Forex trading, also known as foreign exchange trading, is the act of buying and selling currencies in the global marketplace. As the largest financial market in the world, the Forex market operates 24 hours a day, 5 days a week, and processes over $7.5 trillion worth of transactions daily.
In this article, we'll dive into the essentials of Forex trading, explore how the market works, and highlight some key terms and strategies you need to know to get started.
Basics of Forex Trading?
At its core, Forex trading involves exchanging one currency for another with the goal of profiting from changes in the exchange rates (BIS – OTC Markets Report). Currencies are traded in pairs, such as EUR/USD (Euro/US Dollar) or GBP/JPY (British Pound/Japanese Yen). A forex pair consists of a base currency, which is listed first, and a quote currency, which is listed second. Traders speculate on whether the value of one currency will rise or fall against the other.
For instance, if you believe the euro will strengthen against the US dollar, you might buy EUR/USD. If the euro's value increases, you can sell it later for a profit.
How the Forex Market Works
The Forex market operates over-the-counter (OTC), meaning trades are made directly between two parties without a centralized exchange. Forex trading is done electronically through networks rather than on centralized exchanges. There are four trading sessions: Tokyo, Sydney, London, and New York. The Tokyo and Sydney sessions combined are referred to as the Asian Session. This structure ensures that there is almost always an active market somewhere in the world.
Forex trading occurs in different sizes called lots:
- Standard Lot: 100,000 units of the base currency.
- Mini Lot: 10,000 units.
- Micro Lot: 1,000 units.
There are two primary types of Forex trading:
Spot Forex: Trading currencies at the current exchange rate for immediate settlement.
Forex Futures: A contract to exchange currencies at a future date at a pre-set price.(CME Group – Currency Futures)
Benefits of Forex Trading
Forex trading offers several benefits to traders:
High Liquidity: The Forex market is the most liquid financial market in the world, meaning trades can be executed quickly and easily.
Leverage: Brokers often allow traders to use leverage, enabling them to control a larger position with a smaller amount of capital. Leverage amplifies both potential profits and losses.
Accessibility: The market is open 24/5, and with modern trading platforms, anyone with internet access can start trading. Margin is the amount of money needed to open a trade, often a percentage of the total trade value.
Risks of Forex Trading
While the Forex market presents great opportunities, it also carries significant risks:
High Volatility: Currency prices can fluctuate rapidly, sometimes leading to large losses. (IMF Global Financial Stability Report).
Leverage Risk: Although leverage increases potential returns, it also magnifies the risk of significant losses.
Market Complexity: Understanding global economic indicators, geopolitical events, and other factors influencing currencies can be challenging.
Key Forex Trading Strategies
Successful Forex traders use various strategies to guide their decisions. Some popular ones include:
Day Trading: Buying and selling currencies within a single trading day. Traders aim to capitalize on small price movements. Check out our introduction to day trading for more insights.
Swing Trading: Holding positions for several days or weeks to benefit from larger price movements.
Algorithmic Trading: Using computer programs to execute trades based on pre-set conditions. Learn more from our introduction to algorithmic trading.
Scalping: A trading style that involves making numerous small trades to profit from minor price changes (Bank of England – FX Market Papers).
Key Terms in Forex Trading
Pip: A "pip" is the smallest price movement a currency pair can make, typically the fourth decimal place (0.0001). In currency pairs involving the Japanese yen (JPY), a pip is represented by the second decimal place.
Spread: The difference between the bid price (what buyers are willing to pay) and the ask price (what sellers are asking for).
Leverage: A tool that allows traders to control a large position with a smaller initial investment. Learn more from our introduction to leverage.
Margin Call: When a trader's account falls below the required level of funds to maintain open positions, the broker may issue a margin call. Discover more from our introduction to margin call.
Forex trading offers unique opportunities in a market that is both accessible and liquid. With its high liquidity, 24-hour availability and use of leverage, it attracts traders worldwide.
However, it’s important to understand the risks involved, such as market volatility and the potential for large losses, especially when using leverage.
Forex Trading FAQs
1. What is forex trade and how does it work?
Forex (foreign exchange) trading is the act of buying one currency while simultaneously selling another, usually in currency pairs like EUR/USD. Traders speculate on currency price movements to profit from exchange rate fluctuations. It works through a decentralized global market operating 24/5.
2. Is $100 enough to start forex?
Yes, you can start forex trading with $100, especially if your broker offers micro or nano lot sizes. However, with a small balance, you should manage risk carefully, as larger trades can quickly wipe out your capital.
3. What is the 90% rule in forex?
The “90% rule” is an informal saying in forex: 90% of traders lose 90% of their capital within the first 90 days. It emphasizes the importance of education, risk management, and discipline before trading with real money.
4. Is forex trading good for beginners?
Forex trading can be suitable for beginners if approached with proper education, a demo account, and risk management. Jumping in without knowledge often leads to losses.
5. Is forex trading halal or haram?
In Islamic finance, forex trading can be halal if it meets Shariah principles — such as avoiding interest (riba) and excessive speculation. Many brokers, including FNmarkets, offer swap-free Islamic accounts for Muslim traders.
