Forex, or foreign exchange, is the world’s largest and most liquid financial market and is becoming increasingly popular with more newcomers trying the markets every day. For those who know what they are doing, trading can be a genuinely thrilling and potentially lucrative opportunity to make money, but for those who don’t, it can be expensive due to the market’s high-risk nature.
Therefore, it couldn’t be more important for you to take your time and learn the mechanics behind forex and how it operates, its history, the risks involved, and what kind of opportunities it provides you with. With Forex it’s important to remember that you need to continually develop your skills and further your understanding.
Simply put, in Forex, there is always room for improvement.
But with so much information readily available to you, where do you even begin? Don’t worry, we’ve got you covered, we’ve put together this comprehensive article about everything you need to know about Forex trading. We’ll be taking you through the history of forex since its inception, to more specific topics that will give you the knowledge you need to succeed.
What is forex?
Forex involves the exchange of one currency for another with the intention of earning profit from exchange rate fluctuations. Currency values are constantly in flux due to a whole range of factors – both economic and political. These include inflation, interest rates, natural disasters, conflicts and other geopolitical events.
In Forex trading, you will always have to carry out technical and fundamental analysis, whilst employing a variety of strategies and tools to help keep track of the market’s price and make predictions. Based on your findings, you will then place trades in the hope of being profitable.
Before you can trade on the forex markets, however, you will need to get yourself registered with a broker, create a trading account and then fund it. Brokers like Eightcap make the global currency markets accessible to you by providing you with trading platforms, along with smart tools like Capitalise.ai and market insights from TradeZone to help you trade more effectively.
What are the forex terms I need to know?
- Currency pairs: Trading the forex markets involves buying one currency and selling another simultaneously, hence why currency pairs are used. For example, the EUR/USD pair represents the euro and the US dollar.
- Meaning, when you buy EUR/USD, you are buying euros while selling US dollars. Whereas, if you are selling EUR/USD, you sell euros and buy US dollars.
- Exchange rate: This is the price at which one currency can be exchanged for another. For instance, if the exchange rate for GBP/EUR is 1.20, it means that one pound can be exchanged for 1.20 euros.
- Long and short positions: In forex trading, you can either take long or short positions.
- For a long position, you buy a currency hoping that it will increase in value.
- Whereas, for a short position you will be selling a currency, hoping the value decreases.
- Trading platforms: Forex trading is performed through online trading platforms provided by brokers like Eightcap. These platforms provide access to real-time market data, charting tools, and order entry systems.
- Eightcap provides you with the following trading platforms:
- MetaTrader 4
- MetaTrader 5
- Margin: This is the minimum amount of account balance required to open or maintain a trade in the markets.
- Leverage: Leverage allows you to control positions with a significantly smaller amount of capital. While it can increase your profits, the same is said for your losses, so always plan accordingly.
- Market analysis: The price fluctuations on the global markets are subject to a range of economic and political influences, including economic data releases, geopolitical events, and central bank policy decisions. Before trading, to make informed decisions, you should carry out technical (indicators and market charts) and fundamental (market news) analysis. With an Eightcap account, you can receive various market insights via webinars, videos and blogs to help keep you updated.
A brief history of Forex
Forex trading dates back all the way back to ancient times when merchants exchanged goods like fabrics, spices, herbs and currencies across different regions. However, now things are a little different with the modern forex market as we know it today, beginning in the early 1970s following the abolishment of the Bretton Woods Agreement, resulting in the US dollar no longer being pegged to gold.
- The Bretton Woods Agreement was a system of monetary management established in 1944 to stabilise the international monetary system after the chaos of the Great Depression and World War II. Under the agreement, the US dollar was voted to be the world’s reserve currency, and other currencies were pegged to the dollar at fixed exchange rates. The US dollar, in turn, was linked to gold at a fixed price of $35 per ounce at the time.
After the Bretton Woods system was abolished, all of the major currencies started to float freely against one another, and the foreign exchange market’s size and importance grew significantly. Over time and with the advances in technology in the 1980s and 1990s, such as the widespread adoption of computers and the internet, it’s now a global, 24-hour market where anyone has access to the markets, with the ability to buy and sell currencies in real-time, making it the largest financial market in the world, with an impressive average daily trading volume of over $7 trillion.
What exactly is the forex market?
