About Forex – What is Forex
Forex is the commonly used abbreviation for Foreign Exchange Trading. This abbreviation is commonly used by investors and traders to describe trading activity in the foreign exchange market that is carried out by investors and speculators.
In Forex one currency is traded in exchange for another currency when a trader expects that the currency they have bought will appreciate in value against the currency they have sold. For example if a trader is trading the EURUSD currency pair, then if the trader expects that EUR will appreciate in value against the USD, then the trader can buy EUR and when the value of the EUR goes up then the trader can close the trade and make a profit from the transaction.
In Forex trading a trader can buy or sell a currency. A trader will buy a currency if they think the value of that currency is likely to appreciate in the future, the same way a trader trading stocks will buy a stock if they expect that the value of that stock will move up in the future. A Forex Trader will sell a currency if they think the value of that currency is likely to depreciate in the future, the same way a stock trader will sell their stock at for example $20 if they expect the price to fall, instead of waiting for the price to fall and sell at $15. A stock trader who sells their stock early at $20 makes more money than the one who waits for the price to fall and then sell at $15. For this same reason a Forex trader will sell a currency if they expect that the value of the currency is going to fall.
The Forex Market is a global market which is decentralized and is carried out through a network of the big international banks; this network is commonly referred to as the interbank network. This interbank consists of banks which are in different locations. These interbank network is responsible for providing the exchange rates at any particular time to those traders and other market participants who want to buy or sell currencies. In Forex trading the exchange rate between 2 currencies is constantly changing and this exchange rate is denoted by what is known as a Forex Quote. In Forex currencies are traded in pairs of two and the exchange rate is displayed as a Forex Quote. This currency quote is constantly changing and the interbank network will update automatically the current currency quote and traders can then trade these currencies at the current exchange rate.
For example the currency pair EURUSD which is the most popular currency pair in Forex may be quoted at 1.3450 in the morning and by afternoon the exchange rate may have moved to 1.3500 and this new exchange rate will be the current forex quote that will be displayed by the interbank network. This will mean that the currency pair will have moved up 50 points and EUR will have appreciated by 50 points against the USD. A trader who had bought this currency pair in the morning can then close the trade and make a profit on the 50 point appreciation of the currency EUR against the USD.
Because Forex currencies are traded in pairs of two, the currency pairs exchange rate is displayed using Forex Quotes. In the example above of the currency pair EURO being traded against the US Dollar the exchange rate is 1.3450. The currency EURO is denoted using the symbol EUR while US Dollar is denoted using the symbol USD, the currency pair is then denoted as the EURUSD, and the current exchange rate is quoted as 1.3450. This is the rate at which any forex trader wanting to trade this currency pair will trade and exchange the two currencies being traded.
Because the exchange rate of any currency pair is constantly changing it means that speculators and traders can take advantage of these currency rate movements to make profits by trading these exchange rate movements. The exchange rate of any currency pair will keep moving because of demand supply. This is because there are many participants trading these currencies in the open currency exchange market and therefore this means that the currency quotes will get determined by the current market forces. These market forces may be determined by factors such as an increase in demand for a currency due to the economy of that currency improving may mean that the particular currency rises in value while a decrease in demand for a particular currency due to the economy of that currency doing badly may mean that the currency will depreciate in value.
In Forex the exchange rate moves are measured in points commonly known as Pips in the forex market. The pip is used to calculate the profit or loss that a Forex Trader makes in a particular trade. For example if a trader makes a trade which moves 50 pips in his direction, then the profit of the trader will be calculated as 50 pips. In the above example where EURUSD moved from 1.3450 to 1.3500, then the total pip movement is 50 pips and we can say the EURUSD currency pair has moved up by 50 pips.
In Forex currencies are traded in units known as lots. The standard lot is made up of 100,000 units of currency. There is also the Mini lot which is made up of 10,000 units of currency and the Micro lot which is made up of 1,000 units of currency.
For one standard lot the profit is $10 per pip, for mini lot the profit is $1 per pip and for micro lot the profit is $0.10 per pip. Therefore, in the above example where the currency pair moved up by 50 pips if a trader was trading using one standard lot then their profit would be $10 multiplied by 50 pips which is $500 dollars.
Because not many traders can afford to trade 100,000 units of currency or 10,000 units of currency, there is leverage in Forex which means that traders can borrow money and use the borrowed money to make trades with. For example leverage of 100:1 means that a trader with capital of $10,000 can borrow up to 100 times using the 100:1 leverage option and therefore after borrowing using this leverage the trader will have a total of $10,000 multiplied by 100, which means the trader will have a total of $1,000,000 and can therefore trade ten standard lots of $100,000 units of currency. This leverage is what makes Forex accessible to retail forex traders because retail forex traders can start with little capital of their own and use leverage to borrow the rest of the money required for trading. The money that the trader deposits is referred to as the trader’s margin and a trader can continue borrowing money using this leverage option as long as they have the required margin in their account. This is why traders must have the required account balance in their account to open the trades they want to, for example a trader using leverage 100:1 must have more than $1,000 in their account to be able to open and trade using standard lots.