Table of Contents

Forex Trading: What is it and How Does it Work?

Forex Trading referred to as Forex or FX, is derived from the term “Foreign Exchange Market.” Unlike the stock market, Forex does not possess a centralized physical location. However, the primary centers for currency trading worldwide are found in England, America, and Japan.

Forex, short for “foreign exchange,” is a decentralized global market designed for the trading and exchange of currencies. It stands as one of the largest and most liquid financial markets worldwide. The primary function of the Forex market is to establish the exchange rates for different currencies, enabling the conversion of one currency into another.

Understanding the Forex Market and Forex Trading:

The global currency market began to take shape in a systematic manner in 1971 and witnessed significant growth and development starting in 1998, primarily due to technological advancements. Two historical events, the Gold Standard and the Bretton Woods system, played pivotal roles in shaping and expanding the Forex market. In essence, trading in this market involves converting one currency into another at a specific exchange rate.

These exchange rates are determined by a free system that is influenced by the dynamics of supply and demand among traders from all around the world. The rates of currency transactions in the Forex market serve as a reference point for conducting international transactions across various economic sectors.

Key Players in the Forex Market:

Several key entities are instrumental in the functioning of the foreign exchange market, including:

Central Banks: These institutions play a significant role in regulating their own national currencies and can influence the Forex market through monetary policy decisions.

Large Financial Institutions: Such as multinational corporations that require currency conversion for international trade and financial operations.

Commercial Banks: These institutions facilitate currency exchange for retail traders and corporations and are active participants in the Forex market.

Investment Companies: Which manage portfolios of various assets, including currencies, and participate in Forex trading to diversify their investments.

Stock Exchanges: Some stock exchanges also engage in Forex trading as part of their broader financial services.

Speculators: Individuals and entities who participate in Forex trading purely for profit, often by anticipating and capitalizing on currency price movements.

Understanding these key players is essential for grasping the dynamics and complexities of the Forex market. In the following sections, we will delve deeper into how Forex trading works and the strategies involved.

Stay tuned for more insights on Forex trading and how you can get started in this exciting financial market.

Forex Trading Hours:

The Forex market operates around the clock, making it unique among financial markets. According to the international working calendar, it’s open 24 hours a day, from Sunday to Friday. This continuous operation is made possible by the rotation of trading sessions across major currency centers in different time zones.

There are five main trading sessions in the Forex market:

Sydney: Kicking off the trading week, the Sydney session is particularly active during the morning hours in Australia and the Asia-Pacific region.

Tokyo: The Japanese market takes the reins during its trading session, attracting East Asian and Eurasian traders. This session typically follows the Sydney session and overlaps with it.

Frankfurt: As the European trading day begins, the Frankfurt session comes into play. European traders, along with those in the Middle East, contribute to the activity.

London: The London session is one of the most influential and liquid sessions. It overlaps with the Frankfurt session, creating a period of high trading volume.

New York: The final trading session of the day is in New York, where American traders dominate. This session also sees considerable trading activity.

It’s important to note that the Forex market remains open for trading 24 hours a day, and there are no restrictions on when individuals from around the world can participate. You can choose the trading session that aligns with your schedule and preferences.

How to Buy and Sell Currencies in the Forex Market (Forex Trading):

Trading in the Forex market is akin to buying and selling shares, but instead of shares of a company, you are exchanging one currency for another. Transactions in the Forex market are facilitated by brokerage firms, which connect buyers and sellers through an interbank channel, acting as intermediaries. These brokerage firms operate under the supervision of regulatory institutions.

Given the decentralized nature of the Forex market, regulatory organizations aim to establish rules and oversee broker activities to prevent problems and violations. It’s worth mentioning that these regulatory institutions themselves are subject to oversight within their respective countries’ economic systems.

Today, a multitude of regulatory organizations are active worldwide, including but not limited to:

NFA (USA)
FCA (UK)
FINMA (Switzerland)
BaFin (Germany)
MiFID (EU)
ASIC (Australia)
FMA (New Zealand)
CySEC (Cyprus)

These regulatory bodies play a critical role in ensuring the integrity and fairness of the Forex market. As a prospective Forex trader, it’s advisable to engage with a reputable brokerage firm that operates under the guidance of these regulatory bodies to protect your interests.