Forex is a global marketplace where currencies are traded from different countries in order to make a profit from changes in exchange rates. It runs electronically over the counter (OTC) through a decentralized global network of banks, financial institutions, and individual traders.
On this decentralized global network, currencies are traded in pairs, like the EUR/USD, with the value of one currency (EUR is the base currency) quoted against the other( quoted currency is the USD). The exchange rate of the currency pair determines how much of the quoted currency is required to buy one unit of the base currency.
- For example:
- The current exchange rate for EUR/USD is 1.2000, so 1 euro can be exchanged for 1.2000 US dollars. To buy 100 euros, you would exchange them for 120 US dollars (100 x 1.2000 = 120).
How can I access the forex markets?
Accessing the markets has never been easier, all you need to do is set up a trading account with a reputable forex broker, fund your account and trade. But how do you know if a broker is reputable? Research them. Brokers like Eightcap are regulated, and they come with great ratings on customer review sites like Trustpilot. Another plus is that they are completely transparent with the trading conditions, fees, and types of support they provide.
Eightcap also offers a wide variety of desktop, mobile and web-based trading platforms to choose from, ranging from Metatrader 4 and 5 to TradingView. Once you have downloaded a trading platform, and logged in with a funded trading account, you can then trade on the global forex markets.
After clarifying the details around the Forex Market, let’s look into other types of Forex markets:
There are several types of forex markets:
A Spot Market, sometimes called a “physical market” is a public market where financial instruments and assets such as forex, stocks, cryptocurrencies, and bonds are traded directly and immediately (or within two business days).
In a spot market, the executed trade price, or spot price is determined by its market value. There is also no leverage (which allows you to control positions with a significantly smaller amount of capital) or margin (the minimum amount of account balance required to open/maintain a trade). On spot markets, therefore you can only trade with assets you own.
The two types of Spot Markets:
- Exchanges: On exchanges, trading can be carried out on a trading platform such as MetaTrader or TradingView or a trading floor. Thanks to these trading platforms, despite the large volume of trades, prices can be determined immediately
- Over-the-counter markets: These trades are made directly between traders, with no third-party institution to regulate the trade, which means assets being traded over-the-counter are not always standardized in terms of quantity and price.
Forward Market: A forward market is a marketplace for financial instruments that are priced in advance for future delivery. it’s typically associated with foreign exchange markets, but can also refer to securities, commodities, and interest rates.
Buyers and sellers agree to a customized contract to buy or sell an asset at a predetermined price, at a future date, usually between 30 to 180 days, as opposed to the immediate settlement on Spot markets. This custom contract isn’t traded on an exchange but rather negotiated between two parties, usually banks or financial institutions, with terms tailored specifically to the needs of both parties.
Futures Market: Future contracts are agreements to buy or sell an underlying asset at a later date for a predetermined price. They are sometimes called derivatives because they are derived from underlying assets. By purchasing the right to buy or sell the underlying asset at a later date at a predetermined price, you can profit from an increase in the asset’s value. Whereas if you purchase the right to sell, you should expect to profit from a decrease in the asset’s price.
Now that we clarified the types of forex markets, let’s look into what makes the price fluctuate – Volatility
What does a Volatile Market mean?
Market volatility is a measure of how much a particular market’s overall price fluctuates in relation to its average value, over a period of time. It’s watched closely by traders who are looking to both measure risk and anticipate future price movements in the market.
There are many different factors that contribute to the price fluctuations in a market, including economic events such as economic events (Non-Farm Payroll, Consumer Price Index, GDP), interest rate changes, company announcements (Tesla announces a new model of EV car) and shifts in overall sentiment. Additionally, market volatility can also be affected by the actions of market participants, such as buying and selling by large-scale institutional investors, pooled investment hedge funds, or even retail traders.
It’s essential for you to understand market volatility so that you are able to make informed decisions. During times of high market volatility, you will be exposed to two things; an increased opportunity to make profits from your trades and an increased exposure to risk, which can result in loss. The rule here is, the higher the reward, the higher the risk.
In order for you to protect yourself from such risks during high market volatility, you need to carry out the following:
- Employ a solid trading strategy
- Use features such as limit orders:
- Stop-loss – Automatically closes a position if the level of loss reaches a predefined amount.
