What Is Forex Trading And How Does It Work?
- Forex stands for Foreign Exchange Market
- It is a decentralized global market for currency trading
- In Forex, currencies are traded against each other, in pairs of two
- There is no central marketplace for Forex exchange
So What Is Forex Trading Really?
Forex trading explained simply: Forex is a global market established for exchanging national currencies.
Forex, short for the foreign exchange market, is a place where currencies are traded. There are millions of Forex traders around the world.
In fact, you might be part of it without even knowing. Currencies are essential for people, as they enable purchasing of goods and services. When you visit a foreign country, you might need to exchange currencies to be able to purchase goods and services there.
Let’s say that you are from the USA and decided to have a trip to Europe for your summer vacation, and you take some US dollars with you. To be able to purchase goods in Europe, in most countries, you will need Euro. By exchanging US dollars for Euros, you are basically trading Forex even without realizing it.
Because USD is not a locally accepted currency in Europe and many other parts of the world, you will need to exchange it at some point. This shows precisely how important currency trading is. It enables you to purchase goods and services in a different country by simply converting your own currency.
A unique aspect of the international foreign exchange market is that there is no central place for exchange. Currency trading is conducted electronically over the counter, meaning that transactions happen thanks to the computer networks between traders globally.
As Forex trading meaning indicates, there are two different types of Forex trading. They are retail Forex trading and institutional Forex trading. Let’s discuss each of them and see how they differ.
Retail FX Trading
Retail Forex trading represents one, but a prevalent, part of the larger foreign exchange market. Retail Forex trading gives individuals access to the trading market by speculating the exchange rate between different currencies.
Thanks to the development of the online Forex trading platforms in recent years, retail Forex trading has become very popular. There are millions of people who are investing in currency pairs as retail traders.
According to the official data from 2016, retail Forex trading represented about 5.5% of the whole Forex market. The number is increasing every year because of the popularity of the market.
Understanding what is online Forex trading and how it works can be a bit confusing. Many things go into this market, which is why traders sometimes have to dedicate a lot of their time to research and education.
The development of modern technology, most notably the internet, has changed the way people look at Forex trading. Once, only the biggest financial companies, such as banks, were able to access the market.
However, thanks to retail Forex trading, this market has become more accessible for everyone worldwide. Online Forex brokers and trading platforms have enabled people globally to trade Forex, and the only thing you need for becoming a Forex trader is an internet connection.
Institutional FX Trading
While Forex trading is very accessible for retail traders, there still is another part of the market, called institutional Forex trading. Institutional traders tend to be more sophisticated traders.
While retail traders are often individual traders who are simply buying or selling currency pairs using personal accounts, institutional traders buy and sell currencies for accounts managed by a group of people or even institutions. Although institutional traders had a considerable advantage over retail traders, the advantages have slowly started to disappear.
So, what is Forex trading by institutional traders? In fact, it is very similar to retail Forex trading. However, it is taken to a whole another level. These institutions are enormous companies that are full of professionals who are trading Forex for the company.
These people are working together to plan the trade, follow the guidelines and execute the trades. A very interesting this about Forex trading is that there was a time when retail traders did not have access to the market whatsoever.
A few decades back, only massive institutions were able to invest in Forex trading. In most cases, these institutions were banks. As the market developed, it has become more accessible for everyone around the world. Today, no matter who you are, you can easily invest in Forex trading.
How Does Forex Trading Work?
Forex trading explained quickly: Forex trading involves selling one currency while buying another one.
Understanding FX trading and the way it works can be a little confusing for beginners. However, in reality, there is nothing too complicated about it. There are certain things that you will have to do before you start trading Forex. This includes finding a broker, opening an account, making a deposit, and so on.
Unlike other trading markets, Forex trading does not take place at one specific location; instead, it is an over-the-counter market and is executed directly between two parties. The market is run by a global network of banks that are from all around the world.
The biggest financial centers for Forex trading are London, New York, Sydney, and Tokyo. Due to the different time zones worldwide, Forex trading is available 24 hours a day, five days a week. Most of the Forex traders are speculating and predicting the future price movements to make a profit.
When you are trading Forex, you are dealing with currency pairs. The currency pair is made up of two currencies, base and quote. The first currency you see in the pair is called the base currency, while the second is called the quote currency. Forex always involves selling one currency to buy the other.
