What is Forex Exchange?
Forex trading is a conversion of one currency to another. This currency exchange process is considered a forex transaction. Based on supply and demand, the exchange rate fluctuates, leaving room for speculation on how the price could change in the future. Most currency conversion transactions are made with the aim of earning profit from the exchange by forex traders, while others, of course, are done for practical purposes, such as visiting a foreign country. The market is characterised by volatile price movements, which increases both the chance of profits and the risk of losses. Nonetheless, the forex market remains one of the most attractive markets for traders.
Traders buy a currency usually as they believe a country's economy will do well, grow or in some cases recover in the future. If this happens, it means they could make a profit when they sell the currency back to the market.
Therefore, the exchange rate of a currency in the forex market may, combined with other external factors, reflect the condition of its country's economy. So, if you believe that a currency is going to increase in value, you can buy it. While if you believe a currency's value will decrease, you can sell it back to the market. The market is so large, you can easily find a seller or a buyer when you want to place a transaction.
Perhaps you hear on the news that South Korea is devaluing its currency to attract more foreign investments into the country. You could then make a forex trade by selling the Korean currency against another currency, for example, the US dollar. The more the Korean currency devalues against the US dollar, the higher the profits you gain. However, if the Korean currency regains its value while you possess an open sell position, your losses may increase.
Understanding Currency Pairs
Forex transactions always involve a currency pair; buying and selling two currencies, one of which is the base currency, and the other is the quote currency. The base currency is listed first, and then the quote currency. The price of each currency pair is the value of 1 unit of the base currency in the quote currency. The currencies are listed in three-letter codes; the two first letters symbolise the region while the third refers to the currency name. GBP/USD, for example, indicates that you're buying British Pounds (Great Britain or the UK) and selling US Dollars (United States).
Currency pairs can be classified into these main categories:
- Major Currency Pairs
These are the most traded currency pairs in the market, which typically have low volatility and high liquidity (in simple terms, high liquidity means how many buyers and sellers are present in a particular market, and whether transactions can take place easily). What makes these currencies attractive to traders is the fact that they belong to strong and stable economies.
- Minor Currency Pairs or Crosses
As the name suggests, currencies in this category are uncommonly traded. Unlike major pairs, a minor pair does not contain the US dollar but contains two currencies of major economies as both base and quote currencies. This category is also referred to as cross currency pairs or "crosses".
- Exotic Pairs
Exotic pairs are those pairs in which a major currency is paired against a currency of an emerging or a small economy. They're riskier to trade since they are characterised by lower liquidity, higher volatility and wider spreads than major pairs, which makes them more vulnerable to sudden shifts in cases of financial and political changes.
Here’s a table with all the different currency pairs you need to know about with their nicknames.
Types of Forex Markets and Working Hours
The forex market is decentralised and governed by a global network of banks in four primary trading centres in different time zones: New York, Tokyo, London and Sydney. It is open globally, five days a week, 24-hours a day; beginning with the financial institutions in New Zealand and continuing throughout the day as institutions across Asia, Europe and the Americas open. The trading hours are so flexible; you can trade any time of the day in these following types of forex markets:
- The spot forex market is settled on the spot, as the name implies. It involves the physical exchange of a currency pair within a short period of time, at the exact point that the trade is processed.
- Future forex market is a buying or selling contract which is legally binding. The point of it is to plan a date in the future at which the trade will be settled.
- The forward forex market or forward contracts set the price of the asset for future delivery. The trade is to be settled within a range of future dates or at a set date in the future, at a specified rate.
Essential Forex Trading Terminology
The forex trading market is riddled with terms that traders use. Before you start trading, it's essential to gain an overall understanding of each of these following terms:
Position: It stands for trades in progress; a long position means buying a currency while expecting its value to increase. A short position means selling a currency while expecting it to decrease in value. The position is considered closed when the trade is complete.
Leverage or Margin: When opening a forex trade, a small proportion of the opening amount is required. What determines this percentage is the margin or leverage settings when first creating a trading account. At ADSS leverage up to 500:1 is allowed if you trade majors forex pairs.
Pip: This is an acronym for "percentage in point", which is a very small percentage of a unit of currency's value. Most currency pairs are priced out to four decimal places, and the pip change is the last (fourth) decimal point. Pips help assess the variation in the currency pairs or exchange rate.
Spread: A spread is the price difference between the price of buying and selling an underlying asset.
Lot: Since currencies in the forex market move in very small amounts, a lot is required to standardise trades. A 100,000 unit of a currency is the standard size for a lot.
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