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Forex Trading for Beginners

Forex trading is open to both beginners and advanced traders. Forex stands for foreign exchange. It is the exchanging of one currency for another. Investors trade in currencies because they can take advantage of the fluctuating exchange rates in order to make a profit. There are many ways of dipping your toes into this relatively new type of trading marketplace.

The foreign exchange market is also known as the forex market or FX market. It is a huge market with more than 5.1 trillion dollars in value being traded daily. Currencies are traded against each other in pairs, for example, euros to US dollars. Currencies are a very liquid asset. That is, you can easily find a way to sell off the assets quickly. You will not be stuck with an asset that takes time to sell. The forex market is actually made up of multiple marketplaces.

There are various different forex markets. Some are spot markets, dealing in cash trades, while others are derivatives markets, meaning they offer options, futures, forwards, and currency swaps. Traders have many reasons to enter the forex markets. They can be used as a hedge against interest rate risk or international currency risk. They can diversify your portfolio. And they allow you to bet on your own interpretation of various geopolitical happenings.

The Forex Market Explained

In the modern world, there is always a need to exchange currencies between people or companies. People from various countries are constantly purchasing goods from other countries. For example, a person in the United States may want to buy some French wine. This person would have to exchange dollars for euros in order to complete the purchase. Tourists traveling to other countries also need to exchange currency so that they have the local currency in their wallet for traveling. The process of doing these exchanges of currencies is called the foreign exchange market, or forex market.

The forex market is not a centralized marketplace. Rather, trades are done individually over computer networks. This is called over-the-counter (OTC) trading. These OTC trades are done directly between individual dealers or brokers. There is not one central exchange where all trades are done. The computer networks for trading are open for five and one half days per week, for 24 hours each day. They are located in major cities such as Paris. Hong Kong, Sydney, Singapore, Zurich, New York, London, Tokyo, and Frankfurt. These cities span most of the time zones of the world. Thus, if a market is closed in one city, markets in other parts of the world are still open. Activity occurs around the clock, and the prices are always changing, allowing you to trade and take advantage of beneficial market pricing at all times.

Forex Markets History

Most stock markets have been around for a long time, for decades and even centuries. The forex market, however, is very new. People have always been exchanging one currency for another, but the modern forex markets have only been around since 1971 when the Bretton Woods agreement took effect. This agreement allowed currencies to adjust to each other freely. Before that, exchange rates were fixed so there was no way to make money from the exchange of currency. Now there are plenty of foreign exchange services to accommodate currency traders of every type. Although banks do most of the currency trading, there are also markets that are used by individual traders to profit from the variable exchange rates.

Types of Forex Markets

There are three types of forex markets, the spot market, the forwards market, and the futures market.

Spot Market

The spot market is the largest type of forex market. It deals in the actual currencies which form the basis for other types of markets, such as futures and forwards. There are now many forex brokers where individuals can trade currencies electronically. Since these brokers have sprung up, the spot market has become extremely active. Individual speculators and traders in the forex marketplace have now turned to the spot market to do most of their trading.

In the spot market, you buy and sell currencies at their current price. This price is the result of the supply and demand for the currency. It can be influenced by interest rates, economic news and events, politics, and speculation on the future situation in the country. The deals made in the spot market are called “spot deals.” They are made in cash, as each party to the deal delivers the amount of cash in the currency they have agreed on. Of course, this refers to electronic cash, not actual bills of currency. It does take two days for the settlement to be complete, so it is not quite instantaneous.

Forwards Market

The forwards market does not trade the currencies themselves. This market deals in the contracts for currency trades that will actually take place in the future. The contract specifies the type of currency and the price and date at which it will be settled. These contracts are conducted over-the-counter in the forwards market.

Futures Market

The third type of forex market is the futures market. In this market, the futures contracts are traded on commodities markets such as the Chicago Mercantile Exchange. The contracts specify a standard size and a settlement date. Only certain price increments are allowed. It is not very flexible. The contracts, as in the forwards market, are binding. When they expire, they are settled for a cash amount as specified. However, they can be purchased and sold before expiration if desired.

Both the forwards and futures markets can protect the trader from risk when doing currency exchanges. They are mostly used by large corporations, but some individual traders use them too.

Hedging Currency Risk

Companies that manufacture goods for export to other countries are vulnerable to currency exchange risk. They may plan to manufacture a certain number of items to sell in a foreign company. For example, a company in the United States may plan to sell their items to a European country for 150 euros. Because of the exchange rate at the time, they will make a 50 dollar profit. However, if the price of euros rises with respect to the dollar, by the time they sell their products, the exchange rate of euros to dollars changes, and their profit ends up being only 20 dollars. To hedge against problems such as this, the company can purchase a forwards or futures contract at the current exchange rate to lock in the current exchange rate. This way, they will still achieve all the profit that they originally planned on.

Speculation in Forex

In the forex market, currencies are constantly changing in value with regard to each other. An astute trader can take advantage of this volatility in the market to profit from making trades. The trader will need to consider all the factors that can cause currency values to change, such as politics, interest rates, trade, tourist activity, and strength of economies. By timing when to trade in specific currencies and when to purchase one currency and pay with another, the trader can make profits in a very short timeframe. Investors can profit from what is called the “carry trade,” that is, shorting a currency with a lower interest rate and buying a currency with a higher interest rate. These types of speculation can be very lucrative for forex traders, but they must know what they are doing, or their losses can be great as well.

About Currency Trading


Before the internet, it was difficult to trade in foreign currencies. It required a great deal of capital, and it was only done by large corporations or hedge funds. Now, individual traders can easily trade on the forex market in small amounts. A retail market has developed which caters to small individual traders. Some brokers offer high leverage to their traders. Leverage is essentially the ability to borrow when trading so that you don’t have to use as much of your own money to execute the trades. Many small investors have now entered the forex markets.

