forex quote since it influences the price at which they enter and leave a transaction. The Euro is known as the base currency in the EUR/USD pair, while the USD is known as the variable or quote currency in this combination.

Most FX markets provide prices to five decimal places, albeit the first four are the most important. The number to the left of the decimal point denotes one unit of the counter currency, which in this instance is the US dollar and hence equals one dollar. In this example, the following two digits are the cents, therefore 13 US cents. The third and fourth numerals are known as pips because they represent penny fractions.

It is critical to note that the number at the fourth decimal place is known as a ‘pip.’ If the EUR falls by 100 pips against the USD, the new sell price will be 1.12528 because one Euro will cost less in USD.

One Euro is worth one dollar, 13 cents, 52 pips, and 8/10ths of a pip in US dollars, according to another way of expressing the above-mentioned bid price.

[ Don’t forget to read: How to Make Profits in Forex Trading? ]

Dangers of FOREX Trading

Forex trading is riskier than other types of assets since it requires leverage and traders utilise margin. Currency values are constantly changing, but in tiny amounts, necessitating traders to conduct large transactions (using leverage) in order to benefit.

If a trader wins a bet, this leverage may significantly boost profits.

However, it has the ability to magnify losses to the point where they exceed the initial loan amount. Furthermore, if the value of a currency falls significantly, leverage users are vulnerable to margin calls, which may force them to sell equities purchased with borrowed funds at a loss. Aside from possible losses, transaction fees may accumulate and deplete the value of a successful trade.

Furthermore, keep in mind that currency traders are little fish in a sea of smart, experienced traders—and the Securities and Exchange Commission warns about probable fraud or information that may be deceptive to starting traders.

Why is Forex Trading Flexible and Profitable?

Once you understand what forex trading is, you will know the perks of it. The $6.6 trillion Forex market may be rewarding for traders who understand how to utilise it. Even so, if you don’t plan and prepare your trades ahead of time, the odds are stacked against you.

Ability to Travel Long or Short Distances

Short selling is an integral part of FX trading, and derivative products such as CFDs may be used to go short on other markets. This is because you’re continually selling one currency (the quote currency) in order to buy another (the base currency). The price of a forex pair is the value of one unit of the base currency in the quotation currency.

[ Don’t forget to read: Is Forex Trading Legal in India? ]

Hours of the Forex Market

The foreign exchange market is open 24 hours a day, five days a week – from 9 p.m. Sunday to 10 p.m. therefore, it is better to do the transaction on Friday for sure. Since forex transactions are handled between parties directly, over the counter (OTC), rather than through a central exchange, these extended hours are necessary. 

Forex Has a lot of  Liquidity

The foreign exchange market is the most liquid in the world. This depicts that there are always a significant number of buyers and sellers available. Besides this, all of them are eager to make a deal for sure. Individuals, organisations, and institutions change about $5 trillion in money every day, with the great bulk of this activity aimed at making a profit.

You can Trade a Variety of Currency Pairings

Forex trading allows you to speculate on global events and the relative strength of significant and minor economies. This enables trading in a wide range of currency pairings undoubtedly.

You may pick from over 90 currency pairings. Thus, doing forex trading online is really beneficial. However, one needs to be cautious about the market risks.

Forex is an ideal place to start despite its dangerous reputation if you’ve never traded before. When no leverage is employed, Pairings of currency is less volatile than stocks. It’s tough to confuse a bull market for a financial genius when passive investment returns in the FX market are poor. 

GoDoFX, a pioneer in Forex Trading, offers trading services in financial instruments to corporate investors. If you are a novice or professional trader, you may rely upon this worthwhile organisation for advice, training, and much more in order to profit from Forex trading in India. You will succeed in business in general if you succeed in the currency market.

Don’t forget to check: How Leverage Works in The Forex Market? | Forex Day Trading Strategies