Basics of Forex Trading
Forex trading is one of the most popular investment options out there. The term “forex” stands for “foreign exchange.” Basically, investors engage in forex trading by buying and selling currencies from around the world. Before the 1970s, exchange rates were based on a fixed system called the Bretton Woods System. During the 1970s, however, countries started to switch to the modern foreign exchange market, which featured floating exchange rates determined by various economic factors such as inflation levels and trends, as well as government budget deficits or surpluses. The economic growth and health of a country also affect the forex market. This is determined through reports of GDP (gross domestic product), retail sales, employment levels, and other factors.
Today, the foreign exchange market is one of the world’s most expansive, liquid, and active financial markets. Before you make any investment, read on to learn about the basics of forex trading.
How forex trading works
At first glance, the forex exchange market can seem rather complicated and intimidating. With a little research and some experience though, you can easily use forex trading to your advantage for some great investment options and turnover rates. Perhaps the most important thing to understand about the foreign exchange market is that it has various levels of access as a means of regulating the market.
Access to the foreign exchange market is divided depending on the amount of money that is being traded. At the top level of the market are the large investment banking firms, which account for over 50% of the market transactions. The next tier is composed of smaller investment banks. After these banks are the multi-national corporations, followed by hedge funds and smaller institutional investors. More recently, smaller investment groups have been gaining ground, and thus play a more important role in the foreign exchange. Individual retail traders can also participate in the market, but they can only do so through banks or foreign exchange brokers.
Another important aspect to understand about forex trading is that the exchange rate is not fixed across different traders. Exchange rates normally vary depending on the place where you trade your currencies, although the rates do stay relatively close. The primary benchmark for exchange rates are the large trading centers. Perhaps the largest trading market is London, followed by some of the other major trade centers such as Tokyo, New York, Hong Kong, and Singapore. Because the foreign exchange market is an interbank market, it runs 24 hours a day, except on weekends.
There are many aspects of the foreign exchange market that make it an attractive market for investors. First, the market is open for trade around-the-clock, making it easy to trade at any time–except on weekends, when the market is closed from Friday afternoon to Sunday evening EST.
Another advantage is that there are fewer fees involved in forex trading. Instead of charging commission, government, brokerage, or any other types of fees, the only transaction cost you will have to pay is the spread, or the difference in value between the two currencies being traded.
Third, the forex trading market is extremely liquid, and this allows you to buy and sell currencies at any time.
Finally, the forex market gives you lots of leverage, sometimes allowing you to buy at a ratio of 50:1, meaning you can control trades of up to $100,000 with a capital of $2,000.
Concepts in forex trading
Like any other type of exchange market out there, the foreign exchange market involves a lot of terminology, jargon, and concepts. It’s important for all traders to familiarize themselves with these terms and concepts before getting into forex trading. Here are some of the terms and concepts that you are likely to come across while trading in the foreign exchange market:
* Spread – The spread is basically the difference in value between the currency being bought and the currency being sold.
* Spot trade – A spot trade or transaction is a type of trade that is based on a direct exchange between two currencies. Spot trades are normally cash-based and settled within two days, making it the fastest and easiest type of trade in the forex market.
* Forward trade – Forward trades are based on contracts, which are agreed upon by both trading parties. No money is exchanged until a future date is settled by the involved parties. The currencies are only traded once the contract has reached the agreed-upon dates.
* Futures trades – Futures are similar to forward trades. A futures contract usually involves a fixed, standard contract size and maturity date. Also, interest is normally included in the futures contract.
* Swap transactions – In a swap transaction, two parties exchange currencies for a period of time agreed upon by the two traders. At the end of the contract period, the traders swap the currencies again, gaining or losing money depending on the changes in currency values.
* Options – Foreign exchange options allow owners to exchange one type of currency for another type of currency at an agreed date and exchange rate.
Reminders on forex trading
For those who are looking to get into forex trading, the most important thing to remember is to never trade unless you have a good understanding of what the market is all about, how it works, and how to take advantage of the transactions that are available to you. If you are unsure about how to trade currencies, you may want to get the help of a broker, bank, or financial expert who can give you sound information and advice.
Learn about the different strategies involved in forex trading, so you can ensure the safety and success of your investments. Also, make sure not to get carried away while trading in the foreign exchange market. It’s easy to get carried away and invest too much money into the forex, which is why investors should always be rational about the decisions they make, specially the amount of money that they invest in the market.
Invest your money wisely, and the foreign exchange market can reap you great profits. Getting careless, though, can easily lead to large losses.