What is Forex trading about?
A common misinterpretation about Forex trading is that it's about making money.
At its core, Forex trading is about growing money.
It's about (1) understanding what drives currency markets, and (2) growing capital based on that understanding.
If you're a beginner to Forex trading, this guide will get you up to speed quickly.
We won't be spending time going through the unimportant details - such as the history of the Forex market - and will instead focus on the most relevant points so you can get started as soon as possible.
Let's get going.
What is Forex?
Forex is shorthand for Foreign Exchange. It refers to the different currencies used by nations all over the world.
If you've ever traveled abroad and visted a money changer, you've participated indirectly in the Forex market by exchanging one currency for another. This is essentially what currency trading is about.
There are however, a few major differences between the physical exhange of currency notes and online Forex trading.
Money Changer vs Online Forex Trading
The first difference is that with online Forex trading, you don't actually give or receive currency notes. When you "buy" or "sell" a currency, you are merely betting on whether the exchange rate goes up or down. If you guess right, a profit is deposited into your trading account. If you guess wrong, a loss is deducted. You don't actually take possession of the currencies you "buy".
The second difference is that most money changers update the currency exchange rate just a few times a day. With online Forex trading however, the exchange rate (also called the market price) changes much more frequently, sometimes up to multiple times a second.
The third and most important difference is that online Forex trading allows for the use of financial leverage. This allows one to make a significant amount of money with a relatively small amount of capital. Be warned however, that leverage cuts both ways. If you don't understand how it works, you can lose a lot of money very quickly. You can learn more about Forex trading leverage here.
The Biggest Market In The World
While Forex trading is not (currently) as popular as stock trading, the Forex market has over 100 times the trading volume than the New York, London and Tokyo stock exchanges combined.
The currency market is by far the largest financial market in the world with over US$6.6 Trillion of currencies being traded each day.
Think about that. If you can make just 0.00002% of the daily trading volume in profit, you'd be an instant millionaire. It's a BIG market to be trading.
How Forex Trading Works
The mechanics of making money with Forex trading is straight-forward.
If we enter a 'buy' trade and the market price subsequently goes up, we can then execute a sell order (which nets out the 'buy' trade) and profit from the price difference.
Similarly, if we enter a 'sell' trade and the market price subsequently goes down, we can then execute a buy order (which nets out the 'sell' trade) and pocket the difference.
Here's a price chart that illustrates this:
Looks simple, right?
Well, not exactly.
You see, the question is: how do we determine whether the market price is likely to move up or down?
To find out the answer, we first have to understand what we're trading.
The Spot Forex Market
There are a few different ways to speculate on currency prices, such as through futures, options and ETFs. These are financial assets that are derivatives of (i.e. based on) the actual currency market, known as the spot Forex market.
For the purposes of this guide, we'll only be talking about the spot Forex market as it is the simplest and most assessible market to be trading.
The Major Currencies
There are many different currencies we can trade in the spot market. As a new Forex trader though, you'll want to only pay attention to the major currencies. They are the freely-traded currencies of the nations with the biggest economies in the world.
New Zealand Dollar
Currencies are traded in pairs. In order to buy one currency, we have to sell another (different) currency.
This might be a little confusing at first, since we don't normally think of buying and selling through the perspective of 'pairs'.
So here's a helpful way to think about this: when we buy a car, we are actually buying the car by "selling" our money. We get the car by giving our money.
And when we sell the car, we do the opposite: we sell the car and "buy" the money. We get the money by giving the car.
In Forex trading, we're doing the same thing. We get one currency by giving another currency.
For example we can get Euros (EUR) by giving US Dollars (USD). This is essentially buying EUR and selling USD. In trading lingo, we say that we are buying the EUR/USD.
Conversely, we can give Euros (EUR) to get US Dollars (USD). This is the same as selling EUR and buying USD. In trading lingo, we say that we are selling the EUR/USD.
Without exception, all currency trading is done in pairs. You cannot buy a currency without selling different currency (and vice versa).
Major Currency Pairs
The major currency pairs are the most heavily traded currency pairs in the Forex market, and they all involve the USD.
Major currency pair
Euro / US Dollar
US Dollar / Japanese Yen
US Dollar / swiss Franc
British Pound / US Dollar
Australian Dollar / US Dollar
US Dollar / Canadian Dollar
New Zealand Dollar / US Dollar
The USD is by far the most common currency to be traded in the Forex market, so that's the main one we'll be focusing our efforts on.
There are, of course, other currency pairs that don't involve the USD. They are usually refer to as the minor, cross, and exotic currency pairs. To keep things simple however, let's just focus on the major (USD) currency pairs for now and ignore the rest.
Remember: the goal is to get you practising as soon as possible, and the major pairs are more than enough to get you started.
Reading A Forex Price Quote
In each Forex pair, the first currency is known as the base currency and the second currency is known as the quote currency.
EUR / USD
Here, we see the exchange rate (i.e. market price) for the EUR/USD is quoted at 1.1000.
When we buy a currency pair, we are essentially buying the base currency and selling the quote currency.
Conversely, when we sell a currency pair, we are selling the base currency and buying the quote currency.
So if we buy EUR/USD at the price of 1.1000, we are buying €1 using US$1.1000. In other words, we buy 1 Euro by selling 1.1000 USD.
On the other hand, if we sell EUR/USD at 1.1000, we are selling €1 and getting US$1.1000 in return. In other words, we sell buy 1.1000 USD by selling 1 Euro.
Here's a mental shortcut to help you easily remember this relationship:
- If you buy a currency pair, you are buying the base currency and selling the quote currency.
- If you sell a currency pair, you are selling the base currency and buying the quote currency.
Let's go through one more example.
USD / JPY
Try to answer this question: When we sell the USD/JPY, which currency are we buying and which are we selling?
Answer: We are buying the JPY and selling the USD.
Ok! I hope that clears things up.
Let's now move on to the next section.