Forex trading involves a currency pair and the transaction takes place beyond any central exchange. Foreign exchange trading takes place throughout the day in major financial centers around the world, such as New York and Tokyo.
The foreign exchange market is very liquid and sees the daily transaction volume exceed a trillion dollars. The basics of foreign exchange trading are quite simple and involve trading currencies simultaneously.
If you are new to the world of forex trading, here is how it works.
NOTE: Forex investments involve significant risks. Do not consider the opinions mentioned here to be financial advice. Please research thoroughly before making any investment.
How does Forex trading work?
One currency is treated as the base currency and another as the quote currency. In Forex, the value of one currency is always relative to another. Now suppose you believe that the price of the British pound will increase against the Japanese yen in the near future. Then you’ll buy more of that combination to resell later.
It should always be remembered that Forex trading always works in pairs. The price of one currency is compared against the other, and the comparison is made against the base. If you see something written like this, EUR/USD, this shows that USD is the base currency. So, if EUR/USD is 1.30, this implies that 1 euro is equal to 1.30 US dollars.
Foreign exchange trading, like any other trading market, is dynamic. Movements in currency value change rapidly and are affected by the economic strength of the home country, as evidenced by a strong GDP. Likewise, federal bank policies and world events such as trade bans or excessive tariffs have an effect on foreign exchange markets. War situations or the discovery of new natural resources, which strengthen a country’s currency, also have a profound effect on foreign exchange trading.
Using leverage also affects the profits you make from forex trading. Brokers allow traders to gain leverage, meaning they can deploy more resources to win than they actually have. Leverage of 1:200 means a trader can use 20,000 US dollars with just 100 US dollars. So, leverage helps amplify profits, but the same thing can happen if your trade results in a loss. Therefore, leverage should be used cautiously to hedge risks and book profits.
Types of Transactions Executed in the Foreign Exchange Market
Spot trading
This means you buy and sell at the current value of the currency.
Future and Future Commerce
Here, the parties agree in advance on a specific price and a future date. The transaction is executed at the predetermined price on the agreed date, regardless of the market price at that time.
Forex trading allows for 24/7 trading. It is liquid and can generate large profits if leverage is used carefully. However, many geopolitical events influence the foreign exchange markets and it is best to avoid any emotional decisions.
Edited by Abu Amjad Khan