The First Step in Entering the Forex Market: Choosing the Right Broker

Before you dive into the world of Forex trading, it’s crucial to acquaint yourself with the various types of brokerage companies and understand their differences to make an informed choice. Brokers fall into four main categories, based on how they execute orders and their credit levels:

Types of Forex Brokers:

Market Maker (MM): Market Maker brokers are not directly connected to the central core of transactions. These brokers determine buying and selling prices based on market margins, effectively acting as the counterparty to your trades. In this type of account, commission amounts are typically fixed. However, it’s important to note that you do not have direct access to real market prices. Market Maker brokers are often seen as having less credit in the industry.

No Dealing Desk (NDD) – Main Market: NDD brokers provide access to a global system of supply and demand, where fees are not fixed. NDD accounts can be further divided into two categories: Straight Through Processing (STP) and Electronic Communications Network (ECN).

Straight Through Processing (STP) – Direct Order Execution: STP mode involves entering customer buy and sell orders with precise details, which are then sent directly to the central system. Orders are executed based on global market prices without any delay.

Electronic Communications Network (ECN) – Optimal Direct Order Execution: In ECN, the broker receives all trading offers in a manner similar to STP. However, the key difference lies in the fact that the broker offers customers the best available market price for their orders. Fees in ECN accounts are not fixed, and traders have access to the depth of global market transactions. Generally, the most reputable brokerage firms approved by the most prominent regulatory bodies fall into this category.

When choosing a Forex broker, you need to consider several factors such as your trading strategy, risk tolerance, and the level of transparency and market access you desire.

Here are some key points to keep in mind:

Regulation: Ensure the broker is regulated by a reputable financial authority. The regulatory bodies you mentioned earlier, including the NFA (USA), FCA (UK), and others, play a crucial role in overseeing the industry.

Trading Costs: Different brokers may charge various fees, spreads, or commissions. Consider how these costs align with your trading style and budget.

Platform and Tools: Evaluate the trading platform and tools provided by the broker. A user-friendly platform with essential analytical tools can significantly enhance your trading experience.

Customer Support: Access to responsive and helpful customer support is essential, especially for resolving issues or seeking guidance.

Account Types: Assess the variety of account types offered by the broker and choose one that suits your trading needs.

Security and Data Protection: Verify the broker’s security measures to safeguard your personal and financial data.

The Impact of Daily News on Forex Trading

Given the international and strategic nature of the Forex market, news and significant events in major economic powers play a direct and substantial role in influencing market fluctuations. In recent years, specialized news websites dedicated to global currency market events, such as Forex Factory, DailyFX, Investing, and others, have emerged. These platforms feature economic news calendars that inform traders about all crucial upcoming events.

The continuous flow of economic data, monetary policy decisions, geopolitical events, and global economic shifts can trigger rapid price movements in the Forex market. Traders closely monitor news releases related to employment figures, interest rates, inflation, and political developments, among other factors. The ability to react promptly to these events and make informed decisions is integral to successful Forex trading.

Expanding Forex Trading Opportunities:

Today, due to the advancements in trading platform software and financial resources, Forex market brokers offer an array of trading options beyond currency pairs. These options include precious metals, oil, strategic commodities, shares from prestigious international stock exchanges, and most recently, digital currencies. This diversification allows traders to explore a broader range of assets and investment opportunities.

Understanding Trading Costs in Forex:

One advantage of Forex trading is that it typically boasts lower trading costs compared to parallel markets. The primary cost involved in trading currency pairs is the spread, which represents the difference between the buying and selling rates. Additionally, traders may encounter a concept called commission, which can vary based on the trading symbol, account liquidity, and transaction volume. This commission may be deducted from your account.

Another factor to consider is swap, which denotes the amount credited or deducted from your account when a transaction remains open overnight. The calculation of swap is based on the difference in interest rates between the currencies or base assets involved in the trade.

It’s important to note that trading costs can significantly vary among different Forex brokers. These companies often offer diverse fee structures and discount arrangements to attract and retain customers.

