Currencies

What is Forex?

The term "forex" is short for foreign exchange, a global marketplace where over $5 trillion is traded daily. Forex markets operate 24 hours a day, 5 ½ days a week, closing late on Fridays and reopening about 36 hours later. Unlike centralized markets, forex trading occurs through an electronic network spread across the globe. It’s used by individuals, corporations, institutions, and governments.

How Does Forex Trading Work?

Forex can be traded in several ways, including spot markets, futures, and forward contracts. In essence, all forex trades involve buying one currency while selling another simultaneously. Historically, these transactions were facilitated by forex brokers, but today, many traders use contracts for difference (CFDs) to speculate on forex price movements.

CFDs are popular because they allow traders to use leverage, enabling them to control larger positions with less capital. While this can increase potential profits, it also magnifies potential losses, making risk management crucial.

Popular Forex Pairs

There are seven major currency pairs that dominate the forex market, accounting for approximately 80% of trading volume. These pairs are:

• EUR/USD
• GBP/USD
• USD/JPY
• USD/CHF
• USD/CAD
• AUD/USD
• NZD/USD

Forex Trading Markets

There are three main ways to trade forex:

• Spot Forex – This market involves the physical exchange of currency at the point of trade settlement. The term “spot” refers to trades being settled on the spot. Derivatives like CFDs are often based on spot market prices.
• Forward Forex – In this market, contracts are made to buy or sell a specific amount of currency at a set price with a future settlement date. Companies often use forward contracts to manage payroll for overseas employees. These contracts are traded over-the-counter.
• Futures Forex – Similar to forward contracts, but forex futures are standardized contracts traded on exchanges. They specify the delivery of currency at a set price on a specific future date.

Advantages of Forex Trading

Forex trading offers numerous benefits, regardless of whether you trade in spot markets, futures, or CFDs. Here are eight top advantages:

• The forex market is the largest financial market in the world.
• Both retail and institutional traders can easily participate.
• Forex has high trading volumes and excellent liquidity.
• You can go long or short with ease.
• Forex markets are open 24 hours a day, except on weekends.
• Most forex trades are commission-free.
• Transaction costs are limited to the spread, which is usually small for major pairs.
• Leverage can be used in forex CFD trading to increase the size of your trade.

Trading Example – EUR/USD

Imagine EUR/USD is trading at 1.18560, with an ask price of 1.18556 and a bid price of 1.18564, creating a spread of 0.8 pips. You believe the Euro will strengthen against the U.S. dollar, so you place a market order for 1 lot at 1.18564. In this trade, each pip is worth $10, and the total value of the trade is 100,000 EUR or $118,564. Since it’s a leveraged trade, you only need to provide 2% of the trade value, or $2,370, as margin.