What is Forex? • Forex Trading & How it Works • Benzinga – Benzinga
If you’ve traveled abroad, chances are you had to buy the local currency. In essence, you have traded forex, also known as foreign exchange.
As old as the money itself, foreign exchange has been the tool enabling foreign trade. This, in turn, created product and service specialization, allowing for much faster prosperity.
While trading forex is essential for businesses, it is also a lucrative market to speculate in. Read on to learn the basics of forex — why, how and where to trade it.
The foreign exchange market (forex) is a global, decentralized market for currency trading. It operates through a network of international banks around the world.
This allows for 24-hour coverage, 5 days a week, with the Australian market opening the first and the U.S. market closing the last.
Forex doesn’t trade in absolute value but in a ratio — pitting the value of one currency against another. This creates currency pairs, like the U.S. dollar vs. Canadian dollar, conveniently labeled as USD/CAD.
The modern foreign exchange market formed during the 1970s as countries gradually switched to floating exchange rates. Due to rising globalization, this market quickly became the largest globally, and nowadays, daily volume exceeds $6 trillion.
The rise of the IT sector through the 1990s saw the expansion of the retail trading market. Software development allowed for better charting, faster feeds and lower costs. The estimates show that only 5.5% of the market accounts for retail traders, but that is still around $300 billion in daily volume.
How to Make Money on Forex
From trading currencies on the move to setting realistic goals. The important things to consider while trading forex are multiple:
- Trade volatile currencies. It is hard to make money if the price doesn’t move. Naturally, you’ll be looking to trade markets that move a lot because it would be easier to capture a part of that move. The easiest way to do this is to use the Average True Range (ATR) indicator. It shows the average volatility over the set period (usually 14).
- Set realistic profit expectations. You are only making money once you have exited the trade. Yet, profit expectations have to be realistic. Situations where you capture twice the average daily range are unlikely to happen. While the profit target will depend on the market structure, a reasonable expectation is 25%-30% of the ATR.
- Use the optimal stop-loss size. Trading without a stop-loss is like playing with matches on a petrol station. Too many things can go wrong. Even before you enter the trade, you should have a general idea of where to place a stop-loss. This is usually based on the market structure, but a rule of thumb uses at least 10% of ATR.
- Trade what you see, not what you think. It might sound counterintuitive but avoid anticipating price movements. At any time, the price might do 1 of 3 things: go up, stay put or go down. Every time a candle closes, it is new information telling a story on what price might do next. Interpreting this information correctly and acting upon it when it happens (not before) is the cornerstone of profitable trading.
- Stick with your ideas. Losses are inevitable in trading. Understanding them will be essential for your learning process. Reading and following someone else’s ideas is the easiest way to sabotage this. Regardless of the method, another trader will always have a different perspective. If you follow their suggestion, you will not be sure if you were wrong or just unlucky.
- Do not abuse the leverage. Leverage is a double-edged sword. It can make you money, but it can also destroy months of work momentarily. Leverage doesn’t change the odds; it instead amplifies them. While some offshore brokers allow leverage as high as 1:1,000, U.S. regulators keep them moderate, up to 1:50.
- Keep track of the fundamentals. Just like earnings announcements on the stock market, the forex market has its calendar. Major reoccurring news includes bank interest rate decisions, employment data, inflation reports and gross domestic product projections. Following this data for at least a few most significant currencies will help to form the big picture.
- Avoid trading high-impact news. High impact news can make or break a trade. Even if your research is correct, the market can still overreact and go in the “wrong” direction before reversing. The only thing worse than being wrong is being right, but too early.
- Find a trading style that suits you. There are many ways to trade. From taking the intraday trades that last minutes to swing trades that cover days or even weeks. There is no one-size-fits-all approach. To get the best results, you will have to find what fits your personality the best.
Why Invest in Currencies?
- Easy to understand: Exchanging currencies is as old as the money itself. You are simply selling one to buy the other — because you believe it will gain in value.
- Highly liquid: The forex market is the largest in the world. The daily volume totals over $6 trillion, with the global market of $2 quadrillion (2,000 trillion). Because of the liquidity, this market can absorb trade of (almost) any size without consequences — a significant advantage over an asset class like penny stocks. If you find a good strategy and achieve consistency, you will replicate your results even on a large scale.
- Cheaper to trade: Due to the high liquidity, forex is one of the more affordable assets to trade. With high supply and demand at all times, spreads are tighter and commissions lower. Eventually, this adds up over time as it allows you to take on larger trades while keeping the relative risk on the same level.
- Available 24/5: Except for the weekends, the forex market is always open. Due to its decentralized nature, there is always an open exchange worldwide — an advantage it holds over a stock market that trades in a single daily session.
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One Market to Rule them All
Often overlooked by the retail traders, forex is the only market available around the clock. Conveniently it is also the largest market by far.This means that achieving consistency, even while working with a small portfolio, will be fully scalable to hundreds of thousands, if not millions.
Yet, this sounds easier in theory than it is in practice. The forex market requires patience and planning. You will have to resist the temptation of entering a trade for the sake of simply being in the market.
While slower-paced than other asset classes (like stocks or commodities), forex is not without perils. Violent crashes (like the Swiss Franc in January 2015) do happen, and you must remain vigilant when investing. Using a regulated broker is the first step in the right direction, but ultimately, success in forex comes down to discipline and dedication.
Frequently Asked Questions
Is forex trading illegal?
Forex trading is legal. Yet, brokers need to have proper licenses for each market they serve. Since the US regulations are relatively strict, this cultivated a myth that forex trading is banned over the years.
Some of these regulations include limiting maximum leverage to 50:1 for major or 20:1 for minor currencies, eliminating the hedging capabilities (no simultaneous buying and selling) and holding a $20 million deposit as reserves in qualifying institutions.
What is forex and how does it work?
Forex is an exchange of currency from one to another. It is the largest market in the world, and it is essential for foreign trade.
Forex works through a network of buyers and sellers. This network consists of both institutions and individuals who exchange currencies for both practical and speculative purposes. While a company will buy foreign currency to pay a foreign supplier, an individual might buy it to speculate on the movement in the short term.
Forex market runs through a global banking network and it runs 24 hours a day, 5 days a week. Whilst companies will buy or sell currencies through their banks, individual speculators are likely to operate through brokers.
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