What is forex?

The word ‘forex’ is an abbreviation for the phrase foreign exchange. It is a market that trades over $5 trillion on a daily basis. The forex markets are open 5 ½ days a week and 24 hours a day. They only close late on Friday and resume trading roughly 36 hours later. Unlike other markets, there is no centralized location where trading occurs. Instead it is conducted over an electronic network that spans the globe. Forex trading is used by individuals, corporations, institutions and governments.

How does forex trading work?

There are a number of ways to trade forex, which include spot markets, futures, and forward contracts. At the end of the day though, they all work the same way and is the trader that simultaneously buying one currency while selling another. In the past, these transactions were typically made through a forex broker and they can still be done this way. More recently, the popularity of online trading has led traders to use a derivative known as a contract for difference, or CFD, to speculate on the price movements in the forex markets.

Many traders prefer using CFDs because they are leveraged products, allowing the trader to control a larger position with a smaller amount of capital. This can magnify profits for the traders, but also means risk management becomes more important because it can also magnify losses.

Popular pairs

There are seven forex pairs that are considered the major pairs. These make up roughly 80% of all forex trading volume. The seven major pairs are as follows:

• EUR/USD
• GBP/USD
• USD/JPY
• USD/CHF
• USD/CAD
• AUD/USD
• NZD/USD

Forex Trading Markets

As mentioned above there are three different approaches to trading the forex markets. These are spot forex, forward forex, and futures forex.

The spot forex market involves the actual physical exchange of currency. It is called the spot market because it occurs at the point the trade is settled, or “on the spot.” There are a number of derivatives based on the spot market prices, such as the CFDs offered here at RM.Investment.

The forward forex market involves contracts to buy or sell a given amount of currency at a set price with settlement at some future date or dates. Forward contracts are frequently used by corporations that need to make payroll for overseas operations. Forward contracts are traded over-the-counter.

The futures forex market is also contracting that specify the delivery of a certain amount of currency at a set price at a specific date in the future. Forex futures are standardized and are exchange traded contracts.

Advantages

There are many advantages to trading forex, whether you choose to trade spot markets, futures, or some other derivative like CFDs. Here are 8 of the top advantages:

1. The forex market is by far the largest financial market in the world.
2. Retail traders can participate just as easily as institutions.
3. There is extremely high volumes and great liquidity.
4. You can easily go either long or short when trading the forex market.
5. Forex markets are open 24 hours a day and only close on the weekend.
6. Forex markets are open 24 hours a day and only close on the weekend.
7. The only transaction costs are the spread, which is usually quite small on the major pairs.
8. When you trade forex CFDs you can use leverage to increase the power of your trade.

Trading Example – EUR/USD

Let’s say that EUR/USD is trading at 1.18560 with an ask price of 1.18556 and a bid price of 1.18564. That gives it a spread of 0.8 pips. The trader believes the Euro will increase versus the U.S. dollar, and enters with a market order for 1 lot at 1.18564. With a purchase of 1 lot the pip value in the trade will be $10. The total value of the trade is 100,000 or $118,564. This is a leveraged trade and the trader only needs to put up 2% of the full amount, or $2,370 as margin.

A Winning Trade

The trader was correct and the Euro appreciates against the USD, reaching a level of 1.18860 with an ask price of 1.18856 and a bid price of 1.18864. The trader reverses the position and sells 1 lot at 1.18856. That’s a difference of 29.2 pips, giving the trader a return of $292 on the trade. Because the trader only used $2,370 as margin that’s a return of 12.3% on the trade.

A Losing Trade

It’s also possible the trader was wrong, and the dollar strengthens versus the Euro until it is trading at 1.18010 with an ask price of 1.18006 and a bid price of 1.18014. The trader sells 1 lot at 1.18006 for a loss of 55.4 pips or $554. That’s a loss of 23.4% based on the use of $2,370 as margin for the trade.