Simply put, the base currency is the currency that you are buying, while the quote currency is the one you are selling. By understanding Forex trading definitions and examples, you can become a better trader.
When you are trading Forex, you open a trading platform to register a buy trade. Then, the broker you are using sends your order to the general market, where the order matches a sell trade. After your order has been matched, the trade is executed.
Becoming a successful trader is not easy as it involves taking several steps. So, let’s continue by discussing some of the most critical steps you might have to take to be better at Forex trading.
Step 1: Find a Broker
One of the most critical steps that every trader should take is to find a trustworthy Forex trader. Even if you know everything about Forex trading explained and how this market works, finding a reliable Forex broker might still be challenging.
Forex broker is a company that will give you access to the trading platform through which you can open and close your positions. There are hundreds of online Forex brokers in the market, but how do you know which one to trust?
A great idea is to only trade with Forex brokers that are regulated and licensed by official agencies. There are numerous regulatory bodies around the world, each of them offering traders different types of safety standards.
The Forex trading laws are also different from jurisdiction to jurisdiction, and by understanding Forex regulations in your country, you can find a trustworthy FX broker that follows local rules. By trading with regulated Forex brokers, you are making sure that your funds can stay safe.
Step 2: Choose an Account
After you have found a broker you can trust, you should continue by creating an account. While working on this guide to FX trading explained, we were able to find that the majority of Forex brokers offer traders different types of accounts. Depending on your level of expertise, you can create the account that fits your needs the best.
Forex trading account types can be divided into several subcategories. These are accounts for beginner traders, accounts for intermediate traders, and accounts for highly-skilled Forex traders.
Many beginners prefer to start trading using a demo account, which a vast majority of online Forex brokers offer. This account allows traders to practice without risking any of their hard-earned funds. Another prevalent account for beginner traders is the small account.
With small accounts, beginners can start trading with just a few dollars and gain more experience. The regular account types are usually created for traders with intermediate knowledge.
Finally, most of the brokers offer experienced traders special accounts. There also are some that have VIP accounts created for highly skilled traders. Usually, as our guide to trading Forex explained shows, such accounts require traders to make higher deposits.
A considerable majority of Forex brokers also offer traders Islamic accounts for those who follow the beliefs of the Quran.
Step 3: Make a Deposit
After you have created a live account that fits your needs the best, you can start depositing funds on your account. Most Forex brokers offer traders very comfortable deposit options.
In most cases, you will be able to make deposits using both modern and traditional payment solutions, like E-Wallets, as well as credit cards and direct bank transfers. Depending on your needs and the amount of money that you are planning to deposit into your account, you can choose any of the methods.
Depending on the broker that you are using, you can choose the payment solution that fits your needs the best. The fees for making deposits and withdrawals can vary depending on the broker you are using and the payment method you choose to use.
After you have deposited funds on your trading account, you can continue by choosing which currency pair fits your needs the best.
Step 4: Choose a Currency Pair
While talking about Forex trading how it works and what is the primary meaning behind it, it is very important to understand that when you are trading Forex, you are dealing with currency pairs. The currency pairs available in the market can be divided into three main categories.
These are major pairs, minor pairs, and exotic pairs. There are six major currency pairs representing the biggest economies around the world paired with the USD. Minor pairs are less frequently traded and feature major currencies paired against each other, excluding USD. As for the exotic currency pairs, they are made up of currencies representing emerging economies.
Trading each of these three can be a very different experience for you. The main reason for this is that different types of currency pairs react to the ongoing events in the market differently. Most traders prefer to use major currency pairs as it is much easier to do proper research about them.
At the same time, others prefer to trade other currency pairs because they know more about them and can better predict how they can react to certain events.
Step 5: Do The Research
Understanding Forex trading and the way it works can be a lot easier if you are ready to take your time and do extensive research. After choosing which currency pair you want to trade, it is time for you to start researching the pair.
There are a lot of things that you should keep in mind to be a successful trader. Every minor event around the world could potentially influence the price movements in the market. To know how different events influence price fluctuations in the market, you should learn more about the currencies you are trading, what they are dependent on, and how resistant they are when it comes to shocks.
There are different types of indicators in Forex that you can use to understand price movements in the market better. There are two types of indicators that traders are using; they are technical indicators and fundamental indicators.
