Forex trading is a popular way of making money around the world. Many people reap huge rewards by engaging in the activity, and many more people want to get into the game. Forex trading is risky, that’s why before you can go about tackling complicated topics like candlestick or Bollinger bands, you need to learn the basics.
This article is for those who want to know what Forex trading is, what it’s all about and how it works to decide if it is for them. So, without further ado, let’s get on with it!
What is forex trading?
The term Forex is made up of two words – foreign exchange. Simply put, Forex refers to the act of buying or selling one currency in exchange for another. What’s important to note is that this is fairly easy to do! Think of it like this. If you have ever gone to a foreign country and converted your currency for that country’s money, you will have done a Forex deal.
From that example, it might strike you that it doesn’t require much money to get into it. If you have 20 USD, you can start with just that. Joining the Forex bandwagon is made easier by the fact that the market is easy to get into. People, businesses, and even countries partake in it, making the Forex market the most heavily traded market in the whole world.
Because you trade one currency for another, Forex trades always happen in pairs of currencies. That is something we will be discussing in detail in the next section!
What are currency pairs?
As explained before, a Forex exchange always needs a currency pair. If you are exchanging, say, USD for GBP. Then the paired currency will give you how much of one you need to get a unit, or one, of the other. For example, if you’re exchanging GBP/USD, it lets you know how much USD you need to buy one pound (GBP).
Furthermore, every currency has its shorthand. Just like how US Dollars is USD and Pounds Sterling is GBP, there’s Japanese Yen (JPY), Canadian Dollars (CAD), Euros (EUR), Australian Dollar (AUD), New Zealand Dollar (NZD), etc. You will have to learn all of these – or at least the most commonly used currencies in the trade – in order to make quick trades and read tables at a glance.
The amount of money you need in one currency to get one unit of another is the market price. This market price is never stable. It always fluctuates as exchanges and transactions happen every second of every day, all over the world, all year round. How do you go about making transactions, then, if you never really know what the value is of what you’re buying? That’s right up next.
Market prices in forex trading
Before you get started, some terminology needs to be cleared up. The most basic form of movement you will see is a pip. Now, pip stands for point in percentage and refers to the fourth decimal place in a currency pair. Note that when Yen is concerned, it is instead the second decimal place.
How does this look? Well, imagine that the price of EUR/USD shifts from 1.4700 to 1.4740. So, if you bought the pair at 1.4700 and sold at 1.4740, you will have made a 40 pip profit. What this means in actual terms is a little more complicated. When you’re buying a currency pair, you won’t be buying one unit. You will be buying a lot. You bought the above-mentioned EUR/USD pair for 1000 units, which is called a micro lot. What then?
Each pip is worth about ten cents, so your 40 pip profit turns out to be 4 USD (1000 x 0.0040 USD). The same math applies if you instead bought a mini lot or a standard lot, which are 10,000 and 100,000 units, respectively. The resultant profit would be 40 USD and 400 USD. Now, this only works if the second value is USD. If the second currency is something else, there is a way of finding out the pip value.
Say the USD value is upfront in a pair of USD/INR. At the current exchange rate, 1 USD is worth 75 INR. So, the value of 1 pip for this would be the USD pip value divided by the exchange rate. This comes down to 0.10/0.75, which is 0.1333.
Without melting your brain, that’s about all the basics you need to start trading. Be careful of the volatility, do your research, and you’ll be fine. Good luck!