The foreign exchange market is the most liquid and robust market in the world. In fact, there is no market with a comparably large trading volume. It is estimated that the volume in foreign exchange trading (also known as currency trading) is about 5 trillion dollars per day! This number far exceeds the value of total global equity trading. Read this article to know more about the main factors and theories of the foreign exchange market.
How do I start currency trading?
To start trading Forex, all you have to do is follow these 5 steps:
1. Open a live trading account.
2. Verify your account and make a deposit.
3. Install one of the provided trading platforms and log in with your access data.
4. Find the appropriate currency pair in the list of instruments and open the order window.
5. In the order window, you can define whether you want to set stop-loss or take-profit parameters and what the contract size should be. You can set predefined stop and limit to automatically close the position at a given loss or profit rate.
Basics of Currency Trading
When you trade currencies, you buy one currency while selling another. Let’s explain how this works with a simple example: EUR / USD is the most commonly traded currency pair. Here, EUR represents symbol for the euro and USD is the symbol for the US dollar. In above currency pair, EUR is called the base currency and USD is the counter currency.
The relationship is deemed to be one unit, even if it refers to 2 individual currencies. In other words, you trade the EUR/USD currency pair, not EUR or USD.
Let’s illustrate this basic example of currency trading using a few numbers. Assuming that EUR/USD is traded at 1.21422, it means €1 = $1.21422.
So, if the euro is stronger than the dollar, or vice versa, you would need more dollars to buy euros.
Some basic terms in currency trading
Major currency pair
In currency trading, there are six major currency pairs used in daily trading. These include GBP/USD, USD/CHF, USD/JPY, USD/CAD, AUD/USD, and EUR/USD. Simply put, these are the most commonly traded currency pairs in the world, and their volatility is usually higher. When trading in a ECN acccount, major currency pairs are guaranteed to have very low spreads.
Minor currency pairs
The minor pairs are the currency pairs that trade less frequently than the major currency pairs. They have less liquidity than the major currency pairs and often have higher spreads. Basically, minor currency pairs are all currency pairs except for the major currency pairs listed above. Different brokers can offer you a wide selection of minor currency pairs for trading.
Exotic currency pairs
Exotic currency pairs usually contain a currency of an emerging country. The reason why they are called exotic currency pairs has nothing to do with the country’s situation, but rather with the additional challenges involved in trading these currency pairs. Exotic currency pairs are usually illiquid, with higher spreads and fewer market participants. Examples of exotic currency pairs are the South African Rand (ZAR,) the Hong Kong Dollar (HKD,) and the Mexican Peso (MXN.)
Changes in the exchange rate of currency pairs are measured in pips (percentage in point.) They are the last digit of the exchange rate, the smallest unit in which the price is given. Most of the time this is the fourth digit behind the comma, although there are many brokers who are offering pairs with five decimal points. An exception is a currency pair that includes the Japanese yen, where a pip is the second or third digit after the decimal point.
Currency pairs are traded in lots. A lot is the standard size in currency trading and equals 100,000 units of a currency. There are also mini-lots (10,000 units) and micro-lots (1,000 units) for private/small investors.
It is important for traders to be able to calculate their trading profits and that is why we illustrate the ratio of pips and lots in numerical form.
For example, if EUR/USD exchange rate increases by eighty pips to 1.21502, after you have previously bought one lot at 1.21422, the profit is $80 = 0.00080 (80 pips) x 100,000 (1 lot).
In this case, euro rose and dollar fall or, in other words, the euro has risen 0.00080 against the dollar.
Since a lot of 100,000 currency units in this case corresponds to $100,000, it would not be possible for the small/retail investor to participate in currency trading. For this reason, many brokers offer margin trading, in which the account holder often only needs to have 1% of the capital invested as collateral in his trading account. So, a lot costs $1000, a mini lot $100, and a micro lot $10.
As a result, private investors can trade in the currency market and make profits. It’s not uncommon for an exchange rate to go over 1000 pips in a day and give the investor a $10,000+ profit when he buys a lot.
In troubled market conditions, the broker can increase the security for any number of currency pairs. This is called margin call and alerts investors who do not have enough funds in their foreign exchange trading account. If enough funds are not available, then the given trade must be closed, which can lead to losses. This option is not limited to currency trading but applies to all financial instruments offered by brokers.
Spread is the difference between the buying and selling price. This is an important parameter because spreads are incurred in each transaction. The level of spreads is usually known in advance and will be displayed on the trading platform of your foreign exchange broker. In volatile market conditions, spread is usually increased by the broker. It is therefore advisable to pay attention to the difference between the buying and selling price before opening a trade.
A big advantage in currency trading is the availability of financial markets. There is almost always a market open where foreign exchange can be traded. This means you are not tied to specific trading hours and can participate in international currency trading 24 hours a day.
Europe, the currency markets are open from 3:00 am to 12:00 EST.
The American currency market in New York opens at 8:00 am to 5:00 pm EST.
Japan’s market timings are 7:00 pm to 4:00 am EST.
The Australian market in Sydney is open from 5:00 pm to 2:00 am EST.
It is important to note that the volatility, i.e. the price fluctuation of the currency pairs, increases considerably when two markets of a traded currency pair are open. In case of EUR/USD, opening hours overlap at certain times, so that currency trading at these times carries greater risk but also allows for a higher potential profit.
How do I participate in foreign exchange trading?
Forex trading is usually carried out via a trading platform online. Now, there are also mobile trading platforms that allow traders to trade in international currency markets with their smartphones and tablets. Which trading platform suits you best, you should try out with a free and risk-free demo account.
Another option is to use automatic trading bots. A software searches the international financial markets for good trading opportunities and sends a signal to the user or starts and trade by itself. This signal can be sent by e-mail, SMS, or directly to the trading platform.
Now that you are privy to the basics of currency trading, open a free demo account with a trusted and start trading/practicing. You can trade your favorite major, minor, or an exotic currency pair.