- Take profit – Automatically closes a position when the price reaches a pre-defined level or price.
- Have a risk appetite and risk management plan
- Utilise technical analysis tools to track the volatility and identify entry/ exit points
- Fundamental analysis is crucial as it can help indicate volatility in the markets through upcoming economic (or company) announcements, allowing you to prepare more effectively.
Are Forex Markets Volatile?
Forex markets are known for their volatility, with enormous volumes traded daily, the prices of currencies can fluctuate quite rapidly. As discussed above there are many contributors to market volatility and as we have seen with the unpredictability of what we may face in global changes like the pandemic and recent conflicts, it can be difficult to predict, though not impossible.
In addition, forex trading occurs around the clock, 24 hours a day, five days a week, which means in different time zones and regions of the world, which accounts for sporadic fluctuations in the global currency markets.
Another factor is leverage, which plays a significant role in forex market volatility since it allows you to control large positions with relatively small capital. However, despite its potential advantages, leverage can also cause sharp price movements and increase the risk of losses.
Despite this volatility, however, it’s worth reiterating that even though forex markets can be volatile, they also come with numerous opportunities for you to make profits and with careful analytical research and solid risk management, you can protect yourself from high volatility risks. Remember, without volatility, the price would never change – volatility is a necessity for price movement.
What are the different uses of the Forex markets?
Forex markets are used for a variety of purposes by different participants, including:
- International trade: One of the primary uses of forex markets is to facilitate international trade by enabling currency conversion. For example, if a company located in France imports goods from the United States, it will need to convert its domestic currency (Euro) into the supplier’s foreign currency (US dollar) to make the payment.
- Investment: Traders and institutions invest in currencies, speculating on the future direction of currency prices by buying and selling currency pairs for the purpose of generating profit.
- Hedging: A company can hedge against currency exchange rate changes (currency risk). For example, a company that exports goods to another country can use the forex markets to hedge against the risk of a decrease in the value of the foreign currency it expects to receive.
- Central bank operations: Central Banks such as the US Federal Reserve, the Bank of England and the Reserve Bank of Australia all have numerous responsibilities to help manage the monetary system of their nation, ranging from maintaining a low inflation rate, sustaining the stability of a currency and preserving full employment.
- Arbitrage: Forex arbitrage refers to the strategy of capitalizing on the differences in price between comparable trading instruments in the hope of generating profits.
Let’s wrap this up
You will have realised by now, that the foreign exchange is the world’s largest market for good reason, it provides a multitude of opportunities for a wide range of market participants: from retail traders, and financial institutions looking to make profits from speculative trading to central banks changing monetary policies to maintain inflation rates.
Before you trade, you must have a firm understanding of the many different contributors to the market’s volatility in order to effectively predict the price’s direction. The market price can change for a whole variety of reasons including economic events, company announcements, and natural disasters – so it’s crucial for investors to follow the news and stay updated.
The Forex markets also come with three main segment types that differ in how they operate, giving participants more variety in how they want to operate within the markets. There are spot markets, which involve the direct and immediate exchange of currencies at the current exchange rate and the forwards and futures markets which enable the exchange of currencies at a predetermined date and price in the future.
By trading Forex, you also have the ability to trade on margin, controlling large positions with relatively small amounts of capital, and amplifying potential returns. Also, Forex trading takes place around the clock, providing you with ample opportunities to react to the changes in currency prices around the world.
Overall, you’ll use forex for its liquidity, leverage, and flexibility, as you seek out profit from currency price movements – it’s a complex and dynamic financial market that requires a thorough understanding of its terminologies and concepts. If you are to take away just one word from this entire article that best describes the Forex markets, hopefully, it would be “opportunity”, because with the right mindset, dedication and will to succeed, Forex will always have an abundance of opportunities waiting for you.
Risk Warning: Margin trading involves a high level of risk, and may not be suitable for all investors. You should carefully consider your objectives, financial situation, needs and level of experience before entering into any margined transactions with Eightcap, and seek independent advice if necessary. Forex and CFDs are highly leveraged products which mean both gains and losses are magnified. You should only trade in these products if you fully understand the risks involved and can afford losses without adversely affecting your lifestyle (including the risk of losing the entirety of your initial investment). You must assess and consider them carefully before making any decision about using our products or services.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The majority of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
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