Forex, also called the foreign exchange and currency trading, is the market for trading currencies. Currencies are traded in pairs and traders speculate on the strength of one currency relative to another.
for instance, in the EURUSD pair, traders would speculate on the strength of the EUR against the US dollar. If they expected the EUR to go up, they would ‘buy’ the forex pari, and if they thought it would fall, they would ‘sell’. Traders then make a profit or loss on the difference between the opening and closing prices of the currency pair.
Most forex trading is performed through derivatives, or contracts that represent a set amount of the currencies concerned.
Generally, one contract represents 100,000 units of the first-named currency. The size of these contracts allows you to profit on very small price movements. These movements are measured in ‘pips’, or units of 0.0001 (so 0.01 of one penny), and each movement of 0.0001 is worth 10 units of the second named currency. Consequently, one contract of the EUR/USD represents 100,000 euros, and every movement of 0.0001 would be worth USD10.
For example, if the EUR/USD was trading at 1.3768 and you thought it was going to rise, you could ‘buy’ one contract of the EURUSD. Then, for every pip the currency pair climbs you will make 10 dollars, and for every pip it drops you will lose 10 dollars.
Some time later the forex pair has gone up to 1.3930 and you close your position and take your profit. The difference between your entry and exit price is 162 pips, making your gross profit USD1,620.
Forex trading has a number of benefits, including:
24-hour trading – the fx market is open across three sessions around the world. These sessions stay open for 24 hours a day, 5 days per week, allowing traders to trade at times that suit 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.
Profit opportunities – as currencies are always moving in relation to each other; traders can potentially profit at any time.
No commissions – many fx brokers do not charge commissions. Traders just need to cover the trading 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.
A second risk is the high amount of leverage traders can access – in the example above you traded a EUR100,000 currency lot, and, depending on the broker, you could have entered this position with a deposit as low as 0.5%, or EUR500. Although this leverage allows traders to make large profits on small price movements (the movement in price in the example above was 1.62 cents), it also means they can make losses that are just as large on small movements.
There are numerous ways to manage this risk, including setting automatic exit levels on your trades to reduce your losses should the market turn against you, limiting the amount of money you risk each trade, trading mini contracts rather than standard lots, having a trading strategy that outlines strict criteria for entering and closing trades, and being informed about the market. It is nearly impossible to make continual profits, having a trading strategy that incorporates your knowledge, risk management and trading criteria will increase the consistency of your profits.
FX is leveraged and can lead to losses that surpass your initial deposit.