THE BASICS OF FOREX
Forex stands for Foreign Exchange and the market is used to exchange one currency for another.
Ever heard of the New York Stock Exchange? Its 200X the size of that. Daily there is approximately 5 Trillion Dollars traded across the Forex market in a 24 hour trading day. Even if you combined all the stock, bond AND equity markets together, you still would not come close to the total size of the Forex market.
The Forex market is truly immense compared to any other financial market in the world. It can get confusing if you are not educated on it, but honestly it’s fairly straight forward. In fact you would have already used the Forex market if you:
EXCHANGED MONEY BY TRAVELING TO ANOTHER COUNTRY
If you travelled to another country you would’ve needed to exchange your money to the destinations currency.
PURCHASED A PRODUCT FROM OVERSEAS
If you have bought products online before, you would’ve in the process exchanged your money to the sellers currency.
TRANSFERED MONEY TO AN OVERSEAS BANK ACCOUNT
Again, if you have ever transfered money to a friend/family in a different country you would’ve exchanged your currency in the process
REAL LIFE EXAMPLE OF FOREX
Having a basic understanding on the market and how it works is very important, especially if you want to learn the markets yourself. To give you a more real life insight into currency trading and how it works, picture this:
Lets say you are from Great Britain (GBP), and you go to holiday to America (USD). You find an amazing new t-shirt you want to purchase for $100. When you go to purchase, you find out the currency exchange rate for GBP/USD is 1.3069.
This means every 1 British Pound is equivalent to 1.3069 US Dollar. Therefor, the T-Shirt you are buying for 100 US Dollar is worth approximately 76.51£ in British Pounds.
After completing the transaction, you have effectively took part in the Forex market. You exchanged your British Pound into US Dollars to create a purchase.
GBP/USD Exchange Rate: 1.3069
1 GBP = 1.3069 USD
100 USD = 76.51 GBP
2 YEARS LATER:
After 2 years, the currency exchange for GBP/USD is 1.4069. Meaning 1 British Pound is now equivalent to 1.4049 US Dollar. That means if you bought the T-Shirt after the two years it would cost £71, compare to the £76.51 you paid two years ago.
In review, two years ago you bought a T-Shirt for $100 (£76.51), two years later this same T-Shirt is essentially worth £71, all due to the exchange rate.
GBP/USD Exchange Rate: 1.4069
1 GBP = 1.4069 USD
100 USD = 71.00 GBP
And that’s basically how Forex works, but the way we trade is very different. Instead of buying and selling products bought by currency, we trade the currencies themselfs. The exchange rate for currencies are constantly changing at a rapid rate, making it easier for us online traders to profit off our predictions of which currencies will rise/drop in price.
HOW IS FOREX TRADED?
It’s important to know currencies are bought and sold in pairs. Unlike the stock market, currencies are traded in pairs. For example, EUR/USD being the Euro vs the US Dollar. Compared to stock trading where you can buy or sell a single stock, the foreign exchange market is slightly different, in the foreign exchange market you have to buy one currency and sell another currency.
An example of a few of the major currency pairs are:
- EUR/USD – Euro vs US Dollar
- USD/JPY – US Dollar vs Japanese Yen
- GBP/USD – British Pound vs US Dollar
- USD/CHF – US Dollar vs Swiss Franc
- AUD/USD – Australian Dollar vs US Dollar
- USD/CAD – US Dollar vs Canadian Dollar
- NZD/USD – New Zealand Dollar vs US Dollar
When we trade currencies, we are essentially comparing one price against another price. A good example would be if you was trading GBP/USD, as a trade you would be buying GBP (British Pound) whilst selling USD (US Dollar). Meaning we profit from how much the British Pound increases in comparison to the US Dollar.
In the market we make money based on our predictions of which way the market will go, in the foreign exchange market there are two types of trades. As an example, i’m going to use the currency pair EUR/USD:
A BUY TRADE
If you believe the value of the euro is strengthening against the US dollar, you would usually enter a trade to buy euro in the strong hope that the currency’s value will become stronger compared to the US dollar.
A SELL TRADE
Alternatively, if you think the current value of the euro will weaken against the US dollar, you would enter a trade to sell euro in the strong hope that the currency’s value will become weaker compared to the US dollar.