Published on December 14th, 2020 | by Sunit Nandi0
An Introduction To The Forex Market And Trading For Rookies
The foreign exchange market may seem daunting to a beginner. However, it is also the most interesting one since it trades round the clock, five days a week.
The means of trading in forex is through currency pairs. If you are interested in trading currencies, you need to understand what it means to trade foreign exchange and the basic terms.
What Is The Forex Market?
The foreign exchange market, often shortened as forex, is a trading market that allows individuals to trade different currencies. Since currencies dictate the world, there is an insatiable demand for forex among traders.
Suppose you are an American traveling to India to see the Taj Mahal. Since the USD is not India’s standard currency, you need to exchange your money for INR before you can move freely locally.
It is also true for all businesses and consumers that import or export goods and services from or to another country.
Today, many brokers will offer you a free trading account for your foreign exchange needs. However, before you start trading, you need to understand the basics of the forex market.
How To Trade In The Forex Market?
The foreign exchange market can help you to convert one currency to the other. Hence, currencies work in pairs.
In the forex market, every currency is represented by three letters. For example, the United States Dollar is represented by USD, the British Pound is GBP, and the euro is shown as EUR.
To represent a currency pair, you need to use one currency in front of the other, separated by a ‘/’.
For example, EUR/USD is a currency pair. However, you need to understand what the currency pair means.
Base Currency And Quote
Let us consider the currency pair of EUR/USD. In this case, the EUR is known as the base currency, whereas the USD is the quote currency.
It means you are buying or selling the EUR per USD while invoking a buy or sell transaction.
One currency pair’s exchange rate is irrelevant to any other third currency. The exchange rate determines the value that the currency will amount to if you exchange it from one currency to another.
Although the exchange rate representation is via four decimal places, there is no hard-and-fast rule. However, there are two rates
for exchange—the asking price and the bid price.
Let us take the example of the EUR/USD currency pair once again. The amount of USD that you will require to buy a EUR is known as the asking price.
If the asking price is 1.1118, it means that you can buy 1 EUR for 1.1118 USD.
Just like the asking price, the bid price also provides a relation between EUR and USD. The amount of USD that you will receive after selling 1 EUR is known as the bid price.
If the bid price is 1.1116, it means that after selling 1EUR, you will get 1.1116 USD.
Let us revisit the example of the EUR/USD example. Now that you know about the bid price and ask price, you may feel they are similar. However, they have different values.
The difference between the asking price of 1.1118 and the bid price of 1.1116 is known as the spread. In the above scenario, the spread is 0.0002. It is also represented as 2 pips.
Although 2 pips may seem insignificant, there are millions of currency pair trades, making them relevant. They may bring a significant profit or a loss.
Factors That Affect The Forex Market
Nearly every piece of news about the countries involved, including but not limited to, Gross Domestic Product, interest rates, and geopolitical scenario, can affect the forex market.
In addition to human-made deals, natural disasters can also affect the forex market. Therefore, it is sometimes difficult to predict the forex market.
The Two Forex Trading Techniques
There are two trading techniques that traders use in the forex market. You can either trade using a long position or a short position.
Let us go back to the EUR/USD example, which traded at 1.1116/1.1118.
To open a long position, you will first buy the EUR for 1.1118 USD, expecting to sell the euro once the value increases.
Once you sell the currency back, the long position closes, and the trade is completed. On the contrary, the short position is when you sell a currency first.
If you are shorting the trade, you will sell the EUR for 1.1116 USD, expecting the euro devalues compared to the dollar. Once you buy back the EUR, the short position closes.
Understanding The Forex Chart
Once you have the basic knowledge of how trades are executed, you need to look at charts. The charts can help you understand the investors’ flow and serve as a means of technical analysis.
As a beginner into forex trading, you can check out the line chart. It connects one closing price to the next using a line.
With a line chart, you can determine the currency pair’s price movement that you are trading throughout a time frame and find currency patterns.
The bar chart tells you about the high price, the low price, and the opening and the closing prices within a time frame.
The top of the bar denotes the high price, whereas the bottom represents the low price. The bar represents the deviation between the prices. You can also find horizontal lines for the open and close prices within the time frame.
Japanese Candlestick Chart
For something more advanced, you can use the Japanese Candlestick Chart. It is considered a standard amongst most traders.
The chart indicator looks like a candlestick, hence the name. It has an open and close price, represented by the candle’s bottom and top lines.
The candlestick also has a wick that shows the high and low values within the time frame. Plus, the chart highlights if the opening price is higher than the closing price through color.
How Modern Traders Are Doing Forex Trading
The world has changed a lot, and everything is now digital. Today, technical or fundamental analysis alone is not enough.
In one hot second, a currency pair can increase or decrease the value corresponding to the other. Hence, modern traders rely on algorithmic trading to help them make forex trades.
You can use forex trading to earn money through the exchange of currencies in currency pairs. However, you must acknowledge the risks involved and plan for the future using technical and fundamental analysis.