Forex trading is a growing market. Volume has increased more than two times since 2004, and just between 2007 and 2010, it has grown by 20 percent. The reasons for this large increase include more high-frequency traders entering the market, the rise of small retail investors, and the rising importance of holding foreign currencies as assets. It is now much easier to trade in the forex market because of electronic trading, online brokerages, higher liquidity due to the increased volume of trading, and lower transaction costs compared to the past. In 2010, it was found that trading by retail investors comprised 10 percent of the total spot market.

The Role of Central Banks

Central banks of the various countries try to exert some control of their currencies. Thus, they influence the forex market by their actions. They attempt to reach goals regarding interest rates, inflation, and money supply in their countries. They have large reserves of currencies which they can use to try and influence the market toward greater stability of their currency. However, their efforts are not always effective. They are usually not trying to make a profit, and they can’t go bankrupt from their losses. They do influence the market with these attempts, so it is best to keep their actions in mind.

Sometimes just a rumor of a central bank expecting to perform some action in the market is all it takes to cause changes or to stabilize a currency. Sometimes these rumors are actually followed by aggressive action by the central bank. This can happen multiple times in a year, as they try to exert their influence. As noted, this does not always result in success for the central banks.

Factors Influencing the Forex Market

Economic Factors

A government’s economic policy can influence the forex market by the actions of the central bank, as well as by the government’s budget deficit or surplus. Growing budget deficits usually cause the currency to lose value, while the opposite happens when the deficits shrink. Balance of trade between countries can also affect the currency values of those countries. Inflation can affect a country’s currency. The general health of the economy will also be an influence.

Economic Factors

A government’s economic policy can influence the forex market by the actions of the central bank, as well as by the government’s budget deficit or surplus. Growing budget deficits usually cause the currency to lose value, while the opposite happens when the deficits shrink. Balance of trade between countries can also affect the currency values of those countries. Inflation can affect a country’s currency. The general health of the economy will also be an influence.

Economic Factors

A government’s economic policy can influence the forex market by the actions of the central bank, as well as by the government’s budget deficit or surplus. Growing budget deficits usually cause the currency to lose value, while the opposite happens when the deficits shrink. Balance of trade between countries can also affect the currency values of those countries. Inflation can affect a country’s currency. The general health of the economy will also be an influence.

Factors Influencing the Forex Market

A government’s economic policy can influence the forex market by the actions of the central bank, as well as by the government’s budget deficit or surplus. Growing budget deficits usually cause the currency to lose value, while the opposite happens when the deficits shrink. Balance of trade between countries can also affect the currency values of those countries. Inflation can affect a country’s currency. The general health of the economy will also be an influence.

Economic Factors

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A government’s economic policy can influence the forex market by the actions of the central bank, as well as by the government’s budget deficit or surplus. Growing budget deficits usually cause the currency to lose value, while the opposite happens when the deficits shrink. Balance of trade between countries can also affect the currency values of those countries. Inflation can affect a country’s currency. The general health of the economy will also be an influence.

Economic Factors

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A government’s economic policy can influence the forex market by the actions of the central bank, as well as by the government’s budget deficit or surplus. Growing budget deficits usually cause the currency to lose value, while the opposite happens when the deficits shrink. Balance of trade between countries can also affect the currency values of those countries. Inflation can affect a country’s currency. The general health of the economy will also be an influence.

Economic Factors

Risks in Forex Trading

The market of banks that trade with one another is called the interbank market. It is not always well regulated. The instruments that they use are not always standardized either. In some countries, forex trading is not regulated at all. When banks trade, they take risk into account, and they know how to mitigate against the risk. The banks have also created their own industry standards for trading.

None of these safeguards are available for the individual investor. While the market is large and not easily influenced by one actor, there is still a lot of danger for the individual. It is up to the traders themselves to check on the regulations in the countries where they trade. Sometimes the brokers are not very trustworthy and trade against their own customers. Before using a certain broker, be sure to investigate their reputation. The United States and the United Kingdom do regulate their brokers, but other countries do not have many rules for forex brokers. It is up to you to check on the protections that are offered to you before you begin trading.

Pros and Cons of Forex Trading

Pros

The size of the forex markets is a big advantage. You can always trade whatever you want, since the market has great liquidity. You can get in and out of the market quickly to take advantage of small fluctuations in the currency values. Trading is available at all 24 hours, for 5 days a week.

Cons

The fact that forex brokers allow a great deal of leverage in trading sounds like a good idea, but it can often cause problems with traders overextending themselves. They borrow so much money quickly that they can suddenly run out of money. You really have to know what you are doing when you are dealing with high leverages.

Forex requires that traders have a lot of knowledge of economic conditions in a multitude of countries. The traders need to know how to interpret indices and other fundamental facts which can affect currency values. It is not something that you can get into quickly with little knowledge.

Recommendations

Forex is easy to get into, and if you start out with small amounts, you can start to learn the fundamentals. You are able to get into the markets while using small amounts of money. You can try day trading in forex or do swing trading, in which you hold your position for only a few days to take advantage of currency fluctuations. If you are able to invest for a longer term and have more money to invest, you can do longer term investing as well. In this case, it will really help if you have a good understanding of foreign markets and currencies.

Be sure to look for a reputable broker. The broker should be regulated and have a good track record of at least five years. A legitimate broker will gladly follow the government rules imposed upon the brokerage. After you open an account, slowly start making trades. Don’t risk too much money until you understand what you are doing.

As soon as you start forex trading, be sure to also start educating yourself about the forex market. You can find information in seminars or workshops, or you can read educational materials such as in-depth articles or e-books. Many brokers offer webinars and tutorials on their site. The more you know, the better a forex trader you will become.