What is forex trading?

Forex currencies

What is Forex Trading?

When Breaking down the question “what is forex trading?” we first need to look at the actual name, forex. The name is a portmanteau of the words ‘foreign’ and ‘exchange’ Now that we understand the meaning of the word, we can now explain what forex is.

Forex is the trading of currencies across the globe. The Forex market determines the exchange rate for all currencies worldwide depending on several factors, making the Foreign exchange the world’s most traded financial market.t

Currencies on the Forex market are continuously moving, be that up or down. several factors cause this. 5 of the main reasons are:

  • Economic releases
  • Political News and events
  • Commodity prices
  • The GDP
  • Supply and demand

Open 24hours a day, five days a week. The market is utilized by banks, businesses, hedge funds, investment firms, and sole traders.

The Forex market is classed as an over-the-counter market (OTC), meaning there is no central marketplace or exchange in a central location. All trading is executed electronically via computer networks.

A 2019 report from the bank of international settlements reported that the daily volume of forex trading reached $6.6 trillion in April of that year.

Currency Pairs

All currencies on the market are traded in pairs, speculating one against the other. When choosing a pairing to trade, the currency on the left is the base currency and on the right is the quote currency.

Base currency.

The base currency is always situated on the left of a currency pair and is always equal to the value of 1.

Quote currency

The quote currency is always on the right of the pair and is equal to the actual quote price of the pairing at the current time. Thus indicating how much of the quote currency it costs to buy one of the bases. 

Example:

 

The GBP is the base currency. The USD is the quote currency. From the information on the image above, we can see that it would cost 1.331 dollars to purchase one British pound.

How is it traded?

We’ll use the same image as above to show a trade example.

Let’s say, for example, the Bank of England has reported a period of strong economic growth whilst the US economy has started to underperform. From this information, you believe that the GBP will rise against the dollar. (meaning the price of the dollar would weaken, requiring more USD to purchase a GBP)

You place a trade and buy the dollar at 1.331.

Sometime later, your belief pays off, resulting in the GBP gaining more strength against the USD. The buying price of the pair is now 1.341 ( an increase of 10 pips).

This result means that it would now require even more USD to purchase the GBP

As a result, you close the trade and obtain a profit.

Profit is dependable on the initial amount traded.

On the other hand, if the above scenario played out in a way in which the USD ended up gaining strength against the GBP and decreased by ten pips, then you would lose money on the trade.

Alternatively, you could *short-sell* a currency with the belief that the base currency will fall, requiring less quote currency to purchase. Therefore resulting in higher profit the further it drops.

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