The foreign exchange market allows two currencies to be exchanged, at an exchange rate which is floating or fixed. This allows businesses from around the world to complete transactions across currencies. Currencies need to be exchanged to import produce from different countries, for example: a wine merchant in England exchanges their pound sterling (GBP) for Euros (EUR) in order to purchase wine from France. Exchanging currencies is the basis for all international trades. Unlike the stock market, the Forex market is decentralised – this means that there is no central trading area. Most foreign exchange transactions are executed over-the-counter (OTC) by banks, on behalf of their clients.
The Foreign Exchange Market
What is Currency Trading?
Currency trading, also known as FX trading, is the exchange of currencies between two parties at an agreed price. The trading parties may be financial institutions, multi-national corporations, banks, central banks, hedge funds, money changers, insurance companies, speculators, or individual traders.
Currency trading is done in pairs. A currency pair consists of a base and a quote currency – for example, the currency pair of EUR/USD consists of EUR, which represents the base currency, and USD which represents the quote currency. The exchange rate of EUR/USD at 1.1630 simply means that to own one euro, you need the equivalent of 1.1630 in US dollars.
The ultimate goal of FX trading is to identify the correct direction of the markets. It’s all about buying a financial instrument low and closing the position higher, or selling a financial instrument high and closing the position lower.
To begin, traders choose a trading platform to trade currencies on. There are many different trading platforms to choose from, including MetaTrader, Trading Station, Ninjatrader and Zulutrade.
Once the trader identifies a trend in the market, they place a buy or sell order on their preferred trading platform. If the trader expects a currency pair to rise, they place a buy order to profit from the increase. If a trader expects the opposite, they will place a sell order, to benefit from the fall. Because the Forex market is decentralised, currencies are traded in financial centres across the globe, in New York, London, Frankfurt, Tokyo and Sydney.
The Basics of Currency Trading
Traders can now easily access the markets thanks to devices like Smart phones, and as a result currency trading is becoming increasingly popular.
The user-friendliness of trading platforms and the 24-hours/five-days-a-week trading schedule makes currency trading highly appealing. The markets’ high liquidity means traders can trade almost any volume at their desired price, and are not likely to experience price manipulation.
If that wasn’t enough, a daily turnover of about $5 trillion, the availability of leverage, and educational resources provided by some brokers attract a huge number of traders across the world.
There are many different strategies which are commonly used among traders:
- Day Trading
- Swing Trading
- Position Trading
- Channel Trading
- Discretionary Trading
- Mechanical Trading
- Automated Trading
- Financial News Trading
|FX Market Centres||Currency||FX Trading Hours||UTC Time|
|Wellington New Zealan||NZD||08:00 -17:00||UTC +12 (+13)|
|Sydney Australia||AUD||08:00 – 17:00||UTC +10 (+11)|
|Tokyo Japan||JPY||08:00 -17:00||UTC +9|
|Hong Kong Hong Kong||HKD||09:30 – 16:00||UTC +8|
|Shanghai China||CNY||09:00 -17:00||UTC +8|
|Singapore Singapore||SGD||09:00 – 17:00||UTC +8|
|Mumbai India||INR||09:00 – 17:00||UTC +5:30|
|Moscow Russia||RUB||09:30 – 19:00||UTC +3|
European Forex Session
|Frankfurt Germany||EUR||07:00 – 15:00||UTC +1 (+2)|
|Zurich Switzerland||CHF||09:00 – 17:30||UTC +1 (+2)|
|Paris France||EUR||09:00 – 17:30||UTC +1 (+2)|
|London United Kingdom||GBP||08:00 – 16:00||UTC (+1)|
|North America Forex Session|
|New York United States||USD||08:00 – 17:00||UTC -5 (-4)|
|Chicago United States||USD||08:00 – 16:00||UTC -6 (-5)|
|Toronto Canada||CAD||08:00 – 17:00||UTC -5 (-4)|
What is a Currency Pair?
EUR = the first currency in the pair is known as the Base Currency
USD = the second currency in the pair is known as the Counter Currency or the Quote Currency
All major currency pairs contain the US Dollar and are the most commonly traded FX pairs.
EUR/USD Euro/US Dollar
USD/JPY US Dollar/Japanese yen
GBP/USD British Pound/US Dollar
USD/CHF US Dollar/Swiss franc
USD/CAD US Dollar/Canadian Dollar
AUD/USD Australian Dollar/US Dollar
NZD/USD New Zealand Dollar/US Dollar
Crosses are pairs that do not include the USD otherwise known as FX “crosses”.
AUD/CHF Australian Dollar/Swiss Franc
AUD/JPY Australian Dollar/Japanese Yen
CAD/CHF Canadian Dollar/Swiss Franc
CAD/JPY Canadian Dollar/Swiss Franc
CHF/JPY Swiss Franc/Japanese Yen
EUR/AUD Euro/Australian Dollar
EUR/CAD Euro/Canadian Dollar
EUR/NZD Euro/New Zealand Dollar
GBP/AUD Pound sterling/Australian Dollar
GBP/CAD Pound sterling/Canadian Dollar
GBP/CHF Pound sterling/Swiss Franc
GBP/NZD Pound sterling/New Zealand Dollar
NZD/CHF New Zealand Dollar/Swiss Franc
NZD/JPY Japanese Yen/Japanese Yen
Forex Trading Q&A
An FX trader is any individual who exchanges one currency for another. Individual traders commonly use different platforms to exchange foreign currency. These include banks, financial institutions, money changers, or FX brokers. Most trades are completed over-the-counter, which means that the trade is facilitated via a bank rather than a centralized entity.
