The term Forex is the contraction of the English expression foreign exchange, which designates the market in which the currencies or currencies are traded. There is no central market for currency exchange; Therefore, Forex is an active OTC market in the main international financial centers.
Forex is the largest financial market in the world with a daily trading volume valued at almost 5.3 trillion dollars. Therefore, it is the largest and most liquid market in the world in terms of transaction volume.
Unlike the stock market, Forex allows you to trade 24 hours a day, five days a week (banks are closed on weekends). Forex has long been reserved for wealthy people, but in recent years, an individual can trade with a stake of only a few tens of euros, thanks to the emergence of many online brokers.
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How Currency Trading Works
The forex trading it is completely dematerialized and decentralized and not tied to a particular stock market. Therefore, it allows currency transactions almost 24 hours a day, every day of the week. Almost all transactions take place over the counter: brokers and banks trade directly with each other, without a broker. Therefore, Forex is an unregulated market.
The main players in currency trading are banks and runners that allow people operate online. These make it easier for financial instruments to be available to hedge or speculate exchange rates. With these online brokers, it is possible to access the market through an exchange platform and real-time quotes.
The broker’s compensation is generally made on the margin which corresponds to the difference between the purchase price, called the bid price, and the sale price, called the bid price. Most of the runners offer forex bonuses attractive to encourage trading, for example with double deposit amounts or other bonuses.
In forex, currencies are always bought and sold in pairs: therefore, we are talking about pairs. You can, for example, exchange euros for US dollars. A simple way to do this is to trade in EUR / USD. When the EUR / USD pair has a price from 1.3105, we can:
- or we buy 1 euro against 1.3105 dollars (we say we buy the pair)
- or we sell 1 euro against 1.3105 dollars (we say we sell the pair)
The fourth decimal place in the quote is called pip . So, when the price goes above 1,310 5 to 1,310 7 , is said to have won two pips. On the contrary, when the price goes above 1,310 5 to 1,310 3 , is said to have lost two pips . In fact, the price of the currency pair is unstable and constantly evolving. This allows you to obtain benefits in two ways:
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- either by buying the pair and selling it some time later, when its price has risen;
- either by selling the pair and then buying it again sometime later when its price has dropped.
Therefore, to obtain benefits it is necessary to know how to correctly anticipate the direction of evolution of the prices.
It should be noted that the EUR / USD pair differs from the USD / EUR pair and that they are the subject of two separate quotes, although they are closely related. Thus, if we have euros to exchange for US dollars, we can:
- or sell euros paying in dollars. Then we sell the EUR / USD pair, as seen above. If the EUR / USD parity is 1.3105, we sell 1 euro against 1.3105 dollars;
- or buy dollars paying in euros. Then we buy the USD / EUR pair. For a parity of 0.7632, we buy 1 dollar against the payment of 0.7632 euros.
The United States dollar (USD) remains the reference currency in the market of currencies. In practice, a currency is always quoted against another currency that serves as its reference. Therefore, the dollar can be traded in relation to the euro, the Australian dollar, the Canadian dollar, the British pound …
Leverage in Forex
One of the essential features of currency trading is leverage: forex brokers allow their clients bet more money than you actually have in your account, this is called leverage.
Thus, the leverage effect makes it possible to put on the market an amount up to a thousand times higher than the one the client has, but with a high assumption of risks. There are various levels of leverage, typically ranging from 1: 100 (investing in a currency pair is multiplied by 100) to 1: 400.
It is common to use leverage for exchange operationsSince the price changes of currency pairs are usually very small and it would be very difficult to make a profit without this effect.
Forex Leverage Example:
If your broker allows you a leverage × 100, this means that for 100 euros deposited in your account, you can invest 100 × 100 = 10,000 euros.
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This technique allows increase your earnings in an extraordinary way if you have found the right trend. But it can also accelerate your losses if you don’t, and it can even lead you to lose more than your original bet. Therefore, this technique should be reserved for the more informed investors.