Technical indicators primarily focus on the charts and the patterns that can be detected there. In contrast, the fundamental indicators use ongoing events worldwide to understand how the prices can change.
As we were able to find out while working on this Forex market explained, many traders prefer to use both of these indicators to make sure they are making the right decisions.
Step 6: Place Your Trade
Once you have decided which currency pair you want to trade and did your research, you can continue by placing your trade. After you have learned what does Forex trading mean and how it works, you can download the trading platform offered by the broker and start opening and closing positions.
Trading platforms are an absolute necessity when it comes to trading Forex. There are many different types of Forex trading platforms available in the market, and some brokers have trading platforms created specifically for them.
However, some of the most popular trading platforms globally include platforms like MetaTrader 4 and MetaTrader 5. Both of these platforms were created by a famous Russian company called MetaQuotes and are very easy to use. There are many other platforms available in the market that can be used for trading and charting.
After you download the trading platform and sign in using the account you have created on the broker’s website, you can quickly start opening and closing positions and trade Forex.
Step 7: Withdraw Your Returns
After you have managed to grasp the real meaning of Forex trading and made profits trading Forex, it is time for you to withdraw the returns that you have made. Thankfully, there are numerous withdrawal options that you have while trading Forex.
The same methods that you have used for depositing funds should be used to withdraw your returns. However, keep in mind that some fees and commissions are charged while you are withdrawing funds.
In most cases, the brokers also need some time to process the withdrawals. The amount of fees that you might have to pay to withdraw your funds mostly depends on the payment methods that you are using. In most cases, direct bank transfers have the highest fees.
Also, due to safety concerns, a vast majority of Forex brokers will only allow you to withdraw funds with payment methods registered under your name.
Things to Know About Forex Trading Before You Start
As we have already noted, Forex is the biggest financial market globally. There are many other things that you might have to know about the market than just what is FX trading before you start trading Forex.
The Forex trading market is full of different types of terms and acronyms that traders and market participants use to describe different kinds of concepts and price movements in the market.
It is essential to understand some of the most popular Forex trading terms if you want to become a successful trader. In Forex, as we have already noted, currencies are traded in pairs of two. As you might have already noticed, when you trade Forex, there are two prices shown on the trading platform.
But, what are they, and how do they work? These two are called the bid and ask prices. The bid price in Forex is the price that a trader is selling the currency pair for, and the asking price is the price that a trader is going to buy the pair. Both of these prices are shown at all times and are being updated according to the market conditions.
But, there is much more that you should know about Forex trading terms. So, let’s continue by discussing some of the most popular terms used in Forex trading that every trader should know.
To put it simply, the margin is basically the amount of money that you have to put forward to be able to place a trade and maintain a certain position. However, it is not a transaction cost, rather, it acts as a type of security deposit that the broker holds while a Forex trading position remains open in the market.
While talking about margin trading Forex definition, it should be noted that it allows the trader to increase their exposure. Thanks to margin, traders are able to open leveraged positions. Leverage is another very important term that every trader should know.
Compared to other trading markets, Forex is known for offering traders higher leverage. But what does leverage mean? Essentially, leverage is the process of using borrowed funds to increase your trading positions far beyond what your actual account balance would allow you.
Forex traders very frequently use higher leverage to increase their turnover while trading currency pairs. However, it should be noted that leverage can also increase the risks of Forex trading.
Because leverage is able to increase the risks as well as profits of Forex trading, it is known as a double-edged sword in the market. Still, there are many people who use it to increase the volume of their positions.
However, keep in mind that depending on your location, available Forex leverage might be limited for you. For example, there are certain limitations on the maximum leverage in the USA, EU-member countries, as well as in Australia, and many other parts of the world.
Lot is another very important term frequently used in Forex trading. Lot is a size of a position opened by a trader. A standard lot in Forex equals 100,000 units of the base currency.
There are other types of lots available in the market, such as Mini lot, Micro lot, and Nano lot, equaling 10,000, 1,000, 100 units of a currency respectively. In recent years. more non-standard lot sizes have become available in Forex trading.
In Forex trading, pip stands for the Percentage in Point and represents a tiny measure of the changes in a price of a certain currency pair. For the majority of the currency pairs in the market, a pip represents the fourth number after the decimal point, 0.0001.
