Basics you need to know before trading the forex markets

by David Parker on June 9, 2014

Basics you need to know before trading theforex markets

The forex market is the place where one currency is exchange for another. In this exciting market, daily volumes traded on a daily basis are on average $5 trillion, so it’s easy to understand why it attracts so many investors. This vast liquidity triggers interest from traders across the globe and it looks like it will only expand even more. Unlike many other centralised markets, forex trading takes place over-the-counter (OTC) and this allows for various brokers to provide this service. The currencies are traded as contracts for difference (CFDs) meaning that you don’t physically exchange one currency for another but are instead speculating on the price movements and taking the cash equivalent of your profit (or paying for your loss). The quality of forex brokers can be measured in terms of pricing, customer service, and also the range of products offered.

Tempted to try Forex trading?

Even though everything about forex trading sounds very tempting at first, it is vital to pause any instant urge that you might have to try your luck in these markets until you have some understanding of the basics. Deciding to dive into these markets unprepared might easily result in you losing your precious funds within a matter of minutes.

The main type of asset exchanged within the forex markets are currency pairs. The rate of each currency pair explains how many units of the one currency of the pair can be exchanged with just one unit of the other currency of the same pair. Let’s take for example the EUR/USD, when the exchange rate is 1.36124 it means that one unit of euro (base currency) can be exchanged with 1.36124 units of U.S. dollars (quote currency). And when a trader buys the EUR/USD it means that he or she is giving up 1.36124 U.S. dollars in order to buy 1 unit of euro, with the view that the euro will become stronger in the future and that he will be able to buy back more U.S. dollars than he gave up initially with 1 unit of euro. So in other words, that trader will be expecting the EUR/USD rate to increase.

Currency pairs are quoted by forex brokers with a bid and ask price. The bid price of a currency pair is the one that a broker is willing to buy, and hence the price that the trader would sell. Inversely, the ask price is the one that the broker is willing to sell, and hence the price that the trader would buy. This is an example of how these would appear:

 

Bid

Ask

EUR/USD 1.36084 1.36124

 

You will often come across forex news mentioning exchange rate moves in terms of pips. The minimum incremental move that can be made by a currency pair is one pip. A possible increase of the EUR/USD rate from 1.36124 to 1.36184 would be an increase of 6 pips.

One of the most attractive features of the forex markets for traders is leverage. Many financial markets are asking for the deposit of the full amount to be traded, but many forex market brokers ask for only a small part or ‘margin’ of the trading amount to be deposited. This is also called margin trading. Some forex brokers offer leverage up to 1:400 which means that for the opening of a position only 1/400 of the amount would be required as a deposit. However, note that leverage is a double edged sword and should be used with care, because if a position goes against the trader then it could mean immediate loss of his funds.

The basics of Forex Trading

As you probably figured out by now, it’s not very wise to enter the forex markets without having a good understanding of the basics, and even more particular issues such as the use of a trading strategy. You will have to train yourself and develop a trader’s psychology before you risk your funds, just like Danielson did in the movie ‘Karate Kid’ before he fought the bad guy. You might also want to consider the opening a demo trading account to test all those skills in a safe environment before going for a live trading account.

 

***Photo thanks to LendingMemo.com***

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