Trading Platforms: Forex market and Forex Trading

In the world of Forex trading, various analytical and trading platforms are widely used. One of the most renowned platforms is developed by a Russian company known as MetaQuotes. Their software, branded as MetaTrader, is available for free in versions 4 and 5 and is compatible with multiple operating systems, including Windows, Mac, Android, and iOS.

Forex trading revolves around symbols representing currency pairs. Understanding the dynamics of these pairs is essential for effective trading in the Forex market.

Types of Currency Pairs in the Forex Market

In the Forex market, currency pairs are categorized into three main groups, each with its unique characteristics and trading dynamics:

1. Major Currency Pairs:

Major currency pairs constitute the core of Forex trading, accounting for more than 70% of all market transactions. These pairs are characterized by their stability, low volatility, competitive fees, and high liquidity. Major currency pairs involve currencies from the world’s leading and most powerful economies, such as the United States (USD), Eurozone (EUR), Japan (JPY), United Kingdom (GBP), Canada (CAD), Australia (AUD), and Switzerland (CHF). Examples of major pairs include EUR/USD, USD/JPY, and GBP/USD.

2. Minor Currency Pairs or Crosses (Minors):

Minor currency pairs, often referred to as “cross” or “exotic” pairs, do not include the US dollar (USD). They are ranked lower in terms of transaction volume and popularity compared to major pairs. While they may have slightly higher fees and exhibit less price stability, their liquidity remains relatively strong. Cross currency pairs include currencies from diverse regions and can offer unique trading opportunities. Examples include EUR/GBP, AUD/JPY, and GBP/JPY.

3. Exotic Currency Pairs:

Exotic currency pairs are combinations of a major currency with the currency of an emerging or less-established economy. These pairs represent the smallest share of Forex transactions. Exotic pairs are characterized by substantially higher fees and extreme price fluctuations, making them less popular among traders. Examples of exotic pairs include USD/TRY (United States Dollar/Turkish Lira), EUR/TRY, and USD/SGD (United States Dollar/Singapore Dollar).

The choice of currency pairs to trade depends on various factors, including your trading strategy, risk tolerance, and market conditions. Major pairs are often favored by beginners due to their stability, while experienced traders may explore the opportunities presented by minor and exotic pairs. Diversifying your portfolio with different types of currency pairs can help you manage risk and seize potential profit opportunities in the dynamic world of Forex trading.

Conditional Orders (PO) in Forex

In the world of Forex trading, similar to the stock market, traders have the ability to specify the type of order they wish to place in the order registration section. These orders are classified into two main categories: Market Execution (ME) and Conditional Orders (Pending Orders).

Market Execution (ME) Orders: With Market Execution orders, a trade is executed at the current market price at the moment the trader clicks the buy or sell button. This type of order is executed instantly based on the prevailing market conditions.

Conditional Orders:

Conditional orders are a powerful tool for traders, allowing them to set specific price levels at which they want to enter the market. There are four main types of conditional orders:

Buy Stop: This order sets a buying price higher than the current market price. It’s used when a trader expects the price to rise to a certain level before entering a long position.
Sell Stop: A sell stop order sets a selling price lower than the current market price. Traders use this order when they anticipate a price drop before entering a short position.
Buy Limit: A buy limit order specifies a buying price lower than the current market price. It’s employed when a trader wants to enter a long position at a lower price.
Sell Limit: The sell limit order designates a selling price higher than the current market price. Traders utilize this order when they aim to enter a short position at a higher price.

Before final confirmation, traders must determine the transaction volume. However, they have the flexibility to set values for profit limits and loss limits at any time. Additionally, the expiration date of conditional orders must be set before entering into the transaction.

It’s essential to understand that trading in the Forex market is bidirectional. In addition to buying opportunities, traders can take advantage of selling opportunities when they anticipate a price decline. In a selling position, traders can borrow to sell, considering their account balance, transaction volume, and leverage factor. If the market experiences a price decrease after the transaction entry, traders can exit with a profit. However, if the market moves against their position, it may result in a predetermined stop-loss point or a Margin Call, which is the automatic closure of trades by the broker due to insufficient account balance.