PIP is the abbreviation of “point in price” or percentage in point” and it is the smallest unit of price movement in the foreign exchange market. For example, when the exchange rate of EUR/USD moves to 1.1552 from 1.1550, the currency pair has risen by 2 pips (or 0.0002).
Forex scalping is a trading strategy which aims to benefit from small price movements in the market. Scalp traders will target intraday price movements and only hold positions for a small amount of time to take advantage of small market opportunities. Forex scalpers must be prepared to monitor the markets all day long.
Forex leverage is offered by brokers to enable traders to maximize their trading potential. The Forex market offers higher leverage than other markets, and this attracts potential traders. Leverage allows traders to deposit small amounts and trade with high volumes. The term ultimately means borrowing money in order to increase the potential returns on a trade, but this means losses get increased too.
The difference between the ask price and bid price is known as the spread. The spread represents the cost of a transaction; the lower the spread, the lower the cost. A spread is influenced by a number of factors: the supply of the asset, the stock’s trading activity, and the total demand or interest in a particular asset.
Hedging is a technique designed to reduce the risk caused by adverse price fluctuations. Investors and traders might implement a Forex hedge in order to protect their position from risk as exchange rates change. Foreign currency options are a common hedging method, and grant the trader the possibility to buy or sell at a future exchange rate.
A swap is simply an exchange of one currency for another. At a later date, the two parties who made the swap will receive their original currency back with a forward rate. The forward rate locks in a specific exchange rate and therefore acts as a kind of hedge. The swap varies significantly among different financial instruments.
A drawdown is the difference between a relative peak and a relative trough in the value of an investment. After a new high is reached, drawdowns track the percentage change between the previous high and the smallest trough. In this way, drawdowns are useful for determining the financial risk of a certain asset.
Slippage refers to the difference between the requested price of a trade and the price at which it is eventually executed. Slippage is usually found when the markets are particularly volatile, and prices have moved quickly during the time it takes for the trade to be ordered and completed. Slippage can have positive and negative consequences.
Forex Trading Fundamentals
Forex reserves are foreign currencies held by a central bank in order to grant greater flexibility and resilience. A reserve is any currency held by a financial authority which is centralised. The reserve assets can be used to endure market shocks if a particular currency becomes devalued or suddenly crashes. Higher foreign currency reserves ultimately mean lower risks associated with exchange rate fluctuations.
Forex reserves are usually held in US Dollars, British Pound Sterling, Euros, Chinese Yuan or Japanese yen. This is due to these currencies being the most common on the foreign exchange market.
Forex signals are trade forecasts usually issued by knowledgeable and experienced signal providers. The signals are based upon a series of technical analyses or news events, and are used by traders to help them decide whether they should buy or sell a currency pair. Day traders in particular may use a variety of Forex signals to inform their next trade. Forex signal systems produce either manual or automated signals.
In a manual system, the trader actively looks for signals and interprets them to choose whether to buy or sell. In an automated system, the software identifies a signal and makes the programmed response.
Foreign exchange is the market where one currency is exchanged for another. It is always done in pairs. for example if a trader wants to buy Euro and sell the US Dollar, then he would be trading the EUR/USD currency pair.
Similarly, if a trader wants to sell the US Dollar and buy the Japanese Yen he would be trading the USD/JPY pair. The price of a currency pair is called the exchange rate. It is determined by political, economic and environmental factors.
Transactions in foreign exchange are usually conducted in high volumes. Foreign exchange market has no physical location and hence it is called a decentralized market. It is open 24 hours a day, 5 days a week and is the largest market in the world.
Forex Fundamental Analysis
These are fundamental indicators which directly or indirectly point towards a weak or strong economy. Macroeconomic indicators based on the Gross National Product (GNP) and the Gross Domestic Product (GDP) are used to estimate an economy’s efficiency.
This data is then released in reports which have major effects on a country’s currency. Aside from GNP and GDP, some of the major macroeconomics are:
- Unemployment rate
- Retail sales
- Consumer leverage ratio
These types of events have direct or indirect consequences, either worldwide or for a particular set of countries. Geopolitical events have great psychological and emotional consequences for the equity and currency markets.
A few examples of such events including:
- Trade wars between major countries or economies which arise due to rising tensions among nuclear-armed, powerful countries.
- Major decisions taken by OPEC (Organization of Petroleum Exporting Countries), which have direct effects on oil prices.
- Major events like Brexit, which trigger volatility into worldwide stocks and currency markets.
Gross domestic product (GDP) is a financial economic indicator which measures the total value of goods and services produced in a country, over a designated period of time.
The GDP is one of the most important indicators, and is used to evaluate a nation’s overall economic health. Construction costs, government outlays and investments all contribute to a country’s overall GDP. Inflation is an economic indicator that measures the increase of a country’s prices for major goods and services.
The rate at which prices are rising dictates the rate at which the purchasing power of the currency is falling. In order to maintain a smooth economy, central banks aim to limit inflation and avoid deflation.