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Forex, also called currency trading and the foreign exchange, is the market for trading currencies. Currencies are traded against each other in pairs and traders speculate on the strength of one currency against another.
So, in the EUR/USD pair, traders would speculate on the strength of the EUR relative to the USD. If they thought the euro would rise, they would ‘buy’ the pair, and if they expected it to fall, they would ‘sell’. Traders then make a profit or loss on the difference between the entry and exit prices of the fx trade.
Most FX trading is done through derivatives, or contracts that represent a set amount of the currencies involved.
In general, one contract represents 100,000 units of the first-named currency. The reason why the contracts are so large is that they enable you to profit on very small price movements. These movements are measured in ‘pips’, or units of 0.0001 (so 0.01 of one cent), and each movement of 0.0001 is worth 10 units of the second named currency. Consequently, one contract of the EUR/USD would be worth 100,000 euros, and every movement of 0.0001 would be worth 10 dollars.
For example, if the EUR/USD was trading at 1.3768 and you thought it was going to go up, you could ‘buy’ one lot of the EUR/USD. Then, for every pip the forex pair rises you will make 10 dollars, and for every pip it falls you lose USD10.
A few hours the currency pair has gone up to 1.3930 and you sell and take your profit. The difference between your opening and closing price is 162 pips, which gives you a gross profit 1,620 dollars.
Trading fx has a number of benefits, including:
Round-the-clock trading – the fx market is open across three sessions around the world. These sessions remain open for 24 hours a day, 5.5 days a week, meaning that traders can when it suits them.
Liquidity – the fx market is very liquid, so trading spreads are often smaller than other markets, and it is also very easy to enter and exit positions on the major currency pairs.
Opportunities to profit – as there will always be one currency rising against another; it is possible to profit at any time.
No commissions – many forex brokers charge traders no commissions. Traders just need to cover the spread, and pay no other fees to trade.
However, it is essential that a trader takes the time to research and decide upon a broker that offers transparent pricing information and is regulated by the local authority.
Another risk is the level of gearing traders can access – in the previous example you traded a contract representing EUR100,000, and, depending on the broker, you might have been able to open this position with a deposit as low as 0.5%, or 500 euros. Although this gearing enables traders to make large profits on small price movements (the price movement in the example above was 1.62 cents), it also means they can make equally large losses on small movements.
There are several ways to manage this risk, including setting automatic exit levels on your trades to limit your losses should the market move against you, reducing the amount of equity you risk per trade, trading mini rather than standard lots, having a trading strategy that outlines strict criteria for opening and closing positions, and being educated about the market. Although it is close to impossible to make continual profits, having a trading system that incorporates your knowledge, risk management and trading criteria will increase the consistency of your profits.
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A good place to start trading forex is with my favourite trading provider at http://www.igmarkets.com.sg/cfd/forex.html They offer a variety of forex contracts, including spreads from 1pip.
FX is leveraged and can lead to losses that exceed your first deposit.