Leverage in Forex: Amplifying Trading Power

One of the most compelling features of the Forex market is the concept of leverage. Leverage is a tool that allows traders to control positions that are larger in value than their account balance, without the need for interest payments or bank guarantees. In essence, it magnifies your trading power.

Here’s a simple way to understand leverage: Imagine you have $1,000 in your trading account as a guarantee. With a leverage factor of 1:100, you have the potential to open a position worth $100,000. This means that for every dollar in your account, you can control $100 in the Forex market.

Leverage allows traders to access significant market exposure with relatively modest capital. It can be a powerful tool for profit maximization, but it also amplifies the potential for losses. It’s important to note that the specific leverage factor you can use depends on your broker’s rules and your own preferences.

While leverage enhances the trading potential, it also comes with a critical aspect to consider. When the loss on a trading position surpasses the initial margin (the amount you have as a guarantee), the trade will be automatically closed. This process, known as a margin call, safeguards traders from incurring losses greater than their account balance.

Understanding and managing leverage is crucial for responsible trading in the Forex market. It can be a double-edged sword, offering both opportunities and risks. Effective risk management and a sound trading strategy are essential for harnessing the benefits of leverage while protecting your capital.

Determining the Volume of Transactions in Forex

The Forex market is renowned for its colossal trading volumes. According to the latest statistics, the market witnesses transactions exceeding 5 trillion dollars each day, making it the largest financial market in the world. In Forex trading, transaction volume is determined based on a unit known as a “Lot.”

There are different types of Lot units, each representing varying amounts of the base currency:

Standard Lot: Equals 100,000 units of the base currency.
Mini Lot: Equals 10,000 units.
Micro Lot: Equals 1,000 units.
Nano Lot: Equals 100 units.

In most order registration systems, the minimum approved volume is 0.01 Lot, but some brokerage firms may offer the flexibility to trade with smaller volumes, such as 0.001 Lot.

The measure of market volatility in the Forex market is typically based on two units: “pip” and “point.” Each point represents one-tenth of a pip. For currency pairs without the Japanese yen, prices are calculated with 4 to 5 decimal digits, and the fourth digit after the decimal point is known as a pip. However, for currency pairs that include the Japanese yen, pricing is done with 2 to 3 digits after the decimal point, with the second digit representing a pip.

It’s crucial for traders to calculate the dollar value of a pip, as it enables them to assess their overall profit and loss based on price movements. The dollar value of each pip varies for different types of currency pairs, and it can be determined using the following

formulas:

For Currency Pairs with Base Currency as USD: Dollar value of each pip = Number of Lot units * (Current market price / Decimal value of each pip)
For Currency Pairs with Secondary Currency as USD: Dollar value of each pip = Current market price * Number of Lot units * (Current market price / Decimal value of each pip)
For Currency Pairs with Japanese Yen (JPY): Dollar value of each pip = Number of Lot units * (Current market price / Value of the decimal place of each pip)

It’s important to note that the dollar value of each pip is not a fixed figure; it depends on the current market price.

With the understanding of how to calculate the dollar value of each pip, traders can effectively determine the profit and loss of each transaction. For instance, in a long position in the GBP/USD currency pair with a standard lot volume, if the entry price is 1.2770, the exit price is 1.2790, and the dollar value of each pip is $10, the profit based on pip movement is 20 pips, resulting in a profit of $200 ($10 x 20).

In today’s trading landscape, most brokerage firms and trading platforms provide Forex traders with calculators that automate these calculations. These tools are available online or as software, making manual calculations obsolete.

Forex Market Analysis Methods: A Comprehensive Overview

Similar to the stock market, the Forex market employs various analytical approaches to help traders make informed decisions. Below, we’ll provide a brief overview of the primary methods used in Forex market analysis.

1. Technical Analysis: Forex Market Analysis Methods

Technical analysis in Forex revolves around studying price charts and patterns. Over the years, this method has evolved, giving rise to various technical styles, such as classical analysis, harmonic patterns, Elliott waves, and price action analysis. The core focus is on interpreting price movement and patterns on the charts. Technical analysis provides traders with tools to predict future price movements based on historical price data.

