How to trade forex?

What is forex?

The foreign exchange (forex or FX) market exists wherever one currency is traded for another. It is the largest and most liquid financial market in the world, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The average daily trade in the global forex and related markets is continously growing and was last reported to be over US$ 4 trillion in April 2007 by the Bank for International Settlement; it is more than three times the aggregate amount of the US equity and treasury markets combined.

The forex market has no physical location and no central exchange. It operates through a global network of banks, corporations and individuals trading one currency for another. The lack of a physical exchange enables the forex market to operate on a 24-hour basis, spanning from one zone to another in all the major financial centers.

How is forex traded?

Currency prices only fluctuate relative to another currency, so they are always priced and traded in pairs. For example, the most traded pair is the euro against the US dollar, for which the abbreviation is EUR/USD. Below are the most traded currency pairs, also called majors:

The first currency is referred to as the base currency and the second one is referred to as the counter currency. So, in the EUR/USD example, the base currency is the euro while the counter currency is the US dollar. The price of a pair is the value of the base currency quoted in the counter currency.

So EUR/USD = 1.4212 actually means 1 EUR = 1.4212 USD

Currency pairs always have 2 prices: the sell price (or bid) and the buy price (or ask). When selling, the base currency is sold and the counter currency is bought. When buying, the base currency is bought and the counter currency is sold.

So, if you sell EUR/USD, 1 EUR = 1.4212 USD, if you buy EUR/USD, 1 EUR = 1.4214 USD

The difference between the sell price and the buy price is called the spread. The spread is usually measured in pips. A pip is the fourth digit after the decimal point of the price. In the case of the USD/JPY, it is the second digit.

When to buy? When to sell?

The aim of being profitable in forex is buying when the value of a currency pair goes up and selling when is goes down. A currency pair goes up when the base currency’s value increases with regard to the counter currency. Inversely, a currency pair falls when the base currency’s value decreases with regard to the counter currency. For example, the EUR/USD will go up if the euro strengthens with regards to the US dollar. If, on the contrary, the US dollar strengthens, which means the euro weakens, the EUR/USD will go down.

As with any financial investment, the aim is to buy an instrument at a low price and sell it at a higher price. In forex, it is also possible to sell at a high price and buy at a lower price thus making profits under all market conditions.

Upward market (bullish) example

Initial price:

You buy 100’000 EUR, you pay 142’140.- USD

The market goes up, after some time the new prices for EUR/USD are:

New price:

You decide to close this position, so you sell

You sell 100’000 EUR, you are paid 142’470.- USD

Your profit: 142’470 – 142’140 = 330 USD

Downward market (bearish) example

Initial price:

You sell 100’000 EUR, you are paid 143’840.- USD

The market goes down, after some time the new prices for EUR/USD are:

New price:

You decide to close this position, so you buy

You buy 100’000 EUR, pay 141’700.- USD

Your profit: 143’840 – 141’700 = 2’140 USD

Each transaction has two sides, a buy and sell (or a sell and buy). When buying, traders often call it going long, when selling, going short.

Margin trading

As you have seen in the examples above, the larger the transaction amount, the larger the potential. Does this mean you have deposit a large amount in order to open an account and start trading? The answer is NO, not with margin trading.

When you send funds to your broker, they are not actually used in the transactions. Instead, this deposit acts as a guarantee (also called collateral) used to cover the risk and provide protection from losses incurred during trading. This system allows traders to open positions for larger amounts and increase their purchasing power. Exto Capital offers a 1% margin (or 1:100 leverage) with means you can open positions for 100 times your deposit.

If at any time, the funds in the account fall below the necessary margin, positions will automatically be closed. This protects the trader as the account can never go into negative balance, even in volatile, fast moving markets.

How to analyse the market

There are two main ways of analysing the market:

• Fundamental analysis: this uses economic, political, environmental and other factors and statistics to determine the future price movements of an instrument.
• Technical analysis: in this case, traders study charts and past market performance to predict future price movements. Technical analysts argue that fundamental analysis is unnecessary are all relative information is already reflected in the price. Visit our forex technical analysis page for more information.

Usually, successful traders use a mix of both methods to better predict movements.