Forex – foreign exchange – is trading currencies to make a profit, but to make money, traders have to understand how the market works.
Here, new traders can take a peep under the bonnet of forex to see exactly how the market works.
To help, some basic frequently asked questions about forex trading are answered below:
What is forex?
Forex trading is selling the currency of one country to buy the currency of another – much like tourists from the US going to Europe and having to exchange their foreign US dollars for Euros so they can spend locally.
What happens in a forex trade?
The buyer swaps an amount of one currency for the equivalent amount in another – so if US$1 buys 0.786 Euros, swapping $10 gets £7.86 in return. This is where the term foreign exchange comes from – someone exchanges one currency for an equivalent amount in another currency.
So how does a forex trader make money?
Money is made on the trade as currencies rise and fall on a daily basis. The money decision is on when to buy and sell – get it right and you are in profit, but get it wrong and you can lose big time.
What foreign currencies do forex traders deal in?
The main forex trades are in the four majors – the US dollar, the Euro, the British Pound and the Swiss Franc, although the Japanese Yen is popular as well. These currency rates are often seen paired and have their own symbols:
- USD/JPY – US Dollar v Japanese Yen
- USD/EUR – US Dollar v Euro
- USD/GBP – US Dollar v British Pound
- USD/CHF – US Dollar v Swiss Franc
These are by no means the only paired currencies, but they are the market leaders – others include GBP/EUR or EUR/CHF, for example.
How do forex traders know the exchange rate?
The currency pairs are followed by two numbers – so USD/EUR 0.786, 0.788 is explained as the US Dollar v Euro.
The first number is lower than the second of the pairing and is the ‘bid’ or ‘sell’ price. The next number is the ‘ask’, ‘buy’ or ‘offer’.
The difference between the two is the margin that gives a trader profit. The first number is the selling price of the dollar and the buy price of the Euro, while the second is the price to buy the dollar and sell the Euro.
What is forex brokerage?
Traders need to connect to the bank network online to trade currency. A brokerage gives traders access to the market by holding the trader’s cash in an account. Sometimes, the brokerage will ‘leverage’ or lend against the money in the account to let a trader bid and hold more currency than the cash in the account can cover.