However, in the JPY pairs, a pip represents the second number after the decimal point – 0.01. There are different types of pips available in Forex. For example, there is a nano pip, which for the majority of pairs is the fifth number after the decimal point – 0.00001, while for JPY pairs, it is the third number, 0.001.
In Forex trading, spread stands for the difference between the sell, also known as bid, and buy, ask, price of a currency pair. As we have already noted above, there always are two prices of currency pairs shown in the trading platform. The difference between these prices is called spread and acts as one of the main sources of income for Forex brokers.
The spread is measured in pips and there are several types of them available in the market. While most of the spreads are variable and depend on the market conditions and prices of currency pairs, there also are fixed spreads, which do not change and remain the same no matter what happens in the market.
How Much Does Forex Trading Cost?
Quick Answer: The cost of Forex trading varies according to broker as well as currency pair you are trading and size of your positions
There are certain fees and commissions that traders might have to pay while trading Forex. While there are many brokers where you do not have to pay any commissions for deposits and withdrawals, there are others that charge some commissions on payments.
As we have already discussed earlier in this guide to Forex trading, there might be other commissions that traders might have to pay as well, like, spreads for example. However, a very important thing about the fees of Forex trading is that there really is no ‘cost’ of Forex trading.
Remember that the money that you are using to trade Forex is an investment in the market that has the potential of generating returns. Depending on the Forex broker that you are using, you can start trading with a minimum deposit of just a few dollars, or it might require a minimum deposit of a few hundred dollars.
It varies very much from broker to broker, however, remember that the money that you are depositing to your account is not paid to anyone. It is on your account and is used to invest in the Forex trading market.
That said, there still might be some costs associated with Forex trading. These include different types of commissions. Let’s discuss what they are and how they work below.
We have already offered you detailed information on Forex trading defined, but what are the costs of the market? The amount of money that you might have to pay in commission depends on a lot of things.
First of all, it is the broker that you are using. While there are some brokers that do not charge any fees and commissions on deposits and withdrawals, there are others that have deposit commissions.
The number of commissions mostly depends largely on the payment method used by traders. In most cases, the commissions are lower with modern payment solutions, like online payments for example.
Payment fees are not the only ones that you might have to pay. There are many Forex brokers that charge traders different fees, for example, the non-activity fee. This commission is only charged to accounts that have not traded in a very long time.
In most cases, this commission is just a few dollars, however, it can increase if the inactivity of the account continues for a longer time. However, keep in mind that fees vary broker by broker and some of the fees that we have talked about might not be charged by the broker you are using.
What Did We Learn With This Forex Trading Guide?
Forex trading is the biggest financial market around the world with millions of participants every single day.
Forex traders can be separated into two different groups. They are retail Forex traders and industrial Forex traders.
There are many things that beginner traders should know before they start trading Forex. This includes terms like leverage, margin, pip, lot, spreads, and many others.
While trading Forex, you are dealing with currency pairs. In Forex, there are three types of pairs available, which are Majors, Minors, and Exotics.
Before you start trading Forex, you will need to first find a Forex broker, open an account, deposit funds and download a trading platform.
Detailed Info On What Forex Trading Is
Can You Get Rich By Trading Forex?
While there is a possibility for you to get rich with Forex trading, there are certain things that you should keep in mind. Forex trading is a very risky market, and as much as it can generate profits for traders, it can also end up costing you hard-earned money.
Also, the amount of money that you make by trading Forex depends on your initial investment and trading style.
Is It Legal To Do Forex Trading?
Yes, Forex trading is legal. In fact, Forex represents the biggest financial market in the world. There are millions of people who are trading Forex every single day and it is available in most of the countries around the world.
That said, there are some strict restrictions in several countries. These restrictions are mainly in place to keep the funds of traders safe and secure.
Is Short Selling Allowed When Trading Forex?
While shorting is mostly associated with stocks, you can easily short sell Forex. In every financial market, including Forex, traders sell short when they believe that the value of a certain asset (in the case of Forex, currency) is going to fall.
How Risky Forex Trading Actually Is?
Forex trading is a very risky market and there is a serious chance for you to end up losing most of your hard-earned money while trading Forex. However, there are certain things that you can do to limit the risks of Forex trading.
First of all, you can adopt different types of risk management strategies to make sure that you are not losing more than you can afford. Also, by trading with only licensed, safe, and secure Forex brokers, the risks of FX trading can be much lower.