What is Forex? You might be asking. If so, I will attempt to explain the concept of Forex and the Forex Market in general. For anyone starting out in Forex trading, it is vitally important you understand the basics; as this will form the foundation for your forex trading future. I will try to simplify the concepts with examples, to help with your learning.
So, what is Forex? Well, simply put (Forex, FX, spot FX or currency market) is the Foreign Exchange Market. It is the worldwide decentralised financial market for trading currencies. Unlike the stock market which has its centralised markets such as the NYSE or FTSE 100. The Forex Market is referred to as an over-the-counter financial market. The currency market is a 24 hours a day market. Due to this round the clock open market, you can trade any time of the day or night. The forex trading hours are as follows:
New York Session: Opens @ 08:00 to 17:00 EST
Tokyo Session: Opens @ 19:00 to 04:00 EST
Sydney Session: Opens @ 17:00 to 14:00 EST
London Session: Opens @ 03:00 to 12:00 noon EST
The best time to trade is when the market is most active and has the biggest volume of trades. Also, hours when the two trading sessions overlap, usually generates the highest volume of trades and are preferably the best times to place trades.
Overlapping sessions
New York and London: 08:00 to 12:00 noon EST
Sydney and Tokyo: 19:00 to 02:00 EST
London and Tokyo: 03:00 to 04:00 EST
The purpose of foreign exchange is to assist with international trade and investment, to enable businesses to exchange one currency for another currency. For example, a British company could import US goods by exchanging British pounds for US dollars then pay for these goods with the US dollars it now has in its possession. There are also large players within the financial sectors, mainly the commercial, retail banks and other financial institutions who make money speculating in the currency market. The Forex market is a highly liquid market, with an estimated daily turnover of up to $4 trillion dollars. The dawn of the internet age in the mid 1990's, brought about the proliferation of online forex broker companies. They were able to make forex trading accessible to everyday trader like you and me.
Now back to learning the basic concepts of forex trading. In Forex trading, currencies are traded in pairs namely: Major Pairs and Cross-Pairs. The Cross-Pairs that are most actively traded are derived from the three major currencies: EUR, GBP and JPY. They are all currency pair that don't have any USD pairing. Major crosses are also referred to as "Minors" Here are examples of both Major and Cross (Minor) Currency Pair:
Major Pairs
EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD, NZD/USD
Cross Pairs
EUR/GBP, EUR/JPY, GBP/JPY, AUD/JPY, AUD/NZD
Currency Pair Quotes
In order to be able to read a currency price quote, you need to understand how it is presented. For example, the EUR/USD pair may have a price quote as follows:
EUR/USD = 1.3161
In the above price quote, the EUR currency before the / is the base currency while the USD currency after the / is referred to as the quote currency. So, one EUR unit or ?1 is equal to 1.31615 US Dollar. Therefore, ?1 can buy you $1.3161; alternatively you can say that in order to buy ?1 you need $1.3161.
What is a Spread?
All forex brokers make their commission on the spread, which is the difference between the Bid (Sell) quote and Ask (Buy) quote price.
For example: EUR/USD Price Quote = Bid (1.3163) - Ask (1.3161)
The Spread is 0.0002 = 2 pips
What is a PIP?
A Pip is defined as "Percentage In Point", also known as points. It is the smallest price increment a currency can make. For example, 1 pip = 0.0001 for EUR/USD or 0.01 for USD/JPY. If the EUR\USD pair moves from 1.3161 to 1.3181 which is an increase of 0.0020, it therefore has moved by 20 Pips.
What is a PIP value?
The Value of a pip is either fixed or variable, as this is dependant on the currency pair. But as a general rule, the pip values of the EUR/USD are:
Standard Lot = $10
Mini Lot = $1
Micro Lot = $0.10
What is a Lot?
A lot is the standard unit size of a transaction. Generally one standard lot is equal to 100,000 units of the base currency, while one mini lot is equal to 10,000 units or one micro lot is equal to 1,000 units of base currency. See below
1 Standard Lot = 100,000 units
1 Mini Lot = 10,000 units
1 micro Lot = 1,000 units
What is Leverage?
Most Online Forex Brokers offer Leveraged accounts. By this it means, with a small account balance we can control a large amount with which to trade. Most brokers offer leverage of e.g.: 50:1, 100:1, 200:1 or 500:1
For example: Say we open a trading account balance of $1,000 with a forex broker offering a Leverage of 50:1. This means that we now have a Leverage of $50,000 that we can trade up to.
Forex Trade Example
The concept of Forex Trading is quite simple, so I will attempt to explain it with a basic example.
Currency Pair: EUR/USD
Price Quote: Bid (1.3163) - Ask (1.3161)
Account Deposit = $1,000
Leverage = 50:1
Buy EUR/USD @ 1.3161
In order to trade forex, we need to open an online Forex broker account. We deposit say $1,000 into our broker account. Let's assume we intend to place a trade on EUR/USD pair; we anticipate that the EUR will appreciate more than the USD. We proceed to buy 1 mini lot size ?10,000 at the current quote rate of EUR/USD = 1.3161.
So, one mini lot is (10,000 x 1.3161) = ?13,161
Now let's assume that our predictions are correct and the EUR did appreciate more than the USD. We later SELL our EUR at market rate 1.3181 which give us:
(10,000 x 1.3181) = ?13,181. Therefore our Profit is:
?13,181 - ?13,161 = ?20 Profit
Alternatively, let's assume our trade prediction was wrong and the EUR lost value against the USD. We later SELL our EUR at market rate 1.3141 which gives us:
(10,000 x 1.3141) = ?13,141. Therefore our Loss is:
?13,141 - ?13,161 = - ?20 Loss