It’s important to note that while the framework of chart analysis remains consistent across financial markets, specific features, such as market liquidity, can influence the effectiveness of technical analysis. As a result, those who master technical analysis in Forex can apply their skills to other financial markets, such as stocks, with some adjustments.

2. Fundamental Analysis: Forex Market Analysis Methods

While in the stock market, fundamental analysis entails examining the balance sheets and financial documents of companies, Forex fundamental analysis takes a broader perspective. It involves evaluating economic, political, and sometimes social factors that affect the currency values of countries. For example, changes in unemployment rates, economic stability, and political events can influence currency values. When conducting fundamental analysis in Forex, traders assess the conditions of individual countries and the world at large to make informed trading decisions.

For instance, a reduction in unemployment can positively impact a country’s currency, provided other influencing factors remain stable. In such cases, fundamental analysts might consider buying currency pairs where the respective country’s currency is the base currency.

3. Technical-Fundamental (Techno-Fundamental) Analysis:

In recent years, a growing number of experts have adopted a combined approach that considers both technical and fundamental aspects of the market. They believe that this method minimizes the potential for errors in predictions. Here’s how it works:

Let’s say an economic crisis affects the European Union. From a fundamental analysis perspective, currency pairs where the euro is the base currency may experience a downtrend. A technical analysis of the same situation can help identify correction phases during this downtrend, offering selling opportunities. By analyzing all aspects of the market, the techno-fundamental approach aims to reduce prediction errors and improve the accuracy of trading decisions.

Forex traders often choose one or a combination of these methods based on their trading style, experience, and market conditions. The diversity of analytical tools available in the Forex market ensures that traders can tailor their strategies to their preferences and risk tolerance.

Benefits of Forex for Investors

Largest Trading Volume: Forex markets are unrivaled in terms of daily trading volume. With over $5 trillion in daily turnover, it offers a wealth of opportunities for traders.

High Liquidity: The Forex market provides exceptional liquidity, allowing traders to buy and sell currencies swiftly at market prices. This is due to the vast number of participants and the continuous 24-hour trading schedule.

Speedy Market Entry and Exit: It’s easy to enter and exit positions, often in a fraction of a second, especially for major currencies. This accessibility ensures that traders can act swiftly in response to market developments.

Bidirectional Trading: In Forex, you can profit from both rising (long positions) and falling (short positions) markets. This versatility allows investors to adapt to various market conditions.

24-Hour Trading: Forex operates 24 hours a day, five days a week, enabling traders to engage in the market at any time that suits their schedule. This flexibility is valuable for traders around the world.

Earning in Multiple Currencies: Forex trading can yield profits in various currencies, providing diversification and the potential for gains in a range of global economies.

Capital Management and Tools: Forex traders have the ability to implement effective capital management strategies and utilize trading tools, including technical indicators and expert advisors (EAs), to make informed decisions.

Largest and Most Liquid Market: The Forex market encompasses all the world’s foreign currencies, making it the largest and most liquid market globally.

Risks of Investing in Forex

Complexity and Learning Curve: Forex trading can initially appear complex and daunting, especially for beginners. It requires a good understanding of market dynamics and trading strategies.

Regulatory Variability: Forex trading regulations can vary significantly from one region to another. Some countries impose strict rules, while others have lax or inconsistent regulatory frameworks.

Market Makers and Brokers: Most retail traders deal with market makers and brokers, which may lead to potential conflicts of interest. Traders should choose reputable brokers to mitigate this risk.

Risk Management: Forex trading carries inherent risks, including market volatility and rapid price movements. Effective risk management strategies are crucial to protect capital.

Lack of Centralized Exchange: Unlike stock markets, Forex lacks a centralized exchange. This decentralized nature can lead to disparities in pricing and potential issues with transparency.

Leverage and Margin: While leverage can amplify potential profits, it also magnifies potential losses. Traders must exercise caution when using leverage and maintain sound risk management practices.

Market Manipulation: Although it is challenging to manipulate the Forex market due to its size and liquidity, there may still be instances of price manipulation, particularly in exotic currency pairs.

Educational Resources: To succeed in Forex trading, individuals should invest time in education and training to minimize the risks associated with this complex market.