The Foreign Exchange is the largest financial market in the world, with nearly $5 trillion worth of trade taking place every day. The Foreign Exchange, known as Forex or FX, has extensive trading hours, high volatility and an intrinsic relationship with fundamental factors such as countries’ economic growth, international trade and interest rates.
With all of these elements, Forex trading has plenty of opportunities for investors to profit. But to be a successful Forex trader, you must do your research, understand the market and currencies involved, as well as have a strategy in place before entering the market. This guide explains the details of Forex trading and the techniques you can use to successfully partake in the market.
What is Forex?
Forex in its simplest terms, is the trading of currency pairs, based on the purchase of one currency against the other. This can be for tourism purposes, trading amongst companies internationally, or to gain a profit for investors.
When it comes to Forex trading as an instrument for investing, the exchange mainly takes place on the over-the-counter (OTC) market, but can also sometimes be traded using future contracts, as well as financial derivatives such as contracts for difference (CFDs).
How does Forex trading work?
When you begin Forex trading, the first thing that you should know is that currency is traded in pairs. You need to understand how to read these pairs before taking your first step in your investment journey.
The first currency is the pair is known as the base, whilst the second currency is the quote. The exchange rate between the currencies is reflected in the quote currency.
For example, if you were looking at the euro and US dollar currency pair (EUR/USD), it would mean that you would be buying euros whilst selling dollars. If the euro strengthens against the dollar, then that would lead to a profit. On the occasion that the euro should fall against the dollar, then you would incur a loss. In this instance, if the EUR/USD is trading at a rate of 1.1322, this would equate to €1,000 worth being exchanged for $1,132.20.
There are four categories that currency pairs can fall into:
All Majors involve the USD being traded against another major currency, including the EUR, the British pound (GBP), the Swiss Franc (CHF), the Japanese Yen (JPY), the Canadian Dollar (CAD), the Australian Dollar (AUD), and the New Zealand Dollar (NZD). Minors and crosses involve one of the major currencies against another that is traded in smaller quantities, such as EUR/CHF, EUR/GBP, and AUD/JPY.
The most widely traded currency pair, with the highest volume and liquidity is the EUR/USD, closely followed by USD/JPY. This pairing experiences high volume due to the size of the Japanese economy and its vital role in global trade. GBP/USD is also a popular currency pair, that has increased in volatility, and has been recently affected by fundamental factors, such as political turmoil and Brexit.
Successful Forex strategies
Forex trading strategies can fall into two categories: fundamental and technical analysis.
Fundamental analysis involves the studying of variables that can affect the economy, and their detrimental or positive effect on a currency pair. This involves understanding certain events in the economic calendar, such as the release date of an economic report. From this, a fundamental Forex trader can analyse the information, or speculate what the contents of the report would be, to see if it indicates the movement of a currency against another.
Technical analysis uses charts and data of the past performance of the market, alongside indicators and trend patterns, to determine a prediction of where the currency may swing next. Some indicators or trends involve the analysis of when a currency pair is overbought or oversold, or can predict the volume and price movement.
Traders can use a blend of technical and fundamental analysis to evaluate potential investment opportunities. Once you have established a Forex strategy to suit your trading style, you should trail out your techniques with a free demo account, which can be found on most trading platforms. Mirroring the movement of the real market, without the investment of real capital, is the best way to know your strategies are tried and tested before moving on to Forex trading with real money.