Home » What Is Forex Trading? How Does It Work?

What Is Forex Trading? How Does It Work?

by Nathan Zachary
Forex Trading

You might already know that the forex market has no physical place and is not subject to centralised control by any authority. But this decentralised nature of the forex market also contributed towards its growth and expansion as now it is the largest financial market in terms of trading volume and daily turnover. The currency market operates virtually and is explored by millions of traders worldwide. Before you dive deep into the forex market, you should be well-versed with some basic terms and concepts that co-exist with forex trading. By the end of this article, you will get some basic yet essential knowledge about forex trading to help you get started as a beginner. 

What is Forex Trading?

Forex trading has become much more popular in the past few years. But many of us still need to figure out what it actually means in a real sense. So, before moving forward, we need to understand the true essence of forex trading. Forex trading is simply about buying and selling currencies, or to be more specific, the trading instruments in the forex market are international currency pairs. 

The very essence of forex trading is the exchange rate fluctuations that allow traders to make profits through trading. But predicting the currency price movements with precision requires a lot of planning, analytical skills and calculations, supported by a solid risk management plan. That is why learning to trade forex from scratch is considered to be a time-consuming process. But taking time to learn and understand the forex market is necessary for marking a successful beginning to your trading journey.  

Understanding Forex Pairs

As we mentioned above, the trading instruments of the forex market are currency pairs, where the value of one currency is expressed by comparing it to the value of another currency. A forex pair comprises 2 currencies: 1st one is the base currency ( the one which is bought or sold during a trade), 2nd is quoted currency ( the one against which the value of the base currency is stated). 

There are 3 types of currency pairs in the forex market. The most prominent one is major pairs which include major currencies from the most developed economies quoted against USD, which is the world’s reserve currency. They are also the most traded currency pairs in the forex market. Pairs like EUR/USD and USD/JPY fall into the category of FX majors. They are also the most liquid pairs in the market. 

The second type is minor or cross pairs, which won’t have USD but will have one or two of the next 3 major currencies: Euro, GBP or JPY. They are also popularly traded pairs but came second to major pairs regarding trading volume. EUR/GBP and GBP/CAD are examples of minor pairs. 

The 3rd category is exotic pairs, where currencies from developing economies will be quoted against the major currencies. They are the most volatile and risky pairs, making them the least traded pairs with little liquidity. 

Pips and Profits

The concept of pips and profits go hand-in-hand in forex trading. Because the currency price movements or exchange rate fluctuations are measured with this specific unit called pips, the value of a pip will be a key determinant in the planning of trades and the calculation of profits or losses resulting from trade. The value of a pip is different for different currencies, and calculating with precision is essential for executing your trades perfectly. Most traders will measure their profits or losses as the number of pips gained or lost in a trade. So, understanding the concept of pips should be your first lesson for forex trading.    

What is Margin in Forex Trading?

Margin in forex trading can be described as the amount of funds that should be there in your account for opening a trade position and keeping it running for a specified duration. The margin requirement for trade will depend on many factors, including the position size, the currency pair you are trading with, the currency with which you will be funding your account, and the leverage you avail from your forex broker. Leverage is a facility your broker offers to let you trade with additional funds without actually depositing them into your account. 

If you apply for 100x leverage for your account, you get to trade with $100 for every $1 deposited. But the broker will have set a margin requirement that you are supposed to deposit beforehand to avail the desired leverage. The risk of losing trades is always there, and when you avail leverage, the account balance will be used to make up for the losses, which leads to a margin call from the broker. If your account balance falls below the margin level, the broker will ask you to deposit more funds and close your trade positions when you fail.

How to Choose a Forex Broker?

You can only access or trade in the forex market if you sign up with a forex broker to open a trading account. The broker will connect you to the forex market, with enough liquidity to easily place and execute trades. They will also provide real-time market data and other essential tools which you would need for trading with ease. 

While choosing a forex broker, you need to consider the following factors:

  • The reputation of the broker 
  • Trading conditions offered by the broker in terms of spreads, commission and ma leverage
  • The functionality of their platform
  • Availability of tools and other resources
  • Customer support

Different Trading Platforms

Another essential requirement for trading forex is trading software or a trading platform. Forex brokers have integrated different trading software into their platforms, and their clients can trade on any platform. The broker will be the one helping you with opening a trading account on the chosen trading platform. This platform is actually a software interface connecting you to the forex market for a seamless trading experience. It will also give you access to many free tools and features that can help you become a skilled and successful trader later on. 

MT4 and MT5 are the most popular trading platforms forex traders use. They have been around longer and have all the basic and advanced capabilities a trader looks for. So, consider opening an account with forex brokers who have integrated MT4 and MT5 into their platform for users.  

Bottom Line

In a nutshell, forex trading is all about logical speculation and risk management. The speculation of currency price movements needs to be backed by logic and analysis of market situations. But a risk management plan should also be there to minimise the losses that are part and parcel of the trading process. Beginners Should also spend enough time on a demo account and practise well before switching to a live account for real trading.  

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