The foreign exchange market, also known as the forex market, refers to a set of markets that facilitate the exchange of international currencies. According to Britannica Encyclopedia’s overview, the forex market is one of the oldest, biggest, and most liquid markets in the world. Today, most markets operate as over-the-counter (OTC) dealer’s markets, where two participants exchange assets over telecommunications channels.
There are many reasons one might want to swap one currency for another: tourists, for instance, may buy local currencies while travelling, while international businesses may purchase foreign currencies to pay offshore employees. However, in the world of trading, investors exchange currencies with the goal of making a profit.
If you’re interested in learning more about the complex world of foreign exchange trading, here are a few basic facts.
How do traders profit from forex?
Exchange rates can rise or fall by the minute. Traders profit from such changes by buying currencies while they’re undervalued, then selling them when their prices rise against other currencies.
To illustrate: let’s say a trader predicts that the Great British Pound would become stronger than the US Dollar. Let’s also say that £1 was worth US$1.55. The trader then buys £1,000 for US$1,550. Later, his prediction comes true, and the GBP grows, with £1 becoming worth US$1.75. This time, when he sells his £1,000, he gets US$1,750, thus turning a profit of US$200.
What is leverage?
Traders can also increase their profits by making use of widely available leverage trading options. According to The Balance, leverage allows traders to invest a small amount of capital to use borrowed funds in large trades. Though the trader will still have to return the borrowed capital after the trade has been executed, they will receive the majority of the trade’s profits.
Let’s say that the trader from the previous example wants to stake 15,500 USD in a trade. However, he only has 1,500 USD. Through leverage trading, he can use his 1,500 USD to borrow 14,000 USD, allowing him to purchase 10,000 GBP at 15,500 USD. If the exchange rate again shifts from 1 GBP for 1.55 USD to 1 GBP for 1.75, the trader can sell his 10,000 GBP for 17,500 USD. Returning the 14,000 USD he borrowed leaves him with a profit of 2000 USD.
Of course, it goes both ways. If the trader’s prediction were incorrect, using borrowed funds would also amplify his losses. Thus, when trading on leverage, it’s important to only stake money you can risk losing.
Where can I trade forex?
To get started, traders must first create a trading account at a brokerage. These days, most transactions occur on forex trading platforms online, through websites, software, and mobile apps. According to an overview of trading platforms by FXCM, some of today’s most popular trading platforms include MetaTrader4, Ninja Trader, and FXCM’s Trading Station. These platforms are widely used because they offer resources that can help traders make smarter decisions. For example, some notable tools these platforms provide include access to advanced analytics, charting tools, and risk management applications.
A note for beginners
As with any financial endeavour, it’s best to enter forex trading with a plan in mind. As mentioned in our previous article The Importance of Financial Planning, a lack of understanding of financial risks and returns will make you vulnerable to errors of judgment, which can lead to bad trading decisions. Consequently, it’s important to take time to study the markets thoroughly before starting your trading journey. If you want some hands-on experience without putting your capital at risk, you can practice trading using virtual money on one of the many demo accounts available.
Thanks to resources like leverage and helpful tools on trading platforms, forex trading has become more accessible. Beginners who want to try their hand at foreign exchange trading should study the market, its movements, and different trading strategies in order to safely engage in trading.
This article was contributed by Alex Palmer.