Foreign exchange (forex) trading has gained in popularity among amateur traders in the past several years. This article introduces some of the fundamental concepts related to forex trading.
When trading forex, you trade one currency against the other. The major currencies include US Dollar (USD), Euro (EUR), British Pound (GBP), Swiss Frank (CHF), Japanese Yen (JPY), Canadian Dollar (CAD), and Australian Dollar (AUD).
Base vs. Quote Currency
When you trade currencies, these come into pairs. For example, EUR/USD. The first currency in a pair is the Base currency and the second is called the Quote currency. It basically tells you how much you need to pay in the Quote currency to buy the Base currency. If the price of EUR/USD is 1.1150, it means that you you’ll need to pay $1.1150 dollar to buy one euro.
You can bet on currency fall or rise. If you think that Euro is going to rise, you should buy it, otherwise you press the Sell button.
The Pips and Lot Sizes
An important concept in forex trading is the Pip. It stands for Point-in-Percentage. When you see a forex quote, it is typically the fourth digit after the period. With US Dollars, it represents 1/100th a cent.
In forex trading, one cent change in price is considered to be quite large, especially since most traders use leverage. In a standard 100,000 units lot where the US Dollar is the Quote currency, one0020pip move stands for $10. (It will differ if a dollar is the Base currency, and it will depend on the value of the other currency.)
So, if the dollar goes up 20 pips, it will account for $200 increase in the value of the standard lot (given you bet on dollar’s rise). It may not look like much, but many traders get leverage of 100-1, meaning they can enter trades as the one above with as little as $1,000.
There are also smaller lots for traders looking for less risk or not having enough capital. The mini lot represents 10,000 units, while the micro lot is for 1,000 units. Some forex brokers offer nano lots that stand for just 100 units of currency.
The Margin Interest
When you trade a currency pair, you buy one currency and sell the other. If you hold this pair over the night (open position), you’ll gain and pay interest.
Let’s say you bought EUR/USD. In this case, you’ll pay interest on the currency you borrowed to make a trade (US Dollar) and get interest on the currency you hold (Euro). If Euro pays higher interest rates than US Dollar, you’ll get money posted into your account representing the difference. If lower, you’ll be charged.
Some traders look to exploit such opportunities and it’s called the Carry Trade. It’s actually quite risky as spot prices change.
What Influences Forex Prices?
Various economic and political events influence forex prices. Some of the major influencers are the national central banks such as the Fed in the United States. When these banks change interest rates, their national currencies respond.
Nations’ trade balance changes or inflation rates changes also influence the values of their currencies versus the others. For instance, recently US Dollar has been rising as the Fed is expected to raise interest rates, which will make an American Dollar more attractive.
Political events and many other factors can influence forex prices, too. Traders continuously scan the news and look into economic calendars that point out to upcoming economic announcements.
How to Learn to Trade Forex?
One of the best ways to learn to trade forex is to open a free demo account such as one offered by AlfaTrade. This way you can practice for free and learn the system as well.
When it comes to decision-making, forex traders utilize the technical analysis to trade. You need to master it to increase your chances of success. The technical analysis looks into price action and relies on charts. From charts, traders seek to determine trends in currencies.
In addition, moving averages (such as 50-day or 200-day) are used. When the prices cross the moving average (and, especially if the shorter moving average crosses the longer one), it can indicate a change in trend. But, not always. So traders will use other indicators to help including various oscillators such as Relative Strength Index and MACD.
In fact, there are many of these indicators and traders need to figure out which ones work for them the best. Some traders will use Bollinger Bands to guess where currencies are going.
The ideas about how to use Bollinger Bands differ. Some will say when a currency reaches the upper band, it is time to sell. Others will say the opposite. Basically that the currency might be breaking out of the range or there’s much ongoing strength.
To make those calls, traders look at charts and moving averages to see if there’s a continuation of the pattern, or an upcoming change. Mastering technical analysis to correctly guess price action takes long time. But, this hard work improves your chances of success.
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