How Does Forex Trading Works?
Every trader selects a market to trade by observing the market position and the chance to make a handsome profit. Forex trading means selling one currency to buy another. This market determines the rate of foreign exchange for all currencies. It is the largest market in terms of trading volume.
It is a market with high liquidity, and as a retail trader, you can do better risk management because you can make a low investment. There are very few entry restrictions. So making a profit may not be a trouble.
Now you must be wondering, “How does forex trading work?” If so, then do not worry. In this article, we are going to give all the information about how does forex trading works.
How does forex trading works?
The idea is straightforward, suppose you went to India as a tourist and saved 2000 rupees from your budget. And then you came back after two weeks. So when you went to India, you bought each rupee with 1.1009 takas, so these last decimal number in the currency value is called pep.
So after when you came back from the vacation for two weeks, you went to sell the 2000 rupee and found that 1 rupee became 1.2010 takas. So you make a profit of 0.1001 pip on each taka.
So before you went to India, 2000 INR would be 2201.8 BDT, and now after you came back, 2000 INR would be 2402 BDT, and you made a profit of 200.2 BDT.
And this exactly how a forex trade works except you do it online and you depending on what kind of forex trader you are you make the transaction.
Things you need to know about currencies
Essential terminologies in forex trading.
Pairs and types of pairs
The forex trading involves two parties, a buyer and a seller—there the currencies in the trading functions in pairs. The most popular pair is Euro and USD, and these pairs are shown as EUR/USD. The currency that is in the left side is the base currency (EUR/USD), and currency on the right side is (EUR/USD).
- Base currency: Base currency refers to the currency you are buying in the currency pair
- Quote currency: Quote currency refers to the currency you are selling in the currency pair
There are four kinds of currency pairs involved in forex trading, and they are:
- Major currency pair: The most-traded currencies in the world are the major currency pair like EUR/USD, GBP/USD, USD/JPY, USD/CHF, etc.
- Minor pairs: The pair of currencies that traded less frequently like EUR/JPY, EUR/GBP, etc.
- Exotic pairs: They are a pair of currency where the transaction involves the currency of one nation with an emerging economy and one major currency.
Long and short refers to the direction of your trade.
- Long direction: Making a profit by exchanging currency when the price of the currency is high
- Short direction: Making a profit by exchanging currency when the price of the currency is low
Leverage and margins
- Leverage: The process of getting access to a large amount of currency relative to your accounts.
- Margin: The small deposit you put down to gain and maintain a leverage
The word pip refers to the point of percentage. It’s the smallest decimal amount of currency value placed in the fourth or second decimal place of an exchange rate.
Bid and Ask
- Bid: The selling price of a currency
- Ask: The buying price of a currency
The difference between the bid and the ask is known as the spread.
The trading quantity of a currency pair is known as a lot. Depending on the unit size, a lot is set. Therefore there are many sizes of a lot. A standard lot size is 100000 units, a micro lot, a mini lot, and a nano lot, which is less than 1000 units.
Changes in Price of the Currencies
The main factor that plays a role in determining the price of a currency or make a change in the price of the currency directly supplies and demands. And the supply and demand curve is continually shifting along with the price of currencies accordingly.
In simple words, when a currency is in demand, its price will be higher than the other currencies in the market. In simpler terms, the currency that has more buyers is in demand, so the price of that currency will be more than the other currencies. Few essential factors for this demand and supply curve to shift that determines the exchange rate is
- Economic factors include economic policies, productivity, inflation, and economic growth.
- Political condition
- Market psychology
The forex traders must analyze whether to buy or sell currency and make a decision. Forex analysis works on two methods fundamental method and technical methods.
Technical analysis observes more on history, statistics, and graphs. Probability is the main focus of technical analysis. History and trading trends are a significant matter of study in technical analysis to figure out a pattern of trade and determine where the price is going. Studying charts is one of the vital methods to figure out a model. Technical analysis uses all these methods to learn a purchase and sale of currencies.
Fundamental analysis is a way of reading the forex market by reviewing social, economic, and political factors that plays a role in changing the currencies prices. Fundamental analysis observes factors like economic policies, government policies, employment factors. The main idea is to follow a country’s present and past financial condition to decide whether to purchase or sell.
Buying and Selling
Traders in the forex market look for making a profit by buy and selling by assuming the appreciation depreciation of a currency. Still, the first thing as a forex trader you must do is to choose a currency pair. And with correct analysis, a trader can have an assumption about when to buy or sell a currency.
If your currency pair is EUR/USD and you assume that the price of your base currency will increase compared to the quote currency, you will be able to buy. For example, the price of EUR is 1.2020 at this point, and by doing technical and fundamental analysis, you assume that the price of EUR will rise and you will be able to buy.
Since you are buying your price, it will be a little higher then the current rate, for example, if the price is 1.2020, the price will be 1.2040. Later that day, you see the price of EUR is 1.3020, so you make a 98 pip profit.
In the same way, by doing fundamental and technical analysis, you may assume that the price of your base currency may decrease compared to our quote currency’s price, then you are in a position to sell.
These are just examples for you to understand how the buying and selling work in forex trading.
Be a trader
To be a forex trader, you need to have a few attributes that will help you excel in the business. It is very market. It is running 24/7, and you can easily have access to it through your phone or tablet or computer. If you can attain those few skills, then you will make a fortune in the market. These attributes are
- Market knowledge
- Limit control
- And practice
A good plan for trading is essential to be a trader. To be good at trading, one needs discipline and practice. A trader must have definite goals and ideas before making a move in the market. A trader needs to know when to enter and when to exit. And have control over his or her greed.
Some times it is not easy, but with proper practice and discipline, anything is possible. In this article, you will have a brief idea of what you need to do and have to become a forex trader at the point you must have the idea, “ How does forex